The 2003 Dividend Tax Cut Did Nothing to Help the Real Economy

Jan 20, 2015Mike Konczal

President Obama is going big on capital taxation in the State of the Union tonight, including a proposal to raise dividend taxes on the rich to 28 percent. The President is probably not going to frame this as a move away from the George W. Bush economy, but Bush’s radical cuts to capital taxes are part of his legacy that we are still living with. And it’s a part that the latest evidence tells us did a lot to help the rich without helping the overall economy at all.

In the response to Obama’s proposal, you are going to hear a lot about how lower dividend rates increase investment and help the real economy. Indeed, lowering capital tax rates has been a consistent goal of conservatives. As a result, one of the biggest capital taxation changes in history happened in 2003, when George W. Bush reduced the dividend tax rate from 38.6 percent to 15 percent as part of his rapid and expansive tax cut agenda.

There’s been a lot of research about the effect of this massive dividend tax cut on payouts to shareholders (kicked off by an important 2005 Chetty-Saez paper), but very little on its effect on the real economy. Did slashing the dividend tax rate boost corporate investments, perhaps because it made funding projects easier? We don’t know, and it’s not because economists aren’t interested; it’s because it’s very difficult to construct a control group with which to compare the results. Investments increased after 2003, but they likely would have to some degree independent of the dividend tax cut, as we were coming out of a recession. So did the tax cut make a difference?

This is where UC Berkeley economist Danny Yagan’s fantastic new paper, “Capital Tax Reform and the Real Economy: The Effects of the 2003 Dividend Tax Cut,” (pdf, slides) comes in. He uses a large amount of IRS data on corporate tax returns to compare S-corporations with C-corporations. Without getting deep into tax law, C-corporations are publicly-traded firms, while S-corporations are closely held ones without institutional investors. But they are largely comparable in the range Yagan looks at (between $1 million and $1 billion dollars in size), as they are competing in the same industries and locations.

Crucially, though, S-corporations don’t pay a dividend tax and thus didn’t benefit from the big 2003 dividend tax cut, while C-corporations do pay them and did benefit. So that allows Yagan to set up S-corporations as a control group and see what the effect of the massive dividend tax cut on C-corporations has been. Here’s what he finds:

The blue line is the C-corporations, which should diverge from the red-line if the dividend tax cut caused a real change. But there’s no statistical difference between the two paths at all. (Note how their paths are the same before the cut, so it’s a real trend in the business cycle.) There’s no difference in either investment or adjusted net investment. There’s also no difference when it comes to employee compensation. The firms that got a massive capital tax cut did not make any different choices about things that boost the real economy. This is true across a crazy-robust number of controls, measures, and coding of outliers.

The one thing that does increase for C-corporations, of course, is the disgorgement of cash to shareholders. Cutting dividend taxes leads to an increase in dividends and share buybacks. This shows that these corporations are in fact making decisions in response to the tax cut; they just happen to be decisions that benefit, well, probably not you. If right now you are worried that too much cash is leaving firms to benefit a handful of investors while the real economy stagnates, suddenly Clinton-era levels of dividend taxation don’t look so bad.

This is interesting for people interested more specifically in corporate finance theory. Because this is evidence against the theory that firms use the stock market to raise funding, and toward a “pecking order” theory that internal funds and riskless debt are far above equity in a hierarchy of corporate funding choices. In models like the latter, taxation of dividends does very little to impact the cost of capital for firms, because equity isn’t the binding constraint on marginal investment options.

President Obama will likely focus his pitch for the dividend tax increase on the future, when, in his argument, globalization and technology will cause compensation to stagnate while investor payouts skyrocket and the economy becomes more focused on the top 1 percent. But it’s worth noting that while capital taxes are a solution to that problem, the radical slashing conservatives have brought to them are also partly responsible for our current malaise.

Follow or contact the Rortybomb blog:
 
  

 

President Obama is going big on capital taxation in the State of the Union tonight, including a proposal to raise dividend taxes on the rich to 28 percent. The President is probably not going to frame this as a move away from the George W. Bush economy, but Bush’s radical cuts to capital taxes are part of his legacy that we are still living with. And it’s a part that the latest evidence tells us did a lot to help the rich without helping the overall economy at all.

In the response to Obama’s proposal, you are going to hear a lot about how lower dividend rates increase investment and help the real economy. Indeed, lowering capital tax rates has been a consistent goal of conservatives. As a result, one of the biggest capital taxation changes in history happened in 2003, when George W. Bush reduced the dividend tax rate from 38.6 percent to 15 percent as part of his rapid and expansive tax cut agenda.

There’s been a lot of research about the effect of this massive dividend tax cut on payouts to shareholders (kicked off by an important 2005 Chetty-Saez paper), but very little on its effect on the real economy. Did slashing the dividend tax rate boost corporate investments, perhaps because it made funding projects easier? We don’t know, and it’s not because economists aren’t interested; it’s because it’s very difficult to construct a control group with which to compare the results. Investments increased after 2003, but they likely would have to some degree independent of the dividend tax cut, as we were coming out of a recession. So did the tax cut make a difference?

This is where UC Berkeley economist Danny Yagan’s fantastic new paper, “Capital Tax Reform and the Real Economy: The Effects of the 2003 Dividend Tax Cut,” (pdf, slides) comes in. He uses a large amount of IRS data on corporate tax returns to compare S-corporations with C-corporations. Without getting deep into tax law, C-corporations are publicly-traded firms, while S-corporations are closely held ones without institutional investors. But they are largely comparable in the range Yagan looks at (between $1 million and $1 billion dollars in size), as they are competing in the same industries and locations.

Crucially, though, S-corporations don’t pay a dividend tax and thus didn’t benefit from the big 2003 dividend tax cut, while C-corporations do pay them and did benefit. So that allows Yagan to set up S-corporations as a control group and see what the effect of the massive dividend tax cut on C-corporations has been. Here’s what he finds:

The blue line is the C-corporations, which should diverge from the red-line if the dividend tax cut caused a real change. But there’s no statistical difference between the two paths at all. (Note how their paths are the same before the cut, so it’s a real trend in the business cycle.) There’s no difference in either investment or adjusted net investment. There’s also no difference when it comes to employee compensation. The firms that got a massive capital tax cut did not make any different choices about things that boost the real economy. This is true across a crazy-robust number of controls, measures, and coding of outliers.

The one thing that does increase for C-corporations, of course, is the disgorgement of cash to shareholders. Cutting dividend taxes leads to an increase in dividends and share buybacks. This shows that these corporations are in fact making decisions in response to the tax cut; they just happen to be decisions that benefit, well, probably not you. If right now you are worried that too much cash is leaving firms to benefit a handful of investors while the real economy stagnates, suddenly Clinton-era levels of dividend taxation don’t look so bad.

This is interesting for people interested more specifically in corporate finance theory. Because this is evidence against the theory that firms use the stock market to raise funding, and toward a “pecking order” theory that internal funds and riskless debt are far above equity in a hierarchy of corporate funding choices. In models like the latter, taxation of dividends does very little to impact the cost of capital for firms, because equity isn’t the binding constraint on marginal investment options.

President Obama will likely focus his pitch for the dividend tax increase on the future, when, in his argument, globalization and technology will cause compensation to stagnate while investor payouts skyrocket and the economy becomes more focused on the top 1 percent. But it’s worth noting that while capital taxes are a solution to that problem, the radical slashing conservatives have brought to them are also partly responsible for our current malaise.

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What Happened in 2013? Two Clarifications Among Current Debates

Jan 16, 2015Mike Konczal

Is it useful to clarify data and claims in the economics blogosphere? Probably not, but I’ll give it a shot, as there’s two sets of arguments that could use more light rather than heat.

What Happened in 2013? Sumner and Wren-Lewis

Scott Sumner wrote this about Simon Wren-Lewis:

“Simon Wren-Lewis also gets the GDP growth data wrong, in a way that makes austerity look worse. He claims that RGDP growth was 2.3% in 2012 and 2.2% in 2013 (the year of austerity in the US.) But that’s annual y-o-y data, and since the austerity began on January 1st 2013, you need Q4 over Q4 data. In fact, RGDP growth in 2012, Q4 over Q4, was only 1.67%, whereas growth in the austerity year of 2013 nearly doubled to 3.13%.”

There’s no getting it wrong here: there’s simply two methods. Is it better to take the average annual rates and compare them (as Wren-Lewis does) or is it better to look at strict endpoints (as Sumner does)? An important thing about looking at Q4 vs Q4 data, as Sumner does, is to make sure that you haven’t accidentally set up your endpoints to amplify a trend that isn’t there. That technique is very sensitive to where you put the endpoints.

And sure enough, the quarters before and after that range featured negative or near zero growth. What if you redo this moving the quarters back and forth one period? Well, Q1 over Q1 2014 data drops to 1.9%, while Q3 over Q3 2012 rises to 2.7% (Q1 over Q1 2012 was 2.1%). It’s not encouraging if your argument falls apart because you move the data one step. We can graph out the Q over Q data for every quarter in fact; note Sumner is points to a single quarter that obviously sticks out. There’s a reason people might want to average the data in these situations, as Lewis does.

Simon-Wren Lewis, whose blog I really enjoy, already pointed out austerity didn’t start on January 1st, 2013, of course. And it didn’t; note the more consistent growth in the graphic in late 2010. But even better, the fourth quarter of 2012 featured a massive decline in military spending. According to Alan Krueger for the White House, “A likely explanation for the sharp decline in Federal defense spending is uncertainty concerning the automatic spending cuts that were scheduled to take effect in January.” That’s an additional problem for setting up this issue this way.

What Did People Say Would Happen? Jeffrey Sachs

Jeffrey Sachs argues that people worried about additional austerity in 2013 were saying that it would cause another recession. Sachs: “Indeed, deficit cuts [especially in 2013] would court a reprise of 1937, when Franklin D. Roosevelt prematurely reduced the New Deal stimulus and thereby threw the United States back into recession.”

I paid a lot of attention to these debates, and saw three estimates of the impact of 2013 austerity on the recovery: Mark Zandi at Moody’s Economy, EPI, and the CBO. All three were close to each other in their estimates. None predicted that we'd go back into recession or have no growth.

What were they predicting? Zandi put it clearly: “Altogether, lower federal government spending and higher taxes are expected to reduce 2013 real GDP growth...With such a heavy fiscal weight on the economy, it is hard to see how growth could accelerate, at least in the first half of 2013.”

