Has the White House Changed Its Tune on the Nature of the Recession?

Feb 24, 2012Mike Konczal

It may be coming around to what's really driving weak demand three years too late, but better late than never.

It may be coming around to what's really driving weak demand three years too late, but better late than never.

There's a mini-debate going on over the relationship between the housing crash and weak demand. As Cardiff Garcia of FT Alphaville recently summarized it: "This reminded us of the debate last year about whether the sluggishness in consumer spending was the result of households wanting to deleverage or was caused by the big negative wealth effect caused by the huge crash in home prices." See this from James Surowiecki on the wealth effect and the Q&A I did with Amir Sufi on deleveraging. Which is the main driver, deleveraging balance sheets or a wealth effect?

I'm more on team balance sheet. It must seem like an esoteric debate, but it has some consequences. If it's about deleveraging balance sheets, the problem is an income/debt issue. It can be solved by reducing debt through forgiveness, lower interest rates and refinancing, equity swaps, a jubilee, and many other options. The models used in these stories indicate that any kind of transfer from creditors to debtors will make the economy better off. If it's a wealth effect, forgiving debt is likely to be less important -- it's not the root of the problem. Redistribution between creditors and debtors is unlikely to have a major impact outside of marginal propensities to consume. You'd need to get housing prices back up for there to be a significant adjustment.

(When Jim Bullard made two meta-conservative cases against additional monetary and fiscal stimulus recently, he switched between these narratives. The first case was about how the collapse of the housing bubble represents a technology loss. Though he didn't specify it, people could refer to the collapse of the securitization model, the inability to use housing as collateral, and the now idle Wall Street machine --results from weak balance sheets -- as a type of technology that has been destroyed. I don't think that's a particularly useful way to look at it. The second argument was pure wealth effect: we feel poorer, and the only solution is to beg policymakers to "please reinflate the bubble."  That's a pretty significant change in the underlying theory.)

Garcia noted that the Federal Reserve looks like it is considering joining team balance sheet. It discussed three studies at its most recent meeting, all credit and balance sheet related. One of the studies "used data on borrowing, debt repayments, and other credit factors for individual borrowers; this study found that movements in leverage -- resulting from voluntary loan repayments and from loan charge-offs -- have had a substantial effect on the cash flow of many households over time, and thus presumably on their spending." I'd really like to see that study!

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The White House also looks to be on team balance sheet. See the latest Economic Report of the President (pages 110 to 114).

The standard approach in economics has been to assume that households consume about the same fraction of the increase in their wealth each year, regardless of its source... The severity of losses experienced during the recession that began in December of 2007 in both national output and in labor markets makes these estimates appear too small...

A growing economics literature highlights the importance of household debt balances in influencing the severity of economic slumps... A series of empirical papers attempts to quantify the effect of such deleveraging on consumption (Mian and Sufi 2010; Mian, Rao, and Sufi 2011). These papers broadly suggest that the levered nature of household housing assets amplified the effect of pure wealth losses from the crash in housing prices.

The report even includes this iconic chart of team balance-sheet:

When Noam Scheiber wrote about how the administration viewed the economy in late 2010, he explicitly contrasted its wonks' opinions with that of the balance sheet recession theorist Richard Koo. So is this a revolution within the administration? Is this why it is now pushing for writedowns and refinancing, after having left housing on the side for the past three years? Let's hope so, since I consider being three years late to the party better than never showing up.

Mike Konczal is a Fellow at the Roosevelt Institute.

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An Interview with Occupy the SEC About Their Volcker Rule Comment Letter

Feb 16, 2012Mike Konczal

February 13 was an important deadline for comment letters relating to the implementation of the Volcker Rule. One group that submitted a comment letter was Occupy the SEC, an Occupy Wall Street-affiliated working group that has an excellent web presence outlining their objectives.  The site also includes their comment letter (available as a pdf here) -- all 325 pages of it.

February 13 was an important deadline for comment letters relating to the implementation of the Volcker Rule. One group that submitted a comment letter was Occupy the SEC, an Occupy Wall Street-affiliated working group that has an excellent web presence outlining their objectives.  The site also includes their comment letter (available as a pdf here) -- all 325 pages of it.

Felix SalmonMatt YglesiasSwamplandThe NationJosh Harkinson, and Dave Dayen, among many others, have all said great things about it. I was most impressed with the point-by-point, aggressive answering of the regulators' questions -- the stuff that can make a difference. Felix suggests reading the introduction if nothing else, particularly pages 3-6, and I agree.

Since this blog is a fan of all things financial reform, Volcker Rule, and the Occupy movement, I was very fascinated with the backstory on this letter. I was able to speak with two members of Occupy the SEC, Alexis Goldstein (@alexisgoldstein), a former Wall Street technology VP, and Caitlin Kline, a former credit derivatives trader.

Mike Konczal: What is Occupy the SEC? And what is the Volcker Rule?

Alexis Goldstein: Occupy the SEC is a working group inside Occupy Wall Street, which has been focused on writing a comment letter on the Volcker Rule.

The high-level overview is that the Volcker Rule is meant to keep federally-backed banking entities from proprietary trading and from owning more than 3 percent of any given hedge fund or private equity fund.

MK: How did you end up getting involved in Occupy the SEC?

AG: I was going down to Occupy Wall Street every day and one day Naomi Klein came and gave an open forum talk. And I asked a question, over the people's mic, on whether we should bring back Glass-Steagall, and she said yes.

