Mike Konczal

Roosevelt Institute Fellow

Recent Posts by Mike Konczal

  • Cyclicalists/Structuralist Divide, Redux

    May 18, 2012Mike Konczal

    Karl Smith has had some great posts lately, both about Noah Smith and the cyclicalists/structuralist divide and about Rajan's Foreign Affairs article (I, II). I'm going to add my own thoughts on each topic here.

    Karl Smith has had some great posts lately, both about Noah Smith and the cyclicalists/structuralist divide and about Rajan's Foreign Affairs article (I, II). I'm going to add my own thoughts on each topic here.

    Noah Smith has a blog post arguing that cyclicalists should start talking about structural issues too. Using David Brooks' recent terms, he says "I do not mean that cyclicalists should stop recommending things like quantitative easing. I mean that they should start also throwing out ideas about how to improve our economic performance in the long run."

    There's two issues here worth bringing up. The first is that Obama is in a ton of trouble, because all he's done in the past two years is talk about long-term problems (remember Winning the Future?) while dancing around the short-term unemployment crisis. His big achievement, health-care reform, wasn't about how in a rich, modern society like ours everyone has a right to health care. Instead it was explained as a way of "bending the cost curve." Bending the long-term cost curve is about as much of a "structuralist" way of pitching expanding health care as possible.

    The second is that blurring these two items as an economic matter has been a major problem for both the Obama economics team and for a certain variety of centrist, deficit-hawks in their view of our economic situation. This is the "two deficits" problem. In this argument our short-term deficit isn't large enough, but our long-term deficit is too large. Fine as far as it goes. But in this theory, in order to fix the first you have to make progress on the second at the same time.

    Maybe there are political reasons why this is the case, but the economic ones don't jump out. There are good short-term ideas and good long-term ideas. If they are each good ideas, why not do each on their own? Why do they have to move together? The explanation most give, as a Treasury official told Noam Scheiber, is that the government needs to show “some signal to US bondholders that it takes the deficit seriously” and that “spending more money now [on stimulus] could actually raise long-term [government] rates, thereby offsetting its stimulative effect.” I think this is dead wrong, and if Obama loses this argument will be one of the major reasons why. It is what kept him trying to kick Lucy's football negoitate with Republicans in 2011. If both need to move, they throwing a roadblock in front of one stops the other - and given that Republicans won't budge on tax increases, it takes away the case for more stimulus in the short-term. Meanwhile interest rates continue to stay at record lows.

    As for the Rajan piece in Foreign Affairs, I think there are two big problems with it beyond what Karl mentions ("the piece had little to do with the recession and nothing to do with borrowing and spending for recovery"). The first is the crux of his argument, which is that 2007 featured "artificially inflated GDP numbers." It is no doubt impressive to people who haven't thought about it hard to state that we had a GDP bubble in 2007 alongside a housing bubble. But what does that even mean? What else would be true about the world if US GDP was unsustainably high in 2007?

    Jim Bullard made this argument recently and even then the justification for the argument switched completely within days, once it came under the critical scrunity of the econoblogosphere. In one version the case was about how the collapse of the housing bubble represents a technology loss. In the second argument it was pure wealth effect: we feel poorer, and the only solution is to beg policymakers to “please reinflate the bubble."

    The second issue is that the manitude of numbers are completely off. Subprime mortgages were about refinancing, not about new home construction. As Karl Smith noted, to the extent subprime encouraged single-family home construction, it came at the expense of multi-family home construction. Residential building construction is off about 400,000 workers - even if those jobs are gone completely, we have 5 million more workers unemployed right now than we did in 2007 (12.5m versus 7.5m). I'd be happy to say that the NAIRU is up 400,000 people if we can end these so-called structural arguments here.

