Mike Konczal

Roosevelt Institute Fellow

Recent Posts by Mike Konczal

  • Prioritization, Credit Risks and the Potential for Default

    Jan 15, 2013Mike Konczal

    Does going with "prioritization" if we going through the debt ceiling remove the risk of a debt default, defined in this post as a missed payment on the interest or principal of government debt? Suzy Khimm reports on the extensive talk on the right about how the government can't debt default if it decides to prioritize interest payments by paying them first. There's a lot of pushback on this line of reasoning (see Ezra Klein, Brian Beutler).

    The bigger danger is what happens when the government has to balance its budget in a single day. But it is worth shutting down this specific line of reasoning. Sorry conservatives: though it doesn't guarantee a default, going with this plan significantly increases the probability of default, which is what markets will be looking for.

    Fitch, the ratings agency, rightly calls BS on this logic:

    With no legal authorisation for net debt issuance, the Treasury would be forced to immediately eliminate the deficit - a fiscal contraction twice as great as the recently avoided 'fiscal cliff' - by delaying payments on commitments as they fall due. It is not assured that the Treasury would or legally could prioritise debt service over its myriad of other obligations, including social security payments, tax rebates and payments to contractors and employees. Arrears on such obligations would not constitute a default event from a sovereign rating perspective but very likely prompt a downgrade even as debt obligations continued to be met.

    Even if we successfully prioritize we'd be a higher risk for a default, prompting a downgrade. Trying this "prioritization" plan is not risk-free, but instead introduces substantial credit risk into government debt. I want to justify Fitch's assessment by looking at what would happen.
     
    As a former credit risk financial engineer who's been around a default probability transition matrix in his day, I see 5 major credit risks introduced by prioritization, which means it doesn't eliminate the risk of a debt default but in fact increases it. Let's get them in a chart:

    Let's go through them.
     
    1. Will It Work? The first, and most obvious, problem is that it isn't clear that they'll be able to do this successfully after the debt ceiling is breached. It hasn't been done before. As Brad Plumer notes, Fedwire, the program that handles interest payments, is seperate from the computers that handle other payments. Maybe this means it can work better; maybe it means that it won't be able to sync cash balances. As far as I can tell, nobody knows how this will work in an environment of extreme shutdown. If there are computer glitches, if the IT crowd can't get it all working in time, there's a chance of missing a payment and defaulting.
     
    2. Will There Be Enough Revenue? According to the BPC, February 15th has a $30 billion dollar interest payments with only $9 billion dollars coming in the door. Will we be able to make that payment? In general, we'll know the interest payments well in advance. However the revenues coming in will be uncertain, and, especially if we are making other payments, it may be difficult to match them up. Even a small mismatch could mean a default.
     
    3. Legal and Political Blowback. The civil unrest of paying foreign creditors while Social Security, military and domestic spending goes unpaid will be massive. One can easily see discontent in the streets over such a plan. If we are worried about future payments, this kind of rage generates future credit risks, and could cause the government to switch to a non-prioritization regime.
     
    Meanwhile, there will be extensive lawsuits, both over the lack of payments and President Obama's legal authority to prioritize payments. No matter what people are saying, the President's authority to legally do this is uncertain. Will the courts force him to pay claims in a different manner? All of this leads to huge uncertainty over the payments themselves, which amplify the chance of missing a payment.
     
    4. Rolling Over Debt. There's $500 billion dollars worth of debt that will need to be rolled over during the first month after we go through the debt ceiling. If, for some reason, any of it can't be rolled over, and there isn't a sufficient cash buffer built up, that would be a default. This is unlikely, though how unlikely it is is depends on numbers 1-3 and the level of economic chaos going through the debt ceiling generates. Especially if we are past the debt ceiling for a substantial period of time, rolling over our debt won't be a trivial operation. Though it is unlikely, if it happens it is an automatic default.
     
    5. Repeat Again Next Time. If Republicans are successful at pulling this off, they will do it again the next time the debt ceiling comes up. This will mean the risk of the first four factors identified are intensified.
     
    If anyone tells you that the credit risks from number 1-4 are zero, they are lying to you. Each of these has a very small chance of causing a debt default. Added together, they have a non-negliable chance of debt default such that the financial markets, and citizens themselves, should take note.
     
    Even if you think the chance of default in going through the debt ceiling is only about 2 percent, a 2 percent expected probability of default over the course of one year is what junk bonds have. This may be surprising for some of you, but even very small probabilities of default are big problems for firms. If there's a 0.87% chance, for instance, of default over the course of one year, that's non-investment grade debt.
     
    The government has no possibility of default except for this debt ceiling; hence our normal high rating. However the debt ceiling is where many on the right want to extract maximum concessions, even though it is the one place where you could see a chance of default. This, regardless of what they'll tell you, has consequences.
     

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    Does going with "prioritization" if we going through the debt ceiling remove the risk of a debt default, defined in this post as a missed payment on the interest or principal of government debt? Suzy Khimm reports on the extensive talk on the right about how the government can't debt default if it decides to prioritize interest payments by paying them first. There's a lot of pushback on this line of reasoning (see Ezra Klein, Brian Beutler).

    The bigger danger is what happens when the government has to balance its budget in a single day. But it is worth shutting down this specific line of reasoning. Sorry conservatives: though it doesn't guarantee a default, going with this plan significantly increases the probability of default, which is what markets will be looking for.

