Mike Konczal

Roosevelt Institute Fellow

Recent Posts by Mike Konczal

  • How Do the Long-Term Unemployed Compare to the Rest of the Labor Market?

    Feb 7, 2013Mike Konczal

    The situation for the long-term unemployed looked significantly better after last week's jobs report. The average duration of unemployment dropped from 38.1 to 35.3 weeks over that month, which included statistical rebalancing for the population. A year ago, 43 percent of the unemployed were out of a job for more than 27 weeks; now that number is down to 38 percent.

    This is a good development, though it intensifies two of my larger worries about how people will view the economy. The first is that we'll think the economy is doing too well. If we think the economy is healthy, then the Federal Reserve and Congress will put the brakes on too fast, killing the possibility that full employment, the best social program we have, will really happen. There is already evidence of this happening. The sequestration, which will kill a million jobs, looks increasingly likely to happen, even though there is little long-run justification for premature austerity.

    The other, oddly, is that we'll think the labor market is so weak that it can no longer be helped by emgerency stimulus. Neil Irwin wrote an overview, as a result of the Scarborough and Krugman back and forth, of what I'll call "pundit macroeconomics." It's a theory of why pundits care about cutting social insurance and deficits even though the economic logic is missing. The missing part of this argument is that many elites feel that while there are too many unemployed, they are uniquely unqualified for the jobs that are available.

    Let's update one of my favorite graphs around, which shows how likely it is that the unemployed will find jobs by the duration of their unemployment. I just got new data from the BLS that gives us these numbers through October 2012. Is there a relatively healthy short-term labor market, with a collapsed long-term one? Let's compare 2007, 2011, and 2012:

    As you can see, no matter how long you've been unemployed, the labor market in 2012 is weaker than it was in 2007. It was less likely that those unemployed for less than 5 weeks could find a job in 2012 than they could in 2007. The same goes for the long-term unemployed.

    This pushes back against recent research by Rand Ghayad and William Dickens of the Boston Fed. They dissagregate the Beveridge Curve by duration, arguing that our problems are primarily concentrated among the long-term unemployed. However, they are likely just picking up on changes in the long-term distribution of the unemployed (which, as noted above, has been collapsing since June 2012, when their data ends), rather than strictly structural elements. Looking at the labor market through the graph above, we can see that it is generally weak, which is not just a function of the long-term unemployed.

    Is duration falling because the unemployed are simply dropping out of the labor force? Here's the transition from unemployment to no longer in the labor force, or the liklihood of the unemployed simply dropping out, comparing the pre-crisis time period and today:

    Compared to before the recession, the long-term unemployed are less likely to drop out of the labor force. People are still looking for jobs, though a little less in 2012 than in 2011. That said, there wasn't a large pickup in this rate in 2012, so it is unlikely to be the primary driver in the drop of unemployment duration.

    Rob Valletta of the Federal Reserve Bank of San Francisco just put out an economic letter on the long-term unemployed. He does the actual work of parsing out weekly transitions from the CPS data and finds this transition, the same dyanmic noted above.

    If you break it down by month and look at it over a longer timeframe, it still has the same result. The labor market is depressed for everyone, not just a select group.

    Notice the bump out at month 20 for the recovery period, where it actually goes above the expansionary period. Though it isn't clear what is driving this, it is likely both a function of an improving job market as well as people no longer qualifying for unemployment insurance. Unemployment insurance pulls in several directions then. It increases duration both through encouraging longer searches with better matches by providing liquidity. It provides stimulus to the economy, while also keeping people from leaving the labor force and giving up on their searches entirely.

    Valletta also finds that "for most categories of workers, the share of long-term unemployment differs little from the share of short-term unemployment." There are some exceptions, notably younger workers. However, the long-term unemployed aren't a dumping ground for certain types of workers; it reflects a general malaise in the labor market.

    This isn't to downplay the serious issues of long-term unemployment. The long-term unemployed do have a harder time finding jobs. But the best cure for this situation is to broadly boost the economy through fiscal and monetary stimulus while dealing with the housing market, rather than transitioning to either targeted job policy or deficit reduction.

