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!

Follow or contact the Rortybomb blog:

  

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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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.

 

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What Does the New Community Reinvestment Act (CRA) Paper Tell Us?

Dec 11, 2012Mike Konczal

There are two major, critical questions that show up in the literature surrounding the 1977 Community Reinvestment Act (CRA).

The first question is how much compliance with the CRA changes the portfolio of lending institutions. Do they lend more often and to riskier people, or do they lend the same but put more effort into finding candidates? The second question is how much did the CRA lead to the expansion of subprime lending during the housing bubble. Did the CRA have a significant role in the financial crisis?
 
There's a new paper on the CRA, Did the Community Reinvestment Act (CRA) Lead to Risky Lending?, by Agarwal, Benmelech, Bergman and Seru, h/t Tyler Cowen, with smart commentary already from Noah Smith. (This blog post will use the ungated October 2012 paper for quotes and analysis.) This is already being used as the basis for an "I told you so!" by the conservative press, which has tried to argue that the second question is most relevant. However, it is important to understand that this paper answers the first question, while, if anything, providing evidence against the conservative case for the second.
 
Where is the literature on these two questions? One starting point is the early 2009 research of two Federal Reserve economists, Neil Bhutta and Glenn B. Canner, also summarized in this Randy Kroszner speech. On the first question Kroszner summarizes research by the Federal Reserve, the latest being from 2000, arguing that "lending to lower-income individuals and communities has been nearly as profitable and performed similarly to other types of lending done by CRA-covered institutions." The CRA didn't cause changes to banks' portfolios, but instead required them to find better opportunities. More on this in a minute.
 
What about the second question? Here the Bhutta/Canner research notes that only six percent of higher-priced loans (their proxy for subprime loans) were extended by CRA-covered lenders to lower-income borrowers or CRA neighborhoods. 94 percent of these loans were either made by non-traditional banks not covered by the CRA (the "shadow banking system"), or not counted towards CRA credits. As Kroszner noted, "the very small share of all higher-priced loan originations that can reasonably be attributed to the CRA makes it hard to imagine how this law could have contributed in any meaningful way to the current subprime crisis."
 
How did those loans do? Here the research compared the performance of subprime and alt-A loans in neighborhoods right above and right below the CRA's income threshold, and found that there was no difference in how the loans performed. Hence the idea that a CRA-driven subprime bubble isn't found in the data. (The FCIC's final report, starting at page 219, has more on this and other research.)
 
So what does this new research do? It takes banks that were undergoing a normal examination to see if they were in compliance with the CRA, and thus under heightened regulatory scrunity, and compares their loan portfolios with banks that were not undergoing a CRA examination. It finds that the CRA exam increases loans 5 percent every quarter surrounding the event and those loans default 15 percent more often, under the idea that those banks were ramping up their loans to pass the CRA exam.
 
But this is question 1 territory. 94 percent of higher priced loans came outside CRA firms and outside CRA loans, and this research doesn't really change that. Since we are talking about regular mortgages - more on that in a second - that higher default isn't that scary. To put that in perspective, loans made in the quarter following the initiation of a CRA exam in a non-CRA tract are 8.3 percent more likely to be 90 days delinquent. That sounds scary, but it is an increase of 0.1, from 1.2 percent to 1.3 percent. In the CRA tract it is 33 percent more likely to default, going from 1.2 percent to 1.6 percent. FICO scores drop 7 points from 713.9 to 706.9. That's an increase I wouldn't want in my portfolio, but it is light-years away from 25%+ default rates, and very low FICO scores, on actual subprime.
 

This research, if anything, pushes against movement conservative CRA arguments. In light of the evidence in question 2, many conservatives argue that regulators used CRA to push down lending standards, which then impacted other firms. But this paper finds that extra loans aren't more likely to have higher interest rates, lower loan-to-value, or be balloon/interest-only/jumbo/buy-down mortgages, although there is a slight increase in undocumented loans. And their borrowers aren't more likely to have risky characteristics themselves. The authors conclude that "this pattern is consistent with banks’ strategic attempts to convince regulators that the loans they extend that meet CRA criteria are not overtly risky."