    Fitch, the ratings agency, rightly calls BS on this logic:

    With no legal authorisation for net debt issuance, the Treasury would be forced to immediately eliminate the deficit - a fiscal contraction twice as great as the recently avoided 'fiscal cliff' - by delaying payments on commitments as they fall due. It is not assured that the Treasury would or legally could prioritise debt service over its myriad of other obligations, including social security payments, tax rebates and payments to contractors and employees. Arrears on such obligations would not constitute a default event from a sovereign rating perspective but very likely prompt a downgrade even as debt obligations continued to be met.

    Even if we successfully prioritize we'd be a higher risk for a default, prompting a downgrade. Trying this "prioritization" plan is not risk-free, but instead introduces substantial credit risk into government debt. I want to justify Fitch's assessment by looking at what would happen.
     
    As a former credit risk financial engineer who's been around a default probability transition matrix in his day, I see 5 major credit risks introduced by prioritization, which means it doesn't eliminate the risk of a debt default but in fact increases it. Let's get them in a chart:

    Let's go through them.
     
    1. Will It Work? The first, and most obvious, problem is that it isn't clear that they'll be able to do this successfully after the debt ceiling is breached. It hasn't been done before. As Brad Plumer notes, Fedwire, the program that handles interest payments, is seperate from the computers that handle other payments. Maybe this means it can work better; maybe it means that it won't be able to sync cash balances. As far as I can tell, nobody knows how this will work in an environment of extreme shutdown. If there are computer glitches, if the IT crowd can't get it all working in time, there's a chance of missing a payment and defaulting.
     
    2. Will There Be Enough Revenue? According to the BPC, February 15th has a $30 billion dollar interest payments with only $9 billion dollars coming in the door. Will we be able to make that payment? In general, we'll know the interest payments well in advance. However the revenues coming in will be uncertain, and, especially if we are making other payments, it may be difficult to match them up. Even a small mismatch could mean a default.
     
    3. Legal and Political Blowback. The civil unrest of paying foreign creditors while Social Security, military and domestic spending goes unpaid will be massive. One can easily see discontent in the streets over such a plan. If we are worried about future payments, this kind of rage generates future credit risks, and could cause the government to switch to a non-prioritization regime.
     
    Meanwhile, there will be extensive lawsuits, both over the lack of payments and President Obama's legal authority to prioritize payments. No matter what people are saying, the President's authority to legally do this is uncertain. Will the courts force him to pay claims in a different manner? All of this leads to huge uncertainty over the payments themselves, which amplify the chance of missing a payment.
     
    4. Rolling Over Debt. There's $500 billion dollars worth of debt that will need to be rolled over during the first month after we go through the debt ceiling. If, for some reason, any of it can't be rolled over, and there isn't a sufficient cash buffer built up, that would be a default. This is unlikely, though how unlikely it is is depends on numbers 1-3 and the level of economic chaos going through the debt ceiling generates. Especially if we are past the debt ceiling for a substantial period of time, rolling over our debt won't be a trivial operation. Though it is unlikely, if it happens it is an automatic default.
     
    5. Repeat Again Next Time. If Republicans are successful at pulling this off, they will do it again the next time the debt ceiling comes up. This will mean the risk of the first four factors identified are intensified.
     
    If anyone tells you that the credit risks from number 1-4 are zero, they are lying to you. Each of these has a very small chance of causing a debt default. Added together, they have a non-negliable chance of debt default such that the financial markets, and citizens themselves, should take note.
     
    Even if you think the chance of default in going through the debt ceiling is only about 2 percent, a 2 percent expected probability of default over the course of one year is what junk bonds have. This may be surprising for some of you, but even very small probabilities of default are big problems for firms. If there's a 0.87% chance, for instance, of default over the course of one year, that's non-investment grade debt.
     
    The government has no possibility of default except for this debt ceiling; hence our normal high rating. However the debt ceiling is where many on the right want to extract maximum concessions, even though it is the one place where you could see a chance of default. This, regardless of what they'll tell you, has consequences.
     

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  • Are "Educational Services" Off-Setting the Reduced Number of Public Education Workers?

    Jan 15, 2013Mike Konczal

    One important reason the recovery has been so weak has been the collapse in the number of government employees, a decline that continues years after the recession has technically "ended." An important check on the economy, unemployment would be significant lower if there weren't 651,000 fewer government jobs since January 2009.

    Education jobs are a large part of this decline. State and local education job together declined 224,700 since January 2009. These losses are entirely at the local level, with state-level education workers going up slightly over the time period. This is consistent with declining spending on public primary and secondary education broadly in the states, and a large increase in the number of young people attending higher educaiton.

    But what if these public sector jobs are being replaced with private sector ones? Several people on twitter have noted that the number of "educational service" jobs have gone up quite significantly in the past several years, gaining 244,500 jobs since January 2009. What if they are replacing K-12 education workers? That would be a much different picture of how the public sector is evolving in the past several years.

    Luckily, the CES has the ability to break out primary and secondary education workers from education services. Let's graph this out:

    (The breakout is not seasonally adjusted, and education has large seasonal changes. As such, all these numbers are a 12-month moving average. The conclusions are robust to other specifications.)

    As you can see, there's been a minimal increase in the number of private elementary and secondary school workers, on the order of an increase of 39,600, all relatively recent. The vast majority of the increase in education sector workers are working in postsecondary education. This is consistent with the large increase in post-secondary education we are seeing in this recession. The private sector isn't offsetting either the state and local level austerity imposed through the school system, nor is it, as far as I can see, offsetting the major disinvestments we are making in the education and opportunities of our young people.

     

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    One important reason the recovery has been so weak has been the collapse in the number of government employees, a decline that continues years after the recession has technically "ended." An important check on the economy, unemployment would be significant lower if there weren't 651,000 fewer government jobs since January 2009.