Afterwards, all these people came up afterwards and asked me "What's Glass-Steagall?" And I thought I could help out and do a teach-in. After announcing an upcoming teach-in at a General Assembly, Akshat emailed me and asked if I was interested in forming a group to write a comment letter.

Caitlin Kline: A friend of mine who was involved in the movement called me up one day and told me that he had just seen a teach-in, and that the woman “spoke about derivatives the way you do!” So he put me in touch with Alexis, and I started attending the book club meetings.

MK: How much of the group are people currently or formerly in the financial industry?

AG: Probably a slight majority. Not everyone -- we had people who were leaders or people who wanted to learn and get up to speed. But it definitely had a strong industry contingent.

MK: How did you start focusing the letter?

CK: It took a long time to get our minds around all the different elements of the Volcker Rule and what kind of comment letter we wanted to write. We decided early that we wanted to write about the nitty-gritty of the rule and focus on the specifics, so it required a really deep dive into the material to leverage everyone’s expertise. Right off the bat, we decided that this rule was a good idea, and it has to actually be meaningful. That's how we attacked it -- we wanted to strengthen it as much as possible.

MK: Some people (usually not in the movement) complain about the General Assembly and consensus-driven procedures as not workable for a complex task, like writing hundred of pages responding to regulatory rules. What was your procedure and how well did it work?

AG: There were two tasks. The first task was much like a book club. We treated the Volcker Rule as our book, and we'd assign readings and times for discussion. At first we were meeting once a week, then later twice a week for marathon sessions. During those marathon sessions we'd go through all the questions the agencies asked about the rule.

MK: How many questions were there?

AG: 395. But each of those questions had around three or four questions in it. But 395 numbered questions.

CK: So a total of around 1,200 to 1,400 individual questions.

AG: It's easiest to visualize this. So we are all there in the atrium with our laptops. We are going through this question by question, discussing them, debating what we think the answer should be. Once we all agree on something we put it in a bullet or several bullets. And sometimes we'd go off on these huge tangents and have debates on the best way to address the topic. We'd often have to say "let's move on to the next topic," but we always tried to work from consensus.

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When we went to try and write the initial draft of the letter we'd work collaboratively on these online documents that everyone could see at all times. That way if there was something someone didn't agree with they could leave a comment or send an email to the group and we could talk it out. For the most part we tended to agree -- though there were many instances where we clashed horns.

After that initial pass we broke it up section by section so everyone had their focus area. From there we could embellish those central consensus bullet points we had come up with.

MK: How many people are involved?

AG: There was a core group of seven people, with a variety of people coming in and out. There were many experts in an area who couldn't commit to all the meetings but wanted to work on very narrow areas. They'd drop in and drop out.

There was one person who was very interested with the metrics section. So she attended one meeting where we were going to talk about that and she gave us some great ideas. There was a gentleman who used to work at a special purpose vehicle and was really involved with securitizations. He did a really great job writing and giving insights on those topics via e-mail, even though he couldn't make the groups.

CK: In a lot of cases we pooled our resources to find people with certain expertise on issues we wanted to address in the letter.

MK: What are you worried about with the implementation of the Volcker Rule?

CK: The one that comes up often is that liquidity is going to evaporate overnight, crippling markets. This is the base of the lobbyists' efforts. We spent a while debunking that argument.

MK: How do you respond to that?

CK: Well the whole theory is predicated on the idea that these federally-backstopped banks are the only institutions that can provide liquidity. It is a profitable business, especially the market-making end of it, and any number of firms will step in in order to take this.

MK: Were the members of Occupy the SEC involved broadly with the movement?

AG: It depends on the person. For me I was highly active in the woman's caucus. I would go to the General Assembly often, I'd go to the Spokes Council meetings. I was very involved in the day-to-day. When this letter got started I had to take a step back and focus on that instead.

We had some people that weren't involved with the letter but they'd help us by coming to the meetings, organizing and planning direct actions. Others were involved in the Politics and Electoral Reform group, the Direct Action working group, and the Think Tank, which conducts open air discussions on various topics.

CK: This was the first time that I thought that I could jump in and get involved. Particularly as an ex-trader, I could do this, and be involved with the movement in a meaningful way. Since we started, I've met so many smart people and encountered so many issues that I'm going to continue to be involved with, and I think most of the group has had a similar experience.

MK: There's a saying that goes "Occupy Everything, Demand Nothing." You've written a document giving very technical advice to regulators. Part of Occupy is about creating alternatives instead of making demands, yet your group set out to reform a system very resistant to reform. How do you handle that tension?

AG: There's two points. The first is that all working groups at Occupy are autonomous. Since no one can speak for Occupy Wall Street, each group can choose their own goals that they want to work for as long as you don't say you speak for Occupy Wall Street (without going to the New York City General Assembly). So there's a lot of freedom to work on Occupy Wall Street on whatever projects you want.

The second thing is that though the system is broken and difficult to repair, you don't have to choose between abandoning it or reforming it. I think you can do both -- try to reform it from within while building a new system. This particular effort is about reforming the current system, but that doesn't mean, at all, that we aren't interested in alternative systems. There's another group called Occupy Bank thinking through a completely new banking system from scratch.

CK: From those of us who saw how big and screwed up the financial system is, it's very difficult to know, or even understand, what it would take to fix it. Some people would say to us "why are you even bothering with this? Why not go back to Glass-Steagall?" Well, that's not on the table right now, but this is. And the Volcker Rule is something very real and concrete. It's good intellectual work to think through alternative systems and I want to be a part of it and see where it goes, but in an immediate way there's ways to clean up things right in front of us. A lot of people I know get stuck on this -- "it's really screwed up and there has to be another way" -- and you end up thinking about that other way forever.

