JP Morgan Proves That Size Does Matter

May 15, 2012Mike Konczal

Breaking up the big banks might not be the whole solution, but it could make resolution authority more credible.

Breaking up the big banks might not be the whole solution, but it could make resolution authority more credible.

Before we start talking about the advantages and disadvantages of introducing size caps and restricting business lines through a new Glass-Steagall, it is important to understand how very big the five biggest banks are. If you need a sense of how big JP Morgan is and why it is hard for it to "hedge" without moving the market, the graph below gives you a sense. This is a graph I put together during Dodd-Frank based on data that was floating around at the time:

When bills restricting size of a large financial institution have been introduced they usually put size in the context of deposit liabilities (what we provide a backstop for and what reflects consumer savings, expressed as a percent of all deposits) and non-deposit liabilities (what reflects a blunt measure of size and potential for shadow banking runs, expressed as a percentage of GDP). The SAFE Banking Act, which has been reintroduced, mostly impacts the six firms listed above. The original SAFE Banking Act had a cap of 3 percent of GDP for non-deposit liabilities for financial firms (2 percent for actual banks) -- a space that ignores over 8,000 banks to just focus on the biggest six.

Yesterday Elizabeth Warren sent out an email with PCCC calling for a new Glass-Steagall. Let's back up: what kind of regulation do we have in the financial sector? First, there's the background regulation that structures and forms the financial markets. How are derivatives treated in bankruptcy? How is capital income and debt taxed? How are contracts and corporations set up and enforced? And so on.

The second level of regulation is "prudential" regulation. Prudential regulation of financial institutions is the various ways regulators regulate banks. Capital requirements are one example. So is prompt corrective action, restricting dividends for troubled firms, etc. One reason to do this for regular banks is to act as a coordinator for dispersed depositors who are unable or unwilling to perform these functions. Another is that financial firms have serious macroeconomic effects on the economy. And another is to intervene in issues of asymmetric information. The everyday libertarian case against regulating a restaurant is "who would want to poison their customers?" As we saw in the last 20 years, Wall Street is comfortable not only selling their customers poison at a high margin, but taking out life insurance on them through the credit swaps market.

The third level is blunter, and that's strict prohibitions, either on businesses or on size. What are the advantages and disadvantages of adding prohibitions? One factor is simplicity compared to other forms of prudential regulations, but what else is there?

Resolution

Adding prohibitions can help ensure the end of Too Big To Fail. In this sense it works to amplify, rather than replace, Dodd-Frank's resolution authority.

A common response is that the problem with Too Big To Fail isn't that the firms are too big or too complex, but too interconnected. Matt Yglesias notes that in the context of resolution, prohibitions aren't that important: "we can't put investment banks through the bankruptcy process because it's too systemically chaotic. In that case, Glass-Steagall is irrelevant and what we really need is a new legislative mechanism for the resolution of investment banking enterprises. That's what Dodd-Frank is supposed to do. This all just backs in to the point that even though the phrase 'too big to fail' has caught the public imagination, it's never been clear that size is relevant."

But here's Martin J. Gruenberg, Acting Chairman of the FDIC, in a big speech last Thursday:

While there are numerous differences between a typical bank resolution and what the FDIC would face in resolving a SIFI, I want to focus on a few key differences...

In addition, the resolution of a large U.S. financial firm involves a more complex corporate structure than the resolution of a single insured bank. Large financial companies conduct business through multiple subsidiary legal entities with many interconnections owned by a parent holding company. A resolution of the individual subsidiaries of the financial company would increase the likelihood of disruption and loss of franchise value by disrupting the interrelationships among the subsidiary companies. A much more promising approach from the FDIC's point of view is to place into receivership only the parent holding company while maintaining the subsidiary interconnections.
 
Another difference arises from sheer size alone. In the typical bank failure, there are a number of banks capable of quickly handling the financial, managerial, and operational requirements of an acquisition. This is unlikely to be the case when a large financial firm fails. Even if it were the case, it may not be desirable to pursue a resolution that would result in an even larger, more complex institution. This suggests both the need to create a bridge financial institution and the means of returning control and ownership to private hands.
Resolution authority is an untested solution for a financial firm, particularly one as large and complex as JP Morgan. Size and complexity make a difference. If financial firms were smaller and more siloed, there is an argument that resolution authority, which is one of the core mechanisms of Dodd-Frank, would work more smoothly and be more credible.
 
