Prioritization, Credit Risks and the Potential for Default

Jan 15, 2013Mike Konczal

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

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

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

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

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

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

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

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

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

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

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

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

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

Jan 15, 2013Mike Konczal

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

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

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

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

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

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

 

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

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

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

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

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

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

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The Game Theory of the Post-Platinum Coin Debt Ceiling

Jan 14, 2013Mike Konczal

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

 

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

 

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On the Geithner Legacy

Jan 11, 2013Mike Konczal

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

I: Sugar

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

 

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

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

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

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

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

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

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

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

II: A Tale of Two Programs

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

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

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

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

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

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

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

I: Sugar

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

 

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

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

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

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

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

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

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

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

II: A Tale of Two Programs

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

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

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

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

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

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

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

Jan 9, 2013Mike Konczal

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

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

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

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

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

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

The Real Problem With a Trillion Dollar Platinum Coin

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

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

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

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

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

Thoughts?

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

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

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

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

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

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

The Real Problem With a Trillion Dollar Platinum Coin

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

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

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

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

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

Thoughts?

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What Was Just Watered Down in Basel's Liquidity Requirements?

Jan 8, 2013Mike Konczal

Let’s say you were trying to make a personal budget. We can imagine two reasonable ideas you would want to incorporate into this budget. The first is that you want to make sure you can pay your bills if your income suddenly freezes up or you suddenly need cash. You want to make sure your savings are sufficiently liquid in case there is an emergency.

Another rule is that you want your time horizon of your debts to match what you are buying with those debts. You don’t want a 4-year mortgage and a 30-year auto loan; you want a 4-year auto loan and a 30-year mortgage. And for our purposes, you really don’t want to buy either on a credit card, since the payment terms can fluctuate so often in the short term.

These two ideas are behind two of the additional special forms of capital requirements designed by the Basel Committee on Banking Supervision in Basel III. The first is a “Liquidity Coverage Ratio” (LCR), which is designed to make sure that a financial firm has sufficiently liquid resources to survive a crisis where financial liquidity has dried up for 30 days. The second is a “Net Stable Funding Ratio,” which is designed to complement the first rule and seeks to incentivize banks to use funds with more stable debts featuring long-term horizons.

Basel has just introduced some changes into their final LCR rule, so let’s take a deep dive into this capital requirement rule. Before we introduce some headache-inducing acronyms, remember that the basics are simple here. Banks have a store of assets and they have obligations that they have to make. Or, at the simplest level, banks have a pile of money or things that can be turned into money and people and firms who are demanding money. So any watering down of the rule has to impact one of those two things.

Remember that in a crisis it is hard to sell assets to get the cash you need to make your payments. Also, crucially, others will want to take out more from the bank if they are worried about the bank’s assets, like in a bank run. So both of these items are stressed in the rule to get numbers sufficient to survive a crisis. Banks would prefer to count riskier kinds of things as those safe assets, and assume that firms would want to take less in times of crisis. Each allows them to have to hold less high-quality capital.

There are three major changes announced. The first is that the requirements will be slowly phased in each year for the next several years, fully online by 2019. This is to avoid putting additional credit stresses on the financial system right now. There's also a clarification that assets can be drawn down in times of crisis. But how will these regulations look when they are online? The other two changes are the way the actual mechanisms are calculated.

Let’s chart out those last two changes that were just introduced:

Originally there were just two levels of assets, level 1 and level 2. The second change is to create a new level of assets, called “Level 2B.” Level 1 is unchanged, as well as the old Level 2, which is now Level 2A. Level 2B will be no more than 15 percent of total assets, but it will include lower rated corporate debt (BBB- or above) and, more shockingly, equity shares. Equity is not what you want as a liquidity buffer, as its value will plummet and volatility will skyrocket during crises. In a crisis all correlations go to 1, and that’s especially true in a financial crisis. The fact that it might have done well in the 2008 crisis is no excuse because, as Economics of Contempt pointed out on this topic, there were massive government bailouts and interventions in the market, which is what we want to avoid.

On the plus side, rather than just putting equities in “Level 2,” they created a separate bucket with harsher penalties. Equities will receive a 50 percent haircut toward qualifying, much larger than the 15 percent haircut Level 2A assets get.

The third change is the lower outflow rate for liquidity facilities, corporate deposits as well as other sources of outflows. To get a sense of this, stable deposits with a serious system of deposit insurance – think of your FDIC savings account – originally had a 5 percent outflow. A bank would have to be prepared for 5 percent of its deposits to leave during this financial crisis. That has been reduced to 3 percent in the new rule.

These changes are particularly large for liquidity facilities. Instead of the assumption that firms will go gunning for any emergency liquidity that they can find, and as such use up most of these outlines, there are much more financial-friendly outflow estimates. In fact, many of these rates have been cut by more than half, with Basel now estimating that liquidity facilities, for instance, will only be drawn down 30 percent instead of 100 percent.