MK: Quick question: did your group do the twinkles during meetings?

AG: Yes. In fact when Caitlin was just talking with you I was twinkling.

MK: Over the phone?

AG: Yes, it is such a habit I can't break it.

MK: What are you excited about for Occupy in 2012?

AG: As an activist you are often isolated to your particular cause. Let's say you are an environmental activist and your cause is sustainability. You fight the same fights with the same people, you go against the same industries, and it is easy to burn out. You are stuck in this little bubble. My favorite thing about Occupy Wall Street is that there is this cacophony of causes. You come together for the things that matter the most to you, but you are surrounded by all these other people fighting for all these other causes, with their own expertise, and all those passions amplify each other. If you need a break from your topic, you can jump into another one. And there's so many new people, fresh faces all the time, it gives you courage and the strength of purpose to continue. Because it's so tough to fight a fight and think you are the only one who cares.

Also, I really hope we can retake more public spaces.

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The Economy Sucks for Those Who Have Jobs, Too

Feb 7, 2012Mike Konczal

New JOLTS data show that people are quitting their jobs less and less and getting hired at a similarly slow rate.

Last week's job numbers were generally positive. Now if those numbers pick up steam, if the housing market begins to recover, if Europe doesn't sink the U.S. economy, if the situation in the Middle East and especially Iran doesn't cause oil prices to spike, and if we don't immediately disrupt government spending through premature austerity, we could see some major job growth in 2012.

New JOLTS data show that people are quitting their jobs less and less and getting hired at a similarly slow rate.

Last week's job numbers were generally positive. Now if those numbers pick up steam, if the housing market begins to recover, if Europe doesn't sink the U.S. economy, if the situation in the Middle East and especially Iran doesn't cause oil prices to spike, and if we don't immediately disrupt government spending through premature austerity, we could see some major job growth in 2012.

What about those who still have a job? We focus on the unemployed for many good reasons. Economists do this because of it is so miserable to be unemployed in this country and because they function as a good barometer for the health of the economy. We "see" changes in unemployed in the data much quicker than movements in GDP and other aggregates.

But the economy also has major problems for those with jobs. Be honest: how many of you spent the past two months thinking, "I'm going to quit this job I have now"? Personally, many friends of mine have discussed how they want to move on and quit their current jobs and were putting in the energy to find new ones. They've mostly failed and are taking it as a personal failure.

Except it's less a personal failure than a macroeconomic one.

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This morning the Bureau of Labor Statistics put out their Job Openings and Labor Turnover Survey (JOLTS) data for December 2010. The "quit rate" -- how many people are walking out of their jobs -- was flat for the month at the very low 1.5 percent rate, and still significantly lower than it's been over the past decade. The quit rate for those with jobs plummeted during the the recession and it's never recovered. And it's remained stagnant even as there's been some encouraging signs for the unemployed. Here is how the rate looks historically:

I also have a few friends -- both employed and unemployed -- who have been strung along by potential new jobs, and I imagine this is happening to many people. They hear a lot of "we'll let you know soon" over the course of several months with no actual offer or hiring on the horizon. Again, think macroeconomics -- the job hire rate also plummeted and has stayed flat recently.

The problem isn't just that there are so many people who have been unemployed for over 99 weeks -- the problems exist for everyone, even those with jobs.

Mike Konczal is a Fellow at the Roosevelt Institute.

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How Government Decides Which Workers Deserve Rights

Feb 1, 2012Mike Konczal

It used to be that white men had steady employment and all the government protection that came with it while minorities and women were stuck with precarious jobs. Now we're all vulnerable.

It used to be that white men had steady employment and all the government protection that came with it while minorities and women were stuck with precarious jobs. Now we're all vulnerable.

Malcolm Harris has a New Inquiry essay on the movie Sleeping Beauty (2011) and the feminization of precarious labor. A lot has been written on precarious labor recently, including both John Schmitt's book review in Dissent and Bhaskar Sunkara's critical response. I want to elaborate on this, since looking at gender and precarious work leads to an examination of a favorite topic -- the relationship between pity-charity liberalism and unconditional, universal programs related to economic security. A perfect example is how labor in the New Deal was treated differently by gender. The wedge between the two groups illuminates the difficulty in bringing economic justice to the 21st century. Precarious, vulnerable work was once relegated solely to women, but in this day and age more and more of us will fall into that category.

For Harris, the precarious worker is "indebted, insecure, vulnerable." If the classic notion of a worker "relies on having a bargaining place at the table with the boss," then precarious workers aren't workers (even though all they do is work or try to cobble work together).

How is the work gendered? Harris focuses on gendered affect: "passivity and her eagerness to please, her vulnerability and blank demeanor would look incredibly strange on a young man. Her willingness to keep treading water without the promise of anything better to come, her ability to communicate nonthreateningly and stay quiet at the right times are parts of what Nina Power describes in the chapter 'The Feminization of Labor.'"

But there's an institutional way to think about how the precarious nature of gender and work is both reflected in and amplified by governmental regulatory regimes, and how the future looks bleak in terms of bending those regimes toward just ends. Suzanne Mettler's Dividing Citizens: Gender and Federalism in New Deal Public Policy (1998) is useful for this conversation. (Mettler, a political scientist and recent author of The Submerged State, is a favorite around here -- III, -- and recently joined our think-tank neighbors at the Century Foundation as a fellow.)