    Follow or contact the Rortybomb blog:
      

     

    The situation for the long-term unemployed looked significantly better after last week's jobs report. The average duration of unemployment dropped from 38.1 to 35.3 weeks over that month, which included statistical rebalancing for the population. A year ago, 43 percent of the unemployed were out of a job for more than 27 weeks; now that number is down to 38 percent.

    This is a good development, though it intensifies two of my larger worries about how people will view the economy. The first is that we'll think the economy is doing too well. If we think the economy is healthy, then the Federal Reserve and Congress will put the brakes on too fast, killing the possibility that full employment, the best social program we have, will really happen. There is already evidence of this happening. The sequestration, which will kill a million jobs, looks increasingly likely to happen, even though there is little long-run justification for premature austerity.

    The other, oddly, is that we'll think the labor market is so weak that it can no longer be helped by emgerency stimulus. Neil Irwin wrote an overview, as a result of the Scarborough and Krugman back and forth, of what I'll call "pundit macroeconomics." It's a theory of why pundits care about cutting social insurance and deficits even though the economic logic is missing. The missing part of this argument is that many elites feel that while there are too many unemployed, they are uniquely unqualified for the jobs that are available.

    Let's update one of my favorite graphs around, which shows how likely it is that the unemployed will find jobs by the duration of their unemployment. I just got new data from the BLS that gives us these numbers through October 2012. Is there a relatively healthy short-term labor market, with a collapsed long-term one? Let's compare 2007, 2011, and 2012:

    As you can see, no matter how long you've been unemployed, the labor market in 2012 is weaker than it was in 2007. It was less likely that those unemployed for less than 5 weeks could find a job in 2012 than they could in 2007. The same goes for the long-term unemployed.

    This pushes back against recent research by Rand Ghayad and William Dickens of the Boston Fed. They dissagregate the Beveridge Curve by duration, arguing that our problems are primarily concentrated among the long-term unemployed. However, they are likely just picking up on changes in the long-term distribution of the unemployed (which, as noted above, has been collapsing since June 2012, when their data ends), rather than strictly structural elements. Looking at the labor market through the graph above, we can see that it is generally weak, which is not just a function of the long-term unemployed.

    Is duration falling because the unemployed are simply dropping out of the labor force? Here's the transition from unemployment to no longer in the labor force, or the liklihood of the unemployed simply dropping out, comparing the pre-crisis time period and today:

    Compared to before the recession, the long-term unemployed are less likely to drop out of the labor force. People are still looking for jobs, though a little less in 2012 than in 2011. That said, there wasn't a large pickup in this rate in 2012, so it is unlikely to be the primary driver in the drop of unemployment duration.

    Rob Valletta of the Federal Reserve Bank of San Francisco just put out an economic letter on the long-term unemployed. He does the actual work of parsing out weekly transitions from the CPS data and finds this transition, the same dyanmic noted above.

    If you break it down by month and look at it over a longer timeframe, it still has the same result. The labor market is depressed for everyone, not just a select group.

    Notice the bump out at month 20 for the recovery period, where it actually goes above the expansionary period. Though it isn't clear what is driving this, it is likely both a function of an improving job market as well as people no longer qualifying for unemployment insurance. Unemployment insurance pulls in several directions then. It increases duration both through encouraging longer searches with better matches by providing liquidity. It provides stimulus to the economy, while also keeping people from leaving the labor force and giving up on their searches entirely.

    Valletta also finds that "for most categories of workers, the share of long-term unemployment differs little from the share of short-term unemployment." There are some exceptions, notably younger workers. However, the long-term unemployed aren't a dumping ground for certain types of workers; it reflects a general malaise in the labor market.

    This isn't to downplay the serious issues of long-term unemployment. The long-term unemployed do have a harder time finding jobs. But the best cure for this situation is to broadly boost the economy through fiscal and monetary stimulus while dealing with the housing market, rather than transitioning to either targeted job policy or deficit reduction.