That’s consistent with what we’ve seen. A drag, preventing accelerate growth and delaying a takeoff in 2013 and into 2014. I don’t see how Sachs can obviously claim that these numbers aren’t consistent with the idea that the government has been a net drag since 2011, or point to a pickup in late 2014 as obviously disproving anything. Maybe on closer, empirical grounds you could (though the empirical literature is finding multiplers), but not at this high level.

In my original question about the Federal Reserve versus austerity in 2013, which seems to animate a lot of these debates, the issue I put forward was whether the Federal Reserve could hit the inflation target it announced with the Evans Rule shifting expectations and open-ended purchases to back that up, while government spending was a drag. It did not.

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Is it useful to clarify data and claims in the economics blogosphere? Probably not, but I’ll give it a shot, as there’s two sets of arguments that could use more light rather than heat.

What Happened in 2013? Sumner and Wren-Lewis

Scott Sumner wrote this about Simon Wren-Lewis:

“Simon Wren-Lewis also gets the GDP growth data wrong, in a way that makes austerity look worse. He claims that RGDP growth was 2.3% in 2012 and 2.2% in 2013 (the year of austerity in the US.) But that’s annual y-o-y data, and since the austerity began on January 1st 2013, you need Q4 over Q4 data. In fact, RGDP growth in 2012, Q4 over Q4, was only 1.67%, whereas growth in the austerity year of 2013 nearly doubled to 3.13%.”

There’s no getting it wrong here: there’s simply two methods. Is it better to take the average annual rates and compare them (as Wren-Lewis does) or is it better to look at strict endpoints (as Sumner does)? An important thing about looking at Q4 vs Q4 data, as Sumner does, is to make sure that you haven’t accidentally set up your endpoints to amplify a trend that isn’t there. That technique is very sensitive to where you put the endpoints.

And sure enough, the quarters before and after that range featured negative or near zero growth. What if you redo this moving the quarters back and forth one period? Well, Q1 over Q1 2014 data drops to 1.9%, while Q3 over Q3 2012 rises to 2.7% (Q1 over Q1 2012 was 2.1%). It’s not encouraging if your argument falls apart because you move the data one step. We can graph out the Q over Q data for every quarter in fact; note Sumner is points to a single quarter that obviously sticks out. There’s a reason people might want to average the data in these situations, as Lewis does.

Simon-Wren Lewis, whose blog I really enjoy, already pointed out austerity didn’t start on January 1st, 2013, of course. And it didn’t; note the more consistent growth in the graphic in late 2010. But even better, the fourth quarter of 2012 featured a massive decline in military spending. According to Alan Krueger for the White House, “A likely explanation for the sharp decline in Federal defense spending is uncertainty concerning the automatic spending cuts that were scheduled to take effect in January.” That’s an additional problem for setting up this issue this way.

What Did People Say Would Happen? Jeffrey Sachs

Jeffrey Sachs argues that people worried about additional austerity in 2013 were saying that it would cause another recession. Sachs: “Indeed, deficit cuts [especially in 2013] would court a reprise of 1937, when Franklin D. Roosevelt prematurely reduced the New Deal stimulus and thereby threw the United States back into recession.”

I paid a lot of attention to these debates, and saw three estimates of the impact of 2013 austerity on the recovery: Mark Zandi at Moody’s Economy, EPI, and the CBO. All three were close to each other in their estimates. None predicted that we'd go back into recession or have no growth.

What were they predicting? Zandi put it clearly: “Altogether, lower federal government spending and higher taxes are expected to reduce 2013 real GDP growth...With such a heavy fiscal weight on the economy, it is hard to see how growth could accelerate, at least in the first half of 2013.”

That’s consistent with what we’ve seen. A drag, preventing accelerate growth and delaying a takeoff in 2013 and into 2014. I don’t see how Sachs can obviously claim that these numbers aren’t consistent with the idea that the government has been a net drag since 2011, or point to a pickup in late 2014 as obviously disproving anything. Maybe on closer, empirical grounds you could (though the empirical literature is finding multiplers), but not at this high level.

In my original question about the Federal Reserve versus austerity in 2013, which seems to animate a lot of these debates, the issue I put forward was whether the Federal Reserve could hit the inflation target it announced with the Evans Rule shifting expectations and open-ended purchases to back that up, while government spending was a drag. It did not.

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A Battle Map for the Republican War Against Dodd-Frank

Jan 15, 2015Mike Konczal

The Republicans have declared war against Dodd-Frank. But what kind of war is it, and on what fronts are they waging this war? I think there are at least three campaigns, each with its own strategic goals and tactics. Distinguishing these campaigns from each other will help us understand what Republicans are trying to do and how to keep them in check.

First, to understand the Republican campaigns, it’s useful go over what Dodd-Frank does. Dodd-Frank can be analogized to the way we regulate driving. First, there are simple rules of the road, like speed limits and stop signs, designed as outright prevention against accidents. Then there are efforts to help with stabilization if the driver gets in trouble, such as anti-lock brakes or road design. And then there are regulations for the resolution of accidents that do occur, like seat belts and airbags, designed to avoids worst-case scenarios.

These three goals map onto Dodd-Frank pretty well. Dodd-Frank also puts rules upfront to prevent certain actions, requires additional regulations to create stability within large financial firms, and lays out plans to allow for a successful resolution of a firm once it fails. Let’s graph that out:

Prevention: Dodd-Frank created a Consumer Financial Protection Bureau (CFPB), reforming consumer protection from being an “orphan mission” spread across 11 agencies by establishing one dedicated agency for it. The act also requires that derivatives trade with clearinghouses and through exchanges or else face additional capital requirements, which brought price transparency and additional capital to the market that brought down AIG. Another piece is the Volcker Rule, which separates the proprietary trading that can cause rapid losses from our commercial banking and payment systems.

Stabilization: Dodd-Frank also provides for the expansion of capital requirements across the financial sector, including higher requirements for the biggest firms relative to smaller ones, as well as higher requirements for those who use short-term funding in the “shadow” banking sector relative to traditional banks. These firms are designed by the Financial Stability Oversight Council (FSOC).

Resolution:  The firms FSOC designates as systemically risky have to prepare themselves for a rapid resolution for when they do fail. They have to prove that they can survive bankruptcy without bringing down the entire system (an effort currently being fought). The FDIC has prepared a second line of defense, a special “resolution authority” (OLA) to use if bankruptcy isn’t a viable option in a crisis.

These elements of the law all flow naturally from the financial crisis of 2008. It would have been very helpful in the crisis for there to be more clarity in the derivatives market, more capital in shadow banks, and a process to resolve Lehman Brothers. Maybe these are great ways to approach the problem or maybe they aren’t, but to suggest they have no basis in the crisis, as the American Enterprise Institute comically does, is pure ideology.

But ignore the more ridiculous arguments. The actual war against Dodd-Frank is much more sophisticated, and it’s being waged on numerous fronts. Let’s make a map of the battlefield:

There are three distinct campaigns being waged:

Guerrilla Deregulation. The goal here is to undermine as much of the efforts of derivatives regulation, the Volcker Rule, and the CFPB as possible through quick, surprise attacks. This, in turn, has a chilling effect across regulators and throws the regulatory process into chaos.

The main tactic, as in any good guerrilla campaign, is to do hit-and-run ambushes of key, important targets vulnerable to raids. David Dayen had a helpful list of some key bills that must pass in 2015, bills likely to be perfect targets for a good guerrilla raid. The guerrilla campaign had a major victory in weakening the Section 716 “push-out” rule in the Cromnibus bill. And that will probably be a model going forward for these tactics, replicated in the recent attacks we’ve seen, down to counting the small handful of Democrats signing on as some sort of concession of bipartisanship.

Another guerrilla element will be the focus on victory through attrition. It’s not like the House Republicans have their own theory of how to regulate the derivatives market, or that they are making the full case against the Volcker Rule or the CFPB, or even proposing their own anything. They are winning simply through weakening both the rules and the resolve of reformers.

Administrative Siege: Aside from the guerrilla war of deregulation, the GOP is also waging war on another front, through a long-term siege of the regulatory agencies. This includes blockading them from resources like funding and personnel, consistent harassment, discrediting them in the eyes of the broader public, and weakening their power to act. This is a long-term battle, going back to the beginning of Dodd-Frank, and their terms are unconditional surrender.

The seriousness of this campaign became clear when the GOP first refused to appoint any director of the CFPB unless there was a complete overhaul to weaken it. This campaign has continued against the CFTC, and now extends to the FSOC trying to designate firms as systemically risky. The recent House bill to extend cost-benefit analysis to financial regulations, where it has little history, unclear analytical benefit, and could easily lead to worse rules, is also part of this siege.

One key argument the GOP is pushing is that the regulators are historically too powerful and out of control. As House Financial Services Committee chairman Jeb Hensarling said to the Wall Street Journal, the CFPB is “the single most unaccountable agency in the history of America.” This is just silly agitprop. The structure -- independent budgets and a single director -- looks exactly like their counterparts in the OCC. It’s not only subject to the same rule-making process as other regulators, but other regulators can in fact veto the CFPB, making it significantly more accountable compared to any other agency.

The same is being said about FSOC. Note that there’s always room for improvement; Americans for Financial Reform (AFR) have some ways to improve the transparency of FSOC here. But as AFR’s Marcus Stanley notes, the House’s recent FSOC bill “appears better calculated to hinder FSOC operations than to improve its transparency.” Indeed, as Better Markets notes, this FSOC battle is in large part over the regulation of money market funds, a crucial reform in fixing shadow banking. But making government work better isn’t the goal of the siege; this campaign’s goal is to break these agencies and their ability to regulate the financial system.

Reactionary Rhetoric: The goal of this ideological programming campaign is to push the argument that Dodd-Frank simply reinforces the worst part of the bailouts and does nothing productive toward reform. Instead of a series of methods to check and reduce Too Big To Fail, this campaign argues that Dodd-Frank does worse than fail. Following the rhetoric of reaction, reform simply makes the problem far worse. The point here is to remove the FDIC’s ability to put systemically risky firms into a receivership while also preparing the ground for a full repeal.

Advancing the argument that Dodd-Frank has made the bailouts of 2008-2009 permanent and serves only to benefit the biggest financial firms has become a marching order for the movement right. It was basically the entire GOP argument against Dodd-Frank in 2012 (Mitt Romney calling the act "the biggest kiss" to Wall Street), and it still dominates their talking points. If this were the case, the largest banks would receive a large Too Big To Fail subsidy, and we’d subsequently see a reduction in their borrowing costs.