To set up the problem, Seth Ackerman has recently discussed universal programs in the context of the Tea Party's war against the state:

...[I]t’s indisputable that Tea Partiers make some kind of conceptual distinction between universal programs like Social Security and Medicare and other government programs. But this says less about the Tea Party than it does about universal social programs. It is easy for liberals to point to the Tea Partiers and call them bigots because they make a distinction between 'people on welfare' and 'normal people.' But in fact it’s the state that made the distinction first. When the state operates a means-tested or other conditional program, it inspects each citizen and stamps him or her as belonging to one category or the other... Political scientists have long known that something almost alchemical happens to public opinion when a universal, as opposed to a mean-tested, welfare program is established.

Mettler argues that this distinction comes out of the dual administrative nature of the New Deal. Part of the New Deal was to be administered by newly created federal government programs, while another part was to be administered by local and state authorities. It just so happened that the federal government's role regulated the work and lives of white men, while the state and local role retained authority over women and minorites. Keeping part of the New Deal's welfare state and floor of economic security administered at the state and local level was predicated intellectually on Brandeis' notion of the states as laboratories of democracy and politically on getting Southern white supremacists to endorse the New Deal. This meant that how people realize economic freedom could be maintained and expanded through illiberal means.

Remember that just three years after the Lochner case, with a Supreme Court hostile to all economic regulations, it made an exception to maximum hours regulations for women. Why? In 1908, the Court ruled in Muller v. Oregon, "That woman's physical structure and the performance of maternal functions place her at a disadvantage in the struggle for subsistence is obvious...as healthy mothers are essential to vigorous offspring, the physical well-being of woman becomes an object of public interest and care in order to preserve the strength and vigor of the race." These are the terms on which economic regulation could exist -- protecting essentialist visions of a women's place.

Mettler argues that "programs geared toward men became nationally administered programs and those aimed toward women retained state-level authority." This welfare state led to citizens becoming "divided by gender between two different sovereignties that govern in very different ways." As she says:

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What it meant to be an "American citizen" meant very different things to the retired male breadwinner, who came to expect his monthly social security check from the national government, and to the poor mother who hoped that the social worker assigned to evaluate her eligibility for a meager welfare check would find her child-rearing and housekeeping efforts worthy. The first was treated with dignity and respect, as an entitled person; the latter, with suspicion and scrutiny.

Mettler maps out a 2X2 grid, dividing out New Deal programs:

The crucial point is that liberal inclusion was based on long-term, full-time work for a single employer. If you had a job along those lines --and these jobs were held by white men at that time -- then you were included in a regime of universal economic security. Short-term, part-time work for multiple employers -- work done by women and minorities -- falls through the cracks into a patchwork of state and local governance. That governance bases inclusion on hierarchical ideals invoking republican notions of where a person stood in his or her community. The notion of the "deserving poor" comes out of this relationship. Aid to Dependent Children (ADC), for instance, was predicated on single mothers being able to retain their "natural" work as housewives and child-raisers. ADC's spot inspections of single mothers for "male callers" gives you a sense of how this played out -- as Mettler notes, "officials monitored and regulated women's moral character."

Progress was made on these New Deal programs up through the 1970s. But there's been significant rollback over the past 30 years. The call to "means-test" social insurance programs, Ending Welfare as We Know It by block-granting welfare's administrative role back to the states, the battles over block-granting Medicaid and privatizing Social Security and Medicare -- all have shifted the momentum in the opposite direction. But where does this leave us now, especially in regard to precarious labor?

I asked Dorian Warren, Columbia political scientist, Roosevelt Institute Fellow, and union expert, about where this stands. As he puts it:

Add up the Mettler argument with Hacker's notion of "policy drift," and most New Deal social policies (especially the FLSA and the NLRA) are outdated and obsolete. They were crafted with assumptions about work and the nature of the economy in mind: an agricultural and industrial economy, where workers had long-term attachments to one employer. That's no longer the case, and labor and employment laws haven't caught up to the new employment relationship. Long story short, we don't have the adequate legal structures to deal with this new employment environment.

The battle to move the welfare state to the federal level, where it could be administered inclusively and universally, was an intellectual and political battle waged within the New Deal. How is this playing out in the Obama administration? I'll eventually build a full case against the "nudge" theory of the administrative state, but for now a theory of using subtle and unconscious government techniques to help people work better within "choice architectures" isn't up to the challenge of recreating a regulatory environment for a new age.

For insight into how the current administration's approach is playing out in this model, take a look at the administration of health care reform. I asked Richard Kirsch, recent author of Fighting for Our Health and Roosevelt Institute Senior Fellow, about the federal/local administration of health care reform. He responded:

The House bill set up a strong federal exchange and let the states do their own only if their exchanges had stronger consumer protections. However with the Senate bill -- the law we have now -- states can set up very weak exchanges. And the insurance industry has lots of clout at the state level. The best hope is that there will be a strong federal exchange for states that don’t set up their own. But that will only be true if HHS creates one.

So we have an outdated regulatory regime, an intellectual climate geared towards local, illiberal control, and the application of economic freedoms designed to keep women yoked to essentialist and moralistic discoures. A "polarizing" workforce means that the labor market, without significant reform, will take on an exaggerated version of the split we saw in the New Deal, with the precarious work falling into a patchwork administration system of moralizing and without opportunities to organize.

Mike Konczal is a Fellow at the Roosevelt Institute.

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Overall Unemployment Rate is at African Americans' Pre-recession Level

Jan 19, 2012Mike Konczal

Today's unemployment levels are miserable, but a reminder that African Americans were experiencing the same pain during boom times.

