Why the Republican CFPB Arguments Are Wrong

Feb 5, 2013Mike Konczal

It's been almost two years, and the GOP still refuses to approve a Consumer Financial Protection Bureau (CFPB) director without a significant overhaul of the agency. Check out Adam Serwer at Mother Jones as well as Jennifer Bendery at Huffington Post for more on this story. Forty-three Republican Senators signed a letter last week, one that is almost exactly the same as the one they signed in July 2011, blocking Cordray's nomination because they want major legislative changes to Dodd-Frank and the CFPB.

As congressional scholar Thomas Mann told Jonathan Cohn, this should be viewed as a form of modern day nullification. Dodd-Frank is the law of the land. Congress legitimately passed this law containing a CFPB designed to have certain features. Even though the GOP doesn't like it doesn't mean they can sabotage it or prevent it from working. And the CFPB needs a director to work.

The letter features a high-level complaint along with three specific changes they want. Beyond the letter, these three points are so common on the right that it is probably useful to point out that they are wrong. This is drawn from Adam Levitin's Congressional testimony on the matter as well as other CFPB analysis over the years. Bold is from the letter.

"...we have serious concerns about the lack of congressional oversight of the agency and the lack of normal, democratic checks on its sole director, who would wield nearly unprecedented powers."
 
The CFPB must regularly make reports and appear before Congress. The CFPB is subject to a veto of its actions by other financial regulators as represented by the Financial Stability Oversight Council (FSOC), a completely unique accountability feature that does not apply to any other regulators. The CFPB is subject to an annual audit by the GAO, which is then turned over to Congress, another unique form of accountability. It is also subject to the Small Business Regulatory Enforcement Fairness Act of 1996 (SBREFA), a feature of OIRA that doesn't apply to other financial regulators.
 
The CFPB is also limited in its actions by the text of Dodd-Frank itself. It can't mandate the offering of any financial product, force the extension of credit, regulate non-financial businesses, require businesses to offer products or credit, impose usury caps, or force consumers to take products. See, among other places, Section 1027 of Dodd-Frank for further restrictions. If you'd like to go further, you can see a list of 19 ways the CFPB is accountable here. Rather than having unprecedented powers, this agency is as accountable and has more checks than any other federal financial regulator.
 
"We again urge the adoption of the following [three] reforms:
 
1. Establish a bipartisan board of directors to oversee the Consumer Financial Protection Bureau."
 
The Office of the Comptroller of the Currency (OCC) and the former Office of Thrift Supervision (OTS), both federal financial regulators, both have single directors, so this is neither odd nor unprecedented. Some other agencies have boards, like the FDIC. There are some reasons to use one model over the other, but the GOP is not making a clear case for why a board of directors is superior to a sole director, much less a case sufficient to justify nullifying parts of Dodd-Frank. A single director encourages direct action, streamlined agency, and more accountability. Given what we've seen in the past 10 years with subprime, action is better than inaction.
 
Five directors can blame each other when things go wrong. Given the concern over accountability in the GOP's letter, a single director strikes me as the right way to go. There's more on oversight here.
 
"2. Subject the Bureau to the annual appropriation process, similar to other federal regulators."
 
Other federal banking regulators have their own independent budgets and are not subject to the appropriations process. The OCC, the FDIC, and the former OTS get their budgets from assessments from the financial institutions they regulate. The CFPB gets its budget from the Federal Reserve in order to avoid the capture that comes with being dependent on industry assessments. However, unlike those institutions, the CFPB has a statutory budgetary cap of 12 percent of the Federal Reserve's budget.

Congress consciously decided to fund the CFPB this way to prevent them from subjecting the important work that needs to be done to the annual appropriations process. This is normal in financial regulation and appropriate for the CFPB. You can read more about how this funding is designed to take the political economy of regulation into account here.

"3. Establish a safety-and-soundness check for the prudential regulators."
 
There is already a safety-and-soundness check at the OCC, which, through the FSOC, can vote on vetoing CFPB actions. Beyond that, safety-and-soundness is often synonymous with profit-making. The broken servicing model at the largest banks, for instance, is an abuse-ridden disaster for borrowers and lenders, but they are profitable activities that, de facto, boost the banks' safety-and-soundness via profits. The CFPB is meant to be a balance against this regulatory impulse. This was debated at length during the Dodd-Frank process, and Congress still decided to mandate the CFPB with its current mission.
 
Immediately after Obamacare passed, conservative David Frum argued, in a now famous piece called "Waterloo," that the GOP could have turned the bill into one far more favorable for conservatives with just a few GOP votes. But they didn't, and now they are stuck with a law they hate. The same dynamic is true for Dodd-Frank. If a dozen Senators and House GOP members decided to make a bipartisan bill in 2009, they could have likely gotten a CFPB that they would like better. But they didn't. And now they want to retroactively try and get that bill they chose not to enact.
 
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It's been almost two years, and the GOP still refuses to approve a Consumer Financial Protection Bureau (CFPB) director without a significant overhaul of the agency. Check out Adam Serwer at Mother Jones as well as Jennifer Bendery at Huffington Post for more on this story. Forty-three Republican Senators signed a letter last week, one that is almost exactly the same as the one they signed in July 2011, blocking Cordray's nomination because they want major legislative changes to Dodd-Frank and the CFPB.

As congressional scholar Thomas Mann told Jonathan Cohn, this should be viewed as a form of modern day nullification. Dodd-Frank is the law of the land. Congress legitimately passed this law containing a CFPB designed to have certain features. Even though the GOP doesn't like it doesn't mean they can sabotage it or prevent it from working. And the CFPB needs a director to work.

The letter features a high-level complaint along with three specific changes they want. Beyond the letter, these three points are so common on the right that it is probably useful to point out that they are wrong. This is drawn from Adam Levitin's Congressional testimony on the matter as well as other CFPB analysis over the years. Bold is from the letter.

"...we have serious concerns about the lack of congressional oversight of the agency and the lack of normal, democratic checks on its sole director, who would wield nearly unprecedented powers."
 
The CFPB must regularly make reports and appear before Congress. The CFPB is subject to a veto of its actions by other financial regulators as represented by the Financial Stability Oversight Council (FSOC), a completely unique accountability feature that does not apply to any other regulators. The CFPB is subject to an annual audit by the GAO, which is then turned over to Congress, another unique form of accountability. It is also subject to the Small Business Regulatory Enforcement Fairness Act of 1996 (SBREFA), a feature of OIRA that doesn't apply to other financial regulators.
 
The CFPB is also limited in its actions by the text of Dodd-Frank itself. It can't mandate the offering of any financial product, force the extension of credit, regulate non-financial businesses, require businesses to offer products or credit, impose usury caps, or force consumers to take products. See, among other places, Section 1027 of Dodd-Frank for further restrictions. If you'd like to go further, you can see a list of 19 ways the CFPB is accountable here. Rather than having unprecedented powers, this agency is as accountable and has more checks than any other federal financial regulator.
 