    Follow or contact the Rortybomb blog:
      

     

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  • Why the Republican CFPB Arguments Are Wrong

    Feb 5, 2013Mike Konczal

    It's been almost two years, and the GOP still refuses to approve a Consumer Financial Protection Bureau (CFPB) director without a significant overhaul of the agency. Check out Adam Serwer at Mother Jones as well as Jennifer Bendery at Huffington Post for more on this story. Forty-three Republican Senators signed a letter last week, one that is almost exactly the same as the one they signed in July 2011, blocking Cordray's nomination because they want major legislative changes to Dodd-Frank and the CFPB.

    As congressional scholar Thomas Mann told Jonathan Cohn, this should be viewed as a form of modern day nullification. Dodd-Frank is the law of the land. Congress legitimately passed this law containing a CFPB designed to have certain features. Even though the GOP doesn't like it doesn't mean they can sabotage it or prevent it from working. And the CFPB needs a director to work.

    The letter features a high-level complaint along with three specific changes they want. Beyond the letter, these three points are so common on the right that it is probably useful to point out that they are wrong. This is drawn from Adam Levitin's Congressional testimony on the matter as well as other CFPB analysis over the years. Bold is from the letter.

    "...we have serious concerns about the lack of congressional oversight of the agency and the lack of normal, democratic checks on its sole director, who would wield nearly unprecedented powers."
     
    The CFPB must regularly make reports and appear before Congress. The CFPB is subject to a veto of its actions by other financial regulators as represented by the Financial Stability Oversight Council (FSOC), a completely unique accountability feature that does not apply to any other regulators. The CFPB is subject to an annual audit by the GAO, which is then turned over to Congress, another unique form of accountability. It is also subject to the Small Business Regulatory Enforcement Fairness Act of 1996 (SBREFA), a feature of OIRA that doesn't apply to other financial regulators.
     
    The CFPB is also limited in its actions by the text of Dodd-Frank itself. It can't mandate the offering of any financial product, force the extension of credit, regulate non-financial businesses, require businesses to offer products or credit, impose usury caps, or force consumers to take products. See, among other places, Section 1027 of Dodd-Frank for further restrictions. If you'd like to go further, you can see a list of 19 ways the CFPB is accountable here. Rather than having unprecedented powers, this agency is as accountable and has more checks than any other federal financial regulator.
     
    "We again urge the adoption of the following [three] reforms:
     
    1. Establish a bipartisan board of directors to oversee the Consumer Financial Protection Bureau."
     
    The Office of the Comptroller of the Currency (OCC) and the former Office of Thrift Supervision (OTS), both federal financial regulators, both have single directors, so this is neither odd nor unprecedented. Some other agencies have boards, like the FDIC. There are some reasons to use one model over the other, but the GOP is not making a clear case for why a board of directors is superior to a sole director, much less a case sufficient to justify nullifying parts of Dodd-Frank. A single director encourages direct action, streamlined agency, and more accountability. Given what we've seen in the past 10 years with subprime, action is better than inaction.
     
    Five directors can blame each other when things go wrong. Given the concern over accountability in the GOP's letter, a single director strikes me as the right way to go. There's more on oversight here.
     
    "2. Subject the Bureau to the annual appropriation process, similar to other federal regulators."
     
    Other federal banking regulators have their own independent budgets and are not subject to the appropriations process. The OCC, the FDIC, and the former OTS get their budgets from assessments from the financial institutions they regulate. The CFPB gets its budget from the Federal Reserve in order to avoid the capture that comes with being dependent on industry assessments. However, unlike those institutions, the CFPB has a statutory budgetary cap of 12 percent of the Federal Reserve's budget.

    Congress consciously decided to fund the CFPB this way to prevent them from subjecting the important work that needs to be done to the annual appropriations process. This is normal in financial regulation and appropriate for the CFPB. You can read more about how this funding is designed to take the political economy of regulation into account here.

    "3. Establish a safety-and-soundness check for the prudential regulators."
     
