Twilight of the Elites Review Up, Plus Weekend Links

Jun 15, 2012Mike Konczal

I have a review of Chris Hayes' excellent new book, Twilight of the Elites, now online at Dissent Magazine.  Check it out here.

More links:

Elise Foley has the best writeup of the policy behind President Obama's important executive order surrounding the Dream Act.

I have a review of Chris Hayes' excellent new book, Twilight of the Elites, now online at Dissent Magazine.  Check it out here.

More links:

Elise Foley has the best writeup of the policy behind President Obama's important executive order surrounding the Dream Act.

JW Mason at Slackwire tries to find the method in the ECB's madness. Great stuff.

The Prison Law Blog is sadly ending (though archives will be available online); long live the new project Evolving Standards of Decency.

Monica Potts big American Prospect story on poverty, reported after living in Kentucky for several months.

Fantastic Elizabeth Anderson Bleeding Heart Libertarian post on economic freedom. I should reread her "What is the Point of Equality?"

A Boston Review interview with Michael Lind on his new book.

Dark times, take comfort in the small victories. Here's a victory from Occupy Minnesota on foreclosure activism, keeping the mother of an activist in her home.

Marcy Wheeler gives an overview of David Dayen's foreclosure fraud panel from Netroots Nation. I got a chance to talk with Neil Barofsky the night before; I'm really looking forward to his new book about the bailouts and the Obama administration.

I love when you can see how much the Roots enjoy being in geeky Jimmy Fallon skits, like everyone singing Call Me Maybe with Carly Rae Jepsen while playing elementary school musical instruments. Also Fallon is having the best time too - I need to watch this show more often, great vibe:


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The Rent(al Income as a Percentage of GDP) Is Too Damn High, and Households Severely Burdened with Housing Costs

Jun 15, 2012Mike Konczal

Here's a great graph from Mike Norman Economics:

Here's a great graph from Mike Norman Economics:

Rental Income is "Rental Income of Persons with Capital Consumption Adjustment" (which you can find in FRED here). What's that? According to the BEA: "It consists of the net income from the rental of tenant-occupied housing by persons, the imputed net income from the housing services of owner-occupied housing, and the royalty income of persons from patents, copyrights, and rights to natural resources."

And, starting in the late 1980s it skyrockets as a percentage of our economy. It declines in the mid-2000s (the BEA explains why here), but is returning with a vengance. (Update: This data includes imputed rents homeowners pay themselves, and that is driving a lot of the increase, and we should emphasize that it makes straightforward analysis more complicated.)

But we are concerned with this impact on real people. What does the rental market look like on the ground, especially for people with high rents? The Joint Center for Housing Studies of Harvard University just released their 2012 State of the Nation's Housing.

(Aside: do we have too many houses? Study: "Given that the number of new homes added in 2002–11 was lower than in any other ten-year period since the early 1970s, it is difficult to argue that overbuilding is dragging down the housing market. Instead, the excess housing supply largely reflects the sharp slowdown in average annual household growth in 2007–11 to just 568,000—less than half the pace in the first half of the 2000s or even the 1.15 million averaged in the late 1990s." This household formation drop is due to the unemployment crisis and "a sharp drop in immigration." There are some good charts that explain this.)

For the purposes of our rentier economy, I want to look at something they emphasize: people burdened by housing expenses. They find that, from 2007 to 2010, there was an increase of 2.3 million households paying more than half of their income for housing (what they define as "severly burdened"); that brings it to a total of 20.2 million. That is no doubt impacted by the unemployment crisis, but this is a longer-term trend too. There was an increase of 4.1 million people paying more than half their income for housing from 2001-2007:

That 20.2 million severly burdened households are equal to 18 percent of all households. 27 percent of renters fall into this severly burdened category, with homeowners roughly half that number.

Who falls into this category? Older people are vunerable, with a rise from 12 percent to 16 percent of 55-64 year olds falling into the severly burdened category from 2007 to 2010. Metropolian areas, especially core cities, are places where this is prevalent. It impacts poorer people the most, with over 60 percent of those making less than $15,000 in this category, and 30 percent of those making between $15 and $30 thousand dollars a year as well. It's negatively correlated with education, with those with a college degree having the lowest rates - so this isn't a matter of young college graduates overpaying to live in a nice city.

Indeed It is worth noting that poor families with children paying more than fifty percent of their income on housing spend less on other essentials. "Among families with children in the bottom expenditure quartile, those with severe housing cost burdens spend about three-fifths as much on food, half as much on clothes, and two-fifths as much on healthcare as those living in affordable housing." No doubt some of these cost burdened households love living where they do, save on transportation and don't mind the spending; others are spending much less on food for their children because they need to spend so much to keep a roof over their heads.

This is what it looks like when working people get squeezed by rents.


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Do I Need to Get Healthy to Save For Retirement? A Response to Peter Orszag's Barbell Approach

Jun 15, 2012Mike Konczal

Why the argument that we can't have short-term stimulus without long-term deficit reduction doesn't hold up.

Let's say there are two obvious things I should be doing to make my life better: being healthier now and saving more for retirement. We'll say that it is hard to disagree with these two items, and that these are obviously smart moves for me to make.

Why the argument that we can't have short-term stimulus without long-term deficit reduction doesn't hold up.

Let's say there are two obvious things I should be doing to make my life better: being healthier now and saving more for retirement. We'll say that it is hard to disagree with these two items, and that these are obviously smart moves for me to make.

Given that they are the smart things to do, I should try to do both at the same time, right? I shouldn't let my failure to do one prevent my ability to do the other. It would be weird for me to tell my doctor I was going keep on eating multiple triple bacon cheeseburgers because I wasn't maxing out my 401(k) contributions; my accountant would be puzzled if I told him I wasn't going to invest my savings for retirement until I dropped some weight. There could be convoluted situations in which I could only do both -- no point in saving for retirement if I'm not going to make it there -- but it would have to be backed up by undeniable facts, since it would involve not trying to do something I believed was a good idea.