Market Power and Competition
 
As Barry Ritholtz noted on the JP Morgan loss, "Simply stated, once you are the market, you are no longer a hedge." Size makes a difference in these markets, and by breaking up the largest firms you'd see reduced market power. In terms of size, Andrew Haldane argues that economics of scale in banking top out at around $100 billion, or signficantly less than a 3 percent GDP liabilities cap. Beyond market power, the largest banks represent a large amount of political power as well.
 
And in terms of business lines, Kevin J. Stiroh and Adrienne Rumble, in "The dark side of diversification," look at financial holding companies as they absorb different business lines in the late 1990s and 2000s. "The key finding that diversification gains are more than offset by the costs of increased exposure to volatile activities represents the dark side of the search for diversification benefits and has implications for supervisors, managers, investors, and borrowers." New business lines introduce new profits but also introduce new volatility. The more volatile a firm is, the harder it is for it to fail without bringing down the financial system.
 
Mike Konczal is a Fellow at the Roosevelt Institute.
 
Follow or contact the Rortybomb blog:
  

 

Share This

The Dimon Fiasco: A Stark Lesson on Why Finance Needs Government Regulation

May 11, 2012Jeff Madrick

J.P. Morgan Chase's trading losses are a perfect example of why we need increased government regulation of banks.

Many people see the $2 billion in trading losses announced by J.P. Morgan Chase as the quintessential example of why strong regulation is needed. There is a lot of irony in this story. It is a true story about the importance of government.

J.P. Morgan Chase's trading losses are a perfect example of why we need increased government regulation of banks.

Many people see the $2 billion in trading losses announced by J.P. Morgan Chase as the quintessential example of why strong regulation is needed. There is a lot of irony in this story. It is a true story about the importance of government.

When Sandy Weill, the rough and tough entrepreneur, ultimately built a financial conglomerate from many pieces—including Salomon, Smith Barney, and Travelers Insurance—into Citigroup, Jamie Dimon, someday to be the outspoken CEO of J.P. Morgan Chase, had always been at his side. A bright and dutiful young man, Dimon stayed with him when Weill was consigned to a number two role at American Express after selling his firm, Shearson Loeb Rhoades, to the credit card giant in the early 1980s. He was with him in San Francisco, when Weill was charged with slimming down American Express’s subsidiary, Fireman’s Fund. Weill’s expertise was making companies lean and mean, which often entailed ruthless lay-offs. Dimon ran the numbers for Weill and participated in the implementation of the lean and mean philosophy.

When Weill finally left American Express, Dimon again went with him. Finally, they found the consumer finance company Commercial Credit Corp, which made high interest loans to low-income consumers, including early subprime mortgages, much like the old Money Store. According to biographers, Dimon liked the industry because it was unregulated. He and Weill took over the company, fired lots of people, issued a stock offering quickly, and used it to rebuild the Weill dynasty, which would soon include Smith Barney, Shearson again, and, the giant Travelers Insurance in 1993.

But Weill still had no serious investment banking presence, so he turned his attention to Salomon Brothers, king of risky bond and currency trading, the birthplace of what later became Long-Term Capital Management, and maker of much money and several major trading losses. How risky was this trading firm?

Dimon was skeptical. But here is the irony. Weill sent Dimon to study how Salomon made its money, and the originally hesitant Dimon said he now believed the risks could be controlled. Immediately after the acquisition in 1997, however, Weill was clobbered by Salomon losses due to the East Asian financial crisis and many more to come. Weill quickly limited trading exposure at Salomon. Dimon must have learned that losses are inherent in such businesses.

Dimon was finally at Weill’s side when Travelers merged with Citicorp to form Citigroup, becoming a massive financial giant. He left soon after in a personal dispute as Citigroup took on more and more risk, more and more debt, and adopted unethical practices that were later unearthed by Eliot Spitzer, which resulted in more fines than for any other company.

Dimon wound up running J.P. Morgan Chase, where he emerged as a hero after limiting mortgage market risks before the crisis that felled so many. He became the most respected of Wall Street’s leaders, and he was arguably the best of them. But Wall Street trading profits are too tempting, and individual Wall Street traders too hard to control. Even with tight oversight, they often go their own way. And they often lose hundreds of millions and sometimes billions of dollars in the process.

