Mike Konczal

Roosevelt Institute Fellow

Recent Posts by Mike Konczal

  • Can We Start the Merkley Plan Now Using TARP (And Bypass a Dysfunctional Congress)?

    Jul 30, 2012Mike Konczal

    Senator Jeff Merkley (D-OR) has just released a new housing plan for dealing with the mortgage crisis by refinancing underwater mortgages titled "The 4% Mortgage: Rebuilding American Homeownership." This plan would create a Rebuilding American Homeownership (RAH) Trust, modeled after the HOLC plan in the Great Depression. It would buy out underwater mortgages for three years, then wind down while managing its mortgage portfolio.

    Senator Jeff Merkley (D-OR) has just released a new housing plan for dealing with the mortgage crisis by refinancing underwater mortgages titled "The 4% Mortgage: Rebuilding American Homeownership." This plan would create a Rebuilding American Homeownership (RAH) Trust, modeled after the HOLC plan in the Great Depression. It would buy out underwater mortgages for three years, then wind down while managing its mortgage portfolio. Underwater mortgages would have three payment options, including a 15-year 4 percent interest rate plan to help rebuild equity, a 30-year 5 percent plan like a standard mortgage, and a two-part plan that splits the loan into a first mortgage equal to 95 percent of the home's current value and a "soft second" for the rest. Here are links to the summarythe full plan and a YouTube video introduction.

    I think it is a great plan. Felix Salmon is also a "huge fan" of the plan and has a description of several of the positive features. Many will probably react to it like Matt Yglesias, who, after discussing the positive parts of the plan, notes that the "chances of Congress actually doing this are slim to none."

    But what if this plan didn't need Congress? What if the Executive Branch could do this right now, on its own?

    There is interest is moving forward. Senator Merkley told David Dayen that he was hoping that "pilot programs for RAH operating in several states between now and the end of the year." Treasury Secretary Timothy Geithner said that he'd be willing to try to "find legal authority and resources to -- to test [the RAH] on a pilot basis."

    The report notes three potential homes for the plan: (1) FHA, (2) Federal Home Loan Banks system, or (3) the Federal Reserve. Of those, FHA seems like a potential place to launch the plan immediately. As the report mentions, "FHA already implements the FHA Short Refi program as one of the government's foreclosure prevention programs." What if the administration took the FHA Short Refi program and replaced it with what is needed to run the RAH? To launch this right away by replacing FHA Short Refi with the Merkley plan you'd need authority and cash, and FHA Short Refi has both.

    Why does FHA Short Refi have the authority to implement this plan? FHA Short Refi plan is a part of TARP designed to deal with the housing crisis by modifying underwater mortgages. When Dodd-Frank passed in July 2010, special language was put in to limit the creation of new programs or initiatives under TARP. However, this project exists as part of that already-existing housing priority, and those programs can be modified. These programs are modified all the time to try to make them work better. HAMP, for instance, was modified earlier this year.

    FHA Short Refi was designed to "enable lenders to provide additional refinancing options to homeowners who owe more than their home is worth." So it looks like it has the authority to act and change its mission structure from Short Refi to the Merkley plan, provided that Treasury's lawyers (I believe) approve of the changes.

    FHA Short Refi also has moneyAccording to SIGTARP's quarterly report to Congress from July 2012, Treasury had allocated $8.1 billion for FHA Short Refinance.

    How many mortgages have been modified under the FHA Short Refi program since it started? "As of June 30, 2012, there have been 1,437 refinancings under the program." Less than 1,500 mortgages in the country have gone through this program. How much money has been spent? "Treasury has pre-funded a reserve account with $50 million to pay future claims and spent $6.6 million on administrative expenses." Less than $57 million dollars. Given $8.1 billion dollars to spend on helping the housing market, less than 0.7 percent of it has been allocated, impacting less than 1,500 people.