Major studies tells us that the opposite is the case; since 2010 Too Big To Fail subsidies have fallen instead of stabilized or increased. This doesn’t mean the work is done - we could still see a major failure cause systemic risk, and just “avoiding catastrophic collapses” isn’t really a headline goal for a functioning financial system. There’s also little evidence that Dodd-Frank enriches the biggest banks; firms go out of their way to avoid a SIFI designation, which they wouldn’t if there were a benefit to them, and Wall Street analysts take it for granted that capital requirements and other regulations are more binding for the largest firms.

There could be a productive discussion here about finding a way to reform the bankruptcy code to help combat Too Big To Fail while keeping resolution authority as a backup option. That backup option is key though. Unlike OLA, bankruptcy is slow and deliberate, isn't designed to preserve ongoing firm business, doesn't have guaranteed funding available, can’t prevent runs from short-term creditors, and has trouble internationally. But again, the point for Republicans isn’t to try to come up with the best regime; it’s to discredit the effort at reform entirely so the other campaigns, and the overall campaign for repeal, can be that much easier.

Why do Republicans want all this? The answer you will normally hear is that they are in the pocket of Wall Street or in the thrall of free-market fundamentalism. And there’s truth to that. But they’ve also created a whole institutionally enforced counter-narrative where there was no real crisis and Wall Street committed no bad behavior except for when ACORN made them. This narrative is, bluntly, dumb. But it is the narrative their movement has chosen, and movements have a way of forcing well-meaning people who’d otherwise want to find good solutions to fall in line.

2015 will require reformers to wage their own campaigns to push additional reform (here’s a start), push for stronger action from regulators, and make the public understand the progress that has been made. But first we need to understand that while conservatives may look like they are running a smash-and-grab operation when it comes to Dodd-Frank, it’s actually a quite sophisticated series of campaigns, and they are already winning battles.

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The Republicans have declared war against Dodd-Frank. But what kind of war is it, and on what fronts are they waging this war? I think there are at least three campaigns, each with its own strategic goals and tactics. Distinguishing these campaigns from each other will help us understand what Republicans are trying to do and how to keep them in check.

First, to understand the Republican campaigns, it’s useful go over what Dodd-Frank does. Dodd-Frank can be analogized to the way we regulate driving. First, there are simple rules of the road, like speed limits and stop signs, designed as outright prevention against accidents. Then there are efforts to help with stabilization if the driver gets in trouble, such as anti-lock brakes or road design. And then there are regulations for the resolution of accidents that do occur, like seat belts and airbags, designed to avoids worst-case scenarios.

These three goals map onto Dodd-Frank pretty well. Dodd-Frank also puts rules upfront to prevent certain actions, requires additional regulations to create stability within large financial firms, and lays out plans to allow for a successful resolution of a firm once it fails. Let’s graph that out:

Prevention: Dodd-Frank created a Consumer Financial Protection Bureau (CFPB), reforming consumer protection from being an “orphan mission” spread across 11 agencies by establishing one dedicated agency for it. The act also requires that derivatives trade with clearinghouses and through exchanges or else face additional capital requirements, which brought price transparency and additional capital to the market that brought down AIG. Another piece is the Volcker Rule, which separates the proprietary trading that can cause rapid losses from our commercial banking and payment systems.

Stabilization: Dodd-Frank also provides for the expansion of capital requirements across the financial sector, including higher requirements for the biggest firms relative to smaller ones, as well as higher requirements for those who use short-term funding in the “shadow” banking sector relative to traditional banks. These firms are designed by the Financial Stability Oversight Council (FSOC).

Resolution:  The firms FSOC designates as systemically risky have to prepare themselves for a rapid resolution for when they do fail. They have to prove that they can survive bankruptcy without bringing down the entire system (an effort currently being fought). The FDIC has prepared a second line of defense, a special “resolution authority” (OLA) to use if bankruptcy isn’t a viable option in a crisis.

These elements of the law all flow naturally from the financial crisis of 2008. It would have been very helpful in the crisis for there to be more clarity in the derivatives market, more capital in shadow banks, and a process to resolve Lehman Brothers. Maybe these are great ways to approach the problem or maybe they aren’t, but to suggest they have no basis in the crisis, as the American Enterprise Institute comically does, is pure ideology.

But ignore the more ridiculous arguments. The actual war against Dodd-Frank is much more sophisticated, and it’s being waged on numerous fronts. Let’s make a map of the battlefield:

There are three distinct campaigns being waged:

Guerrilla Deregulation. The goal here is to undermine as much of the efforts of derivatives regulation, the Volcker Rule, and the CFPB as possible through quick, surprise attacks. This, in turn, has a chilling effect across regulators and throws the regulatory process into chaos.

The main tactic, as in any good guerrilla campaign, is to do hit-and-run ambushes of key, important targets vulnerable to raids. David Dayen had a helpful list of some key bills that must pass in 2015, bills likely to be perfect targets for a good guerrilla raid. The guerrilla campaign had a major victory in weakening the Section 716 “push-out” rule in the Cromnibus bill. And that will probably be a model going forward for these tactics, replicated in the recent attacks we’ve seen, down to counting the small handful of Democrats signing on as some sort of concession of bipartisanship.

Another guerrilla element will be the focus on victory through attrition. It’s not like the House Republicans have their own theory of how to regulate the derivatives market, or that they are making the full case against the Volcker Rule or the CFPB, or even proposing their own anything. They are winning simply through weakening both the rules and the resolve of reformers.

Administrative Siege: Aside from the guerrilla war of deregulation, the GOP is also waging war on another front, through a long-term siege of the regulatory agencies. This includes blockading them from resources like funding and personnel, consistent harassment, discrediting them in the eyes of the broader public, and weakening their power to act. This is a long-term battle, going back to the beginning of Dodd-Frank, and their terms are unconditional surrender.

The seriousness of this campaign became clear when the GOP first refused to appoint any director of the CFPB unless there was a complete overhaul to weaken it. This campaign has continued against the CFTC, and now extends to the FSOC trying to designate firms as systemically risky. The recent House bill to extend cost-benefit analysis to financial regulations, where it has little history, unclear analytical benefit, and could easily lead to worse rules, is also part of this siege.

One key argument the GOP is pushing is that the regulators are historically too powerful and out of control. As House Financial Services Committee chairman Jeb Hensarling said to the Wall Street Journal, the CFPB is “the single most unaccountable agency in the history of America.” This is just silly agitprop. The structure -- independent budgets and a single director -- looks exactly like their counterparts in the OCC. It’s not only subject to the same rule-making process as other regulators, but other regulators can in fact veto the CFPB, making it significantly more accountable compared to any other agency.

The same is being said about FSOC. Note that there’s always room for improvement; Americans for Financial Reform (AFR) have some ways to improve the transparency of FSOC here. But as AFR’s Marcus Stanley notes, the House’s recent FSOC bill “appears better calculated to hinder FSOC operations than to improve its transparency.” Indeed, as Better Markets notes, this FSOC battle is in large part over the regulation of money market funds, a crucial reform in fixing shadow banking. But making government work better isn’t the goal of the siege; this campaign’s goal is to break these agencies and their ability to regulate the financial system.

Reactionary Rhetoric: The goal of this ideological programming campaign is to push the argument that Dodd-Frank simply reinforces the worst part of the bailouts and does nothing productive toward reform. Instead of a series of methods to check and reduce Too Big To Fail, this campaign argues that Dodd-Frank does worse than fail. Following the rhetoric of reaction, reform simply makes the problem far worse. The point here is to remove the FDIC’s ability to put systemically risky firms into a receivership while also preparing the ground for a full repeal.

Advancing the argument that Dodd-Frank has made the bailouts of 2008-2009 permanent and serves only to benefit the biggest financial firms has become a marching order for the movement right. It was basically the entire GOP argument against Dodd-Frank in 2012 (Mitt Romney calling the act "the biggest kiss" to Wall Street), and it still dominates their talking points. If this were the case, the largest banks would receive a large Too Big To Fail subsidy, and we’d subsequently see a reduction in their borrowing costs.

Major studies tells us that the opposite is the case; since 2010 Too Big To Fail subsidies have fallen instead of stabilized or increased. This doesn’t mean the work is done - we could still see a major failure cause systemic risk, and just “avoiding catastrophic collapses” isn’t really a headline goal for a functioning financial system. There’s also little evidence that Dodd-Frank enriches the biggest banks; firms go out of their way to avoid a SIFI designation, which they wouldn’t if there were a benefit to them, and Wall Street analysts take it for granted that capital requirements and other regulations are more binding for the largest firms.

There could be a productive discussion here about finding a way to reform the bankruptcy code to help combat Too Big To Fail while keeping resolution authority as a backup option. That backup option is key though. Unlike OLA, bankruptcy is slow and deliberate, isn't designed to preserve ongoing firm business, doesn't have guaranteed funding available, can’t prevent runs from short-term creditors, and has trouble internationally. But again, the point for Republicans isn’t to try to come up with the best regime; it’s to discredit the effort at reform entirely so the other campaigns, and the overall campaign for repeal, can be that much easier.

Why do Republicans want all this? The answer you will normally hear is that they are in the pocket of Wall Street or in the thrall of free-market fundamentalism. And there’s truth to that. But they’ve also created a whole institutionally enforced counter-narrative where there was no real crisis and Wall Street committed no bad behavior except for when ACORN made them. This narrative is, bluntly, dumb. But it is the narrative their movement has chosen, and movements have a way of forcing well-meaning people who’d otherwise want to find good solutions to fall in line.

2015 will require reformers to wage their own campaigns to push additional reform (here’s a start), push for stronger action from regulators, and make the public understand the progress that has been made. But first we need to understand that while conservatives may look like they are running a smash-and-grab operation when it comes to Dodd-Frank, it’s actually a quite sophisticated series of campaigns, and they are already winning battles.

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On President Obama's Community College Plan and Public Options

Jan 9, 2015Mike Konczal

Looks like a smart plan he announced yesterday. I wrote about it, and public options more generally, here at The Nation. I hope you check it out!

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Looks like a smart plan he announced yesterday. I wrote about it, and public options more generally, here at The Nation. I hope you check it out!

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Guest Post: Will Wall Street Win Again with Antonio Weiss Nomination?