    There is already a safety-and-soundness check at the OCC, which, through the FSOC, can vote on vetoing CFPB actions. Beyond that, safety-and-soundness is often synonymous with profit-making. The broken servicing model at the largest banks, for instance, is an abuse-ridden disaster for borrowers and lenders, but they are profitable activities that, de facto, boost the banks' safety-and-soundness via profits. The CFPB is meant to be a balance against this regulatory impulse. This was debated at length during the Dodd-Frank process, and Congress still decided to mandate the CFPB with its current mission.
     
    Immediately after Obamacare passed, conservative David Frum argued, in a now famous piece called "Waterloo," that the GOP could have turned the bill into one far more favorable for conservatives with just a few GOP votes. But they didn't, and now they are stuck with a law they hate. The same dynamic is true for Dodd-Frank. If a dozen Senators and House GOP members decided to make a bipartisan bill in 2009, they could have likely gotten a CFPB that they would like better. But they didn't. And now they want to retroactively try and get that bill they chose not to enact.
     
    Follow or contact the Rortybomb blog:
      

     

     

    It's been almost two years, and the GOP still refuses to approve a Consumer Financial Protection Bureau (CFPB) director without a significant overhaul of the agency. Check out Adam Serwer at Mother Jones as well as Jennifer Bendery at Huffington Post for more on this story. Forty-three Republican Senators signed a letter last week, one that is almost exactly the same as the one they signed in July 2011, blocking Cordray's nomination because they want major legislative changes to Dodd-Frank and the CFPB.

    As congressional scholar Thomas Mann told Jonathan Cohn, this should be viewed as a form of modern day nullification. Dodd-Frank is the law of the land. Congress legitimately passed this law containing a CFPB designed to have certain features. Even though the GOP doesn't like it doesn't mean they can sabotage it or prevent it from working. And the CFPB needs a director to work.

    The letter features a high-level complaint along with three specific changes they want. Beyond the letter, these three points are so common on the right that it is probably useful to point out that they are wrong. This is drawn from Adam Levitin's Congressional testimony on the matter as well as other CFPB analysis over the years. Bold is from the letter.

    "...we have serious concerns about the lack of congressional oversight of the agency and the lack of normal, democratic checks on its sole director, who would wield nearly unprecedented powers."
     
    The CFPB must regularly make reports and appear before Congress. The CFPB is subject to a veto of its actions by other financial regulators as represented by the Financial Stability Oversight Council (FSOC), a completely unique accountability feature that does not apply to any other regulators. The CFPB is subject to an annual audit by the GAO, which is then turned over to Congress, another unique form of accountability. It is also subject to the Small Business Regulatory Enforcement Fairness Act of 1996 (SBREFA), a feature of OIRA that doesn't apply to other financial regulators.
     
    The CFPB is also limited in its actions by the text of Dodd-Frank itself. It can't mandate the offering of any financial product, force the extension of credit, regulate non-financial businesses, require businesses to offer products or credit, impose usury caps, or force consumers to take products. See, among other places, Section 1027 of Dodd-Frank for further restrictions. If you'd like to go further, you can see a list of 19 ways the CFPB is accountable here. Rather than having unprecedented powers, this agency is as accountable and has more checks than any other federal financial regulator.
     
    "We again urge the adoption of the following [three] reforms:
     
    1. Establish a bipartisan board of directors to oversee the Consumer Financial Protection Bureau."
     
    The Office of the Comptroller of the Currency (OCC) and the former Office of Thrift Supervision (OTS), both federal financial regulators, both have single directors, so this is neither odd nor unprecedented. Some other agencies have boards, like the FDIC. There are some reasons to use one model over the other, but the GOP is not making a clear case for why a board of directors is superior to a sole director, much less a case sufficient to justify nullifying parts of Dodd-Frank. A single director encourages direct action, streamlined agency, and more accountability. Given what we've seen in the past 10 years with subprime, action is better than inaction.
     
    Five directors can blame each other when things go wrong. Given the concern over accountability in the GOP's letter, a single director strikes me as the right way to go. There's more on oversight here.
     
    "2. Subject the Bureau to the annual appropriation process, similar to other federal regulators."
     