    That's a bit mind-boggling, but the failure of FHA Short Refi to either impact homeowners, help the economy or use its resources could be the genesis for the success of the RAH. FHA can provide the baseline funding for the part of the mortgage that isn't underwater, while the additional resources necessary to ensure the additional funding for the underwater part of the mortgage can come from this FHA Short Refi. That $8 billion could be used to insure the other part of the mortgages involved, which would then be sold off in a new bond. Amplified in this way, that $8 billion dollars could be used to backstop tens of billions of dollars of new mortgages.

    At that point funding would end, but we'd have a sense if it was working or not. And if that $8 billion can insure $100 billion dollars worth of underwater debt, between 10 and 18 percent of underwater debt could be refinanced. If it is successful, there will both be a good empirical argument for continuing with additional funding and a political coalition of other underwater homeowners who would want to participate. If it is a failure, then it is a good opportunity to end it right there.

    With that in mind, it might be useful to remind ourselves why this plan is important as an economic matter. Most of the recent research finds that underwater mortgage debt is strongly linked with weak consumption, high unemployment, and sluggish wage growth - our economy is stuck in a "balance-sheet recession." The blockage of prepayment has created a windfall for creditors in a weak economy with low interest rates; as Felix Salmon notes "the CBO is saying that if we paid off current bondholders at 100 cents on the dollar, they would lose as much as $15 billion...They’re basically taking unfair advantage of the fact that homeowners are locked into above-market mortgage rates" and can't prepay or refinance their mortgages.

    Beyond creating a hangover effect on aggregate demand and basic unfairness, underwater mortgages also blunt the ability of monetary policy to do its full job. Even Federal Reserve Chairman Ben Bernanke believes this is happening. Here's Bernanke at a press conference from last November:

    One area where monetary policy has been blunted, the effects have been blunted, has been the mortgage market where very tight credit standards have prevented many people from purchasing or refinancing their homes and therefore the low mortgage rates that we’ve achieved have not been as effective as we had hoped. So, monetary policy maybe is somewhat less powerful in the current context than it has been in the past but nevertheless it is affecting economic growth and job creation.

    That’s Fed speak for underwater mortgage refinancing being a major boom to boosting demand, which helps the economy as a whole, even people who have no mortgage or debt but are stuck in a terrible jobs market. Given how interested the Federal Reserve is in this blocked channel for the efficiency of monetary policy, I hope they are considering how they can play a role in this.

    All in all, Merkley has put together an excellent plan and I believe we have the means to do it. It provides new stimulus while amplifying already existing monetary stimulus, plus it contains a measure of fairness between creditors and everyone else. When can we start?

     

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  • Bubble Standards: Why the Poor Are on the Hook for the Housing Crash

    Jul 23, 2012Mike Konczal

    When it comes to assigning losses from an economic bubble, we apply one set of standards to elite investors and another to struggling homeowners.

    When it comes to assigning losses from an economic bubble, we apply one set of standards to elite investors and another to struggling homeowners.

    Many are discussing a potential collapse of a housing bubble in Canada and what could be done about it right now. Here are posts on that subject from Matt Yglesias, Dean Baker, and Worthwhile Canadian Initiative. As I read the literature being written on this crisis, the key issue to watch for is whether the rapid growth in housing prices is matched by a similar growth in household mortgage debt. To see why, it might be useful to contrast the aftermath of the United States' housing bubble with the stock market bubble.

    The IMF recently studied a series of 25 OECD countries from 1980 to 2011. These countries experienced a total of 99 housing busts ("turning points (peaks) in nominal house prices"). It divided these housing busts into ones with a high run-up in household debt and ones with a low run-up, and found that "housing busts preceded by larger run-ups in household debt tend to be followed by more severe and longer-lasting declines in household consumption...real GDP typically falls more and unemployment rises more for the high-debt busts." This happens with or without a financial crisis occuring at the same time as the housing bust.

    Why is this the case? Let's look at the allocation of losses that occur from the collapse of a bubble.