Read that again. The authors argue, from their empirical evidence, that regulators were trying to make sure these loans had high standards, and CRA banks tried to comply with that as best they could on the major, visible risks of their loans. This is the opposite argument made by people like John Carney, who believes the CRA "encourag[ed] lenders to adopt loose standards for mortgages." It also pushes against people like Peter Wallison, who, in his FCIC dissent, argued that CRA loans were more likely to have subprime characteristics or riskier borrowers in ways not captured by a higher-price variable. Not the case.

It also finds that loan volume and risk increases the most during 2004-2006, and points to the private securitization market as an important channel. This, along with characteristics above, pushes back against the idea that the CRA primed a subprime pump in the late 1990s and early 2000s, another favorite of movement conservative finance writers. If anything, banks undergoing CRA exams were caught up in the same mechanisms that were causing the housing bubble itself.

I'm not sure I buy all of the research. If CRA banks take on too many loans during examination, why wouldn't they just loan less afterwards, balancing out? The paper jumps to argue the opposite, as it is worried that "adjustment costs may cause banks to keep elevated lending rates even after the CRA exam is formally completed." This is meant to establish their results as a lower-bound, rather than an upper-bound. But really? They managed to ramp up their lending in enough time during this time. Either way it would throw a very different set of interpretations on their research. I'm interested in seeing how other researchers react to these problems. But for now these results don't change the way we approach the financial crisis.

 

Follow or contact the Rortybomb blog:
  

 

There are two major, critical questions that show up in the literature surrounding the 1977 Community Reinvestment Act (CRA).

The first question is how much compliance with the CRA changes the portfolio of lending institutions. Do they lend more often and to riskier people, or do they lend the same but put more effort into finding candidates? The second question is how much did the CRA lead to the expansion of subprime lending during the housing bubble. Did the CRA have a significant role in the financial crisis?
 
There's a new paper on the CRA, Did the Community Reinvestment Act (CRA) Lead to Risky Lending?, by Agarwal, Benmelech, Bergman and Seru, h/t Tyler Cowen, with smart commentary already from Noah Smith. (This blog post will use the ungated October 2012 paper for quotes and analysis.) This is already being used as the basis for an "I told you so!" by the conservative press, which has tried to argue that the second question is most relevant. However, it is important to understand that this paper answers the first question, while, if anything, providing evidence against the conservative case for the second.
 
Where is the literature on these two questions? One starting point is the early 2009 research of two Federal Reserve economists, Neil Bhutta and Glenn B. Canner, also summarized in this Randy Kroszner speech. On the first question Kroszner summarizes research by the Federal Reserve, the latest being from 2000, arguing that "lending to lower-income individuals and communities has been nearly as profitable and performed similarly to other types of lending done by CRA-covered institutions." The CRA didn't cause changes to banks' portfolios, but instead required them to find better opportunities. More on this in a minute.
 
What about the second question? Here the Bhutta/Canner research notes that only six percent of higher-priced loans (their proxy for subprime loans) were extended by CRA-covered lenders to lower-income borrowers or CRA neighborhoods. 94 percent of these loans were either made by non-traditional banks not covered by the CRA (the "shadow banking system"), or not counted towards CRA credits. As Kroszner noted, "the very small share of all higher-priced loan originations that can reasonably be attributed to the CRA makes it hard to imagine how this law could have contributed in any meaningful way to the current subprime crisis."
 
How did those loans do? Here the research compared the performance of subprime and alt-A loans in neighborhoods right above and right below the CRA's income threshold, and found that there was no difference in how the loans performed. Hence the idea that a CRA-driven subprime bubble isn't found in the data. (The FCIC's final report, starting at page 219, has more on this and other research.)
 
So what does this new research do? It takes banks that were undergoing a normal examination to see if they were in compliance with the CRA, and thus under heightened regulatory scrunity, and compares their loan portfolios with banks that were not undergoing a CRA examination. It finds that the CRA exam increases loans 5 percent every quarter surrounding the event and those loans default 15 percent more often, under the idea that those banks were ramping up their loans to pass the CRA exam.
 