Dimon may have known precisely what his London trader, the “Whale,” was doing. I doubt it. But it’s likely the so-called “London Whale” had been making big bucks for the firm for a long while. Giving him more line would only be natural.  

Herb Allison, former president of Merrill Lynch, is a strong skeptic of commercial and investment banks’ trading operations. He even thinks over time they may all lose money. What happens is that they make plenty along the way, then lose it in a big bust.  As author Michael Lewis divulged, a Morgan Stanley trader, Howie Hubler, lost $9 billion in 2007 and 2008. Nevertheless, Hubler left Morgan with millions of dollars, and later returned to work on the Street.

Dimon, among the most cautious of executives, couldn’t control this trading animal with a life of its own, either. That’s the important conclusion. A Volcker rule to limit speculative trading for banks is necessary. They are using federally insured money to finance much of their banking operations, enabling them to leverage other facets of the company. They are using shareholder money, not their own, to take risks, yet they take enormous bonuses when all goes right. And they are implicitly using taxpayer money, because if they lose too much, they will be bailed out by the federal government. They remain too big to fail.

Serious capital requirements must be implemented against such trading, and banks must also change banker compensation procedures further. For traders, it’s a heads I win, tails you lose proposition. And so it is with the bank CEO as the firm’s overall earnings rise and are socked with a blow only every once in a while. These compensation plans have changed under pressure from the federal government to some degree. But probably not enough. The firms’ partners and employees have to be on the line for losses over time.

All this is a case study in why finance needs more government rules and regulations than most other industries. The omnipresent claim that such rules undermine liquidity in markets is almost laughable. In truth, we have a lot of liquidity when we don’t need it and little when we do—such as after the Lehman Brothers catastrophe in the fall of 2008. As regulations were eliminated and weakened after the 1970s, finance became more unstable, crises more frequent, and trillions of dollars were invested down the rat holes of speculation and fantasy, while Wall Street employees made countless millions. Yes, finance is important to economic growth, but only if government controls it properly. Otherwise it can be and has been damaging.       

Roosevelt Institute Senior Fellow Jeff Madrick is the Director of the Roosevelt Institute’s Rediscovering Government initiative and author of Age of Greed.

 

Banner image courtesy of Shutterstock.com.

Share This

Assessing Yet Another Round of the Structural Unemployment Arguments

May 8, 2012Mike Konczal

No matter how much elites insist that our unemployment problem is structural, they don't have the data on their side.

David Brooks has the 2012 version of the structural unemployment argument in his editorial today, "The Structural Revolution." Here's rooting for this one, as the previous arguments haven't held up all that well.

No matter how much elites insist that our unemployment problem is structural, they don't have the data on their side.

David Brooks has the 2012 version of the structural unemployment argument in his editorial today, "The Structural Revolution." Here's rooting for this one, as the previous arguments haven't held up all that well.

The 2010 version of the argument had to do with an increase in JOLTS "job opening" data, data that turned out to be incorrectly estimated by the BLS (as we learned in 2011). The 2011 version focused either on the idea that the unemployed had bifuricated into a normal unemployment market and a long-term, zero-marginal productivity market (it hadn't) or that the "regulatory uncertainty" of the Obama administration was holding back the economy (which, as Larry Mishel found, wasn't backed by the data).

There's been a ton of situations where these structural unemployment arguments came charging down the runway only to hit a cement wall of data. One "oops" moment was Raghuram Rajan citing Erik Hurst in claiming that unemployment would be three points lower if it wasn't for "structural" reasons, and Hurst having to publicly point out his preliminary research said nothing of the sort. Another was Rajan arguing, in June of 2011, against monetary policy. Why? Because "one view is that corporate investment is held back by labor-market rigidities (wages are stubbornly too high)....There is, however, scant evidence that the real problem holding back investment is excessively high wages (many corporations reduced overtime and benefit contributions, and even cut wages during the recession)." Empirically that means that there shouldn't be any bunching of wage changes at the zero mark. Here's what the San Francisco Fed found early this year:

Whoops.