    Other federal banking regulators have their own independent budgets and are not subject to the appropriations process. The OCC, the FDIC, and the former OTS get their budgets from assessments from the financial institutions they regulate. The CFPB gets its budget from the Federal Reserve in order to avoid the capture that comes with being dependent on industry assessments. However, unlike those institutions, the CFPB has a statutory budgetary cap of 12 percent of the Federal Reserve's budget.

    Congress consciously decided to fund the CFPB this way to prevent them from subjecting the important work that needs to be done to the annual appropriations process. This is normal in financial regulation and appropriate for the CFPB. You can read more about how this funding is designed to take the political economy of regulation into account here.

    "3. Establish a safety-and-soundness check for the prudential regulators."
     
    There is already a safety-and-soundness check at the OCC, which, through the FSOC, can vote on vetoing CFPB actions. Beyond that, safety-and-soundness is often synonymous with profit-making. The broken servicing model at the largest banks, for instance, is an abuse-ridden disaster for borrowers and lenders, but they are profitable activities that, de facto, boost the banks' safety-and-soundness via profits. The CFPB is meant to be a balance against this regulatory impulse. This was debated at length during the Dodd-Frank process, and Congress still decided to mandate the CFPB with its current mission.
     
    Immediately after Obamacare passed, conservative David Frum argued, in a now famous piece called "Waterloo," that the GOP could have turned the bill into one far more favorable for conservatives with just a few GOP votes. But they didn't, and now they are stuck with a law they hate. The same dynamic is true for Dodd-Frank. If a dozen Senators and House GOP members decided to make a bipartisan bill in 2009, they could have likely gotten a CFPB that they would like better. But they didn't. And now they want to retroactively try and get that bill they chose not to enact.
     
    Follow or contact the Rortybomb blog:
      

     

    Republican with tie image via Shutterstock.com.

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  • Live at the American Prospect: On the Treasury's Second Term Financial Reform Agenda

    Feb 4, 2013Mike Konczal

    I have a new piece at The American Prospect, on what Treasury will need to do in the 2nd term when it comes to financial reform:

    Nevertheless, the Treasury secretary will be responsible for the overhaul of the legal and regulatory framework that governs the financial sector. The incoming Treasury secretary will have three chief responsibilities: complete the implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act, determine how many of the new parts will work together going forward, and parry with congressional efforts to repeal parts of that law.

    I hope you check it out.

    I have a new piece at The American Prospect, on what Treasury will need to do in the 2nd term when it comes to financial reform:

    Nevertheless, the Treasury secretary will be responsible for the overhaul of the legal and regulatory framework that governs the financial sector. The incoming Treasury secretary will have three chief responsibilities: complete the implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act, determine how many of the new parts will work together going forward, and parry with congressional efforts to repeal parts of that law.

    I hope you check it out.

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  • How is Inequality Holding Back the Recovery?

    Feb 4, 2013Mike Konczal

    Is inequality holding back our weak recovery? Joe Stiglitz argues it is, while Paul Krugman argues it is not. John Judis summarizes the debate at The New RepublicI want to rephrase the question and focus specifically on the two most relevant policy points.

    Taxes: Stiglitz argues, "[T]he weakness of the middle class is holding back tax receipts, especially because those at the top are so adroit in avoiding taxes and in getting Washington to give them tax breaks." 
     
    Right now our federal government's tax structure is progressive, while state and local taxes are regressive. Meanwhile, the federal government can borrow at cheap rates and run a large deficit without a problem, while state budgets are constrained and need to be balanced. As a result, large cuts and layoffs at the state and local level have counteracted much of the federal government's stimulus that comes from running a larger deficit. Indeed, Stiglitz's point that inequality makes it harder to fund education is a real life battle: we are currently seeing education funding by state and local governments collapsing in real-time.
     
    Here's a chart on how regressive state and local taxes are from the Institute on Taxation & Economic Policy:

    When it comes to state and local taxes, the top 1 percent pays 6.4 percent, the middle 20 percent pays 9.7, while the poorest 20 percent of families pay 10.9 percent. This isn't counting user fees, though a CEO with 300 times the income of a worker probably doesn't get 300 times as many drivers' licenses.
     