Yet this is how elite, center-leaning policy intellectuals think on the issue of deficits. The Very Serious People, if you will. They think we need to increase the size of the short-term deficit. They also think that we need to reduce the size of the long-term deficit. But they think that these two actions can only move together and, like I told my doctor and accountant, if one doesn't happen the other can't either. This is often known as the two-deficits problem, which I last talked about in The Nation.

Take the Domenici-Rivlin Restoring America's Future plan. In the overview it states, "First, we must recover from the deep recession that has thrown millions out of work... Second, we must take immediate steps to reduce the unsustainable debt ... These two challenges must be addressed at the same time, not sequentially." (The deficit hawk Comeback America Initiative report is similiar, with $500 billion dollars in infrastructure over two years tied to focusing on long-term deficit reduction.)

It's never very clear why these two must move together. The more aggressive argument is that the market will panic and raise interest rates if the long-term deficit is not addressed, immediately canceling out the stimulus. The more widely used version is that stimulus now would increase the longer-term debt, hence making the longer-term challenges worse and the crises and challenges occur more quickly.

This is why something like Delong-Summers paper "Fiscal Policy in a Depressed Economy" is so important. It finds that "under what we defend as plausible assumptions of temporary expansionary fiscal policies may well reduce long-run debt-financing burdens."

As Seth Ackerman noted, there's something gleeful in seeing Delong-Summers, in their focus on hysteresis in Europe, dismiss the "principal alternative theory was that high unemployment in Europe in the 1980s and 1990s" as "principally a supply-side phenomenon...and rigid labor market institutions... See Krugman (1994)" in a footnote (!), as if that's not a major reversal or anything. But the argument that, from the debt-to-GDP point of view, fiscal stimulus in a depressed economy is a smart investment by itself, is important for countering the idea that it must be linked to something else in the long term.

Here's where Peter Orszag's "Barbell Approach Only Way to Lift Heavy Economy" enters the picture. Orszag argues that that Delong-Summers approach is flawed because it ignores this two-deficits (or what he calls the barbell) problem, which argues that even if short-term stimulus is a good idea it should be linked to long-term deficit reduction. To use the opening analogy, even if getting healthy is a good idea, we should only try it if we save more for retirement. Why is this?

But these stimulus-only proposals, by not lifting the other side of the barbell, are incomplete for three reasons: First, substantial stimulus-only proposals have no chance of being enacted. Second, even if they could be, they would accelerate the date at which we again run up against the debt limit -- and their proponents have no strategy for dealing with that impediment. Finally, even if the debt limit were simply assumed away (an ivory-tower approach that might prove appealing to some stimulus-only proponents), the impact of any stimulus would be stronger, and our international credibility enhanced, if it were combined with specific, but delayed, actions to reduce the deficit.
The first is a political problem, not an economic one. It should be noted that the barbell strategy, as enacted in 2011 by President Obama, lead to his lowest approval ratings and the sense that he was being politically destroyed by his Republican counterparts. The Republican presidential primary debates featured all candidates saying that they wouldn't accept a 10-to-1 cut-to-tax ratio; it doesn't seem like this strategy is likely to have a political edge anytime soon. Also politics is a matter of elite opinion, and elite opinion isn't an asteroid that falls out of the sky. It is a series of assertions made and defended by elites like Orszag. He can choose to try and change that, like Summers is, if he'd like. Elite opinion is often wrong, and I believe it is wrong here. But one can't create and defend it while arguing it is a constraint.
The second, referring to the debt ceiling, is also a political problem, but I'd argue that nobody seems to have a particularly good strategy for dealing with it. Even so, if the problem is Republicans refusing to vote to increase the debt ceiling in a time of crisis, that needs to be addressed as a political problem; it doesn't refute the smart economic idea of fiscal stimulus in a depressed economy. (Sometimes the limit is referred to as a debt-to-GDP limit where, once past, growth slows. See Josh Bivens tear apart those kinds of arguments here.)
The third is an economic argument, which says long-term deficit reduction measures would increase the credibility of the United States. Normally that translates into lower long-term interest rates for government borrowing. Would that help? Here's Peter Orszag arguing against QE2 in December 2010: "a modest reduction in long-term interest rates will not have much effect on economic activity at a time when corporations are flush with cash and worried about the future." Would a few basis points gained through credibility help now, especially if the long-term effects were painful? Even if it did, it may bolster the case for the barbell approach, but it still doesn't necessitate it.
That 2010 editorial is fascinating because it argues that we need "more fiscal expansion (read: more stimulus) now" and "much more deficit reduction, enacted now, to take effect in two to three years." It's one and a half years later, and we still need the same exact thing according, to common wisdom: more fiscal expansion now, and deficit reduction in two to three years. That a bond vigilante revolt that was scheduled starting in 2012-2013 turned into a bond vigilante rally; Treasuries are at record lows, even lower than in 2010. Which is to say that our credibility hasn't been in play -- even a ratings downgrade hasn't changed anything. Rather than being terrified of the United States' fiscal position, capital markets are desperate for the U.S. to find something productive to do and are willing to loan us the money to do it at ultra-cheap rates. It would be great for us to take advantage of this smart economic move without holding it ransom to the possibility of challenges in the distant future.
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Mike Konczal is a Fellow at the Roosevelt Institute.

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Public Sector Layoffs and the Battle Between Obama and Conservative States

Jun 12, 2012Mike Konczal

The government job losses that are holding the recovery back are directly related to the Republican state legislators who were swept to power in 2010.

Last Friday, both presidential candidates had a back-and-forth over the issue of public sector jobs. President Obama said that the private sector is doing fine but the public sector needs help and is threatening the recovery, and Mitt Romney attacked the idea that "we need more firemen, more policemen, more teachers.”