    Within a short time after the internet dot-com bubble popped in 2000-2001, people had a sense of the size of the losses and who would take those losses. The equity holders of collapsing dot-com firms, the ones who held companies' stocks, would be wiped out, and the creditors would take huge hits, as there was very little property to be auctioned off or value to be retained. Trying to reorganize and resurrect the dot-com firms under Chapter 11 bankruptcy wouldn't have helped because they were new firms with no real revenues sources, their high-skill employees would flee, and there was little in terms of assets to use as collateral to secure future funding.

    Since the firms were mostly webpages and had small-scale intellectual property, they were auctioned off very quickly under Chapter 7 bankruptcy rules. Even telecom firms that went bankrupt but had a large amount of assets and were eventually relaunched took less than two years. Global Crossing, for example, went bankrupt in January 2002 and relaunched in December 2003. These bankruptcies involved heavy losses for creditors. According to bankruptcy expert Edward Altman, "Default recoveries continued at persistently low average levels, weighed down by the enormous supply of new defaults and communication firms’ 16.6% average recovery." (h/t Greg Ip) But within a two-year span, the losses were understood and allocated.

    It has been roughly five or six years since the United States' housing bubble popped. Have we finished assigning the losses yet? Robbie Whelan at the Wall Street Journal reports that we have a range of estimates from 23 percent of homes with a mortgage being underwater, owing a total of $715 billion more than their homes are worth (CoreLogic's estimates), to 31 percent of homes with a mortgage being underwater, owing a total of $1.2 trillion more than their homes are worth (Zillow's estimate). The evidence is clear that where households are most underwater on their mortgages, consumption is weakest, job losses are the worst, and income gains are struggling.

    Mortgage debtors aren't shareholders, but it is fascinating to contrast their fates. In the dot-com bust, losses were assigned very quickly. In the housing bust, losses stick with the equivalent "equity" holder years and years out (and hang like an albatross around the neck of the economy as a whole). The losses that are allocated come about in large part through painful foreclosures, which create more losses by fire-selling assets into a weak marketplace. This system is designed to destroy all possible value and drag out the procedures in long, painful ways.

    Crucially, in the dot-com bust there weren't the same moral and political arguments that we see in the current one. Economists who demand to know why U.S. mortgages don't stay with people who walk away from their homes didn't demand to know why the equity holders of Pets.com didn't have to dip into their personal savings to pay off the losses creditors took. Very Serious People wonder if debtors' prisons are necessary for homeowners who would walk away from a mortgage or view bankruptcy as an exit strategy, yet no Very Serious People called for the mass imprisonment of Webvan or Flooz shareholders after those firms declared bankruptcy as an exit strategy. Nobody argues that the shareholders of the dot-com era received a gigantic government bailout through the law when they were not personally on the hook for sticking creditors with an 83.4 percent average loss. Meanwhile, efforts to allow for a cleaner way of allocating the housing bubble losses, from retaining value of the household through bankruptcy reform to local municipalities taking action through eminent domain, face a minefield of political and financial industry opposition that gives the impression that the banks "own the place."

    When it comes to assigning losses among elite financial institutions, like shareholders and creditors, there is a clean system in place to make sure that it runs efficiently without dragging the entire economy to a halt. When it comes to assigning losses between household mortgage debtors and elite financial creditors, we sit in a perpetual quasi-recession six years out. As the antropologist David Graber finds historically, "[d]ebts between the very wealthy or between governments can always be renegotiated and always have been throughout world history. They’re not anything set in stone... It’s, generally speaking, when you have debts owed by the poor to the rich that suddenly debts become a sacred obligation, more important than anything else. The idea of renegotiating them becomes unthinkable." This time isn't different.

    Mike Konczal is a Fellow at the Roosevelt Institute.

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  • What Policy Agenda Follows From "You Didn't Build That?"

    Jul 20, 2012Mike Konczal

    (Note: There's a previous post on this subject of "you didn't build that," taking apart the conservative agenda around "job creators," which you can read here.)

    (Note: There's a previous post on this subject of "you didn't build that," taking apart the conservative agenda around "job creators," which you can read here.)