Jan 7, 2015Brad Miller

Mike here. This post is from my colleague Brad Miller over the important debate on the Antonio Weiss nomination. Brad is a former U.S. Representative who recently joined the Roosevelt Institute as a Senior Fellow, so he has firsthand knowledge of the internal negotiations around financial reform. Check it out below.

The opposition to the nomination of another investment banker, Antonio Weiss, to a top position in the U.S. Treasury is not just a demagogic appeal to anti-Wall Street prejudices, as his supporters argue.

Weiss’s actual experience appears to be a poor match for the specific duties of the position in question, and may be less laudable than his supporters claim. Weiss’s principal credential appears to be that he is a product of the same culture that produced our other recent economic policymakers.

And that is the real problem for opponents, who believe that economic policies should be subject to democratic debate and require the consent of the governed.

The response to the financial crisis was the most consequential economic policy in generations. Wall Street and Washington insiders alike argue that those policies, endlessly indulgent of banks and pitiless to homeowners, were technocratic decisions that required the recondite knowledge of Wall Street professionals.

To Weiss’s supporters, disregard for public opinion is a virtue. “Making economic policy isn’t a popularity contest,” David Ignatius wrote in The Washington Post, “especially when financial markets are in a panic.” “Our job was to fix it,“ former Treasury Secretary Timothy Geithner said, “not make people like us.”

Criticism did not just come from politicians pandering to the great unwashed, however.

Most economists argued that the lesson of past financial crises was to take economic pain quickly, recognize losses on distressed debt, and take insolvent banks through an orderly receivership. The standard playbook” for financial crises since the 1870s was to “shut down insolvent institutions so executives and shareholders in the future do not think they will escape the consequences of the moral hazard they created.” “Zombie” banks, economists argued, only delay recovery.

The Bush and Obama Administrations instead helped too-big-to-fail banks pretend to be solvent and provided subsidies and other dispensations until the banks became profitable, an effort that continues.

Unfortunately, any effective effort to reduce foreclosures required banks to recognize losses on mortgages. Insiders regarded foreclosures as a lesser concern. Geithner said that even if the government used federal funds “to wipe out every dollar of negative equity in the U.S. housing market…it would have increased annual consumption by just 0.1 to 0.2 percent.”

According to Atif Mian and Amir Sufi, two prominent economists, “that is dead wrong.” Household wealth fell by $9 trillion after the housing bubble burst in 2006, which greatly reduced consumer demand. “The evidence,” Amir and Sufi said, “is pretty clear: an aggressive bold attack on household debt would have significantly reduced the horrible impact of the Great Recession on Americans.”

Wall Street’s critics did not lose that debate. There was no debate.

Senator Obama endorsed legislation in his presidential campaign to allow the judicial modification of mortgages in bankruptcy. President Obama never publicly wavered from that position, but Treasury officials privately lobbied against the legislation in the Senate, where the legislation died. The determination by economic policymakers to protect their immaculate policies from tawdry politics may extend to attempts by the President to intrude.

Meddling by Members of Congress was certainly unwelcome. In a private meeting between Administration officials and disgruntled House Democrats, I said that foreclosure relief efforts appeared designed to help banks absorb losses gradually, not to help homeowners. Geithner was offended—indignant—at the suggestion. Neil Barofsky, then the Special Inspector General for the Troubled Asset Recovery Program, later confirmed that was exactly the purpose of the programs—in Geithner’s words, to “foam the runway” for the banks.

The success of policies that are unacknowledged or even denied is difficult to measure. Since the financial crisis, however, the financial sector, from whence our unguarded platonic guardians came and soon will return, has prospered. Others fared less well. Wealth and income inequality widened dramatically.

Weiss has not served in government, so opposition to his nomination may punish him for the sins of others, perhaps unfairly. There is nothing to indicate, however, that Weiss questions the assumption that the North Star of economic policy should be the prosperity of the financial sector, or that policies should be freely debated unless there’s money involved.

The presidential campaign in 2016 will undoubtedly largely be about economic policy. Voters may assume that the election of one candidate or another will result in implementation of that candidate’s economic policies.

If the culture of economic policymakers remains unchanged, the public positions of candidates and the votes of citizens may not matter much.

Brad Miller is a Senior Fellow at the Roosevelt Institute. Previously, he served for a decade in the U.S. House of Representatives.

Mike here. This post is from my colleague Brad Miller over the important debate on the Antonio Weiss nomination. Brad is a former U.S. Representative who recently joined the Roosevelt Institute as a Senior Fellow, so he has firsthand knowledge of the internal negotiations around financial reform. Check it out below.

The opposition to the nomination of another investment banker, Antonio Weiss, to a top position in the U.S. Treasury is not just a demagogic appeal to anti-Wall Street prejudices, as his supporters argue.

Weiss’s actual experience appears to be a poor match for the specific duties of the position in question, and may be less laudable than his supporters claim. Weiss’s principal credential appears to be that he is a product of the same culture that produced our other recent economic policymakers.

And that is the real problem for opponents, who believe that economic policies should be subject to democratic debate and require the consent of the governed.

The response to the financial crisis was the most consequential economic policy in generations. Wall Street and Washington insiders alike argue that those policies, endlessly indulgent of banks and pitiless to homeowners, were technocratic decisions that required the recondite knowledge of Wall Street professionals.

To Weiss’s supporters, disregard for public opinion is a virtue. “Making economic policy isn’t a popularity contest,” David Ignatius wrote in The Washington Post, “especially when financial markets are in a panic.” “Our job was to fix it,“ former Treasury Secretary Timothy Geithner said, “not make people like us.”

Criticism did not just come from politicians pandering to the great unwashed, however.

Most economists argued that the lesson of past financial crises was to take economic pain quickly, recognize losses on distressed debt, and take insolvent banks through an orderly receivership. The standard playbook” for financial crises since the 1870s was to “shut down insolvent institutions so executives and shareholders in the future do not think they will escape the consequences of the moral hazard they created.” “Zombie” banks, economists argued, only delay recovery.

The Bush and Obama Administrations instead helped too-big-to-fail banks pretend to be solvent and provided subsidies and other dispensations until the banks became profitable, an effort that continues.

Unfortunately, any effective effort to reduce foreclosures required banks to recognize losses on mortgages. Insiders regarded foreclosures as a lesser concern. Geithner said that even if the government used federal funds “to wipe out every dollar of negative equity in the U.S. housing market…it would have increased annual consumption by just 0.1 to 0.2 percent.”

According to Atif Mian and Amir Sufi, two prominent economists, “that is dead wrong.” Household wealth fell by $9 trillion after the housing bubble burst in 2006, which greatly reduced consumer demand. “The evidence,” Amir and Sufi said, “is pretty clear: an aggressive bold attack on household debt would have significantly reduced the horrible impact of the Great Recession on Americans.”

Wall Street’s critics did not lose that debate. There was no debate.

Senator Obama endorsed legislation in his presidential campaign to allow the judicial modification of mortgages in bankruptcy. President Obama never publicly wavered from that position, but Treasury officials privately lobbied against the legislation in the Senate, where the legislation died. The determination by economic policymakers to protect their immaculate policies from tawdry politics may extend to attempts by the President to intrude.

Meddling by Members of Congress was certainly unwelcome. In a private meeting between Administration officials and disgruntled House Democrats, I said that foreclosure relief efforts appeared designed to help banks absorb losses gradually, not to help homeowners. Geithner was offended—indignant—at the suggestion. Neil Barofsky, then the Special Inspector General for the Troubled Asset Recovery Program, later confirmed that was exactly the purpose of the programs—in Geithner’s words, to “foam the runway” for the banks.

The success of policies that are unacknowledged or even denied is difficult to measure. Since the financial crisis, however, the financial sector, from whence our unguarded platonic guardians came and soon will return, has prospered. Others fared less well. Wealth and income inequality widened dramatically.

Weiss has not served in government, so opposition to his nomination may punish him for the sins of others, perhaps unfairly. There is nothing to indicate, however, that Weiss questions the assumption that the North Star of economic policy should be the prosperity of the financial sector, or that policies should be freely debated unless there’s money involved.

The presidential campaign in 2016 will undoubtedly largely be about economic policy. Voters may assume that the election of one candidate or another will result in implementation of that candidate’s economic policies.

If the culture of economic policymakers remains unchanged, the public positions of candidates and the votes of citizens may not matter much.

Brad Miller is a Senior Fellow at the Roosevelt Institute. Previously, he served for a decade in the U.S. House of Representatives.

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2014's Case Study in the Vertically Integrated Conservative Movement

Dec 30, 2014Mike Konczal

The mass resignation at the New Republic had several people joking about how the magazine wanted to become “vertically integrated.” What does that even mean here? But if anything was vertically integrated in 2014, it was the conservative movement. And you could see this clearly from the reaction to the Halbig decision in July.

I’m occasionally asked what conservative sites people should read. My answer is usually that people should read the blogs of the major think tanks, like AEIdeas, Daily Signal (Heritage), and Cato-at-Liberty. There are many writers who are conservative, or who cover conservatives, who are interesting to read, of course. But if you want to understand the conservative movement as the actual movement it is, you want to look upstream to where the ideas and arguments are first formulated.

From there, you can then watch them move downstream, first to the set of gatekeepers on the right who can give these arguments credibility or otherwise charge them. From there they move down to the front line right-wing writers who incorporate them into their various Hot Takes, as well as the TV and radio stations with their massive audiences.

And we have a real-time example this year. Since 2011, think tanks have been building their Halbig argument, which is that the ACA doesn’t allow state-exchanges created by the federal government to access subsidies. They learned how to discuss it. Most of all they learned how they couldn’t call it a “glitch” but instead, given administrative law, had to argue it was a conscious decision. But the argument wasn’t part of the mainstream discussion.

But then the court case had a success July 22nd, where the Federal Circuit Court for the District of Columbia agreed with Halbig. And you could then watch it move down the river and become mainstream conservative logic almost immediately.

This is where gatekeepers were important. The editors of National Review immediately jumped on it (“States were expected to go along and establish their own exchanges. When it became clear that many states wouldn’t do so because the law was so unpopular, the IRS just rewrote the law”). One of the more important conservative gatekeepers, Ramesh Ponnuru, did the same at Bloomberg (“It's wrong, then, to say that Congress obviously didn't intend to include this restriction”).

With that, the low-level writers could write their takes and mass media personalities could speak as if this was always obviously always the case. Rush Limbaugh (“The Obamacare law specifically says [...] the only people qualified for subsidies are those who acquire their insurance through state exchanges, exchanges established by the state”) is one of many example. Those far away from the think tanks who are good at digging up embarrassing examples soon found numerous examples of Jonathan Gruber embarrassing himself once they knew what to dig for, which in turn boosted the upstream arguments. Vertical integration.