    So, all things being equal, less inequality would mean less revenue for the federal government and more for state and local governments. Since a good plan for boosting demand would entail the federal government collecting less revenue (an extension of the payroll tax cut would have boosted demand) and state and local governments collecting more revenue and thus facing less austerity, less inequality would net provide more stimulus. I doubt it would matter that much, though it's an empirical matter on just how much it would provide.
     
    Spending: The other debate has to do with the marginal propensity to consume. Evidence does find the rich are less likely to spend money on consumption than everyone else, and in a liquidity trap this matters. Steve Waldman at Interfluidity has a larger theory on why it has mattered over the past decades, but I want to focus on the complicating, narrow issue of wealth inequality.
     
    A graph by Amir Sufi, using Federal Reserve data, shows a collapse in the median net worth of households, and his research and others finds that this is a driver of the collapse in demand:

    Meanwhile, precautionary savings are still a problem.
     
    So, all things being equal, what happens if we decrease inequality in a balance-sheet recession? I see two changes running in opposite directions. You could see an increase in spending by the median household, as they have a higher propensity to spend, plus more income could relieve their balance-sheet constraints. However, if more middle-class households have more of the country's income, they may save it even more aggressively; this would amplify the Paradox of Thrift and make the recession worse in the short term. It's not clear which of these effects would dominate over the other.
     
    One way to deal with this is to boost net wealth while keeping incomes consistent, via debt forgiveness or reform our legal mechanisms like bankruptcy so they can handle allocating these losses, though that doesn't seem to be in the cards.
     
    Follow or contact the Rortybomb blog:
      

     

    Is inequality holding back our weak recovery? Joe Stiglitz argues it is, while Paul Krugman argues it is not. John Judis summarizes the debate at The New RepublicI want to rephrase the question and focus specifically on the two most relevant policy points.

    Taxes: Stiglitz argues, "[T]he weakness of the middle class is holding back tax receipts, especially because those at the top are so adroit in avoiding taxes and in getting Washington to give them tax breaks." 
     
    Right now our federal government's tax structure is progressive, while state and local taxes are regressive. Meanwhile, the federal government can borrow at cheap rates and run a large deficit without a problem, while state budgets are constrained and need to be balanced. As a result, large cuts and layoffs at the state and local level have counteracted much of the federal government's stimulus that comes from running a larger deficit. Indeed, Stiglitz's point that inequality makes it harder to fund education is a real life battle: we are currently seeing education funding by state and local governments collapsing in real-time.
     
    Here's a chart on how regressive state and local taxes are from the Institute on Taxation & Economic Policy:

    When it comes to state and local taxes, the top 1 percent pays 6.4 percent, the middle 20 percent pays 9.7, while the poorest 20 percent of families pay 10.9 percent. This isn't counting user fees, though a CEO with 300 times the income of a worker probably doesn't get 300 times as many drivers' licenses.
     
    So, all things being equal, less inequality would mean less revenue for the federal government and more for state and local governments. Since a good plan for boosting demand would entail the federal government collecting less revenue (an extension of the payroll tax cut would have boosted demand) and state and local governments collecting more revenue and thus facing less austerity, less inequality would net provide more stimulus. I doubt it would matter that much, though it's an empirical matter on just how much it would provide.
     
    Spending: The other debate has to do with the marginal propensity to consume. Evidence does find the rich are less likely to spend money on consumption than everyone else, and in a liquidity trap this matters. Steve Waldman at Interfluidity has a larger theory on why it has mattered over the past decades, but I want to focus on the complicating, narrow issue of wealth inequality.
     
    A graph by Amir Sufi, using Federal Reserve data, shows a collapse in the median net worth of households, and his research and others finds that this is a driver of the collapse in demand:

    Meanwhile, precautionary savings are still a problem.
     