    Education jobs are a large part of this decline. State and local education job together declined 224,700 since January 2009. These losses are entirely at the local level, with state-level education workers going up slightly over the time period. This is consistent with declining spending on public primary and secondary education broadly in the states, and a large increase in the number of young people attending higher educaiton.

    But what if these public sector jobs are being replaced with private sector ones? Several people on twitter have noted that the number of "educational service" jobs have gone up quite significantly in the past several years, gaining 244,500 jobs since January 2009. What if they are replacing K-12 education workers? That would be a much different picture of how the public sector is evolving in the past several years.

    Luckily, the CES has the ability to break out different groups of educational services workers, so we can focus on primary and secondary education workers as well more post-secondary workers. Let's graph this out:

    (The breakout is not seasonally adjusted, and education has large seasonal changes. As such, all these numbers are a 12-month moving average. The conclusions are robust to other specifications.)

    As you can see, there's been a minimal increase in the number of private elementary and secondary school workers, on the order of an increase of 39,600, all relatively recent. The vast majority of the increase in education sector workers are working in postsecondary education. This is consistent with the large increase in post-secondary education we are seeing in this recession. The private sector isn't offsetting either the state and local level austerity imposed through the school system, nor is it, as far as I can see, offsetting the major disinvestments we are making in the education and opportunities of our young people.

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  • The Game Theory of the Post-Platinum Coin Debt Ceiling

    Jan 14, 2013Mike Konczal

    In a statement given to wonkblog over the weekend, the Treasury department announced that “Neither the Treasury Department nor the Federal Reserve believes that the law can or should be used to facilitate the production of platinum coins for the purpose of avoiding an increase in the debt limit.” Jay Carney followed up with the statement that there "are only two options to deal with the debt limit: Congress can pay its bills or they can fail to act and put the nation into default."

    The administration decided against negotiating with the GOP over potential terms for raising the debt ceiling, even though they could have tried for the Grand Bargain they’ve been trying to get for the past several years. They’ve asked for a clean increase of the debt limit instead, threatening default. They’ve also now decided to commit to not sidestepping around the debt ceiling using legal measures, either by minting the platinum coin or declaring the debt ceiling unconstitutional via the 14th amendment.

    The administration thinks that this move will strengthen their position. In general, having more choices makes you better off. But in strategic situations, removing some of your options can strengthen other options, by committing to following them through. Every game theory class has a reference to an army burning bridges and ships and otherwise removing their own escape routes, to tell their soldiers--and their opponents--that they’ll fight to the bitter end.

    Since the platinum coin decision and subsequent statements seem compatible with game theory dynamics, it might be useful to diagram out the debt ceiling debate via an extensive-form game:

    Removing the “avoid debt ceiling” option, in red above, is the administration’s way of saying that they want a “clean increase,” in green above, over anything else.

    What are some ideas that can be drawn from viewing the debate as a game?

    What Does a Clean Increase Give the Administration? For the White House, both the strategy of sidestepping the debt ceiling or the strategy of not negotiating and then having the GOP give up a clean increase would end the game. However, going for the clean increase has greater risks, as there’s a possibility of default.

    So why try and force the game down this path? One reason could be that the administration is more worried about the costs of a defusing strategy than the pundits are. Maybe the Obama administration believes that the public will see this as a gross overreach of executive power.

    A more likely explanation is that the administration thinks it is important to its own longer-term strategies for the GOP to play the ending move. Say Treasury had used the coin in the first round. This might have emboldened the more reactionary elements of the GOP. Taking the coin off the table forces the more sensible members of the GOP to take power back from those willing to default and move for a clean increase. This was basically Ezra Klein’s argument for not using the platinum coin.

    Most liberal commentary is split over the second level of the diagram, the branches leading from the “don’t negotiate” option. There are those that think that this will force the more extreme conservatives to fold, further weakening them in the aftermath of the 2012 election and fiscal cliff. And there are those that think that breaching the debt ceiling has such a potential high cost for our economy, and don't see any reason to think the GOP will moderate to the center by February 15th, that it is not worth the risks.

    The Administration Should Emphasize Default Pains... The stated strategy behind abandoning the platinum coin option is to use the threat of the “full default” to force a clean increase. One of the interesting things about the platinum coin and the 14th amendment in this game is that they have a dual strategic value. They could be used to shut down the debt ceiling in advance of having to stare down the House GOP, and they could also be kept as a last-minute option to prevent a default if the GOP doesn’t go for an increase. If the administration wants to commit to a “clean increase” strategy, then they have to remove it in both cases.

    The leverage here for the administration is to emphasize the pain of default and the lack of other ways of mitigating them. The State of the Union speech is February 12th, or three days before the first day we could possibly breach the debt ceiling. There is significant opportunity there to emphasize to the public how bad the outcomes would be if there isn’t an increase, as well as to explain how impossible prioritization and workarounds are.

    In the meantime, expect to see conservatives argue that the various workarounds available for the administration are sufficient and going through the debt ceiling wouldn't be that bad, contrary to the available evidence, to push back against the administration's strategy (and force them into "negotiate").

    ...While Downplaying IOUs and Other Shadow Currency. Several people are putting out the idea that instead of minting a platinum coin, the administration should begin to prepare IOUs, scrips, or other forms of shadow currency promising future payments once the debt ceiling is raised.