    The right is freaking out about President Obama's "you didn't build that" comment. Well, let's hope the conservatives in the audience have their fainting couches nearby and pearls sufficiently clutched, because I am going to start by kicking out two jams by my man, Franklin Delano Roosevelt, from back from when he was on the campaign trail:

    "Our Republican leaders tell us economic laws--sacred, inviolable, unchangeable--cause panics which no one could prevent. But while they prate of economic laws, men and women are starving. We must lay hold of the fact that economic laws are not made by nature. They are made by human beings." (Nomination Address, July 2nd, 1932, Chicago, IL)

    "To insure the first set of rights, a Government must so order its functions as not to interfere with the individual. But even Jefferson realized that the exercise of the property rights might so interfere with the rights of the individual that the Government, without whose assistance the property rights could not exist, must intervene, not to destroy individualism, but to protect it." (Commonwealth Club Address, September 23, 1932, San Francisco, CA)

    Now as long as people are guessing as to what the true, deeper, esoteric meaning is of President Obama saying, "Somebody invested in roads and bridges. If you’ve got a business—you didn’t build that," let throw something out there. It may be less a legal argument for how all property is the creation of the state - or as Roosvelt said, "the Government, without whose assistance...property rights could not exist" - and more a genuine call for actually building roads and bridges, something Congress is no longer capable of doing in these times. The current House went to war over whether or not to fund transportation infrastructure. It barely passed in a last-minute bill that left many issues still on the table. Former Republican congressman and now Transportation Secretary Ray LaHood told Politico that the original proposal was “the worst transportation bill I’ve ever seen during 35 years of public service.” Given that capital markets are willing to lose money to loan to us for 20 years and there's lots of unemployed people around, this should be a no-brainer.

    There's two responses I've seen on the right to this topic that I'd like to address on the "you didn't build that" point, and both come up in Julian Sanchez's post "What Follows from 'You Didn't Build That'?" One is that President Obama is addressing a strawman, and that unless you are speaking to an anarcho-capitalist nobody would disagree with this. "Even we minarchist libertarians are already on board with" basic public goods, he writes, and President Obama's vision of the role of the state is much more expansive than that. I disagree that there is no disagreement. I think that the current vision animating conservatism broadly and GOP policy narrowly is one of an economy in which value is created top-down by "job creators," which I outlined at length here. Rather than "Social Darwinist," as the president refers to it, I think it is clearer to say that the current GOP policy, centered around the Ryan Budget, is "Randian." Now, that doesn't mean the opposition believes every part of Ayn Rand's theories; it just means that their political compass is orientated towards her vision, and if you step in that direction you are getting closer to your goal.

    The other response is that what Obama says is largely true, but there's no actual politics that falls out of it. Sanchez writes, "It’s not that the 'you didn’t build that' argument is wrong as a factual matter—it’s that it’s true about everything, and therefore doesn’t get you much of anything."

    That's a good point. What does a "you didn't build that" agenda look like? Here's what I think it should include broadly, and what matters it should be concerned with, at least on all things related to economics. (Noting in advance that I'm pretty sure the mainstream Democratic Party and President Obama aren't going to sign up for most of this.)

    The first step is what President Obama was calling for in the speech, which is progressive taxation. This doesn't require the state to do more than what it does now, or less than what it does now, but instead changes how we pay for those things. And here the idea would be that those who have benefitted the most have an obligation to contribute the most. This has historically been a controversial policy - when the French economist and statesman Turgot was presented with a project for progressive taxation he responded "we must execute the author, not the project" - and I think it is useful to consider the Ryan Plan as ending progressive taxation. There's a lot of ways to argue for progressive taxation, including shared sacrifice of marginal utility, and this is another.