You can go back and see liberal writers trying to figure out in real time how Halbig became conservative common wisdom, when none of the conservative reporters covering the bill while this was all debated ever noted it, or that it wasn't part of the extensive rollout strategy by ACA supporters. Brian Beutler’s Why Are Conservative Health Journalists Covering for Halbig Truthers? and Jonathan Chait’s The New Secret History of the Obamacare Deniers are good examples. It shows a genuine surprise at how vertically integrated the conservative movement can be, and how quickly a new logic became their reality once an opportunity presented itself.

An important thing I noticed from the outside is how there was no strong opposition at the gatekeeper level, only mild skepticism. Reihan Salam wrote “I’m not a Halbig guy [...] I am (at best) agnostic on whether Halbig is correct.” Ross Douthat tweeted that point while describing his own “conflictedness.” But this was the extent of it. Neither they or any other gatekeepers I could find leveled a strong charge, much less a sustained case, against Halbig from within the movement. In a movement, people know when to be quiet.

I noticed this dynamic quickly when I first started reading conservatives writing about the financial crisis. Virtually all the front-line writers were mimicking an odd argument about the GSEs that I didn’t recognize from my time in the industry. I quickly looked upriver to see it all comes from AEI’s Peter Wallison. Again, some crucial gatekeepers air quite skepticism, like his GOP colleagues on the FCIC whose email trail shows how they tried to minimize his bad arguments. But that doesn’t stop the movement writers from pushing just that narrative at all times.

Next time you read a random article from a conservative site, see if you can see how it’s just a rewritten form of some talking points created far upstream. And always remember that when a movement acts, it creates its own reality.

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The mass resignation at the New Republic had several people joking about how the magazine wanted to become “vertically integrated.” What does that even mean here? But if anything was vertically integrated in 2014, it was the conservative movement. And you could see this clearly from the reaction to the Halbig decision in July.

I’m occasionally asked what conservative sites people should read. My answer is usually that people should read the blogs of the major think tanks, like AEIdeas, Daily Signal (Heritage), and Cato-at-Liberty. There are many writers who are conservative, or who cover conservatives, who are interesting to read, of course. But if you want to understand the conservative movement as the actual movement it is, you want to look upstream to where the ideas and arguments are first formulated.

From there, you can then watch them move downstream, first to the set of gatekeepers on the right who can give these arguments credibility or otherwise charge them. From there they move down to the front line right-wing writers who incorporate them into their various Hot Takes, as well as the TV and radio stations with their massive audiences.

And we have a real-time example this year. Since 2011, think tanks have been building their Halbig argument, which is that the ACA doesn’t allow state-exchanges created by the federal government to access subsidies. They learned how to discuss it. Most of all they learned how they couldn’t call it a “glitch” but instead, given administrative law, had to argue it was a conscious decision. But the argument wasn’t part of the mainstream discussion.

But then the court case had a success July 22nd, where the Federal Circuit Court for the District of Columbia agreed with Halbig. And you could then watch it move down the river and become mainstream conservative logic almost immediately.

This is where gatekeepers were important. The editors of National Review immediately jumped on it (“States were expected to go along and establish their own exchanges. When it became clear that many states wouldn’t do so because the law was so unpopular, the IRS just rewrote the law”). One of the more important conservative gatekeepers, Ramesh Ponnuru, did the same at Bloomberg (“It's wrong, then, to say that Congress obviously didn't intend to include this restriction”).

With that, the low-level writers could write their takes and mass media personalities could speak as if this was always obviously always the case. Rush Limbaugh (“The Obamacare law specifically says [...] the only people qualified for subsidies are those who acquire their insurance through state exchanges, exchanges established by the state”) is one of many example. Those far away from the think tanks who are good at digging up embarrassing examples soon found numerous examples of Jonathan Gruber embarrassing himself once they knew what to dig for, which in turn boosted the upstream arguments. Vertical integration.

You can go back and see liberal writers trying to figure out in real time how Halbig became conservative common wisdom, when none of the conservative reporters covering the bill while this was all debated ever noted it, or that it wasn't part of the extensive rollout strategy by ACA supporters. Brian Beutler’s Why Are Conservative Health Journalists Covering for Halbig Truthers? and Jonathan Chait’s The New Secret History of the Obamacare Deniers are good examples. It shows a genuine surprise at how vertically integrated the conservative movement can be, and how quickly a new logic became their reality once an opportunity presented itself.

An important thing I noticed from the outside is how there was no strong opposition at the gatekeeper level, only mild skepticism. Reihan Salam wrote “I’m not a Halbig guy [...] I am (at best) agnostic on whether Halbig is correct.” Ross Douthat tweeted that point while describing his own “conflictedness.” But this was the extent of it. Neither they or any other gatekeepers I could find leveled a strong charge, much less a sustained case, against Halbig from within the movement. In a movement, people know when to be quiet.

I noticed this dynamic quickly when I first started reading conservatives writing about the financial crisis. Virtually all the front-line writers were mimicking an odd argument about the GSEs that I didn’t recognize from my time in the industry. I quickly looked upriver to see it all comes from AEI’s Peter Wallison. Again, some crucial gatekeepers air quite skepticism, like his GOP colleagues on the FCIC whose email trail shows how they tried to minimize his bad arguments. But that doesn’t stop the movement writers from pushing just that narrative at all times.

Next time you read a random article from a conservative site, see if you can see how it’s just a rewritten form of some talking points created far upstream. And always remember that when a movement acts, it creates its own reality.

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Rortybomb's 2014 Yearly Roundup

Dec 30, 2014Mike Konczal

2014 is over, and good riddance. This year I wanted to start some formal projects, as well as write longer pieces, and I managed to do just that. Here’s the high-level stuff I did this past year.

Financialization. I started a project on financialization with the Roosevelt Institute, and I’m helping with a big inequality project helmed by Joe Stiglitz. All this will bear fruit next year, but I did a piece on financialization for Washington Monthly, Frenzied Financialization, that gives you some sense of what we’ll be doing.

(Seeing one's name on a magazine stand is still the coolest.)

Voluntarism. I wrote a big article on The Voluntarism Fantasy (pdf) for Democracy Journal, that had a lot of responses (collected here). One of my favorite pieces I’ve done; Philanthropy Daily, of all places, red-baited me, which was a neat enemy to make in 2014.



(Remember this cover?)

Piketty-Mania. There were races to see how quickly reviews of Piketty’s Capital in the 21st Century could get written. My review, Studying the Rich for Boston Review, was scheduled for late summer and had to be turned around in a week after the demand for readable summaries of the book exploded. I think my review holds up in describing the way the fault lines around the work would unfold.

The two points I wished I had included were Russell Jacoby’s fantastic comparison to the actual Marx’s Capital, on how economic critique has moved from Marx’s factories of production to Piketty’s spreadsheets of distribution, and that what constitutes a “wealth equality” agenda isn’t clear, which I later covered for The Nation. Speaking of...

The Score. I started as a columnist for The Nation with a new economics column, The Score, where I alternate with my former colleague Bryce Covert. It’s still starting up but I’m already happy with columns on socializing Uber and the growth of incarceration. It’s great to work with Bryce again and get to work with the talented editor Sarah Leonard, who is boosting the economic content of The Nation (she also helped launched The Curve with Kathy Grier since joining).

Issue Editing. I also got to help curate and edit an issue of The New Inquiry, The Money Issue. Rob Horning and I had wanted to do something with the weirdness and newness of the finance blogs circa 2007-2009, and hopefully part of that got through here with pieces by Izzy Kaminska and Steve Waldman. I’m very happy to have helped edit the excellent Disgorge the Cash by JW Mason, which will soon relate to the financialization project mentioned above.

Other Writing. I wrote less for the blog this year, but some notable pieces that caught people’s interest included how the “pragmatic” libertarian case for a basic income makes basic errors about the welfare state, explaining the end-of-year fight over financial reform, pieces on how neoconservatism and libertarians have helped get us to the policing situation in Ferguson and elsewhere, and on the limits of liberalism after the 2014 election.

Big pieces for other sites included a review of Playing the Whore for Wonkblog, explaining how we already have a public option for banking and we could expand it for Al-Jazeera America, and a group book review on the role of profit in the state for Boston Review.

What else? In other news I turned 35. My wife got me a Nick Cage in The Rock birthday cake, which is really the best present ever. I moved to Washington DC after a crazy final summer in New York. I’ve been reading a lot of history lately and want to keep incorporating that into my stuff, and I’m enjoying the Eric Foner MOOC of the Civil War era.

Anything you’d like to see different next year? Thanks for reading everyone, see you in 2015.

(Previous editions:  2013, 2012, 2011.)

Follow or contact the Rortybomb blog:
 
  

 

2014 is over, and good riddance. This year I wanted to start some formal projects, as well as write longer pieces, and I managed to do just that. Here’s the high-level stuff I did this past year.

Financialization. I started a project on financialization with the Roosevelt Institute, and I’m helping with a big inequality project helmed by Joe Stiglitz. All this will bear fruit next year, but I did a piece on financialization for Washington Monthly, Frenzied Financialization, that gives you some sense of what we’ll be doing.

(Seeing one's name on a magazine stand is still the coolest.)

Voluntarism. I wrote a big article on The Voluntarism Fantasy (pdf) for Democracy Journal, that had a lot of responses (collected here). One of my favorite pieces I’ve done; Philanthropy Daily, of all places, red-baited me, which was a neat enemy to make in 2014.



(Remember this cover?)

Piketty-Mania. There were races to see how quickly reviews of Piketty’s Capital in the 21st Century could get written. My review, Studying the Rich for Boston Review, was scheduled for late summer and had to be turned around in a week after the demand for readable summaries of the book exploded. I think my review holds up in describing the way the fault lines around the work would unfold.

The two points I wished I had included were Russell Jacoby’s fantastic comparison to the actual Marx’s Capital, on how economic critique has moved from Marx’s factories of production to Piketty’s spreadsheets of distribution, and that what constitutes a “wealth equality” agenda isn’t clear, which I later covered for The Nation. Speaking of...

The Score. I started as a columnist for The Nation with a new economics column, The Score, where I alternate with my former colleague Bryce Covert. It’s still starting up but I’m already happy with columns on socializing Uber and the growth of incarceration. It’s great to work with Bryce again and get to work with the talented editor Sarah Leonard, who is boosting the economic content of The Nation (she also helped launched The Curve with Kathy Grier since joining).