    As NYC Southpaw notes, this is the equivalent of saying we will “postpone paying back our debts with a no maturity, zero coupon, federal IOU that President Obama creates by executive order” that are almost certainly “a whole new fiat currency. They would be perpetual obligations of the government that are freely transferable and earn no interest—just like the bills in your wallet.”

    This is a weaker option than the platinum coin on every angle, inviting more legal challenges, uncertainty and constitutional issues while also inviting blowback for the administration in the form of how they are prioritized and the likely bank profits. (To use game theory terms, the platinum coin strictly dominated the IOU shadow currency strategy.)

    Since it is weaker across the board, and the administration is trying to downplay both points at which this strategy could be deployed (under “avoid” as well as “workarounds”) expect little play on this topic in the weeks ahead.

    Sequestration Complicates This. As many have noted, the debt ceiling will occur at the same time as the large spending cuts in the sequestration come into play. One doesn’t have to be cynical to think that the debt ceiling will be in the background of any sequestration negotiations. Removing the platinum coin tells us little about this will play out, though throwing in the debt ceiling might make a bad deal look better for the administration and Democrats.

    Finally if the administration gets the better of the GOP on sequestration, it could make the GOP more likely to threaten default to compensate for what see as a loss of power. In theory, the payouts of one game shouldn’t affect a completely different game, but life is often more complicated than what game theory can tell us.

     

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    In a statement given to wonkblog over the weekend, the Treasury department announced that “Neither the Treasury Department nor the Federal Reserve believes that the law can or should be used to facilitate the production of platinum coins for the purpose of avoiding an increase in the debt limit.” Jay Carney followed up with the statement that there "are only two options to deal with the debt limit: Congress can pay its bills or they can fail to act and put the nation into default."

    The administration decided against negotiating with the GOP over potential terms for raising the debt ceiling, even though they could have tried for the Grand Bargain they’ve been trying to get for the past several years. They’ve asked for a clean increase of the debt limit instead, threatening default. They’ve also now decided to commit to not sidestepping around the debt ceiling using legal measures, either by minting the platinum coin or declaring the debt ceiling unconstitutional via the 14th amendment.

    The administration thinks that this move will strengthen their position. In general, having more choices makes you better off. But in strategic situations, removing some of your options can strengthen other options, by committing to following them through. Every game theory class has a reference to an army burning bridges and ships and otherwise removing their own escape routes, to tell their soldiers--and their opponents--that they’ll fight to the bitter end.

    Since the platinum coin decision and subsequent statements seem compatible with game theory dynamics, it might be useful to diagram out the debt ceiling debate via an extensive-form game:

    Removing the “avoid debt ceiling” option, in red above, is the administration’s way of saying that they want a “clean increase,” in green above, over anything else.

    What are some ideas that can be drawn from viewing the debate as a game?

    What Does a Clean Increase Give the Administration? For the White House, both the strategy of sidestepping the debt ceiling or the strategy of not negotiating and then having the GOP give up a clean increase would end the game. However, going for the clean increase has greater risks, as there’s a possibility of default.

    So why try and force the game down this path? One reason could be that the administration is more worried about the costs of a defusing strategy than the pundits are. Maybe the Obama administration believes that the public will see this as a gross overreach of executive power.

    A more likely explanation is that the administration thinks it is important to its own longer-term strategies for the GOP to play the ending move. Say Treasury had used the coin in the first round. This might have emboldened the more reactionary elements of the GOP. Taking the coin off the table forces the more sensible members of the GOP to take power back from those willing to default and move for a clean increase. This was basically Ezra Klein’s argument for not using the platinum coin.

    Most liberal commentary is split over the second level of the diagram, the branches leading from the “don’t negotiate” option. There are those that think that this will force the more extreme conservatives to fold, further weakening them in the aftermath of the 2012 election and fiscal cliff. And there are those that think that breaching the debt ceiling has such a potential high cost for our economy, and don't see any reason to think the GOP will moderate to the center by February 15th, that it is not worth the risks.

    The Administration Should Emphasize Default Pains... The stated strategy behind abandoning the platinum coin option is to use the threat of the “full default” to force a clean increase. One of the interesting things about the platinum coin and the 14th amendment in this game is that they have a dual strategic value. They could be used to shut down the debt ceiling in advance of having to stare down the House GOP, and they could also be kept as a last-minute option to prevent a default if the GOP doesn’t go for an increase. If the administration wants to commit to a “clean increase” strategy, then they have to remove it in both cases.

    The leverage here for the administration is to emphasize the pain of default and the lack of other ways of mitigating them. The State of the Union speech is February 12th, or three days before the first day we could possibly breach the debt ceiling. There is significant opportunity there to emphasize to the public how bad the outcomes would be if there isn’t an increase, as well as to explain how impossible prioritization and workarounds are.

    In the meantime, expect to see conservatives argue that the various workarounds available for the administration are sufficient and going through the debt ceiling wouldn't be that bad, contrary to the available evidence, to push back against the administration's strategy (and force them into "negotiate").

    ...While Downplaying IOUs and Other Shadow Currency. Several people are putting out the idea that instead of minting a platinum coin, the administration should begin to prepare IOUs, scrips, or other forms of shadow currency promising future payments once the debt ceiling is raised.

    As NYC Southpaw notes, this is the equivalent of saying we will “postpone paying back our debts with a no maturity, zero coupon, federal IOU that President Obama creates by executive order” that are almost certainly “a whole new fiat currency. They would be perpetual obligations of the government that are freely transferable and earn no interest—just like the bills in your wallet.”