The government job losses that are holding the recovery back are directly related to the Republican state legislators who were swept to power in 2010.

Last Friday, both presidential candidates had a back-and-forth over the issue of public sector jobs. President Obama said that the private sector is doing fine but the public sector needs help and is threatening the recovery, and Mitt Romney attacked the idea that "we need more firemen, more policemen, more teachers.”

This has lead to new interest in the decline of public sector workers over the past three years. Two major economists from Yale, Ben Polak and Peter K. Schott, just wrote a post at at Economix titled "America’s Hidden Austerity Program."

Polak and Schott argue that "there is something historically different about this recession and its aftermath: in the past, local government employment has been almost recession-proof. This time it’s not... Without this hidden austerity program, the economy would look very different. If state and local governments had followed the pattern of the previous two recessions, they would have added 1.4 million to 1.9 million jobs and overall unemployment would be 7.0 to 7.3 percent instead of 8.2 percent."

But why is this happening? Polak and Schott:

One possibility is that we are witnessing a secular change in state and local politics, with voters no longer willing to pay for an ever-larger work force. An alternative explanation is that even though many state and local governments are constrained not to run deficits, they can muddle through a standard recession without cutting jobs. But when hit by a huge recession like that of 1981 or the latest one, the usual mix of creative accounting and shifting in capital expenditures cannot absorb the shock, and jobs have to go.

This drop in public-sector workers is well documented, and it is great to get more economists ringing the bell on it. But I think there needs to be more research into how this has happened. As my colleague Bryce Covert notes over at The Nation, "the massive job loss we’ve been experiencing in the public sector is no random coincidence or unfortunate side effect. It is part of an ideological battle waged by ultra conservatives who were swept into power in the 2010 elections."

As we've written before (article, white paper), the 11 states that the Republicans took over during the 2010 midterm elections – Alabama, Indiana, Maine, Michigan, Minnesota, Montana, New Hampshire, North Carolina, Ohio, Pennsylvania, and Wisconsin – account for 40.5 percent of the total losses. By itself, Texas accounts for an additional 31 percent of the total losses. So these 12 states account for over 70 percent of total public sector job losses in 2011. This is even more important because there was a continued decline in public sector workers in 2011 even though the economy was no longer in free fall.

The 11 states that the Republicans took over in 2010 laid off, on average, 2.5 percent of their government workforces in a single year. This is compared to the overall average of 0.5 percent for the rest of the states. So while it is a nation-wide event, it is concentrated in states that went red in 2011:

Wisconsin, for instance, lost nearly 3 percent of its workforce in 2011 alone, which shows how high the stakes are. Conservatives are tearing down and rebuilding state governance during this Great Recession. There is an element of state and local layoffs that is strictly budgetary, as the average for all the groups is negative. But there is also an element that is about a face-off between President Obama and new conservative state legislatures.

There's two things worth considering about this dynamic. The first is that any stimulus offered from the federal government could be refused or re-directed to other purposes by state governments. The fighting over getting conservative states to accept stimulus money, which was a battle in 2009-2010, would have been much more heated after the 2010 election. And if money did come in under the rubric of helping retain teachers it may, without a political battle, just go to reducing corporate taxes. We are already seeing this with the AG foreclosure fraud settlement money, which is being redirected to other purposes in many states.

The other is that this should be viewed through the lens of the series of standoffs the administration has with conservatives at the state level. The administration has been fighting with Arizona over its "papers please" immigration law, Florida over voter record purges, and several states in battles over GLBTQ rights and reproductive freedom. Trying to keep red states from slashing their workforces in a time of economic weakness is another front in this battle for those trying to steer the economy toward full employment.

Mike Konczal is a Fellow at the Roosevelt Institute


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At Netroots Nation with a Panel Thursday

Jun 7, 2012Mike Konczal

I'll be at Netroots Nation for the next several days. If you are here and want to say hi, shoot me an email or a twitter message.
Today, Thursday at 4:30pm in room 552, I'll moderating a panel on progressives and the Federal Reserve with Matt Yglesias of Moneybox, Karl Smith of Modeled Behavior, and Lisa Donner of Americans for Financial Reform. If you are there you should check it out.
I believe it will stream online, so you can watch it even if you weren't able to make it. Hopefully it'll be viewable in the box below.

After the fact it should be viewable online. You can stream other panels at this webpage.

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What Constrains the Federal Reserve? An Interview with Joseph Gagnon

Jun 4, 2012Mike Konczal

There's a growing consensus right now that the Federal Reserve could be doing more to bring about a stronger recovery given its current powers. It's even more relevant in light of the recent weakening of the recovery, as shown in the poor job numbers that came out last Friday. But there's a lot of disagreement and confusion about the constraints that prevent the Federal Reserve from taking more action.

There's a growing consensus right now that the Federal Reserve could be doing more to bring about a stronger recovery given its current powers. It's even more relevant in light of the recent weakening of the recovery, as shown in the poor job numbers that came out last Friday. But there's a lot of disagreement and confusion about the constraints that prevent the Federal Reserve from taking more action. It's even more confusing given Federal Reserve Chairman Ben Bernanke's past research, where he described the Bank of Japan falling into “self-induced paralysis.” Some believe the constraints are political, others believe they are related to fighting among the various governors, and there are those that believe Bernanke is comfortable with monetary policy as it is.

In order to make sense of the various constraints the Federal Reserve faces, I spoke with Joseph Gagnon, senior fellow at the Peterson Institute for International Economics, over the weekend. Gagnon was an associate director for the Federal Reserve’s Division of Monetary Affairs and Division of International Finance, where he was involved with the execution of QE1. I last spoke with Gagnon on the issue of QE3 last summer.