    Another would be emphasizing that public goods are actually that: publically provided and shared. There's been a move to both privatize large parts of the government and to emphasize putting costs for the use of publically provided infrastructure directly on end users instead of making them paid for broadly. Higher education, for instance, is now less a conscious set of planning the government does to make sure all who need education can receive it, which is paid for broadly through taxes, but instead of a series of coupons -- grants, loans, tax subsidies -- to subsidize individuals purchasing a self-investment by and for themselves, with the assumption that the "for-profit" sector and innovation broadly will expand in size and quality to pick up the slack of decreasing public provisioning. A broader question is what is treated as a commodity, and under what terms. Fighting back against both of these issues would be part of the agenda.

    Continuing the inter-generational pact of the welfare state is another part. David Frum recently described the current GOP as "a going-out-of-business sale for the baby-boom generation." Not wrecking the entire social safety net and the mechanisms of the goverment on the way out the door, and instead thinking of the government as a pact through time, is another important point to emphasize.

    Now for property. Conn Carroll at the Washington Examiner brings up Robert Hale and the progressive, legal realist attack on laissez faire, and Sanchez brings up the similar arguments of the Nagel/Murphy book “Myth of Ownership.” These arguments are partially inherited from people like Jeremy Bentham, who argued that “property is entirely the creature of the law.”

    One of the critiques that comes out of these arguments is that the picture of property rights as a vertical relationship between a person and an object, one where the issue at play is whether the person's right over the object is “deserved all the way down,” is flawed, or at least insufficient. Property is really a horizontal set of relationships between people; it isn't just your control of an object but your control over others with respect to that object. The fundamental right of private property, of course, has always been the power to exclude others. But in the 1910s, a law professor named Wesley Hohfeld formalized property "rights" into a series of four capacities: "right," "privilege," "power," and "immunity." They contrast with four incapacities: "duty," "no-right," "liability," and "disability" (see here or here for more). Each type of property right is predicated on being able to force others to respond a certain way -- you have certain immunities while others have disabilities in response, certain powers while others have liabilities, and so on.

    And so "liberty" for one comes at an expense of "liberty" for another. Since there's no neutral way for the government to set these rules, certainly no abstraction like "economic liberty" to guide the path, the question over social control of property, as Leonard Trelawny Hobhouse put it, is "not of increasing or diminishing, but of reorganizing, restraints." The issue here isn't that everything is up for grabs - it's that there is no "neutral," and appealing to higher abstractions as "rights" or "ownership" don't get you anywhere.

    Perhaps you find that objectionable or maybe you don't, so let's build out the You Didn't Build That Agenda in regards to property. The first stop is that there needs to be a democratic element and accountability in setting up these rules. If only because trying to back out a system of rules from vague appeals to "liberty" (especially as interpreted by courts) don't actually get us anywhere. The second issue would be acknowledging and confronting the issue that the current set up of the rules of property and economic exchange are important in creating our current economic inequality, from the runaway wealth of the top 1% to the stagnating wages of everyone else.

    The way we set up the rules creates a lot of winners. The top 1% consists mostly of corporate CEOs and financial wealth. The former are influenced by the way we structure corporations through law -- read Demos' Anthony Kammer on "Reimagining the Corporate Form: Toward a More Democratic System of Corporate Governance" -- and compensation packages through tax law. The latter has a clear link with financial deregulation and much of the system exists in a way where finance's failure can pose huge externalities on other market actors and the macroeconomy as a whole. Another example is patent law which, as many note, provides large windfalls for owners. Over half of the windfall that comes from the fact that we privledge income from capital over income from labor in taxation goes to the top 0.1%. Dean Baker’s e-book, "The End of Loser Liberalism: Making Markets Progressive," is great on these points.

    The way we set up the rules also creates a lot of losers. Bankruptcy law has become tougher on regular people while corporations do fine under it, something Robert Kuttner writes about as an important double standard. It is harder to unionize, and simple measures to allow for card check have failed in Congress. Inequality at the low end can be largely attributed to decreased unionization (for men) and a stagnant minimum wage (for women), both of which reduce bargaining power for their respective parties.