These are dramatic reductions. If they are predicated on more closely aligning with 2008 numbers, backstopping the entire liquidity of the financial markets was the whole point of the bailouts and the Federal Reserve’s emergency interventions. The numbers should be much worse in this case.

There is finally a global rule declaring a necessary, but not sufficient, minimum level of liquidity in financial firms. Liquidity does nothing if a firm is insolvent, but it by itself can generate panics. However these rule changes almost all entirely benefit the financial system, and call for less liquidity than in the first drafts. Undercounting the liquidity facilities, as well as letting more of the HQLA consist of assets like stocks and MBS, is a major change from the previous version.

The Basel committee notes that its Liquidity Coverage Ratio is an absolute minimum rate, and that “national authorities may require higher minimum levels of liquidity.” Authorities within the United States should take this seriously. Dodd-Frank calls on regulators to put in sufficient liquidity regulations for large financial firms. Basel III provides a baseline, but regulators could go further by themselves if necessary via their Dodd-Frank mandate. Understanding why the outflow assumptions have so dramatically changed will be one point to follow.

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Let’s say you were trying to make a personal budget. We can imagine two reasonable ideas you would want to incorporate into this budget. The first is that you want to make sure you can pay your bills if your income suddenly freezes up or you suddenly need cash. You want to make sure your savings are sufficiently liquid in case there is an emergency.

Another rule is that you want your time horizon of your debts to match what you are buying with those debts. You don’t want a 4-year mortgage and a 30-year auto loan; you want a 4-year auto loan and a 30-year mortgage. And for our purposes, you really don’t want to buy either on a credit card, since the payment terms can fluctuate so often in the short term.

These two ideas are behind two of the additional special forms of capital requirements designed by the Basel Committee on Banking Supervision in Basel III. The first is a “Liquidity Coverage Ratio” (LCR), which is designed to make sure that a financial firm has sufficiently liquid resources to survive a crisis where financial liquidity has dried up for 30 days. The second is a “Net Stable Funding Ratio,” which is designed to complement the first rule and seeks to incentivize banks to use funds with more stable debts featuring long-term horizons.

Basel has just introduced some changes into their final LCR rule, so let’s take a deep dive into this capital requirement rule. Before we introduce some headache-inducing acronyms, remember that the basics are simple here. Banks have a store of assets and they have obligations that they have to make. Or, at the simplest level, banks have a pile of money or things that can be turned into money and people and firms who are demanding money. So any watering down of the rule has to impact one of those two things.

Remember that in a crisis it is hard to sell assets to get the cash you need to make your payments. Also, crucially, others will want to take out more from the bank if they are worried about the bank’s assets, like in a bank run. So both of these items are stressed in the rule to get numbers sufficient to survive a crisis. Banks would prefer to count riskier kinds of things as those safe assets, and assume that firms would want to take less in times of crisis. Each allows them to have to hold less high-quality capital.

There are three major changes announced. The first is that the requirements will be slowly phased in each year for the next several years, fully online by 2019. This is to avoid putting additional credit stresses on the financial system right now. There's also a clarification that assets can be drawn down in times of crisis. But how will these regulations look when they are online? The other two changes are the way the actual mechanisms are calculated.

Let’s chart out those last two changes that were just introduced:

Originally there were just two levels of assets, level 1 and level 2. The second change is to create a new level of assets, called “Level 2B.” Level 1 is unchanged, as well as the old Level 2, which is now Level 2A. Level 2B will be no more than 15 percent of total assets, but it will include lower rated corporate debt (BBB- or above) and, more shockingly, equity shares. Equity is not what you want as a liquidity buffer, as its value will plummet and volatility will skyrocket during crises. In a crisis all correlations go to 1, and that’s especially true in a financial crisis. The fact that it might have done well in the 2008 crisis is no excuse because, as Economics of Contempt pointed out on this topic, there were massive government bailouts and interventions in the market, which is what we want to avoid.

On the plus side, rather than just putting equities in “Level 2,” they created a separate bucket with harsher penalties. Equities will receive a 50 percent haircut toward qualifying, much larger than the 15 percent haircut Level 2A assets get.

The third change is the lower outflow rate for liquidity facilities, corporate deposits as well as other sources of outflows. To get a sense of this, stable deposits with a serious system of deposit insurance – think of your FDIC savings account – originally had a 5 percent outflow. A bank would have to be prepared for 5 percent of its deposits to leave during this financial crisis. That has been reduced to 3 percent in the new rule.

These changes are particularly large for liquidity facilities. Instead of the assumption that firms will go gunning for any emergency liquidity that they can find, and as such use up most of these outlines, there are much more financial-friendly outflow estimates. In fact, many of these rates have been cut by more than half, with Basel now estimating that liquidity facilities, for instance, will only be drawn down 30 percent instead of 100 percent.

These are dramatic reductions. If they are predicated on more closely aligning with 2008 numbers, backstopping the entire liquidity of the financial markets was the whole point of the bailouts and the Federal Reserve’s emergency interventions. The numbers should be much worse in this case.