Mike Konczal: Let's start with the basics. Does a random person -- not at the highest levels, but among those who make up most of the researchers and workers -- at the Federal Reserve think that the Fed is "out of ammo"? What are their opinions on how well previous expansionary monetary policy at the zero bound, like QE2 and Operation Twist, have worked to bolster the economy?

Joseph Gagnon: Let me start by linking to a blog post from a former classmate at his new blog, Miles Kimball’s Balance Sheet Monetary Policy: A Primer, that spells out what the Fed could do and why it would work. However, he ignores some of the legal restrictions on what the Fed can do. (See below.)

My sense is that most Fed economists believe that the Fed does have substantial, though not unlimited, ammo. They also believe QE1, QE2, Operation Twist, and the language concerning future policy intentions (staying near zero interest rates through late 2014) had significant positive economic effects, but not apparently large enough to achieve the rapid recovery that is desired.

Basically, the Fed has run out of ammo in terms of language about future policy intentions because it cannot credibly signal its intentions for more than two to three years ahead. It can extend the “late 2014” horizon into 2015, but that is fairly minor.

In terms of the asset purchases, the Fed is limited by law to the Treasury, agency, and agency MBS markets plus foreign exchange. Buying foreign exchange would be viewed as economic warfare by many countries, so it is probably ruled out even though it reflects rank hypocrisy on the part of foreign governments that are massively buying dollars. In the Treasury market, yields on three-year notes are only 0.3 percent, so the Fed must buy five-year to 30-year bonds to have any effect. With the 10-year yield at 1.5 percent, the scope for further effects is modest. Even if the Fed bought every 10-year Treasury, it would be hard to get the yield much below 1 percent, because the risks on such a bond become tremendously skewed toward future losses. There is more scope to buy agency MBS to lower the mortgage rate, but already mortgage rates are at a record low of 3.75 percent. At some point between 2 and 3 percent we are likely to reach the limit. So, the Fed has quite a bit of ammo left, but we can see that it is not inexhaustible.  

Research I am doing suggests that it would be much more attractive for the Fed to buy a broad basket of U.S. equities to support the stock market than to try to push down bond yields from these already low levels. Sadly, the Fed is not authorized to buy equities, even though other central banks are allowed to do so.

MK: A story is circulating that there has been a lot of internal disagreements among the members of the Federal Open Market Committee (FOMC), and this has prevented Bernanke, who wants to have consensus on the votes, from expanding further. You see this idea in the series of three dissenting votes against more action throughout much of 2011 and the lack of dissenting votes for more action until Charles Evans' in late 2011. Is it your sense that the FOMC composition has held the Federal Reserve in check on expansion?

JG: The hawks will never get more than three votes. This year only one hawk has a vote. Chairman Bernanke and his close allies (Yellen, Dudley, Pianalto, Williams, Tarullo, Stein, and Raskin) have a comfortable majority.

MK: A lot of economics writers assume that Bernanke is uncomfortable with non-unanimous votes and just the presence of vocal, hawkish votes has constrained how far he is willing to go with expansionary actions. Have those divisions held expansion in check in the past, even if there are fewer hawks now? And would more doves on vacant FOMC seats have made a difference in 2009?

JG: I think Bernanke had some preference for unanimous decisions, but not a strong preference. I expect there will be dissents all year. I don’t think mere voting support would have made much difference in 2009 because Bernanke knew he could get whatever he wanted. But a strong discussion leader in favor of greater ease might have made some difference if he was persuasive enough. I believe Bernanke is intellectually much closer to the doves than the hawks, but he and some of the other doves are more cautious than the hawks.

MK: What's your sense of how the economics profession broadly reacts to the idea that the Federal Reserve could be doing more? Do you think a generic economist thinks the Fed could be doing more and isn't, or that the Fed is "out of ammo" in how it can expand the economy?

JG: I think the average economist outside the Fed thinks the Fed has less ammo than the average economist inside the Fed. I frequently hear people say the Fed has done all it can do. I do not agree, but I do see a limit approaching. Note that that limit arises from legal restrictions on the Fed. If the Fed were empowered to buy all assets, it would never run out of ammo.

MK: Others point to political pressure, especially from the right. There have been rhetorical moves, such as Rick Perry saying he’d treat the Federal Reserve "pretty ugly." There is the blocking of nominees, such as Peter Diamond being blocked because “[h]e supports QE2.” And it also has to do with conservative political infrastructure. The Club for Growth put whether or not Republicans supported Peter Diamond for the FOMC on their checklists for proper Republican behavior.

How much does political pressure place a constraint on the Federal Reserve's ability to do more expansion?

JG: Chairman Bernanke would deny that political pressure influences his vote, and he even went out of his way to make a public appearance in Texas after Rick Perry made his threat. But FOMC members all read the papers. They see the virulent opposition to their policies on the right and the silence on the left. (Paul Krugman is a big exception, but he is not a politician.) They want to avoid any Congressional action that would reduce their independence in the future, in part because they think this might lead to even worse economic outcomes than we are currently experiencing.  I think they should stick to achieving their current mandate and not fail to achieve it out of fear of what a future Congress might do. In my view, Congress and the president are solely responsible for making laws and the Fed is solely responsible for achieving its mandate. But I am pretty sure some FOMC members either consciously or unconsciously disagree with me and shade their actions out of this concern.  

MK: Is it a question of balance? I've noticed that there is little political pressure from liberals on the Fed for more expansionary policy. Is it a matter of there being little countervailing pressure?

JG: I think it would help if politicians on the left criticized the Fed more strongly for failing to achieve its employment mandate.

MK: A very popular theory in the financial blogosphere is that the inflation target functions as a ceiling, not an actual target. Ryan Avent has argued that the Fed goes into action to prevent deflation, but once inflation expectations approach 2 percent it pulls back. Matthew O'Brien at the Atlantic Monthly has referred to a 2 percent ceiling as the new cross of gold. And Greg Mankiw has written, “If Chairman Bernanke ever suggested increasing inflation to, say, 4 percent, he would quickly return to being Professor Bernanke.”