    There's also macroeconomic policy, something the government does (or doesn't do) that has significant impact on economic outcomes but that impacts all kinds of claims to property. As Ryan Avent notes, commenting on the You Didn't Build That issue, the "operating monetary principle over the past generation—price and financial stability at all costs, help for the unemployed if we get around to it and only to the extent that the first priorities aren't endangered—has facilitated the creation of an enormous amount of financial wealth," as well as stagnating wages for everyone else. Full employment for all is a great start, though there's no way to appeal to it by referencing abstractions of economic liberty.

    What else needs to be part of the agenda?

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  • On Nickels, Bulldozers, JP Morgan's Now $5.8 Billion Dollar Loss, and the Volcker Rule

    Jul 19, 2012Mike Konczal

    One of the best metaphors for understanding how hedge funds and other elaborate trading strategies work is that they are "picking up nickels in front of a bulldozer." This contrasts nicely with the view within economics that there can never be $100 bills just lying on the street. There is free money, but it is both dangerous and difficult to go after. And while it is profitable to go after the nickels, when the bulldozer crushes you the losses can be spectacular.

    One of the best metaphors for understanding how hedge funds and other elaborate trading strategies work is that they are "picking up nickels in front of a bulldozer." This contrasts nicely with the view within economics that there can never be $100 bills just lying on the street. There is free money, but it is both dangerous and difficult to go after. And while it is profitable to go after the nickels, when the bulldozer crushes you the losses can be spectacular. Like getting run over by a steamroller (another vehicle used for this metaphor), the losses are huge, painful, and immediate, yet they manage to continue coming.

    The metaphoric bulldozer continues to crush JP Morgan's balance sheet in light of its disastrous credit derivatives trading (remember that?). The losses were originally supposed to be around $2 billion dollars. The losses have now tripled to $5.8 billion dollar, as reported last week in their quarterly losses. According to the New York Times a few weeks ago, some estimate that it will be more like $8 or $9 billion. $9 billion is a lot more than the original $2 billion. And it is a significantly more than the handful of nickles they were looking to pick up if the strategy had worked.

    It's worth looking at this in light of the Volcker Rule. There's an argument that this kind of propritary trading is entirely fine and good for the economy, but it does not need to be done by institutions that have taxpayer money on the line or function as a systemically important part of the financial infrastructure of the economy. It will be both well provided and well compensated on its own through hedge funds and smaller players in the financial markets. If anything, taxpayer subsidizes could crowd out smaller players, distorting the way that the financial market works.

    But there's also the question of what to do if a large, systemically risky firm fails. Here the Dodd-Frank policy regime involves prompt corrective action to begin prepping a firm that looks like it will fail for failure, much like how the FDIC currently does with commercial banks. This system works better if there is adequate time and if there are no gigantic surprises.

    Contrast that with Bear Sterns and its hedge funds. Bear Sterns put up $40 million of its own money into two internal hedge funds between 2004 and 2006, and in June 2007, Bear had to bail out these two funds with a line of credit worth $3.2 billion dollars. $40 million dollars upfront got crushed under the steamroller to the tune of $3 billion. Such a large loss absorbed so quickly put significant pressures on the firm; it later collapsed.

    Given this asymmetric payout, prop trading makes a certain type of failure more likely - one that is quick, out of nowhere, and large. This type of collapse strains our system for resolving large, systematically risky financial firms. This system is what we need in order for financial firms to collapse in a fair way, one that allocates losses to those who gained the most while also preventing huge spillovers to third parties. The Volcker Rule is an essential part of this.

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  • Four Issues with Miles Kimball's “Federal Lines of Credit” Policy Proposal

    Jul 18, 2012Mike Konczal

    Economics professor Miles Kimball has a new blog, Confessions of a Supply-Side Liberal. In one of his first posts, he outlines a plan for stimulus that he calls “Federal Lines of Credit” (FLOC).