    [Also: Rajan's GSE argument has been debunked in several places. It is hard to argue that Congress is pro-consumer-debt and pro-debtor/easy credit policies in the past 30 years when it passed the 2005 bankruptcy reform act. It is not controversial to argue that the 2005 bill was significantly harder on debtors looking to file bankruptcy. Instead of Congress, the major thing that changed the consumer debt markets came from the Supreme Court. In 1978's Marquette Nat. Bank of Minneapolis v. First of Omaha Service Corp, the Supreme Court interpreted the word “located” in the National Bank Act of 1863 as meaning the location of the business and not the location of the customer, which completely changed how credit cards would work in the following decades.

    Also, the conservatives' publically-stated calculus is off. There is a sense in which there are short-term things we can do, or long-term things we can do, and we have limited time and energy, so better to focus on the long-term things. But there's reason to believe that conservatives are purposely ignoring the short-term things, because weak economies are the perfect time to be able to achieve their preferred long-term agenda ideas.

    We know from the explanations for dissenting votes on the Federal Reserve that those dissenting from more demand now believe that this higher demand through monetary policy gets in the way of making "hard choices" on entitlements and tax reform. The Wall Street Journal has Federal Reserve Bank of Dallas President Richard Fisher saying “The more we offer accommodative monetary policy, the less incentive they have to pull their socks up and do what’s right for the American people.” (This is also currently going on in Europe.)

    If you view the Great Society, the New Deal, and the whole regulatory/Keynesian/welfare state as a form of tyranny, well, destroying most forms of tryanny requires bloodshed. If a conservative revolution happens in the next Congress, and the only cost was 4 years of mass unemployment, wouldn't it be worth it to experience liberty in our lives? I fear this explanation drives more conservative commentary on economics than we realize.]

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  • Why a Strong Middle Class Is Necessary For Growth

    May 18, 2012Mike Konczal

    A new paper maps out the best progressive arguments about how inequality is hurting our economy.

    It's great to get to watch the arguments against inequality in the United States being built in real time. On issues ranging from political corruption to a lack of a serious, sustained response to the economic crisis, people are telling sharper and more critical stories about why inequality should be a concern for the country. Which is important, as inequality is not going away.

    A new paper maps out the best progressive arguments about how inequality is hurting our economy.

    It's great to get to watch the arguments against inequality in the United States being built in real time. On issues ranging from political corruption to a lack of a serious, sustained response to the economic crisis, people are telling sharper and more critical stories about why inequality should be a concern for the country. Which is important, as inequality is not going away.

    One of the issue areas where this has been lacking is long-term economic growth. The research has been substantial, but few have collected and curated it into a set of arguments for why inequality is bad for the health of our economy. This is one of the more important battles. The normal assumption is that inequality helps everyone by allowing the economic pie to grow as big and as quickly as it possibly can. The background thought animating this is that there's a serious tension between efficiency and equality -- to support equality is to necessarily sacrifice economic efficiency.

    Heather Boushey and Adam S. Hersh from the Center for American Progress have a new paper out, "The American Middle Class, Income Inequality, and the Strength of Our Economy: New Evidence in Economics," that summarizes the case for why inequality can damage the economy. They start by reviewing the literature trying to link income inequality and growth, and find that the link is, if anything, in the other direction. "Roland Benabou of Princeton University surveyed 23 studies analyzing the relationship between inequality and growth. Benabou found that about half (11) of the studies showed inequality has a significant and strongly negative effect on growth; the other half (12) showed either a negative but inconsistently significant relationship or no relationship at all. None of the studies surveyed found a positive relationship between inequality and growth."

    But why should this be? If the long-term health of the economy is driven by human capital, savings, and technology, what does inequality have to do with anything? Here is where they create a map of the arguments through which a strong middle class and a more egalitarian distribution of income can build long-term growth:

    We have identified four areas where literature points to ways that the strength of the middle class and the level of inequality affect economic growth and stability:
     
    A strong middle class promotes the development of human capital and a well educated population.
    A strong middle class creates a stable source of demand for goods and services.
    A strong middle class incubates the next generation of entrepreneurs.
    A strong middle class supports inclusive political and economic institutions, which underpin economic growth.
    They pull together the current research, as well as the range of supporting evidence, for each point. They focus on how educational attainment is becoming more tied to parents' income, the instability of growth and macroeconomic risks to weak middle-class demand, the fact that the Kauffman Foundation found that less than 1 percent of entrepreneurs come from extremely poor or extremely rich backgrounds, and the way inequality is involved with our polarized politics. All of these have consequences for our economy.
     