There is finally a global rule declaring a necessary, but not sufficient, minimum level of liquidity in financial firms. Liquidity does nothing if a firm is insolvent, but it by itself can generate panics. However these rule changes almost all entirely benefit the financial system, and call for less liquidity than in the first drafts. Undercounting the liquidity facilities, as well as letting more of the HQLA consist of assets like stocks and MBS, is a major change from the previous version.

The Basel committee notes that its Liquidity Coverage Ratio is an absolute minimum rate, and that “national authorities may require higher minimum levels of liquidity.” Authorities within the United States should take this seriously. Dodd-Frank calls on regulators to put in sufficient liquidity regulations for large financial firms. Basel III provides a baseline, but regulators could go further by themselves if necessary via their Dodd-Frank mandate. Understanding why the outflow assumptions have so dramatically changed will be one point to follow.

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Rortybomb's Best of 2012 Roundup and Linkfest

Dec 31, 2012Mike Konczal

I want to thank everyone who has read, commented, emailed, tweeted, shared and otherwised engaged with me and this blog over the past year. Especially as I moved from the old blog to the new one here. I'm pretty happy with how 2012 went, and I hope to keep it going into 2013. Here's a recap of the best stuff I was up to in 2012 for those who would want a best of list. (Here's the equivalent list for 2011.)

One goal for 2012 was writing some longer think pieces, and that went went pretty well. Some of my favorites were a piece on the ideology of mass incarceration for Jacobin, the death of public higher education and the Master Plan for Dissent (with Aaron Bady), a lead essay for a forum on debt reduction and the recession for Boston Review, and a piece against coupon government and for public provisioning for New America (a shorter version in Dissent here).

The most read blog post of the year (which may be the most read thing I've written) was an animated gif explanation to the recent Jackson Hole conference on monetary policy, both here and at Business Insider. The election provided most-read posts number two and three: I wrote a post showing how Mitt Romney's 5-point economic plan was the same plan from 2008 and 2004, and I argued for a policy agenda that followed from the "you didn't build that" comment. Back when everyone was trying to figure out why the Federal Reserve wasn't being aggressive, my interview with Joe Gagnon on the Fed started a debate on the topic. I also analyzed four histories of the 47 percent meme after Mitt Romney's blunder tape.

Personal favorite blog posts that are a little extra econ-geeky: updated my topological map of theories of the recession with latest information, an argument for why taxing capital income is fair, as well as taking apart that dubious "uncertainty index" that floats out there in the economic debates.

At the end of the year I started contributing economic articles to the American Prospect, and you can see the list of articles here. I'm trying to build out where liberalism will evolve post-Obama, and I've written about how liberals will fight over full employment, and the future of the welfare state. The second was read widely on the right, as Bryon York went around Fox News, conservative radio and articles about how it was the liberal agenda. As he wrote, "Obama's liberal supporters do have a second-term agenda, and it is a far-reaching one. That agenda, laid out a new article in the liberal magazine the American Prospect, is enough to set off alarm bells among conservatives in Washington and around the country."

Four things: I'm going to engage more with comments at this site, now that I have a mechanism to see when they are posted easier. Second, if you are looking to expand your magazine subscriptions in 2013, consider subscribing to some of the magazines I've had the privilege of writing for in the past year. These magazines are nurturing all kinds of new talent, and that pipeline is important for the years ahead. Third, feel free to leave a comment with some ideas, either specific to this webpage or more general, about what you'd like to see here in the year ahead. And fourth, thanks for reading and hope to see you in the new year!

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I want to thank everyone who has read, commented, emailed, tweeted, shared and otherwised engaged with me and this blog over the past year. Especially as I moved from the old blog to the new one here. I'm pretty happy with how 2012 went, and I hope to keep it going into 2013. Here's a recap of the best stuff I was up to in 2012 for those who would want a best of list. (Here's the equivalent list for 2011.)

One goal for 2012 was writing some longer think pieces, and that went went pretty well. Some of my favorites were a piece on the ideology of mass incarceration for Jacobin, the death of public higher education and the Master Plan for Dissent (with Aaron Bady), a lead essay for a forum on debt reduction and the recession for Boston Review, and a piece against coupon government and for public provisioning for New America (a shorter version in Dissent here).

The most read blog post of the year (which may be the most read thing I've written) was an animated gif explanation to the recent Jackson Hole conference on monetary policy, both here and at Business Insider. The election provided most-read posts number two and three: I wrote a post showing how Mitt Romney's 5-point economic plan was the same plan from 2008 and 2004, and I argued for a policy agenda that followed from the "you didn't build that" comment. Back when everyone was trying to figure out why the Federal Reserve wasn't being aggressive, my interview with Joe Gagnon on the Fed started a debate on the topic. I also analyzed four histories of the 47 percent meme after Mitt Romney's blunder tape.

Personal favorite blog posts that are a little extra econ-geeky: updated my topological map of theories of the recession with latest information, an argument for why taxing capital income is fair, as well as taking apart that dubious "uncertainty index" that floats out there in the economic debates.