Is the 2 percent "ceiling" a serious constraint, and why?

JG: The Fed has said 2 percent is the target, not the ceiling, but I agree that their actions over the past three years are not consistent with their statements. I think we should be willing to accept temporarily higher inflation if that would help to reduce unemployment faster. Indeed, combining actions like QE with an announced willingness to accept temporarily higher inflation could create a synergy that would increase the potency of QE (by reducing the real interest rate). But I fear that announcing a goal of higher inflation, either temporary or permanent, will not actually do anything unless it is backed by actions.

Also, I do not think we should permanently raise the inflation target. It is not necessary to do that to get more monetary stimulus and it would jeopardize the hard-won war on inflation of the past two decades.

MK: There’s the idea that, in the past, economists believed a lack of explicit inflation target gave central banks flexibility, but it doesn't seem that we've seen this flexibility.

JG: The general view is that you do not make up periods of being above or below target, you simply always strive to get back to the target. The problem is that the Fed is not taking this approach equally to unemployment and inflation.

Some have argued for a price path target or a nominal GDP path target. In that case you do make up for past deviations in inflation. But I think it is difficult to explain to the public how the specific path is chosen. Why should the CPI be 105 in 2013, 107 in 2014, 109 in 2015, and so on indefinitely? People care about the inflation rate not, some arbitrary price level. And it means that after booms you must have deflation. Indeed, if one had started the path in the early 1990s, the late 1990s boom would have put us way above it. Then the Fed would have had to make the 2001 recession much more severe to get us back on the path. That would have been a tough sell politically.

MK: There are those that think Bernanke should be much more explicit in declaring expectations. This became a big idea recently after an article by Paul Krugman said that Ben Bernanke has abandoned the insights of Professor Bernanke. Bernanke is essentially doing things that the Fed can't fail at instead of the things he proposed Japan should do in a similar downturn. What's your take on this disagreement?

JG: I think it is sensible for the Fed to stick to statements about things it is confident it can achieve, provided that it feels it is doing enough to achieve its objectives. For example, it can talk about purchasing MBS and pushing down the mortgage rate, thus stimulating the economy. The problem is that it has not achieved its objectives over the past three years and its own forecast shows it does not expect to achieve its objectives over the next three years. My advice is to take stronger actions of the type already taken. But if the scope for doing that runs out, then the Fed has to try riskier actions, including those of the type Paul Krugman described. Among those actions, I would tend to favor those for which the Fed has direct tools, such as buying foreign exchange to push down the dollar, rather than trying to raise inflation expectations by verbal jawboning.

MK: Finally, there are those who think that Bernanke is pretty happy with the rate of recovery and is mostly focused on downside risks. As Bernanke said at his recent press conference, "the question is does it make sense to actively seek a higher inflation rate in order to achieve a slightly increased pace of reduction in the unemployment rate? The view of the committee is that that would be very reckless." Is this, by itself, a significant barrier to future monetary expansion?

JG: Yes, this is a significant barrier. I think it reflects ill-defined concerns about the costs of taking more action to reduce unemployment faster. Some Wall Street economists fear that more aggressive Fed action now will give rise to more inflation in the future, but no Fed economist I know agrees with that. The Fed knows how to fight inflation and there is no reason that policy actions now need to cause excess inflation later. Another concern might be that expanding the Fed’s balance sheet will expose it to greater losses in the future when interest rates eventually rise (because higher interest rates will reduce the value of the bonds the Fed holds).

But the Fed’s mandate does not include maximizing profits. From the point of view of the United States, what matters is the consolidated government balance sheet (Fed + Treasury), and there is no way that QE can do anything but reduce our national debt burden. Any future losses by the Fed would be more than matched by gains to the Treasury.

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Toward More Market-Oriented Financial Reforms

May 29, 2012Mike Konczal

In Joe Nocera's editorial today, "The Simplicity Solution," he calls for financial reforms to be more focused on solutions that are both simple and market-based. He draws on recent writing by Sallie Krawcheck who "lays out a handful of market-oriented ideas that would almost surely pare back the complexity risk posed by banks." Nocera goes through Krawcheck's reforms, which are focused on corporate boards and dividend policy for financial institutions.

In Joe Nocera's editorial today, "The Simplicity Solution," he calls for financial reforms to be more focused on solutions that are both simple and market-based. He draws on recent writing by Sallie Krawcheck who "lays out a handful of market-oriented ideas that would almost surely pare back the complexity risk posed by banks." Nocera goes through Krawcheck's reforms, which are focused on corporate boards and dividend policy for financial institutions.

I think people have a good sense of the arguments for simple rules in financial regulation. The clearer the lines are drawn, the less likely they are to be gamed, financially engineered-around, or ignored by regulators. As Elizabeth Warren noted in an interview with Ezra Klein, financial institutions "want layers and layers of complexity because it’s in complexity that there are loopholes. That’s where it’s possible to back up regulators who are not quite certain about the ground they stand on. And it’s a larger problem with our regulatory structure: Complexity favors those who can hire armies of lobbyists and lawyers." This is part of the big battle over the Volcker Rule.

But what about market-oriented reforms? What about reforms designed to make financial markets work better, more transparently, and in a way that prevents both cronyism and instability? The Roosevelt Institute's big financial reform program was named Make Markets Be Markets because we think that a focus on markets will be essential to the future of financial reform. There are two things worth noting: first is that the best parts of Dodd-Frank build on this insight, and secondly the first wave of battles brought by financial institutions were over smaller parts of Dodd-Frank, but parts that embraced market-based reforms.