    Economics professor Miles Kimball has a new blog, Confessions of a Supply-Side Liberal. In one of his first posts, he outlines a plan for stimulus that he calls “Federal Lines of Credit” (FLOC). It's presented in a longer policy paper, “Getting the Biggest Bang for the Buck in Fiscal Policy." This has gotten interest across the political spectrum. Bill Greider has written about it in The Nation, as has Reihan Salam in the National Review.

    What's the idea? Under normal fiscal stimulus policy in a recession, we often send people checks so that they'll spend money and boost aggregate demand. Let's say we are going to, as a result of this current recession, send everyone $200. Kimball writes, "What if instead of giving each taxpayer a $200 tax rebate, each taxpayer is mailed a government-issued credit card with a $2,000 line of credit?" What's the advantage here, especially over, say, giving people $2,000? "[B]ecause taxpayers have to pay back whatever they borrow in their monthly withholding taxes, the cost to the government in the end—and therefore the ultimate addition to the national debt—should be smaller. Since the main thing holding back the size of fiscal stimulus in our current situation has been concerns about adding to the national debt, getting more stimulus per dollar added to the national debt is getting more bang for the buck."

    Let's kick the tires of this policy. There's a lot to like about the proposal, particularly how it could be used after a recession is over to provide high-quality government services to the under-banked or those who find financial services yet another way in which it is expensive to be poor (modified, it turns right into Steve Waldman's Treasury Express idea). It's not clear whether this is meant to supplement or replace normal demand-based fiscal policy - at one point he proposes it could balance out a "relatively-quickly-phased-in austerity program."

    As a supplement it has promise, but I think there are some major problems with this proposal, which can be grouped under four categories.

    I: Isn't deleveraging the issue? Is this a solution looking for a problem? From the policy description, you'd think that a big is credit access holding the economy in check.

    But taking a look at the latest Federal Reserve credit market growth by sector, you can see that credit demand has collapsed in this recession. Consumer credit drops throughout the beginning of the recession, particularly in 2009. This is true even for consumer credit by itself, which rebounds in 2011. It's not clear that these lines of credit would be used to expand demand at the macro-level; likely, given what we see, it would be used to replace other, higher-interest forms of debt (see III), a giant transfer of credit risk from credit card companies to taxpayers. But certainly some people will benefit, so let's examine why this policy is supposed to work.

    II: This policy is like giving a Rorschach test to a vigilante. No, not that vigilante. I mean the bond vigilantes. Because to assume this plan would work, you need to make some curious assumptions about how bond vigilantes think, as it increases the debt by a significant amount.

    Let's say our country has a balanced budget with a debt-to-GDP ratio of 50 percent and we hit a recession while at the zero-bound. As a result of less tax revenue coming in and more automatic stabilizers going out, debt-to-GDP will be 60 percent at the end of the year. We want to stimulate the economy further using fiscal stimulus.

    Let's say our default is that we take three percent of GDP, divide it among the population, and mail it out. At the end of the year, the debt-to-GDP ratio will be 63 percent (I am ignoring that fiscal stimulus at the zero-bound can be largely self-financing for this example).

    In Kimball's FLOC, we instead take 9 percent of GDP, divide it evenly among the population, and mail out lines of credit that add up to that 9 percent of GDP. Let's also say that perfect forecasting tells us that within the year, 6 percent of it will be utilized as a loan not yet paid back, and 3 percent is still available as credit.

    What's the government's debt-to-GDP ratio at the end of the year in Kimball's example? I'm not sure how he'd account for it. I imagine it should be 69 percent (60 + 9). Perhaps it is 66 percent (60 + 6)? Either way, it is more than the 63 percent of just giving people money. His plan requires a larger debt-to-GDP ratio. If his accounting ends up with just 60 percent, I'm not sure I understand how he is doing it.

    Now Kimball will say that bond vigilantes will be happy with this. Why? Because there's a built-in plan for repaying it. "[T]he fact that much of the money would ultimately be repaid would dramatically reduce the ultimate addition to the national debt...(though at a relatively attractive ratio of additional aggregate demand to addition to national debt)."