"We again urge the adoption of the following [three] reforms:
 
1. Establish a bipartisan board of directors to oversee the Consumer Financial Protection Bureau."
 
The Office of the Comptroller of the Currency (OCC) and the former Office of Thrift Supervision (OTS), both federal financial regulators, both have single directors, so this is neither odd nor unprecedented. Some other agencies have boards, like the FDIC. There are some reasons to use one model over the other, but the GOP is not making a clear case for why a board of directors is superior to a sole director, much less a case sufficient to justify nullifying parts of Dodd-Frank. A single director encourages direct action, streamlined agency, and more accountability. Given what we've seen in the past 10 years with subprime, action is better than inaction.
 
Five directors can blame each other when things go wrong. Given the concern over accountability in the GOP's letter, a single director strikes me as the right way to go. There's more on oversight here.
 
"2. Subject the Bureau to the annual appropriation process, similar to other federal regulators."
 
Other federal banking regulators have their own independent budgets and are not subject to the appropriations process. The OCC, the FDIC, and the former OTS get their budgets from assessments from the financial institutions they regulate. The CFPB gets its budget from the Federal Reserve in order to avoid the capture that comes with being dependent on industry assessments. However, unlike those institutions, the CFPB has a statutory budgetary cap of 12 percent of the Federal Reserve's budget.

Congress consciously decided to fund the CFPB this way to prevent them from subjecting the important work that needs to be done to the annual appropriations process. This is normal in financial regulation and appropriate for the CFPB. You can read more about how this funding is designed to take the political economy of regulation into account here.

"3. Establish a safety-and-soundness check for the prudential regulators."
 
There is already a safety-and-soundness check at the OCC, which, through the FSOC, can vote on vetoing CFPB actions. Beyond that, safety-and-soundness is often synonymous with profit-making. The broken servicing model at the largest banks, for instance, is an abuse-ridden disaster for borrowers and lenders, but they are profitable activities that, de facto, boost the banks' safety-and-soundness via profits. The CFPB is meant to be a balance against this regulatory impulse. This was debated at length during the Dodd-Frank process, and Congress still decided to mandate the CFPB with its current mission.
 
Immediately after Obamacare passed, conservative David Frum argued, in a now famous piece called "Waterloo," that the GOP could have turned the bill into one far more favorable for conservatives with just a few GOP votes. But they didn't, and now they are stuck with a law they hate. The same dynamic is true for Dodd-Frank. If a dozen Senators and House GOP members decided to make a bipartisan bill in 2009, they could have likely gotten a CFPB that they would like better. But they didn't. And now they want to retroactively try and get that bill they chose not to enact.
 
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Republican with tie image via Shutterstock.com.

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Live at the American Prospect: On the Treasury's Second Term Financial Reform Agenda

Feb 4, 2013Mike Konczal

I have a new piece at The American Prospect, on what Treasury will need to do in the 2nd term when it comes to financial reform:

Nevertheless, the Treasury secretary will be responsible for the overhaul of the legal and regulatory framework that governs the financial sector. The incoming Treasury secretary will have three chief responsibilities: complete the implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act, determine how many of the new parts will work together going forward, and parry with congressional efforts to repeal parts of that law.

I hope you check it out.

I have a new piece at The American Prospect, on what Treasury will need to do in the 2nd term when it comes to financial reform:

Nevertheless, the Treasury secretary will be responsible for the overhaul of the legal and regulatory framework that governs the financial sector. The incoming Treasury secretary will have three chief responsibilities: complete the implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act, determine how many of the new parts will work together going forward, and parry with congressional efforts to repeal parts of that law.

I hope you check it out.

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How is Inequality Holding Back the Recovery?

Feb 4, 2013Mike Konczal

Is inequality holding back our weak recovery? Joe Stiglitz argues it is, while Paul Krugman argues it is not. John Judis summarizes the debate at The New RepublicI want to rephrase the question and focus specifically on the two most relevant policy points.

Taxes: Stiglitz argues, "[T]he weakness of the middle class is holding back tax receipts, especially because those at the top are so adroit in avoiding taxes and in getting Washington to give them tax breaks." 
 
Right now our federal government's tax structure is progressive, while state and local taxes are regressive. Meanwhile, the federal government can borrow at cheap rates and run a large deficit without a problem, while state budgets are constrained and need to be balanced. As a result, large cuts and layoffs at the state and local level have counteracted much of the federal government's stimulus that comes from running a larger deficit. Indeed, Stiglitz's point that inequality makes it harder to fund education is a real life battle: we are currently seeing education funding by state and local governments collapsing in real-time.
 
Here's a chart on how regressive state and local taxes are from the Institute on Taxation & Economic Policy:

When it comes to state and local taxes, the top 1 percent pays 6.4 percent, the middle 20 percent pays 9.7, while the poorest 20 percent of families pay 10.9 percent. This isn't counting user fees, though a CEO with 300 times the income of a worker probably doesn't get 300 times as many drivers' licenses.
 
So, all things being equal, less inequality would mean less revenue for the federal government and more for state and local governments. Since a good plan for boosting demand would entail the federal government collecting less revenue (an extension of the payroll tax cut would have boosted demand) and state and local governments collecting more revenue and thus facing less austerity, less inequality would net provide more stimulus. I doubt it would matter that much, though it's an empirical matter on just how much it would provide.
 
Spending: The other debate has to do with the marginal propensity to consume. Evidence does find the rich are less likely to spend money on consumption than everyone else, and in a liquidity trap this matters. Steve Waldman at Interfluidity has a larger theory on why it has mattered over the past decades, but I want to focus on the complicating, narrow issue of wealth inequality.
 
A graph by Amir Sufi, using Federal Reserve data, shows a collapse in the median net worth of households, and his research and others finds that this is a driver of the collapse in demand:

Meanwhile, precautionary savings are still a problem.
 
So, all things being equal, what happens if we decrease inequality in a balance-sheet recession? I see two changes running in opposite directions. You could see an increase in spending by the median household, as they have a higher propensity to spend, plus more income could relieve their balance-sheet constraints. However, if more middle-class households have more of the country's income, they may save it even more aggressively; this would amplify the Paradox of Thrift and make the recession worse in the short term. It's not clear which of these effects would dominate over the other.
 
One way to deal with this is to boost net wealth while keeping incomes consistent, via debt forgiveness or reform our legal mechanisms like bankruptcy so they can handle allocating these losses, though that doesn't seem to be in the cards.
 
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Is inequality holding back our weak recovery? Joe Stiglitz argues it is, while Paul Krugman argues it is not. John Judis summarizes the debate at The New RepublicI want to rephrase the question and focus specifically on the two most relevant policy points.

Taxes: Stiglitz argues, "[T]he weakness of the middle class is holding back tax receipts, especially because those at the top are so adroit in avoiding taxes and in getting Washington to give them tax breaks." 
 
Right now our federal government's tax structure is progressive, while state and local taxes are regressive. Meanwhile, the federal government can borrow at cheap rates and run a large deficit without a problem, while state budgets are constrained and need to be balanced. As a result, large cuts and layoffs at the state and local level have counteracted much of the federal government's stimulus that comes from running a larger deficit. Indeed, Stiglitz's point that inequality makes it harder to fund education is a real life battle: we are currently seeing education funding by state and local governments collapsing in real-time.
 