If you look at the derivatives component of Dodd-Frank, it builds on the core essentials of New Deal financial reform for traded instruments: transparency, disclosure, clearing, capital adequacy, the regulation of intermediaries, anti-fraud and anti-manipulation authority, and private enforcement. The insight and practice is to set up the financial markets so that private entities regulate each other through transparent prices and adequate capital. Regulators need a gentler touch because they empower other parties to regulate the financial institutions in question. Clearing institutions make sure that counterparties are properly capitalized, something that was missing in the financial crisis; exchanges make sure that price information gets into the market broadly.

The same happens with the Consumer Financial Protection Bereau. The idea is to provide simple, clear rules across all firms for consumer financial products, regardless of banking charter, and let them compete against each other on price and product. Rather than racing to the bottom in terms of fees and mangled contracts, standardization of terms allows real market competition to take place. This extends across large parts of Dodd-Frank.

What's interesting is that, as I read it, the first two major battles over Dodd-Frank were precisely over these types of reforms. The first major lawsuit against Dodd-Frank, from September 2010, run by the Chamber of Commerce and the Business Roundtable, was against proxy access. Proxy access allows "[a]ny investor, or a group of investors, with at least 3 percent of a firm's shares for three nominate directors." It re-balances the relationship between dispersed shareholders and boards: it allows shareholders to hold ineffectual boards accountable for everything from business practices to executive pay.

Notice that no regulator is necessary here. Shareholders are granted the power to take these actions on their own, which they'll use their their advantage as necessary. Indeed, just the threat forces boards into action, even if no proxy access is formally held. And shareholders, representing their own money and interests, are going to be more forceful as de facto regulators than a handful of actual regulators staring at and trying to regulate board composition.

The other big initial fight was over "interchange fees." On the urgent lobbying of financial firms, Congress came very close to repealing the part of Dodd-Frank that dealt with these fees in 2011, but that ultimately failed. Interchange balances the relationship between vendors and financial firms in regard to the fees charged on credit cards. It allows vendors to price discriminate between credit and debit cards, and it moves debit cards to clear at par so that people's money actually reflects their transactions. Again, no regulator is needed here. Every small business owner who feels squeezed by financial firms' fees becomes a regulator in this case. Their ability to price discriminate helps keep interchange on credit cards from spiraling out of control in a way a handful of regulators sitting in Washington DC could never pull off.

Going forward, we need Dodd-Frank implimented in the simplest, clearest regulatory way. But we also need to make sure that it makes financial markets work the way they are supposed to and allows the market itself to be the best regulator. Financial lobbyists know this, and will respond accordingly.


Wall Street image via Shutterstock.

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The Insane Idea Hidden in the Debate Over Obama's Spending

May 24, 2012Mike Konczal

Instead of debating whether Obama is responsible for a spending surge, we should ask why anyone expects the ratio of spending to GDP to remain constant in a recession.

Instead of debating whether Obama is responsible for a spending surge, we should ask why anyone expects the ratio of spending to GDP to remain constant in a recession.

There's a recent debate about whether or not a federal government spending boom has happened on President Obama's watch. This was kicked off two days ago by Rex Nutting's post at MarketWatch, "Obama spending binge never happened." Nutting notes that "federal spending is rising at the slowest pace since Dwight Eisenhower brought the Korean War to an end in the 1950s." He argues that the 2009 fiscal year, outside the stimulus spending, belongs to President Bush, as it was four months into that budget when Obama entered the presidency. He draws on OMB's numbers, which you can access here.

As you can imagine, the right wing has gone into action. Here's "Actually, the Obama spending binge really did happen" by AEI's James Pethokoukis, which argues that you must look at the government spending as a percentage of GDP to see the increase. Now there's a technical debate about how to approach the numbers in the 2009 fiscal year, and there's a fair debate on how to understand the increase in automatic stabilizers, such as unemployment insurance. Do they "belong" to Obama, given that they were already starting up due to a recession that started in December 2007? And then there's the economic debate: shouldn't the proper response have been to run a much larger federal government spending program?

But underneath it is an insane debate about an insane idea -- that the government should keep a consistent ratio of government spending to GDP in a recession. The attack on Obama is focused on this number without acknowledging the crazy part of what this number actually does in a recession.

Let's run through a quick example to show why I think this is insane. Imagine a government spends 20 percent of GDP this year, there is no expected GDP growth in the next year, and the government will spend the same exact amount of money next year. And then imagine that GDP drops 2.7 percent for the year, as it did from 2008-2009, for this hypothetical economy.

Now even though there is no additional money spent, government spending as a share of GDP will go up. The number goes up if the numerator increases (governments spend more) or the denominator decreases (GDP falls in a recession). It goes up to 20.6 percent in this hypothetical example. If the government wanted to keep the 20 percent ratio consistent, it would have to cut spending. But in a weak economy, in the middle of a recession, the last thing you want to do is cut government spending -- that will make the recession worse, which will decrease GDP further. Then you have to cut government spending even further, which creates a nasty loop.

Federal government spending as a percentage of GDP went from 20.8 percent in 2008 to 25.2 percent in 2009. How much was GDP falling? If GDP had grown 3.4 percent as it had done the year before, instead of dropping 2.7 percent, spending as a percentage of GDP would have gone to 23.7 percent. That means a third of the rise in government spending as a percentage of GDP is a mechanical effect of GDP falling in the Great Recession. And if GDP didn't fall in the Great Recession, automatic stabilizers wouldn't have kicked in and there wouldn't have been the stimulus bill, meaning less spending.

It is worth noting that one reason why the Great Recession wasn't a Great Depression was likely because of the increased size of government spending in the economy compared to the 1920s.  Here's Josh Mason in a great post:

We always ask, why was the Great Recession so deep? But you could just as well turn the question around and ask why, despite initial appearances, did it turn out to be not nearly as deep as the Depression?
I can think of four families of answers....The second answer would be that the sheer size of government makes a Depression-scale collapse of demand impossible, regardless of policy. In 1929, with government final demand only a couple percent of GDP, autonomous spending basically was investment spending, especially if we think at the global level so exports wash out. Today, by contrast, G is significantly larger than I (about 20 vs 15 percent of GDP), so even if private investment had collapsed at the same scale as in 1929-1933, the percentage fall in autonomous demand would have been much less. (And of course that fact alone helped keep private investment from collapsing.) Interestingly, despite Hyman Minsky's association with stories about finance, this, and not anything to do with the financial system, was why his answer to the question Can "It" Happen Again was, No. Policy is secondary; big government itself is the ballast that stabilizes the economy.