At the end of the year I started contributing economic articles to the American Prospect, and you can see the list of articles here. I'm trying to build out where liberalism will evolve post-Obama, and I've written about how liberals will fight over full employment, and the future of the welfare state. The second was read widely on the right, as Bryon York went around Fox News, conservative radio and articles about how it was the liberal agenda. As he wrote, "Obama's liberal supporters do have a second-term agenda, and it is a far-reaching one. That agenda, laid out a new article in the liberal magazine the American Prospect, is enough to set off alarm bells among conservatives in Washington and around the country."

Four things: I'm going to engage more with comments at this site, now that I have a mechanism to see when they are posted easier. Second, if you are looking to expand your magazine subscriptions in 2013, consider subscribing to some of the magazines I've had the privilege of writing for in the past year. These magazines are nurturing all kinds of new talent, and that pipeline is important for the years ahead. Third, feel free to leave a comment with some ideas, either specific to this webpage or more general, about what you'd like to see here in the year ahead. And fourth, thanks for reading and hope to see you in the new year!

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How Do the Elderly Spend Money and the Difficulty of Protecting Against Social Security Cuts

Dec 18, 2012Mike Konczal

Dean Baker and Doug Henwood both have good analysis on the cuts involved in chaining inflation. Since the rumored cuts to Social Security will hinge on this way of calculating inflation, I want to dig one level into the data to convey what it will mean and then look at some of the distributional impact.

I.

Let's start with two groups of people. The first is urban wage earners and clerical workers, one select group of the population, who purchase a representative basket of goods and services. How much does the basket of goods they purchase increase in price over time? This cost is called CPI-W, and it is currently used for adjusting Social Security benefits. The second group is all people aged 62 and over. Since the 1980s, the government has calculated the cost of goods and services for this group as well, and it is referred to as CPI-E. What do they spend money on? Here's the relative importance of major categories of spending, provided by the BLS, for each group from December 2007:

Green is where the group spends compartively less. As we can see, the elderly spend a lot more of their (more limited) money on housing, utilities, and medical care. And as you probably know, health care costs have been rising rapidly over the past several decades. With the notable exception of college costs, the things urban wage earners spend money on haven't increased in prices as fast as what the elderly purchase. As a result, the CPI-E has increased 3.3 percent a year from 1982 to 2007, while the CPI-W has only increased 3.0 a year.

But wait, what's this chained thing that is being proposed? Picture that in response to a price increase for one good you could substitute similar items. So if the price of chicken goes up, you could eat more beef. Or if the price of a movie went up, you would rent movies more often. This substitution effect blunts some of the price increases. As such, inflation is lower when you take this into account. It's more complicated than that, but it is a start for a definition.

But we don't have a "chained" version of the CPI-E. And the items that the elderly purchase probably aren't impacted in the same competitive way. If the price of beer goes up, you can drink more wine; if the price of utilities go up, your options are limited. The areas where the elderly pay more don't have the same competitive pressures, and their geography is going to be more limited. We could get a chained version of the CPI-E if Congress told economists to make one. However it's likely not to have the cuts built in the same way.

II.

Brad Delong, who signed a letter from over 300 economist experts and social scientists organized by EPI arguing that there's no empirical basis for the COLA change, says that "Chained-CPI" is code for "let's really impoverish some women in their 90s!" This will fall on those who live the longest and rely on Social Security the most. But can we find a way to have this impact the poor less so that it doesn't fall too hard on those with the least?

The White House is saying that there will be such a set of protections, and think tanks have proposed some, but we won't know what they'll entail until they are better reported. No matter what additional measures are proposed, it's important to understand how compressed the distribution of income is for those receiving Social Security. From the Social Security Administration, here's a chart on the importance of Social Security relative to total income by income quintile for beneficiary families over 65 years of age (Table 9.B6):

I hate using charts that have so many percents of a percent of a percent, but this data is really important. To get a sense of what this chart is telling us, let's look at a box. From this chart, in the botom 20 percent of income, or those that make $11,417 or less, 65 percent of beneficiaries families get 90 percent of their income from Social Security. So the poorest are very dependent on Social Security, and a large cut will impact them harshly.

But let's say we wave a policy wand and protect those in the bottom 20 percent. The problem is that the income here is very compressed, and that Social Security is a major source of income up the ladder. Even for those in the 60-80 percent of income bracket, 41 percent of their income comes from Social Security. The group around the middle, in the third quintile, have only around $20,000 a year to live on and get a majority of their income from Social Security.

This is not a program that just helps the destitute; it provides a broad level of income security in old age for the majority of retirees. The average elderly family receiving Social Security gets 58.2 percent of their income from the program. A quarter of families get 90 percent or more of their income from Social Security. Once you leave the top income quintile, Social Security is the major source of retirement security. It is hard to see how means-testing these across-the-board cuts will be sufficient to prevent this from having a serious impact on our most vulnerable.

