Mike Konczal

Roosevelt Institute Fellow

Recent Posts by Mike Konczal

  • The GAO Can't Distinguish Between a Good and a Bad Liquidation

    Aug 1, 2014Mike Konczal

    To emphasize a point I made yesterday, we need to think of ending Too Big To Fail (TBTF) as a continuum rather a simple yes-no binary. The process of failing a large financial firm through the Ordinary Liquidation Authority (OLA) can go very well, or it could go very poorly. It's important to understand that the recent GAO report, arguing that the TBTF subsidy has largely diminished, is incapable of telling the difference.

    What would make for a successful termination of a failed financial firm under OLA? To start, bankruptcy court would be a serious option as a first response. Assuming that didn't work, capital in the firm is structured in such a way that facilitates a successful process. There's sufficient loss-absorbing capital both to take losses and give regulators options in the resolution. There's also sufficient liquidity, both within the firm due to strong new capital requirements and through accountable lender-of-last-resort lending, that prevents a panic from destroying whatever baseline solvency is in the firm. As a result, less public funding is necessary to achieve the goals.

    Living wills actually work, and allow the firm to be resolved in a quick and timely manner. The recapitalization is sufficient to repay any public funding without having to assess the financial industry as a whole. There's no problems with international coordination, and the ability of the FDIC to act as a receiver for derivatives contracts is standardized and clear in advance, reducing legal uncertainty.

    That's a lot! And it's a story that is becoming more and more prevalent in the reform community [1]. Let's chart it out, along with the opposite happening.

    Again, from the point of view of the GAO report, these are identical scenarios. Both would impose credit losses on firms. Thus the GAO's empirical model, scanning and predicting interest rates spreads to imply credit risk, picks up both scenarios the same way. Whether OLA goes smoothly or is a disaster doesn't matter. But from the point of view of taxpayers, those trying to deal with the uncertainty and panic that would come with such a scenario, and the economy as a whole, the bad scenario is a major disaster. And we are nowhere near the point where success can be taken for granted. Tightening the regulations we have is necessary to making the successful scenario more likely, and the apparent lack of a subsidy should not distract us from this.

     

    [1] Note the common similarities along these lines in the critical discussion of OLA from across the entire reform spectrum. You can see this story in different forms in Stephen Lubben's "OLA After Single Point of Entry: Has Anything Changed?" for the Unfinished Mission project,  the comment letter from the Systemic Risk Council, Too Big to Fail: The Path to a Solution from the Bipartisan Policy Center, and the "Failing to End Too Big to Fail" report rom the Republican Staff of the House Committee on Financial Services.

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    To emphasize a point I made yesterday, we need to think of ending Too Big To Fail (TBTF) as a continuum rather a simple yes-no binary. The process of failing a large financial firm through the Ordinary Liquidation Authority (OLA) can go very well, or it could go very poorly. It's important to understand that the recent GAO report, arguing that the TBTF subsidy has largely diminished, is incapable of telling the difference.

    What would make for a successful termination of a failed financial firm under OLA? To start, bankruptcy court would be a serious option as a first response. Assuming that didn't work, capital in the firm is structured in such a way that facilitates a successful process. There's sufficient loss-absorbing capital both to take losses and give regulators options in the resolution. There's also sufficient liquidity, both within the firm due to strong new capital requirements and through accountable lender-of-last-resort lending, that prevents a panic from destroying whatever baseline solvency is in the firm. As a result, less public funding is necessary to achieve the goals.

    Living wills actually work, and allow the firm to be resolved in a quick and timely manner. The recapitalization is sufficient to repay any public funding without having to assess the financial industry as a whole. There's no problems with international coordination, and the ability of the FDIC to act as a receiver for derivatives contracts is standardized and clear in advance, reducing legal uncertainty.

    That's a lot! And it's a story that is becoming more and more prevalent in the reform community [1]. Let's chart it out, along with the opposite happening.

    Again, from the point of view of the GAO report, these are identical scenarios. Both would impose credit losses on firms. Thus the GAO's empirical model, scanning and predicting interest rates spreads to imply credit risk, picks up both scenarios the same way. Whether OLA goes smoothly or is a disaster doesn't matter. But from the point of view of taxpayers, those trying to deal with the uncertainty and panic that would come with such a scenario, and the economy as a whole, the bad scenario is a major disaster. And we are nowhere near the point where success can be taken for granted. Tightening the regulations we have is necessary to making the successful scenario more likely, and the apparent lack of a subsidy should not distract us from this.