And, for the record, it's a massive shame that government spending didn't go up more, reducing unemployment, getting the economy back on track, and ultimately really bringing down the debt-to-GDP ratio.

Mike Konczal is a Fellow at the Roosevelt Institute.

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What Theory is Animating Rajan's FT Mortgage-Debt Reduction Policy Recommendation?

May 23, 2012

Ok, I'm genuinely confused. There's two interesting things about this from Raghuram Rajan's Financial Times editorial, Sensible Keynesians see no easy way out, that we should unpack (my bold and numbering):

Ok, I'm genuinely confused. There's two interesting things about this from Raghuram Rajan's Financial Times editorial, Sensible Keynesians see no easy way out, that we should unpack (my bold and numbering):

The key question then is whether more government spending can make a real difference to the most severe employment problems. Here the case for a general stimulus becomes less compelling. [1] In the US, demand is weakest in communities where a boom and bust in house prices has left an overhang of household debt. Lower local demand has hit employment in industries such as retail and restaurants. A general increase in government spending may be too blunt – greater demand in New York is not going to help families eat out in Las Vegas (and hence create more restaurant jobs there). [2] Targeted household debt write-offs in Las Vegas could be a better use of stimulus dollars....
Targeted government spending, or reduced austerity, along the lines suggested by sensible Keynesians, might be feasible in some countries and helpful in speeding recovery. But we should examine each policy based on a country’s circumstances. We should be particularly wary of populist Keynesians, who parrot “in the long run we are dead” to justify any short-sighted government action. They do the world a disservice by suggesting there are easy ways out.
So Rajan is a sensible Keynesian who would push us towards targeted, household mortgage-debt write-offs. Meanwhile others, including presumably Paul Krugman, are a dangerous, populist variety of Keynesian who want fiscal or monetary stimulus.
The first numbered argument is true - places where housing prices collapsed the most are hardest hit by unemployment. But unemployment is still a nation-wide phenomenon, hitting places that didn't even have a housing bubble.  Let's chart the ratio of unemployment for April 2012 versus the unemployment for December 2007 state-by-state (source, click for larger image):

The average increase is 1.65. In New York, which Rajan singles out as being ok, unemployment has gone from 4.7 percent to 8.5 percent, which gives us an above-the-average ratio of 1.8. This is not a localized crisis.

Now Rajan is almost certainly alluding to a graph like this, which we put together a year and a half ago (sigh), of unemployment against the percentage of homes that are deeply underwater, or more than 50% underwater:

There's a lot of ways to visulize this relationship between housing bust and unemployment - Jared Bernstein had one recently. But let's examine this relationship in light of Rajan's suggestion that "Targeted household debt write-offs" could be "a better use of stimulus dollars."

There's three stories explaining this this relationship between unemployment and underwater housing. The first is a structural story. Can't turn housing construction workers into nurses, underwater homeowners can't move, etc. The mobility story turns out to be incorrect, and the "skills" story has problems we've discussed elsewhere. But notice that writing down mortgage debt doesn't make a construction worker into a nurse. So writing down mortgage debt doesn't help with this story.

There's a second story about this graph that describes a "wealth effect." People where housing values collapsed feel poorer, so they spend less. The latest Economic Report of the President argued that the "severity of losses experienced during the recession that began in December of 2007 in both national output and in labor markets makes these [wealth-effect] estimates appear too small." Also households are the net seller, but also net buyer, of housing - it's not clear, outside demographics, that housing shifts should make the macroeconomy feel poorer. But either way, writing down mortgage debt would not help with the wealth effect: if all the housing was paid in cash we'd still have the same recession under this second story.

Now there's a third story, a "balance-sheet" story of the recession. Here consumers are overleveraged and are cutting back on consumption until their balance-sheet, or their amount of debt, is repaired. In this story, reducing household mortgage debt can be a really great use of stimulus dollars. We walked through this story in this interview with Amir Sufi, who has done the leading empirical work on this. And the key, recent, theorectical work on this story, the best model of how this happens, was done by.....Paul Krugman. Specifically Eggertsson/Krugman's "Debt, Deleveraging, and the Liquidity Trap."

If the problem is household's balance-sheets, you can either make people richer or reduce their debts. Rajan thinks that taking money and writing down debt is a good idea. You could also take that money, give it to people in exchange for building useful public stuff; they can pay down debts, and then everyone has some stuff that helps the productive capabilities of the economy. You could also just give people money by not collecting taxes and mailing out checks, and they can efficiently choose whether or not to reduce debts. But under the three most common stories for the relationship between housing and debt, Rajan's policy recommendation only makes sense in the context of deleveraging, or a serious demand story, or the theory that is animating the so-called "populist" Keynesian wing.

This debate is frustratingly not new. Christina Romer was telling media in early 2009 that balance-sheet problems become worse if you let unemployment soar, even if you reduce debts. Romer: "Actually, you know, a crucial thing–when [FDR] did the bank holiday, it took the next two years to actually clean up the banks, that we actually did not get the things really cleaned up until 1935. And that a big part of that cleanup was he managed to turn around the real economy. We saw employment growing again, GDP growing again, and that inherently helps your financial system." Nothing messes up balance-sheets like mass unemployment and falling median wages.