    So, all things being equal, what happens if we decrease inequality in a balance-sheet recession? I see two changes running in opposite directions. You could see an increase in spending by the median household, as they have a higher propensity to spend, plus more income could relieve their balance-sheet constraints. However, if more middle-class households have more of the country's income, they may save it even more aggressively; this would amplify the Paradox of Thrift and make the recession worse in the short term. It's not clear which of these effects would dominate over the other.
     
    One way to deal with this is to boost net wealth while keeping incomes consistent, via debt forgiveness or reform our legal mechanisms like bankruptcy so they can handle allocating these losses, though that doesn't seem to be in the cards.
     
    Follow or contact the Rortybomb blog:
      

     

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  • Is the Right Shifting Course on Dodd-Frank?

    Feb 4, 2013Mike Konczal

    During the 2012 election, conservatives' main goal was to either repeal Dodd-Frank completely or remove such large sections of it that it was a completely different bill. There was very little engagement with the content of Dodd-Frank itself and how to make them work better. One important example was Republican candidates like Jon Huntsman calling for bold new financial reforms that were already part of Dodd-Frank

    It now appears that the flagship policy journal on the right, National Affairs, is moving towards a reform rather than replace agenda for Dodd-Frank and financial reform. The latest issue featured an large, 7,000+ word article, "Against Casino Finance," by Eric Posner and E. Glen Weyl of University of Chicago law school. What's fascinating about the piece is less the authors' counter proposals for reform, which are lacking, than the fact that they accept two of the ideas put forward by financial reformers that have generally been resisted on the right. The first is that derivatives require regulation and the second is that prudential regulation of the largest systemically risky financial firms is necessary.

    Let's take those in order. First the authors argue, "[I]n today's derivatives market...no such sensible restriction exists to separate the use of the instruments as insurance from their use as gambling devices." They describe these instruments as "pure gambling," or a transaction in which "one party loses exactly what the other party gains, and both are made worse off by the additional risk they take on in this bargain." They argue that these instruments can increase pure risks and are zero-sum, differentiating them from other trades. They go as far as to argue against the Commodity Futures Modernization Act of 2000.

    It isn't clear what they think of the general Dodd-Frank approach to derivatives, which emphasizes transparency through exchanges and clearinghouses, capital adequacy, private enforcement, and regulation of intermediaries. Their focus is partially on the "insurable interest doctrine" of common law as it relates to insurance, which requires that a party to an insurance contract have a stake in the event. If you can't buy fire insurance on your neighbor's house, why can you buy credit insurance on his business if you don't have an ownership claim on it? That's a dog whistle for either banning so-called "naked" derivatives or running them under state-level insurance law. The vote to ban naked credit default swaps, proposed in the Senate by Bryan Dorgan, failed (and was generally opposed on the right). 

    The other regulations relate to bailouts and prudential regulations. As they put it:

    When banks fail, the government must act as lender of last resort.

    Today, the government serves this role in two ways. First, it compels banks to buy government-supplied deposit insurance, which covers depositors up to $250,000. Second, it provides emergency loans at below-market rates -- bailouts -- to any financial institution whose collapse would take down enough banks with it to endanger the entire economy.

    Few seriously doubt that governments must play this role.

    Bagehot’s rule is usually summarized as, “Lend without limit, to solvent firms, against good collateral, at high rates." In exchange for this, certain regulations are necessary. Dodd-Frank includes higher capital and liquidity requirements for larger and riskier firms, as well as certain organizational requirements (loosely referred to under the term "living wills") to help with collapsing the company in question via FDIC's resolution powers.

    Again, it would be interesting if they addressed the specific reforms to lender of last resort functions included in Dodd-Frank, or the combination of regulation and resolution. Section 13(3) of the Federal Reserve Act was amended so that "any emergency lending program or facility is for the purpose of providing liquidity to the financial system, and not to aid a failing financial company." and any such lending program has to have "broad-based eligibility.” Some have argued this is too loose to deal with a liquidity crisis. Do these authors agree? Are the regulations and FDIC's resolution powers sufficient in this case, or do we need a different approach?