Issue Editing. I also got to help curate and edit an issue of The New Inquiry, The Money Issue. Rob Horning and I had wanted to do something with the weirdness and newness of the finance blogs circa 2007-2009, and hopefully part of that got through here with pieces by Izzy Kaminska and Steve Waldman. I’m very happy to have helped edit the excellent Disgorge the Cash by JW Mason, which will soon relate to the financialization project mentioned above.

Other Writing. I wrote less for the blog this year, but some notable pieces that caught people’s interest included how the “pragmatic” libertarian case for a basic income makes basic errors about the welfare state, explaining the end-of-year fight over financial reform, pieces on how neoconservatism and libertarians have helped get us to the policing situation in Ferguson and elsewhere, and on the limits of liberalism after the 2014 election.

Big pieces for other sites included a review of Playing the Whore for Wonkblog, explaining how we already have a public option for banking and we could expand it for Al-Jazeera America, and a group book review on the role of profit in the state for Boston Review.

What else? In other news I turned 35. My wife got me a Nick Cage in The Rock birthday cake, which is really the best present ever. I moved to Washington DC after a crazy final summer in New York. I’ve been reading a lot of history lately and want to keep incorporating that into my stuff, and I’m enjoying the Eric Foner MOOC of the Civil War era.

Anything you’d like to see different next year? Thanks for reading everyone, see you in 2015.

(Previous editions:  2013, 2012, 2011.)

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Two Contradictory Arguments That Dodd-Frank is Crony Capitalism

Dec 17, 2014Mike Konczal

I’m pretty convinced that the term “crony capitalism,” as deployed by the right, is useless as a political or analytical tool. I keep a close eye on how conservatives talk about financial reform, and according to the right, Dodd-Frank is crony capitalism. Oh noes! But what does that mean, and how can we stop it? Here’s a fascinating case in point: two AEI scholars with different publications argue that we need to stop Dodd-Frank from enabling crony capitalism, and then proceed to describe two opposite, mutually exclusive sets of problems and solutions.

First, a good test question: The Federal Reserve recently required that the largest firms have a greater capital surcharge than had been originally proposed. Is that cronyism?

Here’s one story, from James Pethokoukis in ”Fighting the Crony Capitalist Alliance”: “our highly concentrated and interconnected, Too Big to Fail financial system [...] gives a competitive edge to megabanks.” How is that? Regulators create incentives for big banks to take on risks “such as investing in mortgage-backed securities and complex derivatives.” Banks are the size they are, and do the activities that they do, because of the actions of regulators.

So how do we combat this problem? According to Pethokoukis, we should “substantially raise the capital requirements for Too Big To Fail banks” to limit risk. Even more, “such capital requirements might well nudge the biggest banks into shrinking themselves or breaking up.”

Here’s another story, from Tim Carney’s “Anti-Cronyism Agenda for the 114th Congress”: Dodd-Frank is cronyism because “[e]xcessive regulation is often the most effective crony capitalism.” What’s worse is that Dodd-Frank designates the biggest firms as Systemically Important Financial Institutions (SIFIs), meaning that they pose a systemic risk to the economy. Those firms are put under more regulation, but it’s obviously a cover for a permanent set of protections.

So what should we do? According to Carney’s agenda, Congress should “open banking up to more competition by repealing regulations that give large incumbent banks advantages over smaller ones.” Well, which regulations are those? “Congress should repeal its authority to designate large financial firms as SIFIs.”

Note that though these are from the same institution and carry the same banner of fighting “cronyism,” these agendas are the exact opposite of each other. For Pethokoukis, the important goal is identifying the largest and riskiest institutions and putting aggressive regulations on them, with capital requirements set high enough that they could fundamentally shrink those banks. For Carney, it’s important that we do not identify any firm as too large that it is risky for the economy, and thus increase their capital requirements, since doing so just encourages cronyism -- indeed, it is the logical conclusion of cronyism. Don’t regulate the largest firms with more attention or care; just don’t do anything to them.

In the Pethokoukis version, the financial sector poses a real threat to the stability of the economy, and as such special efforts should be made to prevent failure and handle failure when it does occur. His answer is, essentially, to do more. In the Carney version, there’s no real danger outside the government’s interference, or at least not a danger that is worth a policy solution. His answer is to do nothing, except repeal what regulation already exists.

And, crucially, for Pethokoukis, the recent increase in capital surcharges for SIFIs are a good idea; for Carney, they enshrine the problem by working through the SIFI framework, and are a bad idea. How can a policy agenda be built around such a “cronyism” framework?

There are other problems with “cronyism” as described here. Pethokoukis blames cronyism for the concentration in the financial sector in the last few decades. However the previous argument had been that the size and geographic restrictions that prevented this concentration before the 1990s are the real cronyism. Dodd-Frank blocks a single financial firm from having liabilities in excess of 10 percent of all liabilities, benefitting smaller firms at the expense of larger ones. Is that cronyism or the opposite? Cronyism can’t just be “things turned out in a terrible way when left to the markets.”

As Rich Yeselson notes in a fantastic essay on New Left historians in the recent issue of Democracy, the Gabriel Kolko-inspired stories about how regulations evolves (stories that influence Carney) are monomaniacally mono-causal. So just quoting CEOs’ statements to the press about Dodd-Frank constitutes analysis, as the regulations must obviously flow from elite desires through their captured lackeys in the state.

But Dodd-Frank is more complicated than that - look at the effort to stop the CFPB from starting, or the epic battles both between and within regulators, the state and consumers over derivatives. Carney’s top-down inescapable vision of how reform works leaves no room for the contingency of actual efforts to fix a broken system. In turn, this leaves us with no way to actually critique what Dodd-Frank does. Worse, it conflates fighting “cronyism” with an agenda of laissez-faire economics, liberty of contract, and hard money, sneaking in a three-legged stool of reactionary thought through our concerns about fairness.

Actual cronyism is a real problem, but I’ve seen no evidence that it adds up to a systemic criticism of our economy as a whole. Instead, we need a language of accountability, benefit and power in how markets are structured. Without this, we’ll have no working compass for reform.

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I’m pretty convinced that the term “crony capitalism,” as deployed by the right, is useless as a political or analytical tool. I keep a close eye on how conservatives talk about financial reform, and according to the right, Dodd-Frank is crony capitalism. Oh noes! But what does that mean, and how can we stop it? Here’s a fascinating case in point: two AEI scholars with different publications argue that we need to stop Dodd-Frank from enabling crony capitalism, and then proceed to describe two opposite, mutually exclusive sets of problems and solutions.

First, a good test question: The Federal Reserve recently required that the largest firms have a greater capital surcharge than had been originally proposed. Is that cronyism?

Here’s one story, from James Pethokoukis in ”Fighting the Crony Capitalist Alliance”: “our highly concentrated and interconnected, Too Big to Fail financial system [...] gives a competitive edge to megabanks.” How is that? Regulators create incentives for big banks to take on risks “such as investing in mortgage-backed securities and complex derivatives.” Banks are the size they are, and do the activities that they do, because of the actions of regulators.

So how do we combat this problem? According to Pethokoukis, we should “substantially raise the capital requirements for Too Big To Fail banks” to limit risk. Even more, “such capital requirements might well nudge the biggest banks into shrinking themselves or breaking up.”

Here’s another story, from Tim Carney’s “Anti-Cronyism Agenda for the 114th Congress”: Dodd-Frank is cronyism because “[e]xcessive regulation is often the most effective crony capitalism.” What’s worse is that Dodd-Frank designates the biggest firms as Systemically Important Financial Institutions (SIFIs), meaning that they pose a systemic risk to the economy. Those firms are put under more regulation, but it’s obviously a cover for a permanent set of protections.

So what should we do? According to Carney’s agenda, Congress should “open banking up to more competition by repealing regulations that give large incumbent banks advantages over smaller ones.” Well, which regulations are those? “Congress should repeal its authority to designate large financial firms as SIFIs.”

Note that though these are from the same institution and carry the same banner of fighting “cronyism,” these agendas are the exact opposite of each other. For Pethokoukis, the important goal is identifying the largest and riskiest institutions and putting aggressive regulations on them, with capital requirements set high enough that they could fundamentally shrink those banks. For Carney, it’s important that we do not identify any firm as too large that it is risky for the economy, and thus increase their capital requirements, since doing so just encourages cronyism -- indeed, it is the logical conclusion of cronyism. Don’t regulate the largest firms with more attention or care; just don’t do anything to them.

In the Pethokoukis version, the financial sector poses a real threat to the stability of the economy, and as such special efforts should be made to prevent failure and handle failure when it does occur. His answer is, essentially, to do more. In the Carney version, there’s no real danger outside the government’s interference, or at least not a danger that is worth a policy solution. His answer is to do nothing, except repeal what regulation already exists.

And, crucially, for Pethokoukis, the recent increase in capital surcharges for SIFIs are a good idea; for Carney, they enshrine the problem by working through the SIFI framework, and are a bad idea. How can a policy agenda be built around such a “cronyism” framework?

There are other problems with “cronyism” as described here. Pethokoukis blames cronyism for the concentration in the financial sector in the last few decades. However the previous argument had been that the size and geographic restrictions that prevented this concentration before the 1990s are the real cronyism. Dodd-Frank blocks a single financial firm from having liabilities in excess of 10 percent of all liabilities, benefitting smaller firms at the expense of larger ones. Is that cronyism or the opposite? Cronyism can’t just be “things turned out in a terrible way when left to the markets.”

As Rich Yeselson notes in a fantastic essay on New Left historians in the recent issue of Democracy, the Gabriel Kolko-inspired stories about how regulations evolves (stories that influence Carney) are monomaniacally mono-causal. So just quoting CEOs’ statements to the press about Dodd-Frank constitutes analysis, as the regulations must obviously flow from elite desires through their captured lackeys in the state.

But Dodd-Frank is more complicated than that - look at the effort to stop the CFPB from starting, or the epic battles both between and within regulators, the state and consumers over derivatives. Carney’s top-down inescapable vision of how reform works leaves no room for the contingency of actual efforts to fix a broken system. In turn, this leaves us with no way to actually critique what Dodd-Frank does. Worse, it conflates fighting “cronyism” with an agenda of laissez-faire economics, liberty of contract, and hard money, sneaking in a three-legged stool of reactionary thought through our concerns about fairness.