As we've seen, writing down mortgage debt is a viciously ugly, difficult, zero-sum battle. I think it makes good sense to consider, and will have some more formal writing on it, but the idea that it is the sensible ideal while everyone else pushing fiscal or monetary stimulus is behaving irresponsibly is wrong - they both are working from the same intellectual framework.

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Can Private Equity Firms Like Bain Do Whatever They Want With the Companies They Buy?

May 22, 2012Mike Konczal

Three critiques of the notion that private equity's actions are above public concern.

The question of Romney's tenure at private equity firm Bain Capital will stay in the headlines as the Obama team releases ads on the subject and Romney continues to run on that record. But what can we take away from this debate?

Three critiques of the notion that private equity's actions are above public concern.

The question of Romney's tenure at private equity firm Bain Capital will stay in the headlines as the Obama team releases ads on the subject and Romney continues to run on that record. But what can we take away from this debate?

Ezra Klein argues that running a leveraged buyout company ought to give one some sense of solidarity with those left behind. As LBO/private equity creates winners and losers, winners should be in favor of an expanded social safety net that helps those who lose in the layoffs get back on their feet with minimial disruptions. Since LBO overall creates more wealth, part of that wealth should be taxed for the benefit of those who need help adjusting to their new economic reality afterwards - such as providing continuous health care coverage, job training, etc.

One thing I'm noticing in these debates is an almost tautological idea that since shareholders own the firm, anything shareholders do with their firm is legitimate and outside the boundaries of public concern or critique. It was in the background of what Karl Smith was discussing on Sunday's "Up With Chris Hayes," and Josh Barro made it more explicit this morning on twitter.

A Stick

Let's imagine that I buy a stick. Under a idea of general, everyday libertarianism, since I own the stick I can do anything I want with it. I can break it in half, burn it in a fireplace, carve it into something else, turn it into woodchips, attach a kite to it, exclude people from using it, etc. I can't hit people with it, or use it to set their stuff on fire, or attach duct tape to it in order to steal their stuff - but that's a function of general prohibitions against force and fraud. Short of that, it would be weird to say that I shouldn't do whatever I want to my stick of wood - that something I do with it could be illegitimate - as long as I enjoy it.

But does a private equity firm own its portfolio businesses in the same exact way that I own my stick? Is it weird to even think, outside general prohibitions against force and fraud (which I'll treat as unproblematic as it relates to the question at hand), that their actions could be illegitimate? There are many references to increasing profits, or making firms more dynamic, or "creative destruction," but those are side effects of shareholders doing whatever they want with its portfolio. The core issue is that there could be nothing illegitimate in terms of how a private equity firm runs those businesses in the sense there's nothing illegitimate I could do with a stick I own.

Three Critiques

Starting from this baseline, the critiques as far as I read them (which will draw on two previous posts) break down along three lines:

1. Tax/regulatory loopholes. I did an interview with Josh Kosman, author of The Buyout of America, where he argued that the whole point of the enterprise is to game tax law loopholes. Private equity "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."

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.

That's one thing in an industry with large and predictable cash flows. But after those low-hanging fruits were picked, as Kosman explained, "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."

This critique has power as far as it goes. But let's combine it with another issue.

2. Risk-shifting among parts of the firm. Traditional "creative destruction" is about putting rivals out of business with better products and techniques. Leveraged buyouts and private equity are about something different, something that exists within a single firm. This is often described as putting new techniques into place, firing people and divisions that are not performing, and generally making the firm more efficient.

The critique here is that, instead of making the firm more efficient, it often simply shifts the risks into different places. As Peter Róna, head of the IBJ Schroder Bank & Trust in New York, described it in 1989:

The very foundation of the LBO is the current actual distribution of hypothetical future cash flows. If the hypothesis (including the author’s net present value discounted at the relevant cost of capital) tums out to be wrong, the shareholders have the cash and everyone else is left with a carcass. “Creating shareholder value” and “unlocking billions” consists of shifting the risk of future uncertainty to others, namely, the corporation and its current creditors, customers, and employees…
The notion that underleveraging a corporation can cause problems is neither new nor unfounded. What is new is the assertion that shareholders shouid set the proper leverage because, motivated by maximizing the return on their investment, they will ensure efficiency of all factors of production. This hypothesis requires much more rigorous proof than Jensen’s episodic arguments… although Jensen denies it, the maximization of shareholder returns must take place, at least in part, at someone else’s expense.
Shareholders gain, but at the expense of other stakeholders in the firm. This isn't the normal winner/loser dynamic, where some suffer in the short-term to do what's best for the long-term. Here the long-term suffers to create short-term winners. Once again, this issue becomes problematic when combined with another critique.
3. Dividend looting. The theory behind private equity, as Róna caught above, is that it requires shareholders to be the proper and most efficient group to set the leverage ratio. But what if, instead of setting leverage for the long term to make the firm more efficient, shareholders simply use additional debt to pay themselves, regardless of the health of the firm? As Josh Kosman put it:
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...
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...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.

This runup in dividend payouts is feature of the post 1980 financial markets more broadly, one that LBO had a hand in creating:

The blue line is profits, the solid red line is payouts. As Josh Mason noted (my bold), "In the pre-neoliberal era, up until 1980 or so, nonfinancial businesses paid out about 40 percent of their profits to shareholders. But in most of the years since 1980, they’ve paid out more than all of them...It was a common trope in accounts of the housing bubble that greedy or shortsighted homeowners were extracting equity from their houses with second mortgages or cash-out refinancings to pay for extra consumption. What nobody mentioned was that the rentier class had been doing this longer, and on a much larger scale, to the country’s productive enterprises."

Versions of these three arguments form the core of the private equity critique. Instead of simply carving a figurine or starting a BBQ, private equity uses its stick to game tax law while cashing out short-term value, leaving others in the firm worse off and the firm itself more prone to collapse and less able to produce long-term value. Do you find this critique convincing? What else is missing?

Mike Konczal is a Fellow at the Roosevelt Institute.

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