But this is question 1 territory. 94 percent of higher priced loans came outside CRA firms and outside CRA loans, and this research doesn't really change that. Since we are talking about regular mortgages - more on that in a second - that higher default isn't that scary. To put that in perspective, loans made in the quarter following the initiation of a CRA exam in a non-CRA tract are 8.3 percent more likely to be 90 days delinquent. That sounds scary, but it is an increase of 0.1, from 1.2 percent to 1.3 percent. In the CRA tract it is 33 percent more likely to default, going from 1.2 percent to 1.6 percent. FICO scores drop 7 points from 713.9 to 706.9. That's an increase I wouldn't want in my portfolio, but it is light-years away from 25%+ default rates, and very low FICO scores, on actual subprime.
 

This research, if anything, pushes against movement conservative CRA arguments. In light of the evidence in question 2, many conservatives argue that regulators used CRA to push down lending standards, which then impacted other firms. But this paper finds that extra loans aren't more likely to have higher interest rates, lower loan-to-value, or be balloon/interest-only/jumbo/buy-down mortgages, although there is a slight increase in undocumented loans. And their borrowers aren't more likely to have risky characteristics themselves. The authors conclude that "this pattern is consistent with banks’ strategic attempts to convince regulators that the loans they extend that meet CRA criteria are not overtly risky."

Read that again. The authors argue, from their empirical evidence, that regulators were trying to make sure these loans had high standards, and CRA banks tried to comply with that as best they could on the major, visible risks of their loans. This is the opposite argument made by people like John Carney, who believes the CRA "encourag[ed] lenders to adopt loose standards for mortgages." It also pushes against people like Peter Wallison, who, in his FCIC dissent, argued that CRA loans were more likely to have subprime characteristics or riskier borrowers in ways not captured by a higher-price variable. Not the case.

It also finds that loan volume and risk increases the most during 2004-2006, and points to the private securitization market as an important channel. This, along with characteristics above, pushes back against the idea that the CRA primed a subprime pump in the late 1990s and early 2000s, another favorite of movement conservative finance writers. If anything, banks undergoing CRA exams were caught up in the same mechanisms that were causing the housing bubble itself.

I'm not sure I buy all of the research. If CRA banks take on too many loans during examination, why wouldn't they just loan less afterwards, balancing out? The paper jumps to argue the opposite, as it is worried that "adjustment costs may cause banks to keep elevated lending rates even after the CRA exam is formally completed." This is meant to establish their results as a lower-bound, rather than an upper-bound. But really? They managed to ramp up their lending in enough time during this time. Either way it would throw a very different set of interpretations on their research. I'm interested in seeing how other researchers react to these problems. But for now these results don't change the way we approach the financial crisis.

 

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Another Reason to Kill the Debt Ceiling: Conservative Think Tanks' Responses to Default

Dec 5, 2012Mike Konczal

House Republicans are looking to weaponize the debt ceiling again, while the Obama administration is trying to make removing the threat of default part of any agreement.

Here's one reason why the debt ceiling needs to go: the conservative intellectual infrastructure cheered on a potential default. I had imagined that there would be a good cop/bad cop dynamic to the right. Very conservative political leaders would be the bad cop, saying that they weren't afraid to default on the debt, while conservative think tanks would play a version of the good cop, warning of the dire consequences of a default for the economy if their bad cop friend didn't get his way.

For instance, here's bad cop Sen. Pat Toomey (R-PA) saying that the markets "would actually accept even a delay in interest payments on the Treasuries," especially "if it meant that Congress would right this ship, address this fiscal imbalance, and put us on a sustainable path, and that the bond market would rally if it saw we were making real progress towards this." Missing interest payments is fine; in fact, it is great for the country if it is used to pass the Ryan Plan.

Financial analysts, to put it mildly, disagreed. JP Morgan analysts wrote that "any delay in making a coupon or principal payment by Treasury would almost certainly have large systemic effects with long-term adverse consequences for Treasury finances and the US economy."