Actual cronyism is a real problem, but I’ve seen no evidence that it adds up to a systemic criticism of our economy as a whole. Instead, we need a language of accountability, benefit and power in how markets are structured. Without this, we’ll have no working compass for reform.

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New Score: Socialize Uber

Dec 17, 2014Mike Konczal

I have a new Score column at The Nation: Socialize Uber. It's about Uber and other sharing economy companies as worker cooperatives. Normally I eyeroll when people talk about cooperatives as an economic solution, but I think there's compelling stuff here. Given that the workers already own all the capital in the form of their cars, why aren’t they collecting all the profits? I'm particularly interested in the comparisons to the Populist movement in this new economy, as back then workers also were amazed by new technologies but also wanted fairness on the terms they could access them.

We've also revamped how the Score looks, particularly the online part of it, so I hope you check it out. There's some commentary already from Will Wilkinson and Brian Dominick. It's definitely a moment where people are thinking about this, as columns from Nathan Schneider and Trebor Scholz also came out at the same time making similar arguments about worker cooperatives.

Sure Pricing

Uber is also in the news because they turned on surge pricing during a terrorist hostage situation in Sydney, Australia. This has gotten people talking about surge pricing. I don't mind surge pricing, but the moralizing way journalists talk about it is really off-putting. Matt Bruenig has a good response to an example of this by Olivia Nuzzi ("How does the world owe you a private car, priced as you deem acceptable, that didn't exist five years ago? [...] you might consider meandering over to a country with a different economic system").

To expand on Matt, there's two reasons why people might want to avoid surge pricing that virtually never get discussed.

One is that people care about fairness. As Arin Dube wrote about the minimum wage, "the economists Colin F. Camerer and Ernst Fehr have documented in numerous experimental studies that the preference for fairness in transactions is strong: individuals are often willing to sacrifice their own payoffs to punish those who are seen as acting unfairly, and such punishments activate reward-related neural circuits." This is why you see high support for the minimum wage among people who otherwise support right-wing economic ideas, as we just saw in the 2014 elections.

People care about fairness; it's in their utility function if you prefer. It's a funny economic argument where markets are meant to serve what people want, and producers are meant to meet those needs at the lowest possible cost, but if people want fairness built into the cost model then it's all sneering all the time. It's almost as if the moment is about conditioning people to serve market needs, rather than markets to serve people needs. If people demanded a cola beveridge that, say, was less sweet, would we get Daily Beast articles about "how dare you, the world doesn't owe you a less sweet cola, move to North Korea if you want to see your market demands turn into products." And there's a long history of using moral persuasion to try and limit price-gouging - check out Little House on the Prairie.

But the first issue becomes more relevant with a second concern, however, and that's the increasingly negative view of Uber's tactics. People don't have perfect information, and it's reasonable that they might want to pool the risk that they'll be targeted for price discrimination. The obvious comparison here was that early moment Amazon turned out to be charging higher prices based on your browsing history, which it promptly shut down after public outcry. (Why don't you meander over to a different country if you don't want Amazon data-mining your browser to rip you off?)

Why were people offended? Because in that case the price discimination just transfered the surplus from the customers to the producers - there wasn't any allocative effect. And the same worry can carry over to surge pricing.

Without perfect information, customers don't really know if they are getting price surged based on supply-and-demand fundamentals or on their own individual characteristics. Imagine if the algorithm increased the liklihood of price surging based on people's past willingness to select price surging. Or because a neighborhood is more like to accept price surging. I assume we'd be mad, right? That wouldn't have an allocative effect - it would just be ripping off those people because the code can tell they'd be willing to pay more.

Are they doing this now, or will they do this in the future? Normally trust is what would help mitigate both these worries, but with stories about "God mode" and their take-no-prisoners approach to everything, trust is in increasingly low supply.

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I have a new Score column at The Nation: Socialize Uber. It's about Uber and other sharing economy companies as worker cooperatives. Normally I eyeroll when people talk about cooperatives as an economic solution, but I think there's compelling stuff here. Given that the workers already own all the capital in the form of their cars, why aren’t they collecting all the profits? I'm particularly interested in the comparisons to the Populist movement in this new economy, as back then workers also were amazed by new technologies but also wanted fairness on the terms they could access them.

We've also revamped how the Score looks, particularly the online part of it, so I hope you check it out. There's some commentary already from Will Wilkinson and Brian Dominick. It's definitely a moment where people are thinking about this, as columns from Nathan Schneider and Trebor Scholz also came out at the same time making similar arguments about worker cooperatives.

Sure Pricing

Uber is also in the news because they turned on surge pricing during a terrorist hostage situation in Sydney, Australia. This has gotten people talking about surge pricing. I don't mind surge pricing, but the moralizing way journalists talk about it is really off-putting. Matt Bruenig has a good response to an example of this by Olivia Nuzzi ("How does the world owe you a private car, priced as you deem acceptable, that didn't exist five years ago? [...] you might consider meandering over to a country with a different economic system").

To expand on Matt, there's two reasons why people might want to avoid surge pricing that virtually never get discussed.

One is that people care about fairness. As Arin Dube wrote about the minimum wage, "the economists Colin F. Camerer and Ernst Fehr have documented in numerous experimental studies that the preference for fairness in transactions is strong: individuals are often willing to sacrifice their own payoffs to punish those who are seen as acting unfairly, and such punishments activate reward-related neural circuits." This is why you see high support for the minimum wage among people who otherwise support right-wing economic ideas, as we just saw in the 2014 elections.

People care about fairness; it's in their utility function if you prefer. It's a funny economic argument where markets are meant to serve what people want, and producers are meant to meet those needs at the lowest possible cost, but if people want fairness built into the cost model then it's all sneering all the time. It's almost as if the moment is about conditioning people to serve market needs, rather than markets to serve people needs. If people demanded a cola beveridge that, say, was less sweet, would we get Daily Beast articles about "how dare you, the world doesn't owe you a less sweet cola, move to North Korea if you want to see your market demands turn into products." And there's a long history of using moral persuasion to try and limit price-gouging - check out Little House on the Prairie.

But the first issue becomes more relevant with a second concern, however, and that's the increasingly negative view of Uber's tactics. People don't have perfect information, and it's reasonable that they might want to pool the risk that they'll be targeted for price discrimination. The obvious comparison here was that early moment Amazon turned out to be charging higher prices based on your browsing history, which it promptly shut down after public outcry. (Why don't you meander over to a different country if you don't want Amazon data-mining your browser to rip you off?)

Why were people offended? Because in that case the price discimination just transfered the surplus from the customers to the producers - there wasn't any allocative effect. And the same worry can carry over to surge pricing.

Without perfect information, customers don't really know if they are getting price surged based on supply-and-demand fundamentals or on their own individual characteristics. Imagine if the algorithm increased the liklihood of price surging based on people's past willingness to select price surging. Or because a neighborhood is more like to accept price surging. I assume we'd be mad, right? That wouldn't have an allocative effect - it would just be ripping off those people because the code can tell they'd be willing to pay more.

Are they doing this now, or will they do this in the future? Normally trust is what would help mitigate both these worries, but with stories about "God mode" and their take-no-prisoners approach to everything, trust is in increasingly low supply.

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The Bipartisan Policy Center Gets It Wrong: The Lincoln Amendment is Critical to Financial Reform

Dec 11, 2014Mike KonczalAlexis GoldsteinCaitlin Kline

A wide variety of people, ranging from Senators Elizabeth Warren and David Vitter to Representative Maxine Waters and FDIC’s Thomas Hoenig, are trying to stop a last-minute attempt to remove an important piece of financial reform. They are all speaking up against a move to repeal the Lincoln Amendment using language written by Citigroup in the year-end budget process.

Given the wide variety of people against it, it’s interesting how few people are for it. One of the few institutions that has defended it is the Bipartisan Policy Center (BPC), whose Financial Regulatory Reform Initiative released a statement saying:

“The Consolidated and Further Continuing Appropriations Act is consistent with BPC’s recommendations to repeal the Lincoln Amendment and to substantially increase funding for the SEC and CFTC.”

These recommendations they cite date back to a 2013 paper, “Better Path Forward on the Volcker Rule and the Lincoln Amendment,” that included arguments against pushing out swaps.

What’s their case, and does it hold up under scrutiny? We argue it does not. It misreads the purpose and scope of the Volcker Rule, disregards their own analysis on how financial reform should proceed, misses recent developments in the derivatives market, and ignores the issue of what an implicit government support means for exotic derivatives.

As a reminder, the Lincoln Amendment pushing out swaps (which we’ll refer to as 716) insists that the largest banks hold their exotic, customized, and non-cleared derivatives outside of their FDIC-insured entities in separately capitalized subsidiaries. 716 exempted most standardized derivatives, including interest rate and foreign exchange swaps, as well as cleared credit default swaps (CDS). This provision only applies to the odd and dangerous stuff.

So what are BPC's arguments?

716 and Volcker Accomplish Different Goals

Their core argument is that 716 is redundant, and therefore unnecessary, because of the Volcker Rule.  As they put it,“[L]ike the Volcker Rule, the Lincoln Amendment was intended to separate certain securities-related activities from traditional banking activities.” BPC further argues that with a “proper implementation of the Volcker Rule… the rationale for the Lincoln Amendment may no longer apply.”

This is not the case. The Volcker Rule is about risky activities, and focuses on eliminating the gambling risks associated with proprietary trading and exposure to certain types of investment funds. 716, on the other hand, is about risky products, and aims to reduce risk to the Deposit Insurance Fund (DIF) by utilizing separately capitalized entities for the riskiest derivatives.

While there is some overlap between the two, there are significant gaps. For instance, exemptions in the Volcker Rule allow some of the riskiest trades to be done within FDIC-insured entities -- things like making markets in bespoke, exotic, uncleared credit default swaps. Indeed, walking away from the financial crisis with an attitude that uncleared credit default swaps are no big issue is quite troubling. This puts the Deposit Insurance Fund at risk. 

716 complements Volcker by forcing the riskiest and most non-vanilla derivatives and CDS into a separately capitalized entity, something Volcker doesn’t do by itself. This helps protect the DIF in case a firm gets into trouble market-making bespoke trades that can’t be perfectly hedged – a Volcker-compliant activity. 