Here's a chart on how regressive state and local taxes are from the Institute on Taxation & Economic Policy:

When it comes to state and local taxes, the top 1 percent pays 6.4 percent, the middle 20 percent pays 9.7, while the poorest 20 percent of families pay 10.9 percent. This isn't counting user fees, though a CEO with 300 times the income of a worker probably doesn't get 300 times as many drivers' licenses.
 
So, all things being equal, less inequality would mean less revenue for the federal government and more for state and local governments. Since a good plan for boosting demand would entail the federal government collecting less revenue (an extension of the payroll tax cut would have boosted demand) and state and local governments collecting more revenue and thus facing less austerity, less inequality would net provide more stimulus. I doubt it would matter that much, though it's an empirical matter on just how much it would provide.
 
Spending: The other debate has to do with the marginal propensity to consume. Evidence does find the rich are less likely to spend money on consumption than everyone else, and in a liquidity trap this matters. Steve Waldman at Interfluidity has a larger theory on why it has mattered over the past decades, but I want to focus on the complicating, narrow issue of wealth inequality.
 
A graph by Amir Sufi, using Federal Reserve data, shows a collapse in the median net worth of households, and his research and others finds that this is a driver of the collapse in demand:

Meanwhile, precautionary savings are still a problem.
 
So, all things being equal, what happens if we decrease inequality in a balance-sheet recession? I see two changes running in opposite directions. You could see an increase in spending by the median household, as they have a higher propensity to spend, plus more income could relieve their balance-sheet constraints. However, if more middle-class households have more of the country's income, they may save it even more aggressively; this would amplify the Paradox of Thrift and make the recession worse in the short term. It's not clear which of these effects would dominate over the other.
 
One way to deal with this is to boost net wealth while keeping incomes consistent, via debt forgiveness or reform our legal mechanisms like bankruptcy so they can handle allocating these losses, though that doesn't seem to be in the cards.
 
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Is the Right Shifting Course on Dodd-Frank?

Feb 4, 2013Mike Konczal

During the 2012 election, conservatives' main goal was to either repeal Dodd-Frank completely or remove such large sections of it that it was a completely different bill. There was very little engagement with the content of Dodd-Frank itself and how to make them work better. One important example was Republican candidates like Jon Huntsman calling for bold new financial reforms that were already part of Dodd-Frank

It now appears that the flagship policy journal on the right, National Affairs, is moving towards a reform rather than replace agenda for Dodd-Frank and financial reform. The latest issue featured an large, 7,000+ word article, "Against Casino Finance," by Eric Posner and E. Glen Weyl of University of Chicago law school. What's fascinating about the piece is less the authors' counter proposals for reform, which are lacking, than the fact that they accept two of the ideas put forward by financial reformers that have generally been resisted on the right. The first is that derivatives require regulation and the second is that prudential regulation of the largest systemically risky financial firms is necessary.

Let's take those in order. First the authors argue, "[I]n today's derivatives market...no such sensible restriction exists to separate the use of the instruments as insurance from their use as gambling devices." They describe these instruments as "pure gambling," or a transaction in which "one party loses exactly what the other party gains, and both are made worse off by the additional risk they take on in this bargain." They argue that these instruments can increase pure risks and are zero-sum, differentiating them from other trades. They go as far as to argue against the Commodity Futures Modernization Act of 2000.

It isn't clear what they think of the general Dodd-Frank approach to derivatives, which emphasizes transparency through exchanges and clearinghouses, capital adequacy, private enforcement, and regulation of intermediaries. Their focus is partially on the "insurable interest doctrine" of common law as it relates to insurance, which requires that a party to an insurance contract have a stake in the event. If you can't buy fire insurance on your neighbor's house, why can you buy credit insurance on his business if you don't have an ownership claim on it? That's a dog whistle for either banning so-called "naked" derivatives or running them under state-level insurance law. The vote to ban naked credit default swaps, proposed in the Senate by Bryan Dorgan, failed (and was generally opposed on the right). 

The other regulations relate to bailouts and prudential regulations. As they put it:

When banks fail, the government must act as lender of last resort.

Today, the government serves this role in two ways. First, it compels banks to buy government-supplied deposit insurance, which covers depositors up to $250,000. Second, it provides emergency loans at below-market rates -- bailouts -- to any financial institution whose collapse would take down enough banks with it to endanger the entire economy.

Few seriously doubt that governments must play this role.

Bagehot’s rule is usually summarized as, “Lend without limit, to solvent firms, against good collateral, at high rates." In exchange for this, certain regulations are necessary. Dodd-Frank includes higher capital and liquidity requirements for larger and riskier firms, as well as certain organizational requirements (loosely referred to under the term "living wills") to help with collapsing the company in question via FDIC's resolution powers.

Again, it would be interesting if they addressed the specific reforms to lender of last resort functions included in Dodd-Frank, or the combination of regulation and resolution. Section 13(3) of the Federal Reserve Act was amended so that "any emergency lending program or facility is for the purpose of providing liquidity to the financial system, and not to aid a failing financial company." and any such lending program has to have "broad-based eligibility.” Some have argued this is too loose to deal with a liquidity crisis. Do these authors agree? Are the regulations and FDIC's resolution powers sufficient in this case, or do we need a different approach?

Their specific recommendations for how the right should tackle Dodd-Frank, which is the last third of the piece, involve applying stricter cost-benefit analysis to all rules. There's no talk about repeal, or huge changes to the framework, or long court battles. Cost-benefit has significant problems, but that's a debate for another day. Conceptually, it is tinkering with Dodd-Frank rather than repealing it, which has dominated the conversation on the right. Will this signal a larger change?

Follow or contact the Rortybomb blog:

  

During the 2012 election, conservatives' main goal was to either repeal Dodd-Frank completely or remove such large sections of it that it was a completely different bill. There was very little engagement with the content of Dodd-Frank itself and how to make them work better. One important example was Republican candidates like Jon Huntsman calling for bold new financial reforms that were already part of Dodd-Frank

It now appears that the flagship policy journal on the right, National Affairs, is moving towards a reform rather than replace agenda for Dodd-Frank and financial reform. The latest issue featured an large, 7,000+ word article, "Against Casino Finance," by Eric Posner and E. Glen Weyl of University of Chicago law school. What's fascinating about the piece is less the authors' counter proposals for reform, which are lacking, than the fact that they accept two of the ideas put forward by financial reformers that have generally been resisted on the right. The first is that derivatives require regulation and the second is that prudential regulation of the largest systemically risky financial firms is necessary.

Let's take those in order. First the authors argue, "[I]n today's derivatives market...no such sensible restriction exists to separate the use of the instruments as insurance from their use as gambling devices." They describe these instruments as "pure gambling," or a transaction in which "one party loses exactly what the other party gains, and both are made worse off by the additional risk they take on in this bargain." They argue that these instruments can increase pure risks and are zero-sum, differentiating them from other trades. They go as far as to argue against the Commodity Futures Modernization Act of 2000.