     

    [1] Note the common similarities along these lines in the critical discussion of OLA from across the entire reform spectrum. You can see this story in different forms in Stephen Lubben's "OLA After Single Point of Entry: Has Anything Changed?" for the Unfinished Mission project,  the comment letter from the Systemic Risk Council, Too Big to Fail: The Path to a Solution from the Bipartisan Policy Center, and the "Failing to End Too Big to Fail" report rom the Republican Staff of the House Committee on Financial Services.

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  • Let's Hope the GAO Report Ends the Too-Big-to-Fail Subsidy Distraction

    Jul 31, 2014Mike Konczal

    The GAO just released its long-awaited report on whether Wall Street receives an implicit subsidy for still being seen as Too Big To Fail (TBTF). I'm still working through the report, but the headline conclusion is that "large bank holding companies had lower funding costs than smaller ones during the financial crisis" and that there is "mixed evidence of such advantages in recent years. However, most models suggest that such advantages may have declined or reversed."

    For a variety of reasons, whether this subsidy exists has become a major focal point in the discussion about financial reform. The Obama administration wants the headline that TBTF is over, and the President's opponents want to argue that Dodd-Frank has institutionalized bailouts. Hopefully this GAO report puts that "permanent bailouts" talking point to rest.

    More generally, however, I find that there are three problems with this emphasis on a possible Wall Street subsidy in the financial reform debate:

    The first is that it makes it seem like the bailouts were the only problem with the financial sector. Let's do a thought experiment: imagine that in September 2008, Lehman Brothers went crashing into bankruptcy and...nothing happened. There was no panic in interbank lending or the money market mutual funds. The Federal Reserve didn't do emergency lending, and nobody suggested that Congress pass TARP. There was nothing but crickets out there in the financial press.

    Even if that had happened, we'd still have needed a massive overhaul of the financial system. Think of all the other things that went wrong: Wall Street fueled a massive housing bubble that destroyed household wealth and generated bad debts that have choked the economy for half a decade. Neighborhoods were torn apart by more than 6 million foreclosures while bankers laughed all the way to the bank. A hidden derivatives market radically distorted the price of credit risk and led to the creation of instruments designed to rip off investors. Wall Street failed at its main job -- to allocate capital to productive ends in the economy. Instead, it went on a rampage that did serious harm to investors, households, and ultimately our economy. 

    TBTF is the most egregious example of the out-of-control financial system, and it's a major problem that needs to be checked. But if emphasized too much, it makes it seem as if the problem is only how much damage a firm can do to the economy when it fails. In fact, the problem is much broader than that, and solving it requires transparency in the derivatives market, consumer protections, accountability in the securities Wall Street makes and sells, a focus on actual business lines, and regulation of shadow banking as a whole, not just last rites for individual firms.

    This is important because the second problem is that some will take this report as evidence that reform is just right, or has even gone too far. And scanning the coverage, I see that the commentators who are applauding the GAO's conclusions are often the same people who have said that, for instance, liquidity rules in Dodd-Frank have gone too far, or that the Volcker Rule should be tossed out. This is even as the GAO points to these provisions as necessary reforms.

    We can debate whether a subsidy for failing banks exists or how big it is, but the goal of regulation should not be to fine-tune that number. The subsidy is only a symptom of much larger problems with the financial system, and the point of regulation is to build a system that works. 

    Finally, the third issue is that emphasizing the subsidy makes us think of ending TBTF as a binary, check either yes-or-no, pass-fail kind of test. Again, there are political reasons for this emphasis, but TBTF isn't a switch that can be flipped on or off. Addressing the problem is an ongoing process that will be carried out through the Orderly Liquidation Authority (OLA), and that process can be either more or less robust.

    It's good that the financial markets have confidence in the OLA, but the FDIC is still crafting the living wills and the details of how they will be implemented. Major questions and challenges still remain. For instance, a rule has not yet been written to determine how much unsecured debt firms are required to carry. And conservatives are already floating the idea that a successful OLA would be a "bailout" anyway

    The success of an orderly liquidation process will depend on many different factors, but we should think of it not as a binary, but as a continuum -- a continuum on which one end has more capital and slimmer business lines to protect taxpayer dollars and keep the risks contained, and the other end has us crossing our fingers and hoping that the aggregate damage isn't too bad. [UPDATE: See more on this point from me here.]

    The GAO report is welcome news. We've made progress on the most outrageous problem with the financial sector. But that doesn't mean the work is done by any means.

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    Header image via Thinkstock

    The GAO just released its long-awaited report on whether Wall Street receives an implicit subsidy for still being seen as Too Big To Fail (TBTF). I'm still working through the report, but the headline conclusion is that "large bank holding companies had lower funding costs than smaller ones during the financial crisis" and that there is "mixed evidence of such advantages in recent years. However, most models suggest that such advantages may have declined or reversed."