Today's unemployment levels are miserable, but a reminder that African Americans were experiencing the same pain during boom times.

There's been a lot of expectation management over the recent news that the U.S. unemployment rate has dropped from 8.7 percent to 8.5 percent. Alan Krueger noted that "[i]t is critical that we continue the economic policies that are helping us to dig our way out of the deep hole that was caused by the recession that began at the end of 2007." Many economists expect unemployment to increase if the economy picks up, because people who have drifted out of the labor force will start looking for work again, raising the unemployment rate. And as everyone recognizes, there's still a terrible amount of suffering with unemployment as high as 8.5 percent -- wasted capacity, wasted opportunities, and mass misery. Though things may be looking up, they are still quite painful.

One interesting thing to note is that the number in between 8.7 percent and 8.5 percent, a threshold the country just crossed, was the average unemployment rate for African Americans going into the recession. The rate from 2006-2007 for African American men and women over 16 was 8.6 percent. Let's chart that out (click through for larger image):

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Total African American unemployment is currently at 15.8 percent and has been hovering around 16 percent for three years now. All the other major employment health indicators are down as well. For instance, the employment-to-population ratio is down to 51 percent from 60 percent in 2001. Nearly half of all African Americans aren't working.

The economy is terrible for all Americans right now and we desperately need action to both expand the economy and repeal attempts to contract it. But it is worth remembering that the unemployment misery all Americans are experiencing right now is equal to what it was like during the best two years of the 21st century for African Americans.

Mike Konczal is a Fellow at the Roosevelt Institute.

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Josh Kosman on the Loopholes That Fuel Private Equity Buyouts

Jan 12, 2012Mike Konczal

kosman_paperback_launchAs a result of a series of attacks and counter-attacks on Republican presidential candidate Mitt Romney's work with Bain, there's been a lot of discussion about private equity, buyouts of firms, and their ultimate relation to the economy.

kosman_paperback_launchAs a result of a series of attacks and counter-attacks on Republican presidential candidate Mitt Romney's work with Bain, there's been a lot of discussion about private equity, buyouts of firms, and their ultimate relation to the economy. So far the discussion has been a back-and-forth on layoffs and "creative destruction," with very little on how laws and regulations structure the way private equity and buyouts happen in this country.

I interviewed Josh Kosman, author of The Buyout of America: How Private Equity Is Destroying Jobs and Killing the American Economy, on this topic. Bob Kuttner reviewed his book in May 2010, and Kosman was on Up with Chris Hayes last weekend. The interview has been edited for length.

Mike Konczal: What are private equity funds, and what do they do?

Josh Kosman: Private equity firms are mostly former Wall Street bankers who raise money to buy companies on credit. They used to be called leveraged buyout (LBO) firms, and when the first leveraged buyout boom went bust in the 1980s they regrouped and called themselves private equity.

The big difference between them and venture capitalist or hedge funds is that the companies that they buy borrow money to finance the acquisitions.

Private equity firms own more than 3,000 U.S. companies and employ roughly one out of every 10 Americans in the private workforce. This is just America, so it doesn't include companies or employees overseas. Some companies include HCA, the largest hospital chain, to Clear Channel, the largest radio station operator, to Dunkin' Donuts. They are in every industry.

MK: People coming to the defense of private equity from both the left-neoliberal and conservative spaces directly invoke or allude to "the market" as a natural, already existing thing. But a key progressive retort to this laissez-faire view of economics argues that all markets are deeply embedded in and constructed through legal, tax, and other regulatory government codes. Your research has found that, far from being natural, private equity exists largely due to issues with the tax code. Can you explain?

JK: The whole industry started in the mid-to-late 1970s. The original leveraged buyout firms saw that there were no laws against companies taking out loans to finance their own sales, like a mortgage. So when a private equity firms buys a company and puts 20 percent down, and the company puts down 80 percent, the company is responsible for repaying that.

Now the tax angle is that the company can take the interest it pays on its loans off of taxes. That reduces the tax rate of companies after they are acquired in LBOs by about half. Banks, also realizing this tax effect, were willing to finance these deals. At the time, you could also depreciate the assets of the company you were buying -- that's not true today.

They saw that you could buy a company through a leveraged buyout and radically reduce its tax rate. The company then could use those savings to pay off the increase in its debt loads. For every dollar that the company paid off in debt, your equity value rises by that same dollar, as long as the value of the company remains the same.

MK: So the business model is based on a capital structure and tax arbitrage?

JK: Yes. It's a transfer of wealth as well. It's taking the wealth of the company and transferring it to the private equity firm, as long as it can pay down its debt.  It think it is real - the very early firms targeted industries in predictable industries with reliable cash flows in which they by and large could handle this debt. As more went into this industry, it became very hard to speak to the original model. Now firms are taken over in very volatile industries. And they are taking on debts where they have to pay 15 times their cash flow over seven years -- they are way over-levered.

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MK: The most common argument for why Bain Capital and other private equity firms benefit the economy is that they are pursuing profits. They aren't in the business of directly "creating jobs" or "benefitting society," but those effects occur indirectly through the firms making as much money as they can.

But even here, "profits" -- how they exist, where they come from, and how they are timed -- have a crucial legal and regulatory function. A recent paper from the University of Chicago looking at private equity found that "a reasonable estimate of the value of lower taxes due to increased leverage for the 1980s might be 10 to 20 percent of firm value," which is value that comes from taxpayers to private equity as a result of the tax code. Can you talk more about this?