    The research will continue to move forward here. There's a lot of fascinating work done on the relationship between inequality, balance-sheet recessions, and slow recoveries right now. I'm interested in the way the government creates and enforces property changes under massive, entrenched inequality. Do exclusive, 1%-dominated political and economic institutions produce property regimes -- high rents from patents, repressive creditor/debtor relationships, all labor income from finance viewed as capital income for tax/regulatory purposes, privatization of public goods, corporation structures predisposed for financialization -- that are terrible for growth?
     
    This paper gives us the best up-to-date arguments that progressives discussing inequality should understand inside out. I thought I was fairly versed in these arguments, and I learned a ton from it. As they say, read the whole thing.
     

    Mike Konczal is a Fellow at the Roosevelt Institute.

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  • JP Morgan Proves That Size Does Matter

    May 15, 2012Mike Konczal

    Breaking up the big banks might not be the whole solution, but it could make resolution authority more credible.

    Breaking up the big banks might not be the whole solution, but it could make resolution authority more credible.

    Before we start talking about the advantages and disadvantages of introducing size caps and restricting business lines through a new Glass-Steagall, it is important to understand how very big the five biggest banks are. If you need a sense of how big JP Morgan is and why it is hard for it to "hedge" without moving the market, the graph below gives you a sense. This is a graph I put together during Dodd-Frank based on data that was floating around at the time:

    When bills restricting size of a large financial institution have been introduced they usually put size in the context of deposit liabilities (what we provide a backstop for and what reflects consumer savings, expressed as a percent of all deposits) and non-deposit liabilities (what reflects a blunt measure of size and potential for shadow banking runs, expressed as a percentage of GDP). The SAFE Banking Act, which has been reintroduced, mostly impacts the six firms listed above. The original SAFE Banking Act had a cap of 3 percent of GDP for non-deposit liabilities for financial firms (2 percent for actual banks) -- a space that ignores over 8,000 banks to just focus on the biggest six.

    Yesterday Elizabeth Warren sent out an email with PCCC calling for a new Glass-Steagall. Let's back up: what kind of regulation do we have in the financial sector? First, there's the background regulation that structures and forms the financial markets. How are derivatives treated in bankruptcy? How is capital income and debt taxed? How are contracts and corporations set up and enforced? And so on.

    The second level of regulation is "prudential" regulation. Prudential regulation of financial institutions is the various ways regulators regulate banks. Capital requirements are one example. So is prompt corrective action, restricting dividends for troubled firms, etc. One reason to do this for regular banks is to act as a coordinator for dispersed depositors who are unable or unwilling to perform these functions. Another is that financial firms have serious macroeconomic effects on the economy. And another is to intervene in issues of asymmetric information. The everyday libertarian case against regulating a restaurant is "who would want to poison their customers?" As we saw in the last 20 years, Wall Street is comfortable not only selling their customers poison at a high margin, but taking out life insurance on them through the credit swaps market.

    The third level is blunter, and that's strict prohibitions, either on businesses or on size. What are the advantages and disadvantages of adding prohibitions? One factor is simplicity compared to other forms of prudential regulations, but what else is there?

    Resolution

    Adding prohibitions can help ensure the end of Too Big To Fail. In this sense it works to amplify, rather than replace, Dodd-Frank's resolution authority.

    A common response is that the problem with Too Big To Fail isn't that the firms are too big or too complex, but too interconnected. Matt Yglesias notes that in the context of resolution, prohibitions aren't that important: "we can't put investment banks through the bankruptcy process because it's too systemically chaotic. In that case, Glass-Steagall is irrelevant and what we really need is a new legislative mechanism for the resolution of investment banking enterprises. That's what Dodd-Frank is supposed to do. This all just backs in to the point that even though the phrase 'too big to fail' has caught the public imagination, it's never been clear that size is relevant."