    This is a weaker option than the platinum coin on every angle, inviting more legal challenges, uncertainty and constitutional issues while also inviting blowback for the administration in the form of how they are prioritized and the likely bank profits. (To use game theory terms, the platinum coin strictly dominated the IOU shadow currency strategy.)

    Since it is weaker across the board, and the administration is trying to downplay both points at which this strategy could be deployed (under “avoid” as well as “workarounds”) expect little play on this topic in the weeks ahead.

    Sequestration Complicates This. As many have noted, the debt ceiling will occur at the same time as the large spending cuts in the sequestration come into play. One doesn’t have to be cynical to think that the debt ceiling will be in the background of any sequestration negotiations. Removing the platinum coin tells us little about this will play out, though throwing in the debt ceiling might make a bad deal look better for the administration and Democrats.

    Finally if the administration gets the better of the GOP on sequestration, it could make the GOP more likely to threaten default to compensate for what see as a loss of power. In theory, the payouts of one game shouldn’t affect a completely different game, but life is often more complicated than what game theory can tell us.

     

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  • On the Geithner Legacy

    Jan 11, 2013Mike Konczal

    As Ben Walsh of Reuters mentions, the Tim Geithner Legacy Project is underway. There was a large post by Neil Irwin in the Washington Post, arguing that he'll be one of the most important Treasury secretaries in history. Joe Weisenthal argues he's done a great job guiding us out of the recession compared to other countries. As there will be several pieces like this in the weeks ahead, I want to make some general criticisms. This will probably go across several posts.

    I: Sugar

    Joe Weisthnal notes that our recovery has been better than other financial crisis recessions.

     

    Four things about the chart. First, I’d note as a matter of the empirical research that “financial crisis” isn’t a coherent unit of measurement for these purposes. If Finland was going to have a recession three-times worse than the United States, it would also have a "financial crisis" at some point. But that doesn't mean the recessions are identical. This idea that financial crises creates long recessions when long recessions really create financial crises is the weak part of the whole Rogoff-Reinhart argument.  So I’m not sure these are equal starting points for a comparison.

    Second: Joe argues that what saved us was bailing out the financial sector with a blank-check. Maybe, but I'd need to see more. What has the financial sector done to boost the real economy during this time period? The financial sector shutdown in 2009, even after the bailouts. The government became the de facto financial sector during the worst of the crisis and in its aftermath. A more generous or more harsh bailout wouldn't have changed this fact.

    The biggest threat to the real economy would have been the shutdown of the commercial paper market, which the Federal Reserve backstopped and ran by itself through emergency lending facilities (but only after TARP had passed). The private student loan market collapsed, which had to be taken up by the public sector (a relationship that became permanent in Obamacare). FHA basically took over the housing market, saving it when the financial sector disappeared. The private market was incapable of generating funding to save the auto industry, which the government had to do. So, ummm, thanks financial sector?

    (To go further, while the best and brightest of the financial sector were busy gambling and not beating the S&P 500, the United States provided financing for long-term R&D investments in things like energy during the recession. As root_e notes, what value does a private capital market even provide at this point?)

    Third: The real credit for that graphic almost certainly goes to House Republicans, which wouldn’t take yes for an answer when it came to prematurely getting to austerity. Geithner, as Zachary Goldfarb reported in the Washington Post, famously had this exchange with Christina Romer:

    By early last year [in 2010], Geithner was beginning to gain the upper hand in a rancorous debate over whether to propose a second economic stimulus program to Congress, beyond the $787 billion package lawmakers had approved in 2009. [....]
     
    Once, as Romer pressed for more stimulus spending, Geithner snapped. Stimulus, he told Romer, was “sugar,” and its effect was fleeting. The administration, he urged, needed to focus on long-term economic growth, and the first step was reining in the debt.
     
    Wrong, Romer snapped back. Stimulus is an “antibiotic” for a sick economy, she told Geithner. “It’s not giving a child a lollipop.”
     
    In the end, Obama signed into law only a relatively modest $13 billion jobs program, much less than what was favored by Romer and many other economists in the administration.
     
    “There was this move to exit fiscal stimulus a lot sooner than we should have, and we’ve been playing catch-up ever since,” Romer said in an interview.

    If running large fiscal deficits are what is keeping the economy afloat as it delevers, Geithner’s choice to turn to the long-term would have been a disaster if the Republicans would have met him halfway.

    Fourth: The other credit goes to Ben Bernanke, who hasn’t taken his foot off the pedal (but should be pushing more). It’s worth noting that, besides the destruction it has put on families and communities, the lack of a serious response on housing has put monetary policy in check. Experts in monetary policy have noted how the Federal Reserve has pushed for the lowest mortgage rates in modern history only to find that Treasury had no plan in place to allow underwater mortgages to refinance. By the time they did put programs in place, in Spring 2012, the way it was setup and the lack of public refinancing means that a huge amount of the monetary stimulus is going to banks’ profits.

    II: A Tale of Two Programs

    Speaking of housing, let’s compare two programs instituted under Secretary Geithner.

    The first is the FHA Short Refi program. It is an $8.1 billion dollar line of credit allocated through TARP designed to "enable lenders to provide additional refinancing options to homeowners who owe more than their home is worth." According to the latest SIGTARP numbers, it has modified 1,772 mortgages and allocated $57 million dollars for potential future claims as well as expenses. Which means it has spent less than 1 percent of its funds, even though those funds are allocated for this purpose. I’ve noted it would be perfectly legal for Treasury to use this fund to provide up to around $100 billion dollars of funding for a HOLC program, like the one Senator Merkley has proposed, and it can be done without going to Congress.