JK: That sounds about right. If you took away this deduction, you'd still have takeovers, but you'd have a lot less leverage and the buyer would be forced to really improve the company in order to make profits. I think that would be a great thing.

If you look at the dividends stuff that private equity firms do, and Bain is one of the worst offenders, if you increase the short-term earnings of a company you then use those new earnings to borrow more money. That money goes right back to the private equity firm in dividends, making it quite a quick profit. More importantly, most companies can't handle that debt load twice. Just as they are in a position to reduce debt, they are getting hit with maximum leverage again. It's very hard for companies to take that hit twice.

If you look at Ted Forstmann, an original private equity person who just passed away, he would rail against dividends in this manner -- borrowing money to pay out dividends. He was more interested in taking companies public and selling shares and paying down debts and collecting proceeds that way. I can respect that a lot more. The initial private equity model was that you would make money by reselling your company or taking it public, not by levering it a second time.

Private equity and buyouts started as a way to take advantage of tax gimmicks, not as a way of saying "we're going to turn around companies." And now it's out of control. I look at the 10 largest deals done in the 1990s, during ideal economic times, and in six cases it was clear that the company was worse off than if they never been acquired. Moody's just put out a report in December that looked at the 40 largest buyouts of this era and showed that their revenue was growing at 4 percent since their buyout, while comparable companies were growing at 14 percent.

In January -- so just in the past 12 days -- Hostess, the largest bakery in the country, just went bankrupt. Coach, the largest bus company, just went bankrupt. And Quizno's is about to go bankrupt. All of these were owned by private equity.

MK: This battle is part of a larger discussion of, in Henry Manne's phrase, "the market for corporate control." The tax code is set to overlever firms, which require increases in earnings to go toward debt payments instead of research and development, expansion, and other things that build the firm. What could we change to generate different outcomes?

JK: That's exactly right. Right after this goes on for a few years, you've starved your firm of human and operating capital. Five years later, when the private equity leaves, the company will collapse -- you can't starve a company for that long. This is what the history of private equity shows.

What I'd like to see Mitt Romney do is to show an example of a buyout that went well. The only success stories he's talking about on any level are venture capital investments -- Staples and Sports Authority. Personally I like venture capital, I think it provides a lot of value, but that's not what he did mostly, and that's not what these takeovers are about.

The big fix I'd encourage is an end to interest-tax deducibility for leveraged buyouts. The tax system encourages companies to borrow as much as they can. For certain industries, like telecom, these deductions might make a lot of sense. But it was never intended for financing leveraged buyouts. If you put a cap on this you would find buyouts and private equity firms that were much more focused on building companies.

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Jobs Numbers: The Good, the Bad, the Meh

Jan 6, 2012Mike Konczal

Some good news lurks in today's jobs numbers, but we're still a long way away from a real recovery.

Some good news lurks in today's jobs numbers, but we're still a long way away from a real recovery.

The new jobs numbers are out. Overall, 212,000 private sector jobs were created while 12,000 government jobs were lost, for a net total of 200,000 job gains. That loss, 12,000, is less than the average 23,000 government jobs that were lost per month in 2011, so it boosts the headline number. Yet 12,000 is still a lot to lose, especially when so many of those numbers come from education -- at least 9,000 local-level education jobs were cut.

Where's the good news? There were solid increases in weekly hours (+0.5%) and payroll (+0.7%), meaning employed people are getting more money in their pockets. With more money, they can spend more, which will employ other people and create a virtuous loop of spending and employment. This will help boost demand broadly and start to add some energy to a depressed economy. If sustained, it could help take the current jobs reports -- which are good but not enough to end the unemployment crisis we currently have -- and turn them into jobs numbers capable of bringing about a serious recovery.

But there's also an apparent queue for who will get jobs first. Right now we are seeing most job gains go to men and to those with higher education. Men have been gaining jobs over women across industries and occupations throughout 2011 -- and in the household survey women lost jobs last month. The employment-to-population ratio went down to 53 percent for women last month, bringing it to the lowest levels since 1988. The Roosevelt Institute will be doing additional research on this topic in 2012.

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What's on the horizon? Something needs to trigger these 200,000 jobs a month reports into the 250,000 to 400,000 range.  At the current rate, we won't see full employment until 2024. Something needs to kick in. One way this could happen is if household formation takes off in 2012. There's a shadow household inventory of adults living with parents and adults living with other adults who, in better times, would have moved out. Household formations would take stress off the terrible housing market, but is it likely to take off itself without a boost? I'll be following this argument throughout the year.

The other big way to put more gas in the economy's engine is through expanded fiscal and monetary policy. There's no sign from inflation or government borrowing rates that we've hit a danger zone in stimulating the economy, and there's plenty of slack in the short-term to put idle resources to work.

Mike Konczal is a Fellow at the Roosevelt Institute.

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Cordray's Recess Appointment Helps Implement a Law That Already Passed

Jan 4, 2012Mike Konczal

President Obama rightfully sidestepped a GOP that insists on dismantling a law that addresses some of the fundamental breakdowns of the crisis.

President Obama rightfully sidestepped a GOP that insists on dismantling a law that addresses some of the fundamental breakdowns of the crisis.

One way to think about how the Dodd-Frank Wall Street Reform and Consumer Protection Act goes about policing finance is that it levels the playing field of rules and regulations between bank and non-bank financial firms. In the lead up to the crisis, financial firms acted like "shadow banks" without having to follow the rules regular banks did. The legal and regulatory infrastructure that evolved since the Great Depression for regular banks was never extended to these new shadow banks.