    Their specific recommendations for how the right should tackle Dodd-Frank, which is the last third of the piece, involve applying stricter cost-benefit analysis to all rules. There's no talk about repeal, or huge changes to the framework, or long court battles. Cost-benefit has significant problems, but that's a debate for another day. Conceptually, it is tinkering with Dodd-Frank rather than repealing it, which has dominated the conversation on the right. Will this signal a larger change?

    Follow or contact the Rortybomb blog:

      

    During the 2012 election, conservatives' main goal was to either repeal Dodd-Frank completely or remove such large sections of it that it was a completely different bill. There was very little engagement with the content of Dodd-Frank itself and how to make them work better. One important example was Republican candidates like Jon Huntsman calling for bold new financial reforms that were already part of Dodd-Frank

    It now appears that the flagship policy journal on the right, National Affairs, is moving towards a reform rather than replace agenda for Dodd-Frank and financial reform. The latest issue featured an large, 7,000+ word article, "Against Casino Finance," by Eric Posner and E. Glen Weyl of University of Chicago law school. What's fascinating about the piece is less the authors' counter proposals for reform, which are lacking, than the fact that they accept two of the ideas put forward by financial reformers that have generally been resisted on the right. The first is that derivatives require regulation and the second is that prudential regulation of the largest systemically risky financial firms is necessary.

    Let's take those in order. First the authors argue, "[I]n today's derivatives market...no such sensible restriction exists to separate the use of the instruments as insurance from their use as gambling devices." They describe these instruments as "pure gambling," or a transaction in which "one party loses exactly what the other party gains, and both are made worse off by the additional risk they take on in this bargain." They argue that these instruments can increase pure risks and are zero-sum, differentiating them from other trades. They go as far as to argue against the Commodity Futures Modernization Act of 2000.

    It isn't clear what they think of the general Dodd-Frank approach to derivatives, which emphasizes transparency through exchanges and clearinghouses, capital adequacy, private enforcement, and regulation of intermediaries. Their focus is partially on the "insurable interest doctrine" of common law as it relates to insurance, which requires that a party to an insurance contract have a stake in the event. If you can't buy fire insurance on your neighbor's house, why can you buy credit insurance on his business if you don't have an ownership claim on it? That's a dog whistle for either banning so-called "naked" derivatives or running them under state-level insurance law. The vote to ban naked credit default swaps, proposed in the Senate by Bryan Dorgan, failed (and was generally opposed on the right). 

    The other regulations relate to bailouts and prudential regulations. As they put it:

    When banks fail, the government must act as lender of last resort.

    Today, the government serves this role in two ways. First, it compels banks to buy government-supplied deposit insurance, which covers depositors up to $250,000. Second, it provides emergency loans at below-market rates -- bailouts -- to any financial institution whose collapse would take down enough banks with it to endanger the entire economy.

    Few seriously doubt that governments must play this role.

    Bagehot’s rule is usually summarized as, “Lend without limit, to solvent firms, against good collateral, at high rates." In exchange for this, certain regulations are necessary. Dodd-Frank includes higher capital and liquidity requirements for larger and riskier firms, as well as certain organizational requirements (loosely referred to under the term "living wills") to help with collapsing the company in question via FDIC's resolution powers.

    Again, it would be interesting if they addressed the specific reforms to lender of last resort functions included in Dodd-Frank, or the combination of regulation and resolution. Section 13(3) of the Federal Reserve Act was amended so that "any emergency lending program or facility is for the purpose of providing liquidity to the financial system, and not to aid a failing financial company." and any such lending program has to have "broad-based eligibility.” Some have argued this is too loose to deal with a liquidity crisis. Do these authors agree? Are the regulations and FDIC's resolution powers sufficient in this case, or do we need a different approach?

    Their specific recommendations for how the right should tackle Dodd-Frank, which is the last third of the piece, involve applying stricter cost-benefit analysis to all rules. There's no talk about repeal, or huge changes to the framework, or long court battles. Cost-benefit has significant problems, but that's a debate for another day. Conceptually, it is tinkering with Dodd-Frank rather than repealing it, which has dominated the conversation on the right. Will this signal a larger change?

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