 

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Dean Baker and Doug Henwood both have good analysis on the cuts involved in chaining inflation. Since the rumored cuts to Social Security will hinge on this way of calculating inflation, I want to dig one level into the data to convey what it will mean and then look at some of the distributional impact.

I.

Let's start with two groups of people. The first is urban wage earners and clerical workers, one select group of the population, who purchase a representative basket of goods and services. How much does the basket of goods they purchase increase in price over time? This cost is called CPI-W, and it is currently used for adjusting Social Security benefits. The second group is all people aged 62 and over. Since the 1980s, the government has calculated the cost of goods and services for this group as well, and it is referred to as CPI-E. What do they spend money on? Here's the relative importance of major categories of spending, provided by the BLS, for each group from December 2007:

Green is where the group spends compartively less. As we can see, the elderly spend a lot more of their (more limited) money on housing, utilities, and medical care. And as you probably know, health care costs have been rising rapidly over the past several decades. With the notable exception of college costs, the things urban wage earners spend money on haven't increased in prices as fast as what the elderly purchase. As a result, the CPI-E has increased 3.3 percent a year from 1982 to 2007, while the CPI-W has only increased 3.0 a year.

But wait, what's this chained thing that is being proposed? Picture that in response to a price increase for one good you could substitute similar items. So if the price of chicken goes up, you could eat more beef. Or if the price of a movie went up, you would rent movies more often. This substitution effect blunts some of the price increases. As such, inflation is lower when you take this into account. It's more complicated than that, but it is a start for a definition.

But we don't have a "chained" version of the CPI-E. And the items that the elderly purchase probably aren't impacted in the same competitive way. If the price of beer goes up, you can drink more wine; if the price of utilities go up, your options are limited. The areas where the elderly pay more don't have the same competitive pressures, and their geography is going to be more limited. We could get a chained version of the CPI-E if Congress told economists to make one. However it's likely not to have the cuts built in the same way.

II.

Brad Delong, who signed a letter from over 300 economist experts and social scientists organized by EPI arguing that there's no empirical basis for the COLA change, says that "Chained-CPI" is code for "let's really impoverish some women in their 90s!" This will fall on those who live the longest and rely on Social Security the most. But can we find a way to have this impact the poor less so that it doesn't fall too hard on those with the least?

The White House is saying that there will be such a set of protections, and think tanks have proposed some, but we won't know what they'll entail until they are better reported. No matter what additional measures are proposed, it's important to understand how compressed the distribution of income is for those receiving Social Security. From the Social Security Administration, here's a chart on the importance of Social Security relative to total income by income quintile for beneficiary families over 65 years of age (Table 9.B6):

I hate using charts that have so many percents of a percent of a percent, but this data is really important. To get a sense of what this chart is telling us, let's look at a box. From this chart, in the botom 20 percent of income, or those that make $11,417 or less, 65 percent of beneficiaries families get 90 percent of their income from Social Security. So the poorest are very dependent on Social Security, and a large cut will impact them harshly.

But let's say we wave a policy wand and protect those in the bottom 20 percent. The problem is that the income here is very compressed, and that Social Security is a major source of income up the ladder. Even for those in the 60-80 percent of income bracket, 41 percent of their income comes from Social Security. The group around the middle, in the third quintile, have only around $20,000 a year to live on and get a majority of their income from Social Security.

This is not a program that just helps the destitute; it provides a broad level of income security in old age for the majority of retirees. The average elderly family receiving Social Security gets 58.2 percent of their income from the program. A quarter of families get 90 percent or more of their income from Social Security. Once you leave the top income quintile, Social Security is the major source of retirement security. It is hard to see how means-testing these across-the-board cuts will be sufficient to prevent this from having a serious impact on our most vulnerable.

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Social Security cards image via Shutterstock.com.

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A Cost of Living Adjustment for Social Security in the Fiscal Cliff?

Dec 17, 2012Mike Konczal

I haven't been writing about the various trial balloons and back-and-forths in the fiscal cliff austerity phase-in negotiations. But I do want to make a comment on the latest one. From Ezra Klein, there's rumors that there will be more revenue, some extended unemployment insurance, and additional stimulus money. However, "the Democrats’ headline concession will be accepting chained-CPI, which is to say, accepting a cut to Social Security benefits." Krugman isn't sure if this is better than no deal.

I think it's terrible, and the best way to understand it is by comparing it to the two reasons some liberals, Kevin Drum for instance, give for making a deal on Social Security. This is not my argument, but it's a useful comparison. The first reason is that by proactively changing Social Security you can secure a deal that has more revenue and fewer cuts than you would otherwise. The second reason is that by making a deal on Social Security you take the issue off the policy table. Sure, the people who think Social Security is a form of tyranny will still be after it. But all the deficit scolds will pack up and go home on the issue.