    For a variety of reasons, whether this subsidy exists has become a major focal point in the discussion about financial reform. The Obama administration wants the headline that TBTF is over, and the President's opponents want to argue that Dodd-Frank has institutionalized bailouts. Hopefully this GAO report puts that "permanent bailouts" talking point to rest.

    More generally, however, I find that there are three problems with this emphasis on a possible Wall Street subsidy in the financial reform debate:

    The first is that it makes it seem like the bailouts were the only problem with the financial sector. Let's do a thought experiment: imagine that in September 2008, Lehman Brothers went crashing into bankruptcy and...nothing happened. There was no panic in interbank lending or the money market mutual funds. The Federal Reserve didn't do emergency lending, and nobody suggested that Congress pass TARP. There was nothing but crickets out there in the financial press.

    Even if that had happened, we'd still have needed a massive overhaul of the financial system. Think of all the other things that went wrong: Wall Street fueled a massive housing bubble that destroyed household wealth and generated bad debts that have choked the economy for half a decade. Neighborhoods were torn apart by more than 6 million foreclosures while bankers laughed all the way to the bank. A hidden derivatives market radically distorted the price of credit risk and led to the creation of instruments designed to rip off investors. Wall Street failed at its main job -- to allocate capital to productive ends in the economy. Instead, it went on a rampage that did serious harm to investors, households, and ultimately our economy. 

    TBTF is the most egregious example of the out-of-control financial system, and it's a major problem that needs to be checked. But if emphasized too much, it makes it seem as if the problem is only how much damage a firm can do to the economy when it fails. In fact, the problem is much broader than that, and solving it requires transparency in the derivatives market, consumer protections, accountability in the securities Wall Street makes and sells, a focus on actual business lines, and regulation of shadow banking as a whole, not just last rites for individual firms.

    This is important because the second problem is that some will take this report as evidence that reform is just right, or has even gone too far. And scanning the coverage, I see that the commentators who are applauding the GAO's conclusions are often the same people who have said that, for instance, liquidity rules in Dodd-Frank have gone too far, or that the Volcker Rule should be tossed out. This is even as the GAO points to these provisions as necessary reforms.

    We can debate whether a subsidy for failing banks exists or how big it is, but the goal of regulation should not be to fine-tune that number. The subsidy is only a symptom of much larger problems with the financial system, and the point of regulation is to build a system that works. 

    Finally, the third issue is that emphasizing the subsidy makes us think of ending TBTF as a binary, check either yes-or-no, pass-fail kind of test. Again, there are political reasons for this emphasis, but TBTF isn't a switch that can be flipped on or off. Addressing the problem is an ongoing process that will be carried out through the Orderly Liquidation Authority (OLA), and that process can be either more or less robust.

    It's good that the financial markets have confidence in the OLA, but the FDIC is still crafting the living wills and the details of how they will be implemented. Major questions and challenges still remain. For instance, a rule has not yet been written to determine how much unsecured debt firms are required to carry. And conservatives are already floating the idea that a successful OLA would be a "bailout" anyway

    The success of an orderly liquidation process will depend on many different factors, but we should think of it not as a binary, but as a continuum -- a continuum on which one end has more capital and slimmer business lines to protect taxpayer dollars and keep the risks contained, and the other end has us crossing our fingers and hoping that the aggregate damage isn't too bad. [UPDATE: See more on this point from me here.]

    The GAO report is welcome news. We've made progress on the most outrageous problem with the financial sector. But that doesn't mean the work is done by any means.

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  • Quick Thoughts on Ryan's Poverty Plan: What Are the Risks?

    Jul 25, 2014Mike Konczal

    Paul Ryan released his anti-poverty plan yesterday, and lots of people have written about it. Bob Greenstein has a great overview of the block-granting portion of the plan.

    Paul Ryan released his anti-poverty plan yesterday, and lots of people have written about it. Bob Greenstein has a great overview of the block-granting portion of the plan. I'm still reading and thinking about it, but in the interest of answering the call for constructive criticism, a few points jump out that I haven't seen others make yet.

    How did we get here?

    Republicans obviously have an interest in branding themselves as a "party of ideas." And many liberals and Democrats also have an interest in trying to make the GOP seem like it's been devoid of any ideas in the past several years.

    But it's worth noting that within a year of Democrats and liberal thinkers getting actively behind a serious increase in the minimum wage, and many activists making strides toward it on the local level, Paul Ryan just wholesale adopted President Obama's EITC expansion program. That demonstrates the value of pushing the envelope.