Apparently none of that changed anything for anyone. So what do we have now? I want to address three specific points in Brooks's essay which I think are wrong in a very useful way. First, Brooks argues that "Running up huge deficits without fixing the underlying structure will not restore growth." The argument here is that a larger deficit will not help with short-term growth. I'll outsource this to Josh Bivens, addressing a similar argument from Adam Davidson:

This is the reverse of the truth – there is wide agreement that debt-financed fiscal support in a depressed economy will lower unemployment. Now, it’s true that there are holdouts from this position. And others who think the benefits of lower unemployment are swamped by the downsides of higher public debt (they’re wrong, by the way). But, the agreement is much more widespread – ask literally any economic forecaster, in the public or private sector, that a casual reader of the Financial Times has heard of if, say, the Recovery Act boosted economic growth. They will all tell you “yes.”

You won’t find anywhere near such a consensus on long-run tax or education or health care policy. In fact, public finance economists can’t get unanimous agreement on if, in the long run, income accruing to holders of wealth should be taxed at all (it should, by the way). In short, anybody waiting for the current unpleasantness to pass and for economists to unite in harmony in future policy debates shouldn’t hold their breath...

Lastly, Davidson notes that there is a rump of economists (he calls them, reasonably enough, the Chicago School) that argue that debt-financed fiscal support cannot help economies recover from recessions. But, it’s important to note that there is pretty simple evidence that can be brought to bear on this Keynesian versus Chicago debate. Nobody denies, for example, that the government could borrow money and just hire lots of people – hence creating jobs. What the Chicago school argues is that this borrowing will raise interest rates (new demand for loans will increase their “price,” or interest rates) and this increase in interest rates will dampen private-sector demand. But interest rates have not risen at all since the Recovery Act was passed and private investment has risen, a lot.

Second, Brooks argues that "there are the structural issues surrounding the decline in human capital. The United States, once the world’s educational leader, is falling back in the pack." If this is the case -- that our problems are a lack of education and investment in human capital -- then recent college graduates would have significantly lower unemployment rates than most, or they would be the same, or if they were higher then they'd come down even faster. Also from EPI, Heidi Shierholz, Natalie Sabadish, and Hilary Wething, "The Class of 2012":

Young people with recent college degrees have high unemployment rates. That's not good, either for Brooks's argument or for the huge number of young people being devastated by the weak economy and the weak response of elites.

Third, we have Brooks arguing that there are issues "surrounding globalization and technological change. Hyperefficient globalized companies need fewer workers. As a result, unemployment rises, superstar salaries surge while lower-skilled wages stagnate, the middle gets hollowed out and inequality grows." Some occupations require high skills and have sufficient demand, but some occupations require mid-skills and are disappearing. (Low-skill jobs should be fine on unemployment, but low on wage growth, in most versions of this "job polarization" theory.)

Let's take BLS CPS unemployment data by occupation, March 2007 and March 2012, and see if you can tell me which occupations require these high-end skills from their low 2012 unemployment rates:

I'm having trouble seeing them in the data.

So here's the important thing about the demand-side recessions: If I wanted to come up with a "supply" theory for Brooks, I'd say, looking, at the data above, that we have too many college graduates and too many business and professional workers. I'd also say we have too many non-college graduates and too many service workers. I'd also say we have too many of all ages, all educations, and all occupations. Something is weak at a fundamental level in the economy, which is impacting everything, even before we get to the pressing issues related to job polarization or education. That weakness is demand, and that is where the policy response should be. Don't tackle it, and the longer-term problems are even harder to manage.

As David Beckworth noted, "[t]his evidence in conjunction with that of downward wage rigidity excess money demand, and the Fed handling the housing recession just fine for two years should remove any doubt about there an aggregate demand problem. The real debate is how best to respond to this problem." The evidence he referred to was the SF data noted above along with the tracking he found between sales being reported as the "single most important problem" by small businesses and the unemployment rate:

Mike Konczal is a Fellow at the Roosevelt Institute.

Follow or contact the Rortybomb blog:

  

Share This

A Message to World Leaders: Ignore the Financial Markets

May 7, 2012Jeff Madrick

A solution for the eurozone? Listen to the people, not to the markets.

For 40 years, there has been a tug of war between government in democracies and what we may call “the other government.” By the latter I mean, of course, the financial markets. James Carville highlighted his concerns when he announced that in the next life he would want to be a bond trader. Alan Greenspan followed the bond markets religiously for signs of increased or reduced inflationary expectations.