This deal would do neither. You'd cut Social Security without putting in any new revenue. And it wouldn't be sufficient to close the long-term gap, so the issue would stay on the table. Indeed, it's obvious that Very Serious People would view this as a "downpayment" on future cuts, and require any future attempts to get more revenue for Social Security, say by raising the payroll tax cap, to involve significant additional cuts.

From CBO's Social Security Policy Options, you can see 30 options for Social Security. 

The CBO puts the 75-year actuarial balance deficit at 0.6 percent, and this chart shows how much of that 0.6 percent would be filled by various options. The last one, basing the cost-of-living-adjustments (COLA) on the chained CPI-U, is only 0.2, or about a third of what the deficit hawks will say is necessary. From the CBO, it would only extend the trust fund four years. There will be demands for going back to Social Security in the years ahead, and those changes will not come solely from revenue increases. That's giving up a major piece for nothing in terms of Social Security, which is a very bad deal.

Personally, I think changing the COLA is a bad idea in general. The elderly face a higher rate of inflation since their spending is so dependent on health care, which is difficult to adjust or comparison shop for (the idea behind chaining the inflation rate). More importantly, of the three legs of the stool of retirement security - Social Security, private savings and employer savings plans - the two that aren't Social Security are struggling. Employer pensions will become less secure and less available going forward. Housing wealth was wiped out in the crash. 401(k)s appear to have been a great way to shovel tax savings to the rich, but are in no shape to take over for a lack of pensions. Median wages have dropped in the recession, and are likely to show little growth in the years ahead, which makes building private savings harder. Social Security will become more important, not less, in the decades ahead. Its benefits should be expanded, not cut.

UPDATE: Kevin Drum has a similar conclusion on the deal.

I haven't been writing about the various trial balloons and back-and-forths in the fiscal cliff austerity phase-in negotiations. But I do want to make a comment on the latest one. From Ezra Klein, there's rumors that there will be more revenue, some extended unemployment insurance, and additional stimulus money. However, "the Democrats’ headline concession will be accepting chained-CPI, which is to say, accepting a cut to Social Security benefits." Krugman isn't sure if this is better than no deal.

I think it's terrible, and the best way to understand it is by comparing it to the two reasons some liberals, Kevin Drum for instance, give for making a deal on Social Security. This is not my argument, but it's a useful comparison. The first reason is that by proactively changing Social Security you can secure a deal that has more revenue and fewer cuts than you would otherwise. The second reason is that by making a deal on Social Security you take the issue off the policy table. Sure, the people who think Social Security is a form of tyranny will still be after it. But all the deficit scolds will pack up and go home on the issue.

This deal would do neither. You'd cut Social Security without putting in any new revenue. And it wouldn't be sufficient to close the long-term gap, so the issue would stay on the table. Indeed, it's obvious that Very Serious People would view this as a "downpayment" on future cuts, and require any future attempts to get more revenue for Social Security, say by raising the payroll tax cap, to involve significant additional cuts.

From CBO's Social Security Policy Options, you can see 30 options for Social Security. 

The CBO puts the 75-year actuarial balance deficit at 0.6 percent, and this chart shows how much of that 0.6 percent would be filled by various options. The last one, basing the cost-of-living-adjustments (COLA) on the chained CPI-U, is only 0.2, or about a third of what the deficit hawks will say is necessary. From the CBO, it would only extend the trust fund four years. There will be demands for going back to Social Security in the years ahead, and those changes will not come solely from revenue increases. That's giving up a major piece for nothing in terms of Social Security, which is a very bad deal.

Personally, I think changing the COLA is a bad idea in general. The elderly face a higher rate of inflation since their spending is so dependent on health care, which is difficult to adjust or comparison shop for (the idea behind chaining the inflation rate). More importantly, of the three legs of the stool of retirement security - Social Security, private savings and employer savings plans - the two that aren't Social Security are struggling. Employer pensions will become less secure and less available going forward. Housing wealth was wiped out in the crash. 401(k)s appear to have been a great way to shovel tax savings to the rich, but are in no shape to take over for a lack of pensions. Median wages have dropped in the recession, and are likely to show little growth in the years ahead, which makes building private savings harder. Social Security will become more important, not less, in the decades ahead. Its benefits should be expanded, not cut.

UPDATE: Kevin Drum has a similar conclusion on the deal.

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Are High College Costs Redistributive?

Dec 11, 2012Mike Konczal

Aaron Bady has a fantastic piece on the boosters who argue that MOOCs and other forms of online education will fundamentally transform higher education, addressed as a response to Clay Shirky. There's a few important moves to watch when people make this line of argument. Many who prize the "disruptive innovation" of higher education usually concede that what it will mostly do is provide a cheaper but poorer alternative to the large number of non-elite public institutions that educate the majority of those who seek higher education. The talk is all "Watch out Harvard and Yale! This online education company is going to take you down like Napster took down the record companies." Then it quickly reverts to the idea of providing "access," which gets much of its power through the ongoing dismantling of mass public higher education.