    If we are guessing as to what the bond vigilantes want, it is clear they want more U.S. government debt. Ten-year Treasuries are selling at 1.5 percent, while real interest rates are negative! But for the purposes of the FOLC, we need a few assumptions about what the bond vigilantes think, which aren't clear.

    First (i) it assumes that the bond market will only care about the government's long-run debt ratio instead of the short-term. I think that's correct. But much of the bond vigilante argument is predicated on the opposite, that no matter what the long-term is, the capital markets will freak on short-term deficits.

    It also assumes (ii) that the repayments of these FOLC will be made easier through debt collection than just collecting the equivalent amount of money through taxation. I see no reason why that's the case, and many reasons to believe the opposite.

    III: This policy will involve trying to get blood from a turnip. I very much distrust it when economists waive away bankruptcy protection. Especially for experimental, controversial debts that have never been tried in known human history.

    As the paper admits, this is a machine for generating adverse selection, as the people most likely to use it are people whose credit access is cut due to the recession. High-risk users will likely transfer their balances from higher rate credit cards to their FOLC (either explicitly or implicitly over time if barred) - transferring a nice chunk of credit risk from the financial industry to taxpayers.

    It's also not clear what happens a few years later when consumers start to pay off the FOLC. Could that trigger another recession, especially if the creditor (the United States) doesn't increase spending to compensate?

    The issue isn't whether or not the government will be able to collect these debts at some point. It has a long time-horizon, the ability to jail debtors and use bail to pay debts, the ability to seize income, old-age pensions and a wide variety of income, and the more general ability to deploy its monopoly on violence. The question is whether this will be smoother, easier, and more predictable than just collecting the money in taxes. We have a really smooth system for collecting taxes, one at least as good as whatever debt collection agencies are out there. If that is the case, there's no reason to believe that this will satisfy the bond vigilantes or bring down our debt-to-GDP ratio in a more satisfactory way.

    IV: Since we've very quickly gotten to the idea that we'll need to jettison legal protections under bankruptcy for this plan to work, it is important to emphasize that this policy is the opposite of social insurance.

    I don't see a macroeconomic difference between the government borrowing 3 percent of GDP and giving it away and collecting it through taxes later versus the government borrowing 3 percent of GDP, loaning it to individuals, and collecting it later through debt collectors except in the efficiency and the distribution.

    The distributional consequences of this proposal aren't addressed, but they are quite radical. Normally taxes in this country are progressive. Some people call for a flat tax. This proposal would be the equivalent of the most regressive taxation, a head tax. And it also undermines the whole idea of social insurance.

    Let's assume the poorest would be the people most likely to use this to boost or maintain their spending. I think that's largely fair - certainly the top 10 percent are less likely to use this (they'll prefer to use high-end credit cards that give them money back). This means that as the bottom 50 percent of Americans borrow and pay it off themselves, they would bear all the burden for macroeconomic stability through fiscal policy. Given that the top 1 percent captured 93 percent of the income growth in the first year of this recovery, that's a pretty major transfer of wealth. One nice thing about tax policy, especially progressive tax policy, is that those who benefit the most from the economy provide more of the resources. This would be the opposite of that, especially in the context of a ""relatively-quickly-phased-in austerity program."

    Efficiency is also relevant - as the economy grows, the debt-to-GDP ratio declines, making the debt easier to bear. The most likely borrowers under FOLC, the bottom 50 percent, have seen stagnant or declining wages overall, especially in recessions. A growing economy would keep their wages from falling in the medium term, but this is still a problematic issue - their income is not more likely to grow to balance out the payment burdens than if we did this at a national level, like normal tax policy.

    The policy also ignores social insurance's role in macroeconomic stability, and that's insurance against low incomes. Making sure incomes don't fall below a certain threshold when times are tough makes good macroeconomic sense and also happens to be quite humane. This is not that. As friend-of-the-blog JW Mason said, when discussing this proposal, the FOLC is like "if your fire insurance simply consisted of a right to borrow money to rebuild your house if it burned down."

    What else am I missing about this proposal?

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