    But here's Martin J. Gruenberg, Acting Chairman of the FDIC, in a big speech last Thursday:

    While there are numerous differences between a typical bank resolution and what the FDIC would face in resolving a SIFI, I want to focus on a few key differences...

    In addition, the resolution of a large U.S. financial firm involves a more complex corporate structure than the resolution of a single insured bank. Large financial companies conduct business through multiple subsidiary legal entities with many interconnections owned by a parent holding company. A resolution of the individual subsidiaries of the financial company would increase the likelihood of disruption and loss of franchise value by disrupting the interrelationships among the subsidiary companies. A much more promising approach from the FDIC's point of view is to place into receivership only the parent holding company while maintaining the subsidiary interconnections.
     
    Another difference arises from sheer size alone. In the typical bank failure, there are a number of banks capable of quickly handling the financial, managerial, and operational requirements of an acquisition. This is unlikely to be the case when a large financial firm fails. Even if it were the case, it may not be desirable to pursue a resolution that would result in an even larger, more complex institution. This suggests both the need to create a bridge financial institution and the means of returning control and ownership to private hands.
    Resolution authority is an untested solution for a financial firm, particularly one as large and complex as JP Morgan. Size and complexity make a difference. If financial firms were smaller and more siloed, there is an argument that resolution authority, which is one of the core mechanisms of Dodd-Frank, would work more smoothly and be more credible.
     
    Market Power and Competition
     
    As Barry Ritholtz noted on the JP Morgan loss, "Simply stated, once you are the market, you are no longer a hedge." Size makes a difference in these markets, and by breaking up the largest firms you'd see reduced market power. In terms of size, Andrew Haldane argues that economics of scale in banking top out at around $100 billion, or signficantly less than a 3 percent GDP liabilities cap. Beyond market power, the largest banks represent a large amount of political power as well.
     
    And in terms of business lines, Kevin J. Stiroh and Adrienne Rumble, in "The dark side of diversification," look at financial holding companies as they absorb different business lines in the late 1990s and 2000s. "The key finding that diversification gains are more than offset by the costs of increased exposure to volatile activities represents the dark side of the search for diversification benefits and has implications for supervisors, managers, investors, and borrowers." New business lines introduce new profits but also introduce new volatility. The more volatile a firm is, the harder it is for it to fail without bringing down the financial system.
     
    Mike Konczal is a Fellow at the Roosevelt Institute.
     
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  • On Hysteresis Hysterics

    May 14, 2012Mike Konczal

    Dean Baker and Kevin Hassett have a great editorial in the weekend's New York Times, "The Human Disaster of Unemployment." They correctly identlfy the many long-term psychological and social problems of periods of mass unemployment for people, families, communities, and ultimately our nation.

    Dean Baker and Kevin Hassett have a great editorial in the weekend's New York Times, "The Human Disaster of Unemployment." They correctly identlfy the many long-term psychological and social problems of periods of mass unemployment for people, families, communities, and ultimately our nation. As is the nature of editorials written by people with cross-ideological committments, the solutions are a bit off, but this weakness is also part of the issue with discussing the urgency of unemployment because of "hysteresis."

    Imagine having a fever so bad that it permanently raised your body temperature. Now imagine a period of unemployment so bad that it permanently reduces our economy's ability to produce things and employ people. That's hysteresis -- the long-term scarring of our economy from periods of short-term unemployment. I've discussed this before, and I think the evidence is very convincing it is a major issue. Hysteresis is part of the engine in the recent Brad Delong/Larry Summers paper arguing for self-sustaining stimulus.

    Crucially, hysteresis is an intellectual challenge to the so-called structuralists who would argue that we should ignore the short-term economy and just focus on the long-run health of the economy. Beyond us all being dead in the long run, the long run is just a series of short runs right after each other. And hysteresis shows that short-run problems can perpetuate themselves and become embedded in the long-run economy.