This was especially true for consumer financial products, particularly home mortgages. There's a solid regulatory network for home mortgages in place when it comes to regular banks. However, when it came to subprime mortgages made through non-bank lenders, those rules didn't apply. Many financial regulators urged Federal Reserve Chairman Alan Greenspan to have the Fed start regulating subprime and leveling the regulatory playing field. So did the GAO and a HUD-Treasury task force. Greenspan wouldn’t. Hence Dodd-Frank's emphasis on reducing regulatory arbitrage by creating a special Bureau to consolidate consumer financial protection in one place.

But the Consumer Financial Protection Bureau (CFPB) needs a director in order to start working on reducing the uneven playing field. As a recent report noted, "[w]ithout a Director, the CFPB cannot fully supervise non‐bank financial institutions such as independent payday lenders, non‐bank mortgage lenders, non‐bank mortgage servicers, debt collectors, credit reporting agencies and private student lenders." Enter our dysfunctional Senate.

In early May of 2011, 44 Republican Senators signed onto a letter that requested three specific changes before they confirmed any nominee, "regardless of party affiliation," to head the CFPB. The changes included replacing "the single Director with a board to oversee the Bureau" and subjecting "the Bureau to the Congressional appropriations process."

Dodd-Frank, signed into law in July 2010, created a Consumer Financial Protection Bureau that had a single director and was consciously funded in a very specific way. In order for the CFPB to fully work, it needs an appointed director -- certain powers don't kick in otherwise. So in effect a minority of Republican Senators say that they won't allow an act of law to be fully implemented unless certain, crucial, parts of the law are overturned.

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People are correctly referring to this as a new nullification crisis (see also here). Brookings Scholar Thomas Mann notes that insisting "that a legitimately passed law be changed before allowing it to function with a director [is] a modern-day form of nullification. Same with the director of the Center for Medicare and Medicaid Services. There is nothing normal or routine about this. The Senate policing of non-cabinet appointments is sometimes more aggressive but the current practice goes well beyond that, more like pre-Civil War days than 20th century practice." This has also gone on with the NLRB and, in a way, went on with the debt ceiling battle. Eventually the administration needed to challenge this.

So it's great to see it recess appoint Richard Cordray as director. ThinkProgress outlines the initial legal analysis as to why Obama has the power to do this. Cordray will make a great director for the CFPB and the Bureau will continue to do the excellent work that it has already done.

It's a shame that more confirmations weren't pushed through with this window. A large number of financial regulator positions need to be filled, and even more judicial spots sit empty. In terms of building a longer-term, ascendent liberalism, it is essential to appoint people such as judges and nurture them to become strong leaders in the future.

It is uncertain whether this will shut down the confirmation process in the Senate, which may escalate tensions. If so, it will be a good time to reexamine how confirmations happen in the Senate more broadly. This is a part of government that was never meant to work the way it does now, and it is having serious consequences for the country.

Mike Konczal is a Fellow at the Roosevelt Institute.

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The Most Popular Post of 2011: Who are the 1% and What Do They Do for a Living?

Dec 23, 2011Mike Konczal

Editor's note: As the year comes to a close, New Deal 2.0 is highlighting our most read post from the year. Our regular posting schedule will resume in January. See you in 2012!

mike-konczal-newThere's good reason to focus on the top 1%: they're distorting our economy.

Look, a crazy anti-capitalist anarchist carrying a bizarre sign incompatible with the basic tenets of liberals:

Or not.

Editor's note: As the year comes to a close, New Deal 2.0 is highlighting our most read post from the year. Our regular posting schedule will resume in January. See you in 2012!

There's good reason to focus on the top 1%: they're distorting our economy.

Look, a crazy anti-capitalist anarchist carrying a bizarre sign incompatible with the basic tenets of liberals:

Or not.

A lot of emphasis is on the "99%" versus the "1%" in these protests. But who are the 1% and what do they do for a living? Are they all Wilt Chamberlains and Oprahs and other people taking part in the dynamism of the new economy? Nope. It's same as it ever was -- high-level management and the financial sector.

Suzy Khimm goes through the numbers here. I'm curious about occupations. I'll hand the mic off to "Jobs and Income Growth of Top Earners and the Causes of Changing Income Inequality: Evidence from U.S. Tax Return Data" by Bakija, Cole, and Heim. This is the latest and greatest report on occupations and inequality. Here's a chart of the occupations of the top 1%:

distribution_1_percent

Inequality has fractals. Let's go into the top 0.1% -- what do they look like? Here's the chart of the occupations of the top 0.1%, including capital gains:

It boils down to managers, executives, and people who work in finance. From the paper: "[o]ur findings suggest that the incomes of executives, managers, supervisors, and financial professionals can account for 60 percent of the increase in the share of national income going to the top percentile of the income distribution between 1979 and 2005."

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For fun, there are more than twice as many people listed as "Not working or deceased" than are in "arts, media, sports." For every elite sports player who earned a place at the top of the income pyramid due to technology changes and superstar, tournament-style labor markets that broadcast him across the globe, there are two trust fund babies.

The top 1% of managers and executives often means C-level employees, especially CEOs. And their earnings versus the average worker have skyrocketed in the past 30 years, so this shouldn't be surprising:

How has this evolved over time? Can we get a cross-section of that protest sign above?

Same candidates. There's a reason the protests ended up on Wall Street: The top 1% and top 0.1% comprises all the senior bosses and the financial sector.