    Complexity and the EITC

    Ryan's plan, correctly, makes a big deal out of the complexity of receiving the EITC. The difficulty of navigating the system, the large number of improper payments, people not receiving what they should, people having to use tax-prep services to get the credit, and so on.

    This is why I'm a huge fan of higher minimum wages as a complement to the EITC. Instead of 40 pages of rules and a dozen potential forms to fill out, you just put a sign that reads "$10.10 an hour" on the wall. Bosses and workers can't trick each other or get confused about this, and nobody has to pay a tax-prep service to figure it out. Easy peasy.

    Ryan wants to "direct the Treasury Department to investigate further" how to fix this, but in practice Treasury just turns around and yells at the IRS. And if the IRS knew how to fix it, they'd probably be on it.

    There is also a simpler plan to fix this issue: just have the government mail people their tax forms already filled out, for them to either sign or correct. When a trial version of this, "Ready Return," was tried in California, people immediately saw the potential for this to fix EITC delivery issues. Perhaps anti-poverty advocates can help provide momentum on this front.

    Bosses and the EITC

    Both Ryan and Marco Rubio have referred to putting the ETIC credit directly into workers' paychecks. Ryan: "[A]nother potential area of reform should focus upon EITC simplicity and delivery. If families received the credit with their paychecks, the link between work and the EITC would be that much clearer."

    I'd be worried if employers were the ones responsible for adding this wage subsidy. I don't think there's a convincing argument that the EITC or food stamps lower wages directly (though there is one indirectly for the EITC), but if employers got a wage subsidy themselves to pass to their workers, it's easy to imagine them pocketing part of it through lower wages, especially in the monopsony of low-wage labor markets.

    A discussion of welfare reform

    Rather than a "welfare reform -- yay or nay?" conversation, it would be really useful if people arguing for the block-granting of the entire anti-poverty agenda would point out what they do and do not like about what happened in the 1990s. Especially as proponents hold up welfare reform as the model.

    As Matt Bruenig notes, the work requirements and other restrictions go against the concept of subsidiarity. Greenstein writes, "the block grant would afford state and local officials tantalizing opportunities to use some block grant funds to replace state and local funds now going for similar services...That’s what happened under the Temporary Assistance for Needy Families (TANF) block grant." In retrospect, TANF didn't survive the business cycle, and it clearly has cut spending by cutting the rolls. Is that what people want to accomplish with food stamps, which have done wonders to boost childhood life outcomes? If not, what can be done other than assert that this time will be different?

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  • Live at TNR: Dodd-Frank at Year Four

    Jul 23, 2014Mike Konczal

    Live at The New Republic, I have a piece describing Year Four of Dodd-Frank, which celebrates its birthday this week. The news coverage of the past year has had a "stuck, spinning its wheels" argument to it. I argue that this past year saw some major and important advancements, directions on where to go next, and also made what will be the biggest challenges going forward very clear. I hope you check it out.

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    Live at The New Republic, I have a piece describing Year Four of Dodd-Frank, which celebrates its birthday this week. The news coverage of the past year has had a "stuck, spinning its wheels" argument to it. I argue that this past year saw some major and important advancements, directions on where to go next, and also made what will be the biggest challenges going forward very clear. I hope you check it out.

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  • Dr. Strangelove and the Halbig Decision

    Jul 22, 2014Mike Konczal

    "Yes, but the whole point of a doomsday machine is lost if you keep it a secret! Why didn't you tell the world, eh?" - Dr. Strangelove

    So the DC Circuit Court ruled in Halbig v. Burwell hat health care subsidies can only go to states that set up their own health care exchanges rather than use the federal ones. That means indivdiuals from the 34 states who get subsidized health care from the federal exchange would no longer be able to get subsidies. (Another court ruled against this logic today.) I don't normally do health care stuff, but I've read a lot about this case and something strikes me as very odd.

    As I understand it, those on the right who are pushing the Halbig case argue that there's a doomsday machine built into Obamacare. (Adam Serwer at MSNBC also caught this doomsday machine analogy.) If states don't set up their health care exchanges then they don't receive subsidies for health care from the federal government. According to this theory, the liberals who designed health care reform did this knowing that if subsidies were pulled, the system would collapse for states that didn't set up their exchanges.

    It's important to note that those on the right are not arguing that this is a typo in the bill, because that wouldn't necessarily be sufficient to overturn the subsidies. They are arguing that Congress intentionally put this language in there to compel, bribe, incentivize, and otherwise threaten states that didn't set up their own exchanges. In the rightwing argument, liberals were saying "we are making the citizens of your state purchase health care, and if you don't set up an exchange they won't get the subsidies necessary to make the system work, so you'd better set up an exchange."