    Where I become ambivalent about the focus on hysteresis is that it too quickly presumes that special policy is required to combat it. Instead of a weak economy and poor job growth, suddenly hysteresis calls for the assumption that jobs are available and that the long-term unemployed, for whatever individual reasons, can't take them. I think the easiest way to fight hysteresis is just to have a lot of jobs available through strong demand, and employers will be perfectly incentivized to train workers however they need to as they look to expand their workforce. But others would take their eye off the ball of full employment and try to focus on just the long-term unemployed policy-wise, through such things as special job training programs.

    Is there data we can use to test this theory one way or the other? I was able to get the people in charge of the flows data at the BLS to send me an update of one of my favorite data sets, flows from unemployment to employment by duration of unemployment. We've talked about this data last year here and here, and now I have it updated through April 2012. The longer you've been unemployed, the less likely it is that you'll find a job over the course of a month.  But how has this changed during the Great Recession and the aftermath?

    Thesis: if hysteresis is problematic in that the long-term unemployed have become detached from the labor force in such a way that it requires policy intervention beyond creating jobs - like special job training programs - then we'll see that people who have only been unemployed a short time (low duration) find jobs easiers than a year ago. But we will also see that those that have been unemployed a longer-time will not show any increase in their job finding rate, and maybe their rate of finding a job has even decreased. The unemployed parts of the economy will be bifurcating into a healthy short-term section and a dislodged long-term section.

    I'm plotting the chance of the unemployed for the average of the first four months of 2007, 2011 and 2012 each (the data is seasonally unadjusted) by duration of unemployment. How did the last year look?

    The purple line for 2012 is pulling away from 2011 across the entire unemployment spectrum. The chances of finding a job are increasing for all unemployment spell lengths, though they aren't anywhere near 2007 levels. Meanwhile, here's a graph of the six month moving average of each duration bucket going back 9 years:

    The entire job market is weaker, even for those who have only been unemployed for a few weeks. Though the suffering the long-term unemployed are going through is real, the best policy for them is providing anti-poverty relief through cash and services while pushing on expansionary fiscal, monetary and debt-relief policies to get the economy back on track.

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  • What Five Hours From Last Thursday Can Tell Us About Dodd-Frank and JP Morgan

    May 14, 2012Mike Konczal

    In the course of an afternoon, we saw the problems Dodd-Frank is trying to solve, the solutions on the table, and the efforts to roll them back -- not in that order.

    Let's take a quick look at a time frame lasting less than five hours from last Thursday, May 10th, 2012.

    In the course of an afternoon, we saw the problems Dodd-Frank is trying to solve, the solutions on the table, and the efforts to roll them back -- not in that order.

    Let's take a quick look at a time frame lasting less than five hours from last Thursday, May 10th, 2012.

    At 12:10 p.m., Martin J. Gruenberg, Acting Chairman of the Federal Deposit Insurance Corporation (FDIC), gave the keynote at the 48th Annual Conference on Bank Structure and Competition held by the Federal Reserve Bank of Chicago. In the long-awaited speech, he outlined the overall vision, as well as the problems and pitfalls, of the FDIC using "resolution authority" to oversee the failure and unwinding of a Too Big To Fail financial firm. These powers were granted to the FDIC in the Dodd-Frank financial reform bill in order to achieve both accountability and stability while avoiding the panic and contagion that occured in the fall of 2008.

    At 2:15 p.m., House Republicans passed H.R. 5652, Paul Ryan's Sequester Replacement Reconciliation Act of 2012, by a vote of 218 to 199. This reconciliation act does many things; one is that it takes lots of money from poverty relief programs and gives it to the military, and another is that it renegs on automatic cuts that were agreed to as a result of the Super Committee's failure, which will almost certainly trigger a crisis on the next debt ceiling fight. But for our purposes, one specific thing it does is revoke Title II of Dodd-Frank, which is the resolution authority powers Gruenberg was presenting. It replaces them with nothing.