    The second is the Public-Private Investment Program for Legacy Assets, also referred to as PPIP or the “Geithner Plan.” Here Geithner proposed a program that would have private hedge funds team up with the government to purchase one trillion dollars of “legacy assets,” or the toxic waste of bad, illiquid mortgage-backed securities on the Too Big To Fail banks' balance sheets. The hedge funds would provide some money and expertise as well as take the first losses, with the FDIC’s fund providing the leverage and eating all the remaining losses.

    This program was correctly identified as the public writing a “put option” on those debts. As such, the public insurance would cause the hedge funds to overbid for the assets, which would help get them off the balance-sheets of the banks.

    PPIP was killed quickly for a number of reasons, including the fact that this subsidy wasn’t enough for the banks' balance sheet, but it is worth noting two things. The core instinct was to put programs in place in 2009 to bid up, rather than write down, bad mortgage debt. Instead of trying to get those assets written down to a manageable level quickly, public money and power was utilized towards trying to keep that value up. That’s the opposite of what one should do in a balance-sheet recession. And the recent evidence all points to the prolonged recession being a result of a large debt overhang.

    The other is the contrast between creativity and energy shown in the pursuit of getting the public to take over the garbage loans of the TBTF banks, and the lack of interest in taking already allocated money for housing relief and using it towards its stated goals. The FDIC fund isn’t meant for this kind of gambling; it reflects a form of social insurance banks and depositors pay to prevent panics. Meanwhile the government isn’t even bothering to spend the money already allocated through programs like FHA Short Refi, much less using them in creative ways. If only half that energy was put into motion on behalf of debtors and homeowners.

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    As Ben Walsh of Reuters mentions, the Tim Geithner Legacy Project is underway. There was a large post by Neil Irwin in the Washington Post, arguing that he'll be one of the most important Treasury secretaries in history. Joe Weisenthal argues he's done a great job guiding us out of the recession compared to other countries. As there will be several pieces like this in the weeks ahead, I want to make some general criticisms. This will probably go across several posts.

    I: Sugar

    Joe Weisthnal notes that our recovery has been better than other financial crisis recessions.

     

    Four things about the chart. First, I’d note as a matter of the empirical research that “financial crisis” isn’t a coherent unit of measurement for these purposes. If Finland was going to have a recession three-times worse than the United States, it would also have a "financial crisis" at some point. But that doesn't mean the recessions are identical. This idea that financial crises creates long recessions when long recessions really create financial crises is the weak part of the whole Rogoff-Reinhart argument.  So I’m not sure these are equal starting points for a comparison.

    Second: Joe argues that what saved us was bailing out the financial sector with a blank-check. Maybe, but I'd need to see more. What has the financial sector done to boost the real economy during this time period? The financial sector shutdown in 2009, even after the bailouts. The government became the de facto financial sector during the worst of the crisis and in its aftermath. A more generous or more harsh bailout wouldn't have changed this fact.

    The biggest threat to the real economy would have been the shutdown of the commercial paper market, which the Federal Reserve backstopped and ran by itself through emergency lending facilities (but only after TARP had passed). The private student loan market collapsed, which had to be taken up by the public sector (a relationship that became permanent in Obamacare). FHA basically took over the housing market, saving it when the financial sector disappeared. The private market was incapable of generating funding to save the auto industry, which the government had to do. So, ummm, thanks financial sector?

    (To go further, while the best and brightest of the financial sector were busy gambling and not beating the S&P 500, the United States provided financing for long-term R&D investments in things like energy during the recession. As root_e notes, what value does a private capital market even provide at this point?)

    Third: The real credit for that graphic almost certainly goes to House Republicans, which wouldn’t take yes for an answer when it came to prematurely getting to austerity. Geithner, as Zachary Goldfarb reported in the Washington Post, famously had this exchange with Christina Romer:

    By early last year [in 2010], Geithner was beginning to gain the upper hand in a rancorous debate over whether to propose a second economic stimulus program to Congress, beyond the $787 billion package lawmakers had approved in 2009. [....]
     
    Once, as Romer pressed for more stimulus spending, Geithner snapped. Stimulus, he told Romer, was “sugar,” and its effect was fleeting. The administration, he urged, needed to focus on long-term economic growth, and the first step was reining in the debt.
     
    Wrong, Romer snapped back. Stimulus is an “antibiotic” for a sick economy, she told Geithner. “It’s not giving a child a lollipop.”
     
    In the end, Obama signed into law only a relatively modest $13 billion jobs program, much less than what was favored by Romer and many other economists in the administration.
     
    “There was this move to exit fiscal stimulus a lot sooner than we should have, and we’ve been playing catch-up ever since,” Romer said in an interview.

    If running large fiscal deficits are what is keeping the economy afloat as it delevers, Geithner’s choice to turn to the long-term would have been a disaster if the Republicans would have met him halfway.

    Fourth: The other credit goes to Ben Bernanke, who hasn’t taken his foot off the pedal (but should be pushing more). It’s worth noting that, besides the destruction it has put on families and communities, the lack of a serious response on housing has put monetary policy in check. Experts in monetary policy have noted how the Federal Reserve has pushed for the lowest mortgage rates in modern history only to find that Treasury had no plan in place to allow underwater mortgages to refinance. By the time they did put programs in place, in Spring 2012, the way it was setup and the lack of public refinancing means that a huge amount of the monetary stimulus is going to banks’ profits.

    II: A Tale of Two Programs

    Speaking of housing, let’s compare two programs instituted under Secretary Geithner.