It isn't clear what they think of the general Dodd-Frank approach to derivatives, which emphasizes transparency through exchanges and clearinghouses, capital adequacy, private enforcement, and regulation of intermediaries. Their focus is partially on the "insurable interest doctrine" of common law as it relates to insurance, which requires that a party to an insurance contract have a stake in the event. If you can't buy fire insurance on your neighbor's house, why can you buy credit insurance on his business if you don't have an ownership claim on it? That's a dog whistle for either banning so-called "naked" derivatives or running them under state-level insurance law. The vote to ban naked credit default swaps, proposed in the Senate by Bryan Dorgan, failed (and was generally opposed on the right). 

The other regulations relate to bailouts and prudential regulations. As they put it:

When banks fail, the government must act as lender of last resort.

Today, the government serves this role in two ways. First, it compels banks to buy government-supplied deposit insurance, which covers depositors up to $250,000. Second, it provides emergency loans at below-market rates -- bailouts -- to any financial institution whose collapse would take down enough banks with it to endanger the entire economy.

Few seriously doubt that governments must play this role.

Bagehot’s rule is usually summarized as, “Lend without limit, to solvent firms, against good collateral, at high rates." In exchange for this, certain regulations are necessary. Dodd-Frank includes higher capital and liquidity requirements for larger and riskier firms, as well as certain organizational requirements (loosely referred to under the term "living wills") to help with collapsing the company in question via FDIC's resolution powers.

Again, it would be interesting if they addressed the specific reforms to lender of last resort functions included in Dodd-Frank, or the combination of regulation and resolution. Section 13(3) of the Federal Reserve Act was amended so that "any emergency lending program or facility is for the purpose of providing liquidity to the financial system, and not to aid a failing financial company." and any such lending program has to have "broad-based eligibility.” Some have argued this is too loose to deal with a liquidity crisis. Do these authors agree? Are the regulations and FDIC's resolution powers sufficient in this case, or do we need a different approach?

Their specific recommendations for how the right should tackle Dodd-Frank, which is the last third of the piece, involve applying stricter cost-benefit analysis to all rules. There's no talk about repeal, or huge changes to the framework, or long court battles. Cost-benefit has significant problems, but that's a debate for another day. Conceptually, it is tinkering with Dodd-Frank rather than repealing it, which has dominated the conversation on the right. Will this signal a larger change?

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Morning Joe vs. the Barbell

Jan 29, 2013Mike Konczal

Paul Krugman was on Morning Joe yesterday, where he was peppered with questions about why he and other liberal economists aren't obsessed with long-term debt as a more pressing, or at least equally pressing, problem compared to mass unemployment. Joe Scarborough wrote a follow-up editorial implying that Krugman's opinion is isolated among economists without citing any actual economists. In response, Joe Weisenthal created a list of economists of varying backgrounds and political persuasions who agree with Krugman.

The segment focused on the idea that the only way to do stimulus is if we also do long-term cuts at the same time.

Some quotes to give a feel:

Joe Scarborough, 8m20s: "Medicare, Medicaid, health care costs, the defense budget, long-term drivers of a long-term debt... I say you can do two things at the same time."

Ed Rendel, 12m23s, 15m49s: "I don't think any of these things are mutually exclusive... I think we can [invest in infrastructure] while at the same time taking care of the long-term... Simpson-Bowles said we can do both. We can stretch out our debt reduction over a course of time and at the same time do some things that will spur the economy."

Joe Scarborough: "Won't that send a good message to the markets if we say, 'Hey listen, here's the deal. We are going to take care of what we have to do in the short term to get people back to work, but in the long term we are taking care of the long-term structure'?"

This is often referred to as a "barbell strategy" (from a Peter Orzag column). Do stimulus, do long-term deficit reduction, but only if you can do them together. As mentioned by the panelists, this is part of several bipartisan debt reduction strategies. Here's Domenici-Rivlin's Restoring America's Future Plan: "First, we must recover from the deep recession that has thrown millions out of work... Second, we must take immediate steps to reduce the unsustainable debt... These two challenges must be addressed at the same time, not sequentially."

It's weird that nobody on Morning Joe seems to understand the obvious problems with this strategy, so let's make a list.

1. There is no solid economic argument for this. There may be political arguments, as in that's the only way to build a coalition to get legislation through a partisan Congress, but they are just that, political. There's no decent economic argument for why if stimulus is a good idea, and long-term deficit reduction is a good idea, that you need to do both at the same time.

Scarborough's argument that "this would send a good message to the markets" implies that interest rates are a constraint, when instead they've been at ultra-low rates. It also seems to imply that additional stimulus would send the markets into a panic. It is true that if we passed a stimulus program interest rates could rise, but this would reflect the market thinking things were getting better, not worse.

2. The political argument for this is also weak, if only because it was the operative strategy over the past several years and didn't work. President Obama just tried to get some $225 billion dollars in stimulus in the fiscal cliff and looked to be willing to accept cuts in the inflation adjustments for Social Security as part of the package. Republicans turned this down. This stimulus was first proposed a year earlier in his American Jobs Act, which, as he told Congress, would be paid for by offsetting long-term budgets. This was dead on arrival.

And it is easy to see why. You can probably get some agreement on the content of a stimulus package, but to get a agreement on long-term deficit reduction, you would need the GOP to accept some new revenues or clarify what it wants on social insurance. It won't do the first outside constructed scenarios like the fiscal cliff and the latter has yet to happen.

3. As for the short term, alleviating unemployment is the most responsible budget action even though it increases the short-term deficit. Austerity is likely to give us a higher debt-to-GDP problem if it causes a double-dip recession. Our current deficit is so large because so many people are not working; more economic activity would mean more things to tax and fewer stablizers like unemployment insurance to pay for.

As Delong and Summers argue, additional fiscal stimulus in a depressed economy can largely offset its own costs. Or as John Maynard Keynes said in 1933, "It is the burden of unemployment and the decline in the national income which are upsetting the Budget. Look after the unemployment, and the Budget will look after itself."

4. As for the part of the budget that won't take care of itself, President Obama fought an ugly and costly battle to bend the cost curve of health care, in which he was accused of everything from creating death panels to looting benefits of seniors in order to pass them out to his army of Takers. Since he's already paid that price, why wouldn't he wait and see how well Medicare cost saving techniques work?

Maybe it's just me, but I find the "if you want to see full employment again, immediately dismantle some social insurance" to be like a form of ransom. Meanwhile millions of people are suffering needlessly as a result of the lack of action.

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Paul Krugman was on Morning Joe yesterday, where he was peppered with questions about why he and other liberal economists aren't obsessed with long-term debt as a more pressing, or at least equally pressing, problem compared to mass unemployment. Joe Scarborough wrote a follow-up editorial implying that Krugman's opinion is isolated among economists without citing any actual economists. In response, Joe Weisenthal created a list of economists of varying backgrounds and political persuasions who agree with Krugman.

The segment focused on the idea that the only way to do stimulus is if we also do long-term cuts at the same time.

Some quotes to give a feel:

Joe Scarborough, 8m20s: "Medicare, Medicaid, health care costs, the defense budget, long-term drivers of a long-term debt... I say you can do two things at the same time."

Ed Rendel, 12m23s, 15m49s: "I don't think any of these things are mutually exclusive... I think we can [invest in infrastructure] while at the same time taking care of the long-term... Simpson-Bowles said we can do both. We can stretch out our debt reduction over a course of time and at the same time do some things that will spur the economy."