Note that, given that online education's success will be a function of the weakness of public education, there's a huge incentive for for-profit higher education firms to participate in that dismantling project. And sure enough, there's a great new article by Sarah Pavlus at the American Independent, "University of Phoenix fought against community college expansion." There's "so much money to be made online, and [for-profit schools] didn’t want community colleges coming in at a much lower tuition rate,” she writes. Public institutions are attempting to innovate and provide better services to citizens, but for-profit schools are trying to stop them to bolster their own bottom lines.

This is why the debate about the actual quality of online education is important. Online education can succeed not by providing a better service at a cheaper price, but instead by just providing "access" if public education slowly becomes unavailable. If there's no public option, then the quality issue becomes moot - then it is just about providing the now missing access to meet the large demand our country has for higher-level education.

Also watch for when online education boosters make an argument of higher education decline rather than online success. They do a rhetorical move to argue that the problems in the non-profit private education institutions extend to public ones. Kevin Carey, for instance, argues that "college spending is the driving force behind affordability or lack thereof in the long run" before noting several paragraphs later that "Inflation-adjusted per-student spending at private research universities, in particular, increased sharply." He quickly notes that "private universities set the aspirational standards for the industry as a whole," but public higher education cost inflation is driven mostly by declining public support, not a competitive war with private schools.

As Josh Mason pointed out, this is the equivalent of saying that since the private savings vehicle of 401(k)s have turned out to be a bit of a bust, we should scale back the public retirement vehicle of Social Security. That's not the case at all! And, if anything, we should view the public option as a version that works.

Tuition as Redistribution

But maybe higher tuition isn't a real problem. Maybe higher costs are driven by the rich paying more to help out the poor in a private form of egalitarian redistribution. A few weeks ago, Evan Soltas at Bloomberg wrote a version of this argument, which Matt Bruenig picked up on his blog (and here as well). Soltas argues that the huge rise in the advertised ("sticker") price of colleges is misleading, because the actual cost people pay ("net cost") is much lower and has been increasing at a lower rate. Soltas argues that "what has happened is a shift toward price discrimination -- offering multiple prices for the same product. Universities have offset the increase in sticker price for most families through an expansion of grant-based financial aid and scholarships." Bruenig and Soltas both emphasize that the rich pay more while the poorest pay less. They use data from the most recent Trends in College Pricing.

There are a few critical points to bring up about this analysis. Contrary to Soltas, this is driven as much, if not more, by public policy, specifically the effect of of a significant expansion in public funding, notably in Pell Grants and military grants. (I believe Soltas' graph also uses data that includes the extensive network of tax credits, which add up to a lot of money; the cross-section graphs in Bruenig's graphs does not.) From Trends in Student Aid:

This is one way of providing public funding. Another would be to drive down tuition directly. I took up the idea of supporting public provisioning directly, instead of coupons that provide targeted support, in my recent New America paper. If there are market imperfections, incumbents can capture some of the subsidy while driving up the price for all those who aren't getting the coupons. Public provisioning, in these cases, lowers the cost for everyone.

Now if you look at the net price by income, you also see those in the top income bracket, here being those with incomes over $100K a year, paying more than the poor, those under $33,000. From Bruenig's piece:

Soltas argues that "the cost burden of college has become significantly more progressive since the 1990s. Students from wealthier families not only now pay more for their own educations but also have come to heavily subsidize the costs of the less fortunate." He argues that differences in price reflects an institutional goal of cross-subsidization, where private firms make the rich pay more to compensate the poor. This didn't strike me as obvious from the data or other resources. In general, price discrimination should be thought of as a transfer from consumers to producers' surplus. Meanwhile, businesses usually don't cross-subsidize, and as we saw from the Pell Grant information, a big driver of this is poor people's payments beng compensated through public funding.

Just to confirm that higher tuition wasn't redistribution, I emailed one of the authors of the study, Sandy Baum, who told me that "very few students pay more than the actual cost of their education. Affluent students are generally subsidized less than low-income students, but they aren't actually paying any part of the cost of education for low-income students. Taxpayers generally are subsidizing Pell Grant recipients. But that's quite different from students paying more than their educational costs to cross-subsidize low-income students."

Another technical note worth making: Bruenig's graph also assumes that the poor are attending the same institutions as those who are better off. But they are almost certainly attending schools part-time instead of full-time, and cheaper institutions compared to more expensive ones. One can see this by just looking at the sticker cost of tuition. The sticker price by income has large differences that are slowly increasing.

(Net room and board and other costs has a similar dynamic.)

 Making sure that the poor can access education through grants could work as a plan over the future, though we must understand that it is a plan, specifically government planning. There are other plans we could do as well.

 

Follow or contact the Rortybomb blog:
  

Aaron Bady has a fantastic piece on the boosters who argue that MOOCs and other forms of online education will fundamentally transform higher education, addressed as a response to Clay Shirky. There's a few important moves to watch when people make this line of argument. Many who prize the "disruptive innovation" of higher education usually concede that what it will mostly do is provide a cheaper but poorer alternative to the large number of non-elite public institutions that educate the majority of those who seek higher education. The talk is all "Watch out Harvard and Yale! This online education company is going to take you down like Napster took down the record companies." Then it quickly reverts to the idea of providing "access," which gets much of its power through the ongoing dismantling of mass public higher education.