    At 5 p.m., the large, systemically risky firm JP Morgan had a surprise conference call where it announced, following what was disclosed on its 10-Q, that it had a giant loss of $2 billion in the last quarter. This suprised the market and sent analysts running to their phones and computers.

    There are two ways to look at the relationship between the Dodd-Frank financial reform framework and JP Morgan's loss disclosure. One is that it shows the need for a strong implementation of Dodd-Frank broadly and the Volcker Rule specifically, which is designed to separate prop trading from large, risky financial firms. Marcus Stanley of Americans for Financial Reform has a great post up discussing what happened, how the principle of the Volcker Rule should work in this situation, and the threats it faces. Dodd-Frank is designed to make the financial markets more transparent and robust to shocks through such mechanisms as expanding clearing requirements for derivatives and reducing interconnectedness between large financial firms. It is also designed to make it less likely that any individual firm will collapse by having stronger capital requirements for larger financial firms and eliminating certain business lines they can participate in through the Volcker Rule. This is crucial for a Too Big To Fail firm like JP Morgan.

    But the second is to acknowledge that businesses run profits and they run losses. There is something to a conservative like Kevin Williamson's remark that "The odd thing about this is that it is now considered somehow scandalous when a business loses money. It’s a scandal when banks make profits, and it’s a scandal when they make losses." On a long enough timeline, the survival rate for everyone drops to zero. Though it was clear quickly at 5 p.m. Thursday that JP Morgan wasn't in danger of collapsing, if things had been different it could have failed.

    This illustrates the need for a mechanism to allow firms to fail in a way that fairly allocates losses to the right parties. The way corporations fail in this country is a series of legal choices we've made, and we found in the fall of 2008 that the mechanism we have for a shadow-bank financial firm failing -- Chapter 11 bankruptcy -- dragged down the entire system with it. Hence the move to bring in the FDIC to make sure a financial firm fails in a way compatible with fairness. The FDIC has special powers -- advance planning and living wills, debtor-in-possession financing and liquidity, making payments to creditors based on expected recoveries, keeping operations running, the ability to transfer qualified financial contracts without termination, and the ability to turn up or down regulations going into a potential resolution based on prompt corrective action -- appropriate to what our 21st century financial system needs.

    Now what did Gruenberg present? The whole speech is recommended, but these goals are worth highlighting:

    The second step will be the conversion of the debt holders' claims to equity. The old debt holders of the failed parent will become the owners of the new company and thus be responsible for electing a new board of directors. The new board will in turn appoint a CEO of the fully privatized new company. For a variety of reasons, we would like this to be a rapid transition.

    In summary, what we envision is a resolution strategy under which the FDIC takes control of the failed firm at the parent holding company level and establishes a bridge holding company as an interim step in the conversion of the failed firm into a new well-capitalized private sector entity. We believe this strategy holds the best possibility of achieving our key goals of maintaining financial stability, holding investors in the failed firm accountable for the losses of the company, and producing a new, viable private sector company out of the process.
    Shareholders are wiped out, the bank is recapitalized through previous debt holders, and the old board is fired. Stability and accountability are both emphasized. This is not simple, and this is where Dodd-Frank hangs together or it falls apart. It is a system of deterrence and detection alongside FDIC resolution. The Volcker Rule is meant to prevent having hedge fund-like gigantic losses out of nowhere, which would allow the FDIC to have some lead time to try to steer a firm back to solvency through prompt corrective action before resolution. Well-capitalized and transparent derivative markets will help with issues of contagion and panic that come with a major financial firm approaching collapse.
     
    This isn't perfected yet. The big problems are given special attention in the speech: the international component of these firms, their size and complex corporate structure, their liquidity needs, and the lack of available or appropriate acquisition firms. These are not simple problems to solve, though it is clear that the FDIC wants to solve them. Now is the worst time to pull the plug and replace it with nothing, though that is the course House Republicans are on. Because no matter how many regulations are put in place, firms fail. We need a system that allows that.
     
    Mike Konczal is a Fellow at the Roosevelt Institute.
     
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