Joe Scarborough: "Won't that send a good message to the markets if we say, 'Hey listen, here's the deal. We are going to take care of what we have to do in the short term to get people back to work, but in the long term we are taking care of the long-term structure'?"

This is often referred to as a "barbell strategy" (from a Peter Orzag column). Do stimulus, do long-term deficit reduction, but only if you can do them together. As mentioned by the panelists, this is part of several bipartisan debt reduction strategies. Here's Domenici-Rivlin's Restoring America's Future Plan: "First, we must recover from the deep recession that has thrown millions out of work... Second, we must take immediate steps to reduce the unsustainable debt... These two challenges must be addressed at the same time, not sequentially."

It's weird that nobody on Morning Joe seems to understand the obvious problems with this strategy, so let's make a list.

1. There is no solid economic argument for this. There may be political arguments, as in that's the only way to build a coalition to get legislation through a partisan Congress, but they are just that, political. There's no decent economic argument for why if stimulus is a good idea, and long-term deficit reduction is a good idea, that you need to do both at the same time.

Scarborough's argument that "this would send a good message to the markets" implies that interest rates are a constraint, when instead they've been at ultra-low rates. It also seems to imply that additional stimulus would send the markets into a panic. It is true that if we passed a stimulus program interest rates could rise, but this would reflect the market thinking things were getting better, not worse.

2. The political argument for this is also weak, if only because it was the operative strategy over the past several years and didn't work. President Obama just tried to get some $225 billion dollars in stimulus in the fiscal cliff and looked to be willing to accept cuts in the inflation adjustments for Social Security as part of the package. Republicans turned this down. This stimulus was first proposed a year earlier in his American Jobs Act, which, as he told Congress, would be paid for by offsetting long-term budgets. This was dead on arrival.

And it is easy to see why. You can probably get some agreement on the content of a stimulus package, but to get a agreement on long-term deficit reduction, you would need the GOP to accept some new revenues or clarify what it wants on social insurance. It won't do the first outside constructed scenarios like the fiscal cliff and the latter has yet to happen.

3. As for the short term, alleviating unemployment is the most responsible budget action even though it increases the short-term deficit. Austerity is likely to give us a higher debt-to-GDP problem if it causes a double-dip recession. Our current deficit is so large because so many people are not working; more economic activity would mean more things to tax and fewer stablizers like unemployment insurance to pay for.

As Delong and Summers argue, additional fiscal stimulus in a depressed economy can largely offset its own costs. Or as John Maynard Keynes said in 1933, "It is the burden of unemployment and the decline in the national income which are upsetting the Budget. Look after the unemployment, and the Budget will look after itself."

4. As for the part of the budget that won't take care of itself, President Obama fought an ugly and costly battle to bend the cost curve of health care, in which he was accused of everything from creating death panels to looting benefits of seniors in order to pass them out to his army of Takers. Since he's already paid that price, why wouldn't he wait and see how well Medicare cost saving techniques work?

Maybe it's just me, but I find the "if you want to see full employment again, immediately dismantle some social insurance" to be like a form of ransom. Meanwhile millions of people are suffering needlessly as a result of the lack of action.

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Live at Bloomberg View, on The Federal Reserve Transcripts

Jan 28, 2013Mike Konczal

I have a new article at Bloomberg View, titled The Fed Is More Out of It Than You Thought It Was. It's about the recently released Federal Reserve transcripts from 2007, and what they say about where the Fed was and wasn't looking when it came to weakness in the economy. It's also implicitly about coverage of the economic crisis that are overtly focused on the financial sector, relevant again in all the new TARP retrospectives that are out there. I hope you check it out.

I have a new article at Bloomberg View, titled The Fed Is More Out of It Than You Thought It Was. It's about the recently released Federal Reserve transcripts from 2007, and what they say about where the Fed was and wasn't looking when it came to weakness in the economy. It's also implicitly about coverage of the economic crisis that are overtly focused on the financial sector, relevant again in all the new TARP retrospectives that are out there. I hope you check it out.

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No, the 90 Percent Debt Threshold Hasn't Been Proven

Jan 28, 2013Mike Konczal

The deficit hawks at the Washington Post editorial board are worried. They are worried that the deficit is falling and the debt-to-GDP ratio is leveling off as a result of the numerous cuts and tax increases implemented over the past two years. Liberals know this and are starting to push back, either claiming that the deficit is coming down too quickly or arguing that the main medium-term deficit issues are taken care of and we should focus more on unemployment and other non-budget issues while implementing Obamacare reforms well. The CBPP has been leading the charge on this, noting various levels at which debt as a percent of GDP would level off in the following graphic:

The editorial focuses on the debt-to-GDP ratio leveling out too close to a 90 percent threshold. The writers also claim that there is a well-defined and well-established 90 percent threshold over which our economy will suffer. They write, "The CBPP analysis assumes steady economic growth and no war. If that’s even slightly off, debt-to-GDP could keep rising — and stick dangerously near the 90 percent mark that economists regard as a threat to sustainable economic growth." This 90 percent threshold was proposed by Carmen Reinhart and Kenneth Rogoff in their 2010 article "Growth in a Time of Debt" (GITD). They found that economies with public debt over 90 percent of debt-to-GDP grew more slowly than other countries.

It's always tough to figure out where consensus among economists lies. But economists don't "regard" the 90 percent mark as definitive; in fact, this study and its claim have never even been peer reviewed by an economics journal. [1]

I don't bring this up because something that's peer reviewed should automatically be accepted as definitive, or that credentials are everything, or that only Very Serious Economics matter. (That's a bad rule in general, and as an economics blogger that would be a doubly insane claim.) I bring it up only because the public should understand that the 90 percent threshold couldn't survive peer review for a very important reason: It's impossible to seperate the cause and effect here given the evidence collected. Policymakers and deficit hawks should reconsider if they're running under the assumption that this is a well-established rule.

Remember that growth that is suprisingly slow will increase the debt-to-GDP ratio relative to expectations by definition. And periods of slower growth will lead to higher debt levels. That doesn't mean that those debt loads caused the slower growth -- in these cases it would be just the opposite. Reinhart and Rogoff present no techniques, tools or theory to break this problem down and determine what is the cause and what is the effect in this debt versus GDP relationship.

As John Irons and Josh Bivens of EPI noted in their review of the GITD paper (my bold):

First, the theory that governs the relation between debt and growth suggests strongly that causality runs more firmly from slower growth to higher debt loads. Slow economic growth, and especially growth that is slower than policy makers’ expectations, will lead to higher levels of debt as revenues fall and as automatic-stabilizer spending increases... Importantly, the timing matters. Persistent slow growth will yield high debt levels, and will thus mechanically yield to contemporaneous combinations of high debt and slow growth...

In short, the statistical evidence strongly suggests that the causality runs from growth to debt, and not the reverse. Given that theory and preliminary investigation agree in this case, it seems clear that the GITD analysis—which looks only at contemporaneous levels of debt and growth—is much more likely to capture causal relationships running from slow growth to high debt. This means there is very little reason for policy makers to think that there is a high-debt threshold that acts to slow growth.