    The first is the FHA Short Refi program. It is an $8.1 billion dollar line of credit allocated through TARP designed to "enable lenders to provide additional refinancing options to homeowners who owe more than their home is worth." According to the latest SIGTARP numbers, it has modified 1,772 mortgages and allocated $57 million dollars for potential future claims as well as expenses. Which means it has spent less than 1 percent of its funds, even though those funds are allocated for this purpose. I’ve noted it would be perfectly legal for Treasury to use this fund to provide up to around $100 billion dollars of funding for a HOLC program, like the one Senator Merkley has proposed, and it can be done without going to Congress.

    The second is the Public-Private Investment Program for Legacy Assets, also referred to as PPIP or the “Geithner Plan.” Here Geithner proposed a program that would have private hedge funds team up with the government to purchase one trillion dollars of “legacy assets,” or the toxic waste of bad, illiquid mortgage-backed securities on the Too Big To Fail banks' balance sheets. The hedge funds would provide some money and expertise as well as take the first losses, with the FDIC’s fund providing the leverage and eating all the remaining losses.

    This program was correctly identified as the public writing a “put option” on those debts. As such, the public insurance would cause the hedge funds to overbid for the assets, which would help get them off the balance-sheets of the banks.

    PPIP was killed quickly for a number of reasons, including the fact that this subsidy wasn’t enough for the banks' balance sheet, but it is worth noting two things. The core instinct was to put programs in place in 2009 to bid up, rather than write down, bad mortgage debt. Instead of trying to get those assets written down to a manageable level quickly, public money and power was utilized towards trying to keep that value up. That’s the opposite of what one should do in a balance-sheet recession. And the recent evidence all points to the prolonged recession being a result of a large debt overhang.

    The other is the contrast between creativity and energy shown in the pursuit of getting the public to take over the garbage loans of the TBTF banks, and the lack of interest in taking already allocated money for housing relief and using it towards its stated goals. The FDIC fund isn’t meant for this kind of gambling; it reflects a form of social insurance banks and depositors pay to prevent panics. Meanwhile the government isn’t even bothering to spend the money already allocated through programs like FHA Short Refi, much less using them in creative ways. If only half that energy was put into motion on behalf of debtors and homeowners.

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  • Should President Obama Announce No Prioritizing Payments in the Debt Ceiling, or Start Minting Platinum Coins Daily?

    Jan 9, 2013Mike Konczal

    Steve Bell, Loren Adler, Shai Akabas and Brian Collins of the Bipartisan Policy Center recently put out an excellent analysis of what will happen if we breach the debt ceiling. Technically we've already breached the debt ceiling on December 31st, but Treasury has started extraordinary measures to juggle payments and borrow money. This can't go on forever, and it won't. The paper concludes that the "X date," when there is officially not enough money to pay all the bills due on that date, will occur between February 15th and March 1st.

    What's most worrisome about the report is how uncertain they are about what will happen afterward. The main possible strategy they discuss is Treasury starting a process of "prioritization," where they pick and choose what payments to make as the money comes in each day. In theory the United States wouldn't default on its debts, because it could prioritize interest payments.

    The only problem is that it isn't clear that they have the legal authority to do that. As the BPC noted in a previous blog post, there's a one-page, non-binding GAO report from the 1980s that suggests the executive branch would be able to do this. However, a long history of "impoundment," or the executive branch ignoring or disobeying spending orders, and the subsequent battles show that this is not uncontroversial.

    And as Josh Barro noted on Twitter, there are days when the Treasury couldn't make the interest payment based on the income of that day. And these are some thin margins on the day-to-day measures; if some come in higher or lower than anticipated, we might miss an interest payment even if Treasury tried to prioritize. According to BPC, the money coming in and out is "lumpy," so these risks are high. Beyond that, it isn't even clear that Treasury has the technology or processes in place to do this successfully.

    It's important to remember that the conservative think tanks argue that the government can always prioritize interest payments, so there's no risk of default if we go past the "X date." I documented this as their argument from 2011, and it still is being used. As the idea of using the debt ceiling becomes normalized in the Washington press, the idea that we can't default because the president can always prioritize the interest payment might become a form of justification for why the new normal isn't so bad.

    Should President Obama announce that if we breach the debt ceiling the government won't make any payments, including on interest, period? The downside is all on the president if he tries. If he says he can still prioritize interest payments, but there's an unknown glitch or difficulty with the day-to-day cash flows, it is a major embarrassment for the White House. And if he does start prioritizing payments, the White House could face serious political blowback from deciding who to pay. Treasury paying bondholders and military contractors but not Social Security or veteran's hospitals -- there are an infinite number of bad headlines. If Treasury is prioritizing these, even because Congress has forced it to, it is a losing proposition for the White House. And you can't lose the game if you don't play.

    The Real Problem With a Trillion Dollar Platinum Coin

    The BPC report also shows a way to operationalize the platinum coin strategy. There have been numerous write-ups of the platinum coin strategy, which would allow the Treasury to create large-denomination platinum coins to deposit at the Federal Reserve, thus keeping the government funded if it can't borrow money. Matt O'Brien sums up everything you want to know, and Interfluidity and Ryan Cooper have link roundups. The link roundups give you a sense of the critics of this strategy. BPC calls it "impractical, illegal, and/or inappropriate" (my favorite things!), while most think of it as unserious.

    I think the bigger problem of the trillion-dollar platinum coin strategy isn't the platinum but the trillion. I worry that the public will either think a trillion-dollar coin means the government is changing, in a big way, how it funds itself permanently, or that President Obama wants to bulldoze Congress on all spending authority to spend an extra trillion dollars, rather than what it is, which is a mechanism to keep spending Congress already passed going.