    The right's argument hinges on the idea that since there's no evidence that this isn't the intent, it must be the intent. As the two authors of the legal challenge put it, Obamacare "supporters’ approval of this text reveals that their intent was indeed to enact a bill that restricts tax credits to state-run Exchanges. At no point have defenders of the rule identified anything in the legislative history that contradicts" their reading.

    Here's the thing, though: like Strangelove notes, a doomsday machine only works if you tell others about it. So, why weren't the people in the vast network associated with Obamacare telling everyone about this threatening doomsday device after the bill passed?

    If this was actually the intent, you'd expect that during the period where states were debating whether to set up exchanges, this would have been a major threat raised by somebody. Anyone, from President Obama to congressional leaders to health care experts and lawyers to activist groups on the ground in red states fighting for implementation, would have been saying, "if your state doesn't set up a health care exchange, your citizens are screwed. At the very least, you'll be leaving money on the table." ("Leaving money on the table" is always a good point to bring up, and if this doomsday machine really were the intent of the law, it would be true.)

    I know of no evidence of this being the case. Does anybody? Numerous people are arguing that the legislative intent is clearly on providing subsidies to the federal exchange users. No wonder the dissent argued that the Halbig ruling was "a fiction, a post hoc narrative concocted to provide a colorable explanation for the otherwise risible notion that Congress would have wanted insurance markets to collapse in States that elected not to create their own Exchanges."

    That doesn't change what the DC Circuit did, of course, but it should make a random person stop and wonder how much of a cynical ploy this whole thing is.

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    "Yes, but the whole point of a doomsday machine is lost if you keep it a secret! Why didn't you tell the world, eh?" - Dr. Strangelove

    So the DC Circuit Court ruled in Halbig v. Burwell hat health care subsidies can only go to states that set up their own health care exchanges rather than use the federal ones. That means indivdiuals from the 34 states who get subsidized health care from the federal exchange would no longer be able to get subsidies. (Another court ruled against this logic today.) I don't normally do health care stuff, but I've read a lot about this case and something strikes me as very odd.

    As I understand it, those on the right who are pushing the Halbig case argue that there's a doomsday machine built into Obamacare. (Adam Serwer at MSNBC also caught this doomsday machine analogy.) If states don't set up their health care exchanges then they don't receive subsidies for health care from the federal government. According to this theory, the liberals who designed health care reform did this knowing that if subsidies were pulled, the system would collapse for states that didn't set up their exchanges.

    It's important to note that those on the right are not arguing that this is a typo in the bill, because that wouldn't necessarily be sufficient to overturn the subsidies. They are arguing that Congress intentionally put this language in there to compel, bribe, incentivize, and otherwise threaten states that didn't set up their own exchanges. In the rightwing argument, liberals were saying "we are making the citizens of your state purchase health care, and if you don't set up an exchange they won't get the subsidies necessary to make the system work, so you'd better set up an exchange."

    The right's argument hinges on the idea that since there's no evidence that this isn't the intent, it must be the intent. As the two authors of the legal challenge put it, Obamacare "supporters’ approval of this text reveals that their intent was indeed to enact a bill that restricts tax credits to state-run Exchanges. At no point have defenders of the rule identified anything in the legislative history that contradicts" their reading.

    Here's the thing, though: like Strangelove notes, a doomsday machine only works if you tell others about it. So, why weren't the people in the vast network associated with Obamacare telling everyone about this threatening doomsday device after the bill passed?

    If this was actually the intent, you'd expect that during the period where states were debating whether to set up exchanges, this would have been a major threat raised by somebody. Anyone, from President Obama to congressional leaders to health care experts and lawyers to activist groups on the ground in red states fighting for implementation, would have been saying, "if your state doesn't set up a health care exchange, your citizens are screwed. At the very least, you'll be leaving money on the table." ("Leaving money on the table" is always a good point to bring up, and if this doomsday machine really were the intent of the law, it would be true.)

    I know of no evidence of this being the case. Does anybody? Numerous people are arguing that the legislative intent is clearly on providing subsidies to the federal exchange users. No wonder the dissent argued that the Halbig ruling was "a fiction, a post hoc narrative concocted to provide a colorable explanation for the otherwise risible notion that Congress would have wanted insurance markets to collapse in States that elected not to create their own Exchanges."

    That doesn't change what the DC Circuit did, of course, but it should make a random person stop and wonder how much of a cynical ploy this whole thing is.

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