As one economist wrote me in an email, "it is likely unpublishable in a top journal due to the fact that they have not developed any techniques to tease out causality in what are suggestive but non-conclusive correlations. For this work to be the *one* thing that politicians decide to take from economics is horrible."

You can think that lower debt is better than higher debt ratios. You can be worried about interest payments, even though those are at a 30-year low and projected to go back to historical averages. But there isn't a great reason to believe that that leveling out at 80 versus 90 percent of GDP matters that much when we have mass unemployment, low interest rates, and inflation in check. Growth matters just as much as GDP for this calculation, and it's a terrible deal if we sacrifice either immediate growth or long-term investments in an attempt to bring down this debt-to-GDP ratio. There isn't good evidence that the levels matter that much if the plan works, and it is likely the plan won't work. Weakening growth is likely to balloon that deficit as well.

It's important to get a sense of where the deficit hawks will focus next because, if it is true that the deficit wars are coming to an end, all those giant deficit hawk groups are still funded through the apocalypse. Their mission will be that of Peter Venkman in Ghostbusters: "Type something, will you? We're paying for this stuff." How will they keep busy and justify their taxpayer-subsidized funding? We may have just gotten an important glimpse.

[1] According to their C.V.s, it's been published in the May 2010 issue of the American Economic Review, which is a special non-reviewed "papers and proceedings" issue.

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The deficit hawks at the Washington Post editorial board are worried. They are worried that the deficit is falling and the debt-to-GDP ratio is leveling off as a result of the numerous cuts and tax increases implemented over the past two years. Liberals know this and are starting to push back, either claiming that the deficit is coming down too quickly or arguing that the main medium-term deficit issues are taken care of and we should focus more on unemployment and other non-budget issues while implementing Obamacare reforms well. The CBPP has been leading the charge on this, noting various levels at which debt as a percent of GDP would level off in the following graphic:

The editorial focuses on the debt-to-GDP ratio leveling out too close to a 90 percent threshold. The writers also claim that there is a well-defined and well-established 90 percent threshold over which our economy will suffer. They write, "The CBPP analysis assumes steady economic growth and no war. If that’s even slightly off, debt-to-GDP could keep rising — and stick dangerously near the 90 percent mark that economists regard as a threat to sustainable economic growth." This 90 percent threshold was proposed by Carmen Reinhart and Kenneth Rogoff in their 2010 article "Growth in a Time of Debt" (GITD). They found that economies with public debt over 90 percent of debt-to-GDP grew more slowly than other countries.

It's always tough to figure out where consensus among economists lies. But economists don't "regard" the 90 percent mark as definitive; in fact, this study and its claim have never even been peer reviewed by an economics journal. [1]

I don't bring this up because something that's peer reviewed should automatically be accepted as definitive, or that credentials are everything, or that only Very Serious Economics matter. (That's a bad rule in general, and as an economics blogger that would be a doubly insane claim.) I bring it up only because the public should understand that the 90 percent threshold couldn't survive peer review for a very important reason: It's impossible to seperate the cause and effect here given the evidence collected. Policymakers and deficit hawks should reconsider if they're running under the assumption that this is a well-established rule.

Remember that growth that is suprisingly slow will increase the debt-to-GDP ratio relative to expectations by definition. And periods of slower growth will lead to higher debt levels. That doesn't mean that those debt loads caused the slower growth -- in these cases it would be just the opposite. Reinhart and Rogoff present no techniques, tools or theory to break this problem down and determine what is the cause and what is the effect in this debt versus GDP relationship.

As John Irons and Josh Bivens of EPI noted in their review of the GITD paper (my bold):

First, the theory that governs the relation between debt and growth suggests strongly that causality runs more firmly from slower growth to higher debt loads. Slow economic growth, and especially growth that is slower than policy makers’ expectations, will lead to higher levels of debt as revenues fall and as automatic-stabilizer spending increases... Importantly, the timing matters. Persistent slow growth will yield high debt levels, and will thus mechanically yield to contemporaneous combinations of high debt and slow growth...

In short, the statistical evidence strongly suggests that the causality runs from growth to debt, and not the reverse. Given that theory and preliminary investigation agree in this case, it seems clear that the GITD analysis—which looks only at contemporaneous levels of debt and growth—is much more likely to capture causal relationships running from slow growth to high debt. This means there is very little reason for policy makers to think that there is a high-debt threshold that acts to slow growth.

As one economist wrote me in an email, "it is likely unpublishable in a top journal due to the fact that they have not developed any techniques to tease out causality in what are suggestive but non-conclusive correlations. For this work to be the *one* thing that politicians decide to take from economics is horrible."

You can think that lower debt is better than higher debt ratios. You can be worried about interest payments, even though those are at a 30-year low and projected to go back to historical averages. But there isn't a great reason to believe that that leveling out at 80 versus 90 percent of GDP matters that much when we have mass unemployment, low interest rates, and inflation in check. Growth matters just as much as GDP for this calculation, and it's a terrible deal if we sacrifice either immediate growth or long-term investments in an attempt to bring down this debt-to-GDP ratio. There isn't good evidence that the levels matter that much if the plan works, and it is likely the plan won't work. Weakening growth is likely to balloon that deficit as well.

It's important to get a sense of where the deficit hawks will focus next because, if it is true that the deficit wars are coming to an end, all those giant deficit hawk groups are still funded through the apocalypse. Their mission will be that of Peter Venkman in Ghostbusters: "Type something, will you? We're paying for this stuff." How will they keep busy and justify their taxpayer-subsidized funding? We may have just gotten an important glimpse.

[1] According to their C.V.s, it's been published in the May 2010 issue of the American Economic Review, which is a special non-reviewed "papers and proceedings" issue.

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The Most Important Graph on the Deficit

Jan 22, 2013Mike Konczal

Another friendly reminder, especially as you are deluged by pundit commentary about the budget, debt, and deficit, that there's one graphic to keep in mind about the current budget situation. From CBO:

As you can see, in 2009 our country goes into a deep recession. As a response, automatic stabilizers kick in, increasing spending through things like unemployment insurance and food stamps. Meanwhile receipts fall, as there is less economic activity and jobs that generate tax revenue, and taxes are cut further as a stimulus measure. This is not only natural, but to push back against it would have made the economy worse. That, in turn, would probably have blown out the deficit more.

The deficit is just the difference between the two lines. As the economy slowly recovers, spending decreases and tax revenues increases. We already see this happening in the CBO graphic. From the Budget Control Act there will be less spending, and from the fiscal cliff there will be more revenue. If anything, we should be worried that gap is closing too quickly, suffocating the recovery as it starts to gain strength. But the gap is still decreasing. As many people noted, the gap is closing at record-high rates.
 
There are long-term challenges driven by health care spending. Our course of action is to see if the cost control mechanisms in Obamacare work, and go from there if they don't, which I think is the right course. Certainly, after all the political pain of "cutting Medicare" and passing Obamacare, they'd be insane not to see how it works. And it is possible it is already working, with Medicare spending starting to drop.
 