    Luckily, scanning the BPC daily timetables, on most individual days the deficit between money coming in and going out will be between $10 and $20 billion. (There are a few days where it will be on the order of $50 or $60 billion, however.) Here's an example:

    So, instead of a trillion-dollar coin, what if the president said, "I have a constitutionally obligated responsibility to carry out the spending Congress has authorized. I have no legal authority to prioritize payments, and the process is too risky for us to try. Therefore I will mint a $20 billion coin each day until Congress raises the debt ceiling. That is just enough to make the payments Congress has required me to make."

    It takes the trillion out of the headline. The focus is back on day-to-day spending rather than higher-level arguments about whether or not the United States government can run out of money. With actual speechwriters, the pitch could make sense to the public. And insiders watching it would understand it is the same exact thing as the trillion-dollar platinum coin. Interfluidity brought up the idea of smaller denomination platinum coins. Tying it to one-coin-a-day will help frame the discussion where it needs to be, which is Congress provoking a constitutional crisis by refusing to fund money it has already spent.

    Thoughts?

    Follow or contact the Rortybomb blog:

      

    Steve Bell, Loren Adler, Shai Akabas and Brian Collins of the Bipartisan Policy Center recently put out an excellent analysis of what will happen if we breach the debt ceiling. Technically we've already breached the debt ceiling on December 31st, but Treasury has started extraordinary measures to juggle payments and borrow money. This can't go on forever, and it won't. The paper concludes that the "X date," when there is officially not enough money to pay all the bills due on that date, will occur between February 15th and March 1st.

    What's most worrisome about the report is how uncertain they are about what will happen afterward. The main possible strategy they discuss is Treasury starting a process of "prioritization," where they pick and choose what payments to make as the money comes in each day. In theory the United States wouldn't default on its debts, because it could prioritize interest payments.

    The only problem is that it isn't clear that they have the legal authority to do that. As the BPC noted in a previous blog post, there's a one-page, non-binding GAO report from the 1980s that suggests the executive branch would be able to do this. However, a long history of "impoundment," or the executive branch ignoring or disobeying spending orders, and the subsequent battles show that this is not uncontroversial.

    And as Josh Barro noted on Twitter, there are days when the Treasury couldn't make the interest payment based on the income of that day. And these are some thin margins on the day-to-day measures; if some come in higher or lower than anticipated, we might miss an interest payment even if Treasury tried to prioritize. According to BPC, the money coming in and out is "lumpy," so these risks are high. Beyond that, it isn't even clear that Treasury has the technology or processes in place to do this successfully.

    It's important to remember that the conservative think tanks argue that the government can always prioritize interest payments, so there's no risk of default if we go past the "X date." I documented this as their argument from 2011, and it still is being used. As the idea of using the debt ceiling becomes normalized in the Washington press, the idea that we can't default because the president can always prioritize the interest payment might become a form of justification for why the new normal isn't so bad.

    Should President Obama announce that if we breach the debt ceiling the government won't make any payments, including on interest, period? The downside is all on the president if he tries. If he says he can still prioritize interest payments, but there's an unknown glitch or difficulty with the day-to-day cash flows, it is a major embarrassment for the White House. And if he does start prioritizing payments, the White House could face serious political blowback from deciding who to pay. Treasury paying bondholders and military contractors but not Social Security or veteran's hospitals -- there are an infinite number of bad headlines. If Treasury is prioritizing these, even because Congress has forced it to, it is a losing proposition for the White House. And you can't lose the game if you don't play.

    The Real Problem With a Trillion Dollar Platinum Coin

    The BPC report also shows a way to operationalize the platinum coin strategy. There have been numerous write-ups of the platinum coin strategy, which would allow the Treasury to create large-denomination platinum coins to deposit at the Federal Reserve, thus keeping the government funded if it can't borrow money. Matt O'Brien sums up everything you want to know, and Interfluidity and Ryan Cooper have link roundups. The link roundups give you a sense of the critics of this strategy. BPC calls it "impractical, illegal, and/or inappropriate" (my favorite things!), while most think of it as unserious.

    I think the bigger problem of the trillion-dollar platinum coin strategy isn't the platinum but the trillion. I worry that the public will either think a trillion-dollar coin means the government is changing, in a big way, how it funds itself permanently, or that President Obama wants to bulldoze Congress on all spending authority to spend an extra trillion dollars, rather than what it is, which is a mechanism to keep spending Congress already passed going.

    Luckily, scanning the BPC daily timetables, on most individual days the deficit between money coming in and going out will be between $10 and $20 billion. (There are a few days where it will be on the order of $50 or $60 billion, however.) Here's an example:

    So, instead of a trillion-dollar coin, what if the president said, "I have a constitutionally obligated responsibility to carry out the spending Congress has authorized. I have no legal authority to prioritize payments, and the process is too risky for us to try. Therefore I will mint a $20 billion coin each day until Congress raises the debt ceiling. That is just enough to make the payments Congress has required me to make."

    It takes the trillion out of the headline. The focus is back on day-to-day spending rather than higher-level arguments about whether or not the United States government can run out of money. With actual speechwriters, the pitch could make sense to the public. And insiders watching it would understand it is the same exact thing as the trillion-dollar platinum coin. Interfluidity brought up the idea of smaller denomination platinum coins. Tying it to one-coin-a-day will help frame the discussion where it needs to be, which is Congress provoking a constitutional crisis by refusing to fund money it has already spent.

    Thoughts?

    Follow or contact the Rortybomb blog:

      

    Share This

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