Note that, given that online education's success will be a function of the weakness of public education, there's a huge incentive for for-profit higher education firms to participate in that dismantling project. And sure enough, there's a great new article by Sarah Pavlus at the American Independent, "University of Phoenix fought against community college expansion." There's "so much money to be made online, and [for-profit schools] didn’t want community colleges coming in at a much lower tuition rate,” she writes. Public institutions are attempting to innovate and provide better services to citizens, but for-profit schools are trying to stop them to bolster their own bottom lines.

This is why the debate about the actual quality of online education is important. Online education can succeed not by providing a better service at a cheaper price, but instead by just providing "access" if public education slowly becomes unavailable. If there's no public option, then the quality issue becomes moot - then it is just about providing the now missing access to meet the large demand our country has for higher-level education.

Also watch for when online education boosters make an argument of higher education decline rather than online success. They do a rhetorical move to argue that the problems in the non-profit private education institutions extend to public ones. Kevin Carey, for instance, argues that "college spending is the driving force behind affordability or lack thereof in the long run" before noting several paragraphs later that "Inflation-adjusted per-student spending at private research universities, in particular, increased sharply." He quickly notes that "private universities set the aspirational standards for the industry as a whole," but public higher education cost inflation is driven mostly by declining public support, not a competitive war with private schools.

As Josh Mason pointed out, this is the equivalent of saying that since the private savings vehicle of 401(k)s have turned out to be a bit of a bust, we should scale back the public retirement vehicle of Social Security. That's not the case at all! And, if anything, we should view the public option as a version that works.

Tuition as Redistribution

But maybe higher tuition isn't a real problem. Maybe higher costs are driven by the rich paying more to help out the poor in a private form of egalitarian redistribution. A few weeks ago, Evan Soltas at Bloomberg wrote a version of this argument, which Matt Bruenig picked up on his blog (and here as well). Soltas argues that the huge rise in the advertised ("sticker") price of colleges is misleading, because the actual cost people pay ("net cost") is much lower and has been increasing at a lower rate. Soltas argues that "what has happened is a shift toward price discrimination -- offering multiple prices for the same product. Universities have offset the increase in sticker price for most families through an expansion of grant-based financial aid and scholarships." Bruenig and Soltas both emphasize that the rich pay more while the poorest pay less. They use data from the most recent Trends in College Pricing.

There are a few critical points to bring up about this analysis. Contrary to Soltas, this is driven as much, if not more, by public policy, specifically the effect of of a significant expansion in public funding, notably in Pell Grants and military grants. (I believe Soltas' graph also uses data that includes the extensive network of tax credits, which add up to a lot of money; the cross-section graphs in Bruenig's graphs does not.) From Trends in Student Aid:

This is one way of providing public funding. Another would be to drive down tuition directly. I took up the idea of supporting public provisioning directly, instead of coupons that provide targeted support, in my recent New America paper. If there are market imperfections, incumbents can capture some of the subsidy while driving up the price for all those who aren't getting the coupons. Public provisioning, in these cases, lowers the cost for everyone.

Now if you look at the net price by income, you also see those in the top income bracket, here being those with incomes over $100K a year, paying more than the poor, those under $33,000. From Bruenig's piece:

Soltas argues that "the cost burden of college has become significantly more progressive since the 1990s. Students from wealthier families not only now pay more for their own educations but also have come to heavily subsidize the costs of the less fortunate." He argues that differences in price reflects an institutional goal of cross-subsidization, where private firms make the rich pay more to compensate the poor. This didn't strike me as obvious from the data or other resources. In general, price discrimination should be thought of as a transfer from consumers to producers' surplus. Meanwhile, businesses usually don't cross-subsidize, and as we saw from the Pell Grant information, a big driver of this is poor people's payments beng compensated through public funding.

Just to confirm that higher tuition wasn't redistribution, I emailed one of the authors of the study, Sandy Baum, who told me that "very few students pay more than the actual cost of their education. Affluent students are generally subsidized less than low-income students, but they aren't actually paying any part of the cost of education for low-income students. Taxpayers generally are subsidizing Pell Grant recipients. But that's quite different from students paying more than their educational costs to cross-subsidize low-income students."

Another technical note worth making: Bruenig's graph also assumes that the poor are attending the same institutions as those who are better off. But they are almost certainly attending schools part-time instead of full-time, and cheaper institutions compared to more expensive ones. One can see this by just looking at the sticker cost of tuition. The sticker price by income has large differences that are slowly increasing.

(Net room and board and other costs has a similar dynamic.)

 Making sure that the poor can access education through grants could work as a plan over the future, though we must understand that it is a plan, specifically government planning. There are other plans we could do as well.

 

Follow or contact the Rortybomb blog:
  

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