The Final Volcker Rule Isn’t Fully Implemented

Shockingly, BPC is violating its own analysis with this recommendation. In the 2013 paper, BPC “recommends a wait-and-see approach regarding the Lincoln Amendment until more experience can be gained from the Volcker Rule.” Only then, if the full implementation of the Volcker Rule is working well, could the Lincoln Amendment “be repealed without any negative effect.”

It is disturbing that the BPC supports this removal of the Lincoln Amendment before the Volcker Rule is fully implemented in mid-2015, and even before we've had time to see how it impacts the financial markets. It’s not even clear how they are judging whether the Volcker Rule is working the way they want, given that the data and metrics they rely on so heavily have only just begun to be reported to regulators, and are non-public.

Shoving a bank-written addition into a budget bill, not unlike the CFMA of 2000 which helped create the crisis, is the exact opposite of a “wait-and-see approach.”

Pushout Doesn’t Harm Bank Resolution

Another argument made against 716 was that it would complicate the ability of regulators to deal with a bank failure. BPC points out that regulators are empowered to grant a temporary stay to derivatives, preventing derivative creditors from grabbing collateral while others wait two days, as they did with Lehman Brothers. (Under bankruptcy, derivatives are exempt from this temporary stay, which can complicate and accelerate bankruptcy.)

Part of the argument is true: Dodd-Frank did grant the FDIC new powers under the Orderly Liquidation Authority, which allows them to force a 24-hour stay on derivatives (overriding the exemption), but this only applies to banks under FDIC purview.

BPC argued that the largest banks should be allowed to keep derivatives inside the FDIC accounts, so that they could utilize the FDIC’s OLA power. BPC writes that the 716 “subsidiaries would not enjoy the temporary stay on the unwinding of contracts that applies to banks under FDIC resolution procedures. Rapid termination of such contracts in the event of a bank failure would have a disruptive impact on financial markets."

But this argument is much less valid than it was when it was written, precisely because regulators are anticipating this problem. Eighteen of the major banks and the International Swaps and Derivatives Association (ISDA) agreed in October that they’d contractually apply temporary stays to derivatives. With wide agreement among the banks to apply temporary stays anyway, the proper course of action is to work through this process of standardizing derivatives for automatic stays across the financial sector, rather than trying to use taxpayer funds to backstop them.

Apart from the BPC arguments, we wish to raise an additional point:  

Should Policy Allow Firms to Capitalize on Market-Perceived Subsidies?

Keeping derivatives in FDIC-insured entities lowers their costs: creditors charge lower rates, as FDIC accounts are seen as having the backing of the federal government. And these FDIC accounts typically have higher credit ratings, which is why, in 2011, Bank of America moved derivatives from its Merrill Lynch subsidiary, which had just suffered a downgrade, into its FDIC-insured subsidiary, much to the chagrin of the FDIC.

As Peter Eavis writes in The New York Times, this directly helps Citigroup, who lobbied for and wrote the change, as they own a lot of CDS: “With some $3 trillion of exposure, the bank is one of biggest default swap dealers in the United States. Those swaps right now live inside an entity called Citibank N.A. that enjoys federal deposit insurance. Nearly $2 trillion of those swaps are based on companies or other entities with a junk credit rating.”

And as Eavis points out, it’s very likely that a huge portion of Citigroup’s CDS are uncleared, as very few CDS overall are cleared: “Only about 10 percent of such swaps are centrally cleared, according to official surveys.”

Banks keeping derivatives in the FDIC accounts lower their cost of doing business, due to the market perception of an implicit government support. It should not be the role of policy to artificially lower the cost of bank borrowing, and as such we find the case for removing the Lincoln Amendment to be unconvincing.

Mike Konczal is a Fellow at the Roosevelt Institute.

Alexis Goldstein is a former Wall Street professional, who now serves as the Communications Director at Other98.org.

Caitlin Kline is a derivatives specialist at Better Markets.

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A wide variety of people, ranging from Senators Elizabeth Warren and David Vitter to Representative Maxine Waters and FDIC’s Thomas Hoenig, are trying to stop a last-minute attempt to remove an important piece of financial reform. They are all speaking up against a move to repeal the Lincoln Amendment using language written by Citigroup in the year-end budget process.

Given the wide variety of people against it, it’s interesting how few people are for it. One of the few institutions that has defended it is the Bipartisan Policy Center (BPC), whose Financial Regulatory Reform Initiative released a statement saying:

“The Consolidated and Further Continuing Appropriations Act is consistent with BPC’s recommendations to repeal the Lincoln Amendment and to substantially increase funding for the SEC and CFTC.”

These recommendations they cite date back to a 2013 paper, “Better Path Forward on the Volcker Rule and the Lincoln Amendment,” that included arguments against pushing out swaps.

What’s their case, and does it hold up under scrutiny? We argue it does not. It misreads the purpose and scope of the Volcker Rule, disregards their own analysis on how financial reform should proceed, misses recent developments in the derivatives market, and ignores the issue of what an implicit government support means for exotic derivatives.

As a reminder, the Lincoln Amendment pushing out swaps (which we’ll refer to as 716) insists that the largest banks hold their exotic, customized, and non-cleared derivatives outside of their FDIC-insured entities in separately capitalized subsidiaries. 716 exempted most standardized derivatives, including interest rate and foreign exchange swaps, as well as cleared credit default swaps (CDS). This provision only applies to the odd and dangerous stuff.

So what are BPC's arguments?

716 and Volcker Accomplish Different Goals

Their core argument is that 716 is redundant, and therefore unnecessary, because of the Volcker Rule.  As they put it,“[L]ike the Volcker Rule, the Lincoln Amendment was intended to separate certain securities-related activities from traditional banking activities.” BPC further argues that with a “proper implementation of the Volcker Rule… the rationale for the Lincoln Amendment may no longer apply.”

This is not the case. The Volcker Rule is about risky activities, and focuses on eliminating the gambling risks associated with proprietary trading and exposure to certain types of investment funds. 716, on the other hand, is about risky products, and aims to reduce risk to the Deposit Insurance Fund (DIF) by utilizing separately capitalized entities for the riskiest derivatives.

While there is some overlap between the two, there are significant gaps. For instance, exemptions in the Volcker Rule allow some of the riskiest trades to be done within FDIC-insured entities -- things like making markets in bespoke, exotic, uncleared credit default swaps. Indeed, walking away from the financial crisis with an attitude that uncleared credit default swaps are no big issue is quite troubling. This puts the Deposit Insurance Fund at risk. 

716 complements Volcker by forcing the riskiest and most non-vanilla derivatives and CDS into a separately capitalized entity, something Volcker doesn’t do by itself. This helps protect the DIF in case a firm gets into trouble market-making bespoke trades that can’t be perfectly hedged – a Volcker-compliant activity. 

The Final Volcker Rule Isn’t Fully Implemented

Shockingly, BPC is violating its own analysis with this recommendation. In the 2013 paper, BPC “recommends a wait-and-see approach regarding the Lincoln Amendment until more experience can be gained from the Volcker Rule.” Only then, if the full implementation of the Volcker Rule is working well, could the Lincoln Amendment “be repealed without any negative effect.”

It is disturbing that the BPC supports this removal of the Lincoln Amendment before the Volcker Rule is fully implemented in mid-2015, and even before we've had time to see how it impacts the financial markets. It’s not even clear how they are judging whether the Volcker Rule is working the way they want, given that the data and metrics they rely on so heavily have only just begun to be reported to regulators, and are non-public.

Shoving a bank-written addition into a budget bill, not unlike the CFMA of 2000 which helped create the crisis, is the exact opposite of a “wait-and-see approach.”

Pushout Doesn’t Harm Bank Resolution

Another argument made against 716 was that it would complicate the ability of regulators to deal with a bank failure. BPC points out that regulators are empowered to grant a temporary stay to derivatives, preventing derivative creditors from grabbing collateral while others wait two days, as they did with Lehman Brothers. (Under bankruptcy, derivatives are exempt from this temporary stay, which can complicate and accelerate bankruptcy.)

Part of the argument is true: Dodd-Frank did grant the FDIC new powers under the Orderly Liquidation Authority, which allows them to force a 24-hour stay on derivatives (overriding the exemption), but this only applies to banks under FDIC purview.

BPC argued that the largest banks should be allowed to keep derivatives inside the FDIC accounts, so that they could utilize the FDIC’s OLA power. BPC writes that the 716 “subsidiaries would not enjoy the temporary stay on the unwinding of contracts that applies to banks under FDIC resolution procedures. Rapid termination of such contracts in the event of a bank failure would have a disruptive impact on financial markets."

But this argument is much less valid than it was when it was written, precisely because regulators are anticipating this problem. Eighteen of the major banks and the International Swaps and Derivatives Association (ISDA) agreed in October that they’d contractually apply temporary stays to derivatives. With wide agreement among the banks to apply temporary stays anyway, the proper course of action is to work through this process of standardizing derivatives for automatic stays across the financial sector, rather than trying to use taxpayer funds to backstop them.

Apart from the BPC arguments, we wish to raise an additional point:  

Should Policy Allow Firms to Capitalize on Market-Perceived Subsidies?

Keeping derivatives in FDIC-insured entities lowers their costs: creditors charge lower rates, as FDIC accounts are seen as having the backing of the federal government. And these FDIC accounts typically have higher credit ratings, which is why, in 2011, Bank of America moved derivatives from its Merrill Lynch subsidiary, which had just suffered a downgrade, into its FDIC-insured subsidiary, much to the chagrin of the FDIC.

As Peter Eavis writes in The New York Times, this directly helps Citigroup, who lobbied for and wrote the change, as they own a lot of CDS: “With some $3 trillion of exposure, the bank is one of biggest default swap dealers in the United States. Those swaps right now live inside an entity called Citibank N.A. that enjoys federal deposit insurance. Nearly $2 trillion of those swaps are based on companies or other entities with a junk credit rating.”

And as Eavis points out, it’s very likely that a huge portion of Citigroup’s CDS are uncleared, as very few CDS overall are cleared: “Only about 10 percent of such swaps are centrally cleared, according to official surveys.”

Banks keeping derivatives in the FDIC accounts lower their cost of doing business, due to the market perception of an implicit government support. It should not be the role of policy to artificially lower the cost of bank borrowing, and as such we find the case for removing the Lincoln Amendment to be unconvincing.

Mike Konczal is a Fellow at the Roosevelt Institute.

Alexis Goldstein is a former Wall Street professional, who now serves as the Communications Director at Other98.org.

Caitlin Kline is a derivatives specialist at Better Markets.

Follow or contact the Rortybomb blog:
 
  

 

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