One of the best things about Occupy Wall Street is that there is no chatter about Obama or Perry or whatever is the electoral political issue of the day. There are a lot of people rethinking things, discussing, learning, and conceptualizing the kinds of world they want to create. Since so much about inequality is a function of the legal structure known as a "corporation," I'd encourage you to check out Alex Gourevitch on how the corporate is structured in our laws.

The paper notes that stock market returns drive much of the manager's income. This is related to a process of financialization, something JW Mason has done a fantastic job outlining here. The "dominant ethos among managers today is that a business exists only to enrich its shareholders, including, of course, senior managers themselves," and this is done by paying out more in dividends that is earned in profits. Think of it as our-real-economy-as-ATM-machine, cashing out wealth during the good times and then leaving workers and the rest of the real economy to deal with the aftermath.

Both articles mention chapter 6 of Doug Henwood's Wall Street; anyone interested in how things have changed and where they need to go would be wise to check it out. It's even available for free pdf book download here.

There's good reason to focus on the top 1% instead of the top 10 or 50%. There is evidence that financial pay at this elite level is correlated with deregulation and the other legal changes that brought on the crisis. High-ranking senior corporate executives' pay has dwarfed workers' salaries, but is only a reward for engaging in shady financial engineering practices. These problems require a legal solution and thus they require a democratic challenge and a rethinking of how we want to structure our economy. Here's to the 99% and Occupy Wall Street helping get us there.

Mike Konczal is a Fellow at the Roosevelt Institute.

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Could We Redirect Tax Subsidies to Pay for Free College?

Dec 20, 2011Mike Konczal

Want a way to pay for free higher education? Take a look at all the tax breaks that ease the burden of student debt.

Want a way to pay for free higher education? Take a look at all the tax breaks that ease the burden of student debt.

Josh Eidelson has a great post at The Nation, "Fighting Privatization, Occupy Activists at CUNY and UC Kick Into High Gear," that dives into the battles currently being waged against the dismantling of public higher education. One of the Occupy movement's major objectives is combating the privatization of public higher education and its replacement with a debt-fueled economy of indenture.

While prepping a recent Occupy panel, Sarah Jaffe brought up how we subsidize student debt in a similar way to mortgage debt, that is, through allowing people to deduce the interest paid on this debt from taxes. According to Pew Charitable Trust's website subsidyscope, the deductibility of student loan interest alone costs taxpayers $1.4 billion dollars. Instead of taking $1.4 billion dollars and directly making college cheaper, students take out massive amounts of student loan debt and we alter the tax code to make that debt $1.4 billion dollars cheaper.

This is an example of what Suzanne Mettler calls "the submerged state," a pattern where the government has, as she says, "shunned the outright disbursing of benefits to individuals and families and favored instead less visible and more indirect incentives and subsidies, from tax breaks to payments for services to private companies. These submerged policies...obscure the role of government and exaggerate that of the market." Instead of directly providing public options, we subsidize the purchasing of private goods, often using the tax code.

Let's take the case of student debt and the tax code. How much would it cost to make public colleges and universities free? Rough estimates (quoting Jeffrey Sach's latest book) put the price of free public higher education at $15-$30 billion, which fits other estimates I've seen.

Now what are the costs of how we subsidize higher education through the tax code? There's already the $1.4 from the interest exemption. Also from subsidyscope, there's the exclusion of employer-provided educational assistance ($1.1 billion), exclusion of interest on student-loan bonds ($0.6 billion), exclusion of scholarship and fellowship income ($3.0 billion), exclusion of tax on earnings of qualified tuition programs: savings account programs ($0.6 billion), the HOPE tax credit ($5.4 billion), the Lifetime Learning tax credit ($5.5 billion), parental personal exemption for students age 19 or over ($3.4 billion), and state prepaid tuition plans ($1.75 billion). There's also the stimulus's American Opportunity Tax Credit ($14.4 billion) and some part of the deductibility of charitable contributions (education) ($4.9 billion).

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Even without the last two, that's $22.75 billion we are paying through the tax code to make college tuition and student debt more manageable. This amount is in the middle the range of the cost of just making public high education free. Now these aren't equivalent -- much of what is spent through the tax code will be biased more towards private and professional schools, which are more expensive. But this also isn't anywhere near the full extent we subsidize student debt (a government creation from 1965).

But there is a choice in how to provide mass higher education. We can either use resources to reduce the price of the good upfront -- make college free -- or to subsidize the purchase of the good -- here through the numerous hoops of the tax code. The amount of money we take from the tax code to try and make student debts and runaway tuition more bearable could be used instead to just provide free public colleges.

There are winners and losers in each case. When we subsidize through the tax code, people who are well off and pay more taxes benefit more. People who can afford support staff, such as accountants and lawyers, are also more likely to understand how to take maximum advantage of these benefits. These subsidies benefit private educational institutions over public ones, as they'll make private education feel more "natural" while obscuring the role of the government in setting up these markets. They give public college a nudge towards corporatization and privatization. Much of these subsidies are likely captured either by the higher education institutions themselves or the debt lenders. These subsidies will make tuition and debt easier to deal with, but providing colleges free as a public option would likely do far more to contain costs (also see here).

Most importantly, it breaks the link between citizenship and education. The subsidy approach replaces the claim to a necessary good to be full, participating citizens in our market economy with the claim of a consumer, whose claim is ultimately one of willingness to pay either through wealth or debt. The first kind is the place where progressives have the stronger argument about freedom, as opposed to those who see the market as the only source of freedom available.

Mike Konczal is a Fellow at the Roosevelt Institute.

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