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Another friendly reminder, especially as you are deluged by pundit commentary about the budget, debt, and deficit, that there's one graphic to keep in mind about the current budget situation. From CBO:

As you can see, in 2009 our country goes into a deep recession. As a response, automatic stabilizers kick in, increasing spending through things like unemployment insurance and food stamps. Meanwhile receipts fall, as there is less economic activity and jobs that generate tax revenue, and taxes are cut further as a stimulus measure. This is not only natural, but to push back against it would have made the economy worse. That, in turn, would probably have blown out the deficit more.

The deficit is just the difference between the two lines. As the economy slowly recovers, spending decreases and tax revenues increases. We already see this happening in the CBO graphic. From the Budget Control Act there will be less spending, and from the fiscal cliff there will be more revenue. If anything, we should be worried that gap is closing too quickly, suffocating the recovery as it starts to gain strength. But the gap is still decreasing. As many people noted, the gap is closing at record-high rates.
 
There are long-term challenges driven by health care spending. Our course of action is to see if the cost control mechanisms in Obamacare work, and go from there if they don't, which I think is the right course. Certainly, after all the political pain of "cutting Medicare" and passing Obamacare, they'd be insane not to see how it works. And it is possible it is already working, with Medicare spending starting to drop.
 

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How Has the Liberal Project Fared Under President Obama?

Jan 22, 2013Mike Konczal

After President Obama's inaugural address yesterday -- “one of the most expansively progressive Inaugural Addresses in decades," as President Clinton's former speechwriter told Greg Sargent -- many are looking at the liberal project from the point of view of what was accomplished in the first term as well as what is possible in the second. Paul Krugman makes one version of this argument in The Big Deal, arguing, "as the second term begins [liberals should] find grounds for a lot of (qualified) satisfaction." Elias Isquith, Ned Resnikoff, and Jamelle Bouie discussed the health of the liberal project, especially the fate of social insurance, last month.

People will be engaging with these questions for the foreseeable future, starting in the next few weeks and continuing for a generation of scholars. I'm not sure if I have good answers, but I do have good questions. I've created a generalizable framework of what the component parts of the modern, domestic liberal project are so I can map how they've fared in the first term and what the challenges for each are going ahead. Liberalism is a project of freedom, of course. But by mapping it into component parts of managing the macroeconomy, a mixed economy, a strong regulatory state, and a system of social insurance, allows us to chart progress and retreat.

I'm going to address where I think these issues stand in the current debate among liberals, so it'll have a "on the one hand and also the other hand" dynamic. (The framework might seem ad hoc, but it could be built from theoretical grounds [1].) 

Managing the Macroeconomy

Goals: Taming the business cycle, Keynesian demand management, full employment.

The first term began with the worst downturn since the Great Depression, and normal monetary policy was immediately put in check. The mass unemployment of the past several years has thrown this Keynesian project into complete disarray. It hasn't helped that voters no longer think that the government is capable of doing much here, which is an unfortunate side effect of the weak response.

There's already been an extensive debate about what could have been done to generate more stimulus early on in the administration instead of pivoting away to deficit reduction. After the GOP took the House in 2010, there were two initiatives to try and meet the GOP halfway on stimulus. There was the approach of trying to propose stimulus the GOP would potentially support, like the American Jobs Bill. Remember that Congressional address in which the president said "pass this jobs bill" over and over? There was also the approach of seeking Grand Bargains for additional stimulus. This involved exchanging, say, Social Security cuts for infrastructure spending and some tax revenue. For better or worse, but mostly better, this failed because Republicans refuse to raise taxes.

But this all means that we are still stuck with high unemployment rates for the foreseeable future. It is unlikely that there will be stimulus in the second term; we should hope that some of the harsher cuts, like the sequestration, are postponed while the economy is weak.

Investing in the Mixed Economy

Goals: Creating the conditions for long-term growth, investing in public goods, protecting the public sector.

In addition to managing the short-term economy, there's also the issue of setting the stage for longer-term growth. This is necessarily a grab-bag category, overlapping with the other categories, but it is useful to distinguish it from short-term unemployment. Michael Grunwald's excellent book The New New Deal revived the extensive investment in energy and other innovations that were part of the stimulus. Preventing the mass firesale and collapse of the auto industry were crucial as well.

But there's been a decline in primary and secondary education investment driven by the states, as well as a large decrease in the number of government employees. That's largely the focus of states. At the federal level, investments in infrastructure, research and development, and education, all crucial to building longer-term prosperity, are at risk. Through the Budget Control Act and upcoming sequestration, President Obama and Congress have cut non-defense discretionary spending in order to balance the medium-term debt-to-GDP ratio. As EPI's Ethan Pollack notes, it is difficult to cut here without threatening long-term prosperity.

The stimulus brought a large wave of investment, but that could be more than cancelled out by both collapsing state budgets and long-term austerity and cuts.

Social Insurance

Goals: Sharing risks from poverty, large declines in income, and health problems.

The obvious win over the past four years is Obamacare. Universal health care was the missing piece in the safety net, and efforts to try and tackle this problem have failed every 20 years going back a century. It also survived the Supreme Court, making it the law of the land.

Democratic Senator Tom Harkin called Obamacare a “starter home," which could be generous. The biggest fear I have is that when the government turns it on in 2013, it is viewed as a costly disaster. It isn't clear that Medicare costs would then be lowered and the whole idea of government health-care could be tossed overboard. The damage could be greater than just Obamacare itself. Greg Anrig worries that states can still sabotage the exchanges. Sarah Kliff has an overview on Obamacare implementation over the next four years.

The defeat of Romney and Ryan means that the conservative plans to voucherize Medicare, privatize Social Security, and block-grant everything that's not bolted to the floor is off the table, perhaps for a while. What's possible in the next few years is means-testing the programs, raising their eligibility age, and otherwise reducing benefits. The administration's proposed willingness to raise the eligibility age for retirement programs in exchange for non-social insurance related goals, like stimulus, is bad news on this frontier.

Much rides on Obamacare's success, both bending the cost curve of healthcare to fix the long-term deficit and the credibility of government more broadly.

Regulatory State

Goals: Creating rules for the marketplace that check market failures and power.

The failure to tackle climate change will be remembered as the biggest problem of President Obama's first term. He was largely silent on the issue while a bill went through Senate, though has gotten louder on the topic recently, including in the Inaugural.

Dodd-Frank consolidated regulators, added powers necessary to rationalize the derivatives market, and created a beefed-up consumer regulator. It didn't break up the banks and the Volcker Rule is very much uncertain. It's fair to say it gives regulators a lot of powers they should have had going into 2008 and checks some of the larger deregulations and market failures of the 2000s. There's a remaining sense, however, that Wall Street is outside of the normal accountability mechanisms of the state.

It's probably too early to tell how much reform was jettisoned through Cass Sunstein, the "ambivalent regulator" in charge of OIRA. But my sense is that there were genuine liberals in regulatory agencies pushing strong reform at places like the EPA and the NLRB.

Carbon is still a major threat, though it looks like the President will make a major push in his second term on the issue. There's a growing bipartisan argument for breaking up the Too Big To Fail banks, which, even if it doesn't turn into law, could put additional pressure on how financial elites have become detached from the normal modes of accountability and law.