A solution for the eurozone? Listen to the people, not to the markets.

For 40 years, there has been a tug of war between government in democracies and what we may call “the other government.” By the latter I mean, of course, the financial markets. James Carville highlighted his concerns when he announced that in the next life he would want to be a bond trader. Alan Greenspan followed the bond markets religiously for signs of increased or reduced inflationary expectations.

Now Europe faces the threat of a financial market rebellion. Democracy has spoken loudly in this weekend’s elections on the Continent and in England. Voters said, "We have had all the austerity economics we can take."  They threw over Sarkozy in France and many Conservative and Liberal candidates in England. In Greece they ran for the extremes. The moderate liberal Pasok party won the least votes in memory, but it may yet form a coalition to run a new government. Italian election results will be in soon.

And democracy is working! The instinct among those in the financial markets is that democracy usually reflects the weak-willed demands of the public. But the public is generally right this time, and it has been many times before. Austerity economics is self-destructive when economies are so weak.   

Yet of course the financial markets’ initial reaction to the European elections was to sell, as if austerity economics was actually working to make nations' bond payments easier to handle. It was not! But the markets fear that a new strategy will make matters worse.

Political leaders should ignore the financial markets in the short run, pure and simple. This may drive up financing costs for a while, but the eurozone should absorb those and adjust policies. The European Central Bank (ECB) ought to accommodate its needs. The right policies are stimulus from the current account countries and the end of extreme austerity in the periphery. Wages should rise in the eurozone core and stabilize in the periphery; they can even rise from their current lows in places like Greece. The 17-nation Eurozone or the 27-nation EU should issue jointly backed bonds to provide social safety net support to the financially weak nations, to raise demand for them and get their economies going, while reducing the extreme financial pain and sacrifice that now jeopardize social stability. As examples, the Greeks voted for extremist parties, the Le Pen party did well in France, and the Tea Party runs amok in the U.S. Austerity fever even grips Washington, which makes the November election especially important.

What the crisis requires is elected government, not bond trader government. Any idea that the financial markets are rational should have been discarded four years ago. They have been absurdly wrong for decades. In the U.S., they persistently overestimated future inflation by driving interest rates too high compared to the CPI and the GDP deflator. Greenspan treated them as the height of rational forecasting, when indeed they were simply following the latest conventional wisdom. In my informal opinion, he used long-term rates as a guide to policy. Now the ECB remains too tight as well. In the U.S., the “rational” bond traders actually traded what they thought the market would think, rather than what rational foretellers of the future would think. It was Keynes’ beauty contest analogy—choose the woman you think others believe is beautiful. The belief that the markets were right was the fallout of extreme efficient markets theory.

The media too often treated the markets as rational as well. Bond traders implicitly endorsed austerity economics until fairly recently, and the media usually reported them as being right. The supposedly sophisticated financial media (with some noted columnists as exceptions) wondered what could possibly work if not austerity. Now there are signs that the press is waking up to reality and realizing that it, along with the financial markets, is not working.

There are some signs of the ice breaking. The German finance minister announced it was okay for German wages to rise. They have actively restrained wage growth to make their exports more competitive for over ten years. The main sources of their demand were the European periphery, where wages were rising a bit due to a property bubble caused by irrationally low interest rates offered in the financial markets. But there are still signs of backward thinking. Many in Europe think of growth policies as nothing more than making labor markets more competitive through deregulation and reduced wages. As if the more flexible labor markets in the U.S. are leading to rapid recovery.

In sum, what’s needed in Europe is fiscal stimulus, a more accommodative ECB, social transfers from rich states, higher wages in many nations, a change in the silly EU agreement to keep deficits absurdly low, and industrial policy to gear capital investment across the continent, free of prejudice and nationalistic tendencies. The elections may bring some of this about. Then, once policies are working to support growth and reduce financial burdens as tax revenues rise, the financial markets will at last respond constructively. They must be waited out for now.

To put it most simply, what’s needed is the will of the government of the people to ignore the financial markets and stop treating them like a more rational government than democracy itself.   

Roosevelt Institute Senior Fellow Jeff Madrick is the Director of the Roosevelt Institute’s Rediscovering Government initiative and author of Age of Greed.

Banner image courtesy of Shutterstock.com.