Here's where the think tanks are fascinating. You could image them saying "our partner Toomey is nuts, we can't control him, and you better do what he says or there's going to be real damage." But that's not what they did. It's best to split the work they did on the debt ceiling in two directions:

1. Technical Default Ain't No Thang. The first is arguing, like Toomey, that a "technical default" wouldn't matter, and in fact it could be a great thing if the Ryan Plan passed as a result. How did James Pethokoukis, then of Fortune and now of AEI, deal with a Moody's report arguing a "short-lived default" would hurt the economy? Pethokoukis: "I guess I would care more about what Moody’s had to say if a) they hadn’t missed the whole financial crisis, b) didn’t want to see higher taxes as part of any fiscal fix and c) if they made any economic sense." Default doesn't matter because Pethokoukis doesn't want taxes to go up, and there's no economic sense because of an interview he read in the Wall Street Journal.

Others went even further, arguing that the real defaulters are those who, umm, don't want to default on the debt. Here's the conservative think tank e21 with a staff editorial arguing that "policymakers need to stay focused on the real default issue: whether the terms of the debt limit increase this summer will be sufficiently tough to ensure that the nation’s debt-to-GDP ratio is stabilized and eventually sharply reduced." All these people who want a clean debt ceiling increase are causing the real default issue. As someone who used to do a lot of credit risk modeling, this is my favorite: "Indeed, those demanding the toughest concessions today actually have a strong pro-creditor bias." S&P disagreed with whoever wrote that editorial and increased the credit risk (downgraded) based on the threat of this technical default.

Heritage wrote a white paper saying that you could just "hold the debt limit in place, thereby forcing an immediate reduction in non-interest spending averaging about $125 billion each month," and that "refusing to raise the debt limit would not, in and of itself, cause the United States to default on its public debt." Dana Milbank noted that these kinds of shuffling plans would still leave the government short and likely cause a recession. Milbank: "Without borrowing, we’d have to cut Obama’s budget for 2012 by $1.5 trillion. That means even if we shut down the military and stopped writing Social Security checks, the government would still come up about $200 billion short." Cato also jumped in with the technical default crowd here.

But that was the reaction from the number-crunching analysts. What about the bosses?

2. Civilization Hangs in the Balance of the Debt Ceiling Fight. Here's the president of AEI, Arthur C. Brooks, in July 2011: "The battle over the debt ceiling...is not a political fight between Republicans and Democrats; it is a fight against 50-year trends toward statism...No one deserves our political support today unless he or she is willing to work for as long as it takes to win the moral fight to steer our nation back toward enterprise and self-governance."

Even better, the president of the Heritage Foundation, also in July 2011, compares Democrats to Japan during World War II and then argues: "We must win this fight. The debate over raising the debt limit seems complicated, but it is really very simple. Look beyond the myriad details of the awkward compromises, and you see an epic struggle between two opposing camps....Congress should not raise the debt limit without getting spending under control."

So the the conservative intellectual infrastructure, which consumes hundreds of millions of dollars a year, looked at the possibility of a debt default and determined it was both inconsequential and also the only way to stop statism in our lifetimes. No wonder the time period around the debt ceiling in 2011 was such a disaster for our economy, killing around 250,000 jobs that should have been created. There's no reason to assume all the same players won't play an even worse cop this time around.

There's no good reason for the debt ceiling, and now there are really bad consequences for its existence. Time to end it.

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House Republicans are looking to weaponize the debt ceiling again, while the Obama administration is trying to make removing the threat of default part of any agreement.

Here's one reason why the debt ceiling needs to go: the conservative intellectual infrastructure cheered on a potential default. I had imagined that there would be a good cop/bad cop dynamic to the right. Very conservative political leaders would be the bad cop, saying that they weren't afraid to default on the debt, while conservative think tanks would play a version of the good cop, warning of the dire consequences of a default for the economy if their bad cop friend didn't get his way.