What's your take? This framework is obviously missing international and civil libertarian projects. There is the escalation of war in Afghanistan, as well as the larger deployment of drones to more theaters, both of which are major problems. The embrace of the legacy of torture is a betrayal of civil liberties. Congress will eventually need to step up and check the power of the executive branch, yet they seem just as bad as the administration.

[1] If you want a more theoretical treatment on one way to get to this mapping, John Rawls proposed four "branches" of government in a Theory of Justice that loosely map onto these categories. The allocation branch works like the regulatory state, the stabilization branch as managing the macroeconomy, and the transfer branch for social insurance.

Follow or contact the Rortybomb blog:

  

After President Obama's inaugural address yesterday -- “one of the most expansively progressive Inaugural Addresses in decades," as President Clinton's former speechwriter told Greg Sargent -- many are looking at the liberal project from the point of view of what was accomplished in the first term as well as what is possible in the second. Paul Krugman makes one version of this argument in The Big Deal, arguing, "as the second term begins [liberals should] find grounds for a lot of (qualified) satisfaction." Elias Isquith, Ned Resnikoff, and Jamelle Bouie discussed the health of the liberal project, especially the fate of social insurance, last month.

People will be engaging with these questions for the foreseeable future, starting in the next few weeks and continuing for a generation of scholars. I'm not sure if I have good answers, but I do have good questions. I've created a generalizable framework of what the component parts of the modern, domestic liberal project are so I can map how they've fared in the first term and what the challenges for each are going ahead. Liberalism is a project of freedom, of course. But by mapping it into component parts of managing the macroeconomy, a mixed economy, a strong regulatory state, and a system of social insurance, allows us to chart progress and retreat.

I'm going to address where I think these issues stand in the current debate among liberals, so it'll have a "on the one hand and also the other hand" dynamic. (The framework might seem ad hoc, but it could be built from theoretical grounds [1].) 

Managing the Macroeconomy

Goals: Taming the business cycle, Keynesian demand management, full employment.

The first term began with the worst downturn since the Great Depression, and normal monetary policy was immediately put in check. The mass unemployment of the past several years has thrown this Keynesian project into complete disarray. It hasn't helped that voters no longer think that the government is capable of doing much here, which is an unfortunate side effect of the weak response.

There's already been an extensive debate about what could have been done to generate more stimulus early on in the administration instead of pivoting away to deficit reduction. After the GOP took the House in 2010, there were two initiatives to try and meet the GOP halfway on stimulus. There was the approach of trying to propose stimulus the GOP would potentially support, like the American Jobs Bill. Remember that Congressional address in which the president said "pass this jobs bill" over and over? There was also the approach of seeking Grand Bargains for additional stimulus. This involved exchanging, say, Social Security cuts for infrastructure spending and some tax revenue. For better or worse, but mostly better, this failed because Republicans refuse to raise taxes.

But this all means that we are still stuck with high unemployment rates for the foreseeable future. It is unlikely that there will be stimulus in the second term; we should hope that some of the harsher cuts, like the sequestration, are postponed while the economy is weak.

Investing in the Mixed Economy

Goals: Creating the conditions for long-term growth, investing in public goods, protecting the public sector.

In addition to managing the short-term economy, there's also the issue of setting the stage for longer-term growth. This is necessarily a grab-bag category, overlapping with the other categories, but it is useful to distinguish it from short-term unemployment. Michael Grunwald's excellent book The New New Deal revived the extensive investment in energy and other innovations that were part of the stimulus. Preventing the mass firesale and collapse of the auto industry were crucial as well.

But there's been a decline in primary and secondary education investment driven by the states, as well as a large decrease in the number of government employees. That's largely the focus of states. At the federal level, investments in infrastructure, research and development, and education, all crucial to building longer-term prosperity, are at risk. Through the Budget Control Act and upcoming sequestration, President Obama and Congress have cut non-defense discretionary spending in order to balance the medium-term debt-to-GDP ratio. As EPI's Ethan Pollack notes, it is difficult to cut here without threatening long-term prosperity.

The stimulus brought a large wave of investment, but that could be more than cancelled out by both collapsing state budgets and long-term austerity and cuts.

Social Insurance

Goals: Sharing risks from poverty, large declines in income, and health problems.

The obvious win over the past four years is Obamacare. Universal health care was the missing piece in the safety net, and efforts to try and tackle this problem have failed every 20 years going back a century. It also survived the Supreme Court, making it the law of the land.

Democratic Senator Tom Harkin called Obamacare a “starter home," which could be generous. The biggest fear I have is that when the government turns it on in 2013, it is viewed as a costly disaster. It isn't clear that Medicare costs would then be lowered and the whole idea of government health-care could be tossed overboard. The damage could be greater than just Obamacare itself. Greg Anrig worries that states can still sabotage the exchanges. Sarah Kliff has an overview on Obamacare implementation over the next four years.

The defeat of Romney and Ryan means that the conservative plans to voucherize Medicare, privatize Social Security, and block-grant everything that's not bolted to the floor is off the table, perhaps for a while. What's possible in the next few years is means-testing the programs, raising their eligibility age, and otherwise reducing benefits. The administration's proposed willingness to raise the eligibility age for retirement programs in exchange for non-social insurance related goals, like stimulus, is bad news on this frontier.

Much rides on Obamacare's success, both bending the cost curve of healthcare to fix the long-term deficit and the credibility of government more broadly.

Regulatory State

Goals: Creating rules for the marketplace that check market failures and power.

The failure to tackle climate change will be remembered as the biggest problem of President Obama's first term. He was largely silent on the issue while a bill went through Senate, though has gotten louder on the topic recently, including in the Inaugural.

Dodd-Frank consolidated regulators, added powers necessary to rationalize the derivatives market, and created a beefed-up consumer regulator. It didn't break up the banks and the Volcker Rule is very much uncertain. It's fair to say it gives regulators a lot of powers they should have had going into 2008 and checks some of the larger deregulations and market failures of the 2000s. There's a remaining sense, however, that Wall Street is outside of the normal accountability mechanisms of the state.

It's probably too early to tell how much reform was jettisoned through Cass Sunstein, the "ambivalent regulator" in charge of OIRA. But my sense is that there were genuine liberals in regulatory agencies pushing strong reform at places like the EPA and the NLRB.

Carbon is still a major threat, though it looks like the President will make a major push in his second term on the issue. There's a growing bipartisan argument for breaking up the Too Big To Fail banks, which, even if it doesn't turn into law, could put additional pressure on how financial elites have become detached from the normal modes of accountability and law.

What's your take? This framework is obviously missing international and civil libertarian projects. There is the escalation of war in Afghanistan, as well as the larger deployment of drones to more theaters, both of which are major problems. The embrace of the legacy of torture is a betrayal of civil liberties. Congress will eventually need to step up and check the power of the executive branch, yet they seem just as bad as the administration.

[1] If you want a more theoretical treatment on one way to get to this mapping, John Rawls proposed four "branches" of government in a Theory of Justice that loosely map onto these categories. The allocation branch works like the regulatory state, the stabilization branch as managing the macroeconomy, and the transfer branch for social insurance.

Follow or contact the Rortybomb blog:

  
 
President Obama image via Shutterstock.com.

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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.
 

Follow or contact the Rortybomb blog:

  

 

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