For instance, here's bad cop Sen. Pat Toomey (R-PA) saying that the markets "would actually accept even a delay in interest payments on the Treasuries," especially "if it meant that Congress would right this ship, address this fiscal imbalance, and put us on a sustainable path, and that the bond market would rally if it saw we were making real progress towards this." Missing interest payments is fine; in fact, it is great for the country if it is used to pass the Ryan Plan.

Financial analysts, to put it mildly, disagreed. JP Morgan analysts wrote that "any delay in making a coupon or principal payment by Treasury would almost certainly have large systemic effects with long-term adverse consequences for Treasury finances and the US economy."

Here's where the think tanks are fascinating. You could image them saying "our partner Toomey is nuts, we can't control him, and you better do what he says or there's going to be real damage." But that's not what they did. It's best to split the work they did on the debt ceiling in two directions:

1. Technical Default Ain't No Thang. The first is arguing, like Toomey, that a "technical default" wouldn't matter, and in fact it could be a great thing if the Ryan Plan passed as a result. How did James Pethokoukis, then of Fortune and now of AEI, deal with a Moody's report arguing a "short-lived default" would hurt the economy? Pethokoukis: "I guess I would care more about what Moody’s had to say if a) they hadn’t missed the whole financial crisis, b) didn’t want to see higher taxes as part of any fiscal fix and c) if they made any economic sense." Default doesn't matter because Pethokoukis doesn't want taxes to go up, and there's no economic sense because of an interview he read in the Wall Street Journal.

Others went even further, arguing that the real defaulters are those who, umm, don't want to default on the debt. Here's the conservative think tank e21 with a staff editorial arguing that "policymakers need to stay focused on the real default issue: whether the terms of the debt limit increase this summer will be sufficiently tough to ensure that the nation’s debt-to-GDP ratio is stabilized and eventually sharply reduced." All these people who want a clean debt ceiling increase are causing the real default issue. As someone who used to do a lot of credit risk modeling, this is my favorite: "Indeed, those demanding the toughest concessions today actually have a strong pro-creditor bias." S&P disagreed with whoever wrote that editorial and increased the credit risk (downgraded) based on the threat of this technical default.

Heritage wrote a white paper saying that you could just "hold the debt limit in place, thereby forcing an immediate reduction in non-interest spending averaging about $125 billion each month," and that "refusing to raise the debt limit would not, in and of itself, cause the United States to default on its public debt." Dana Milbank noted that these kinds of shuffling plans would still leave the government short and likely cause a recession. Milbank: "Without borrowing, we’d have to cut Obama’s budget for 2012 by $1.5 trillion. That means even if we shut down the military and stopped writing Social Security checks, the government would still come up about $200 billion short." Cato also jumped in with the technical default crowd here.

But that was the reaction from the number-crunching analysts. What about the bosses?

2. Civilization Hangs in the Balance of the Debt Ceiling Fight. Here's the president of AEI, Arthur C. Brooks, in July 2011: "The battle over the debt ceiling...is not a political fight between Republicans and Democrats; it is a fight against 50-year trends toward statism...No one deserves our political support today unless he or she is willing to work for as long as it takes to win the moral fight to steer our nation back toward enterprise and self-governance."

Even better, the president of the Heritage Foundation, also in July 2011, compares Democrats to Japan during World War II and then argues: "We must win this fight. The debate over raising the debt limit seems complicated, but it is really very simple. Look beyond the myriad details of the awkward compromises, and you see an epic struggle between two opposing camps....Congress should not raise the debt limit without getting spending under control."

So the the conservative intellectual infrastructure, which consumes hundreds of millions of dollars a year, looked at the possibility of a debt default and determined it was both inconsequential and also the only way to stop statism in our lifetimes. No wonder the time period around the debt ceiling in 2011 was such a disaster for our economy, killing around 250,000 jobs that should have been created. There's no reason to assume all the same players won't play an even worse cop this time around.

There's no good reason for the debt ceiling, and now there are really bad consequences for its existence. Time to end it.

Follow or contact the Rortybomb blog:
  

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