Share This

The EEOC Stands Up for Transgendered Workers While Congress Stalls

Apr 30, 2012Tyler S. Bugg

genderless-icon-144The EEOC's decision to extend protections against discrimination to transgender workers is an important step toward social justice and a stronger economy.

genderless-icon-144The EEOC's decision to extend protections against discrimination to transgender workers is an important step toward social justice and a stronger economy.

Two months ago, I wrote that our country should pass the Employment Non-Discrimination Act (ENDA) and expedite the process of ending discrimination based on sexual orientation and gender identity in the workplace. This month, we’re one step closer. A groundbreaking ruling handed down from the Equal Employment Opportunity Commission (EEOC) on April 20 dictates that protections against gender identity discrimination are covered by Title VII of the 1964 Civil Rights Act and can be called upon in gender and sex discrimination complaints to the bureau and in subsequent lawsuits. This is a major leap forward for transgender Americans and for their job security.

The landmark change came as a response to the case of Mia Macy, a transgender woman and former Phoenix police officer who applied for and was tentatively accepted for a ballistics job -- until the employer conducted a background check. After obtaining information about Macy’s transition from a man to a woman, the employer allegedly (and untruthfully) informed Macy the offer was eliminated due to budget cuts and then promptly filled the position with another (not transgender) applicant. EEOC policy has been vague on exactly the types of cases are covered under its statutes, and are therefore under its legal jurisdiction, and detrimentally so. But under the new ruling, Macy’s filing of a complaint of gender discrimination with the EEOC can move forward to the next investigative steps.

The new ruling, however, has ramifications much larger than Macy’s case alone. It clarifies existing national policy and makes stronger what’s often been a too slowly evolving area of employment law. It sets into motion protections for potential employees from workplace discrimination regardless of their gender identification, expression, or status. The policy holds obvious significance for cutting away unnecessary pressures within the workplace environment, pressures that are both bad social policy and bad business policy.

Human Rights Watch’s “Corporate Equality Index” has striking evidence in support of the last point. Not only are employees who usually face discrimination finding more inclusive employment laws beneficial, so are employers. While employees experience higher confidence in their job searches and eventual careers, employers can access improved applicant pools. Benefits like more inclusive health plans and policies, gender-minority support and focus groups, and diversity councils are all additional assets that strengthen the commitment to productive and respectful employer-employee relations, guided by principles of fairness and equity. The economic outlook, in the long run, is the real winner.

The EEOC ruling will also have profound effects in curbing some disturbing trends. Data from the National Center for Transgender Equality (NCTE) shows that mistreatment at work is widespread. A disturbingly high 90 percent of transgender individuals reported feeling harassed or mistreated at work, and 47 percent reported being fired, not hired, or denied a promotion or salary increase as a result of their non-conforming gender status.

On top of this, the lack of protection against discrimination in the workplace has long had alarmingly adverse effects on gender-minority individuals elsewhere. The NCTE further reports that as transgender employees face workplace discrimination, their personal lives suffer as well. As a result of negative workplace environments, transgender individuals are four times more likely to be homeless, 70 percent more likely to abuse drugs and/or alcohol, and 85 percent more likely to be incarcerated.

The EEOC ruling is a vital first step with the potential to be a game changer in the job market. Its potential for setting a precedent for the passage of laws like the ENDA, one of the most stagnant pieces of legislation of the past two decades, is also promising. But it’s not the whole solution. While it's certainly a strong deterrent for employers with histories or ongoing incidents of gender discrimination, it’s only a mechanism as strong as we make it. It shouldn’t only be a reactive method that penalizes discrimination by threatening lawsuits, legal fees, and unwanted government intervention. Rather, it should foster a culture of prevention aimed at normalizing acceptance of all workers.

Tyler S. Bugg is a member of the Roosevelt Institute | Campus Network and an Organizing Fellow with Obama for America studying international affairs and human geography at the University of Georgia.

Share This

A Year of Ben Bernanke Press Conferences

Apr 25, 2012Mike Konczal

A year ago, in April of 2011, Ben Bernanke gave his first press conference.  I wrote it up for the American Prospect here.  Looking back, I had flagged that more of the questions asked Bernanke whether he was doing too much, rather than too little, to stimulate the economy.  I noted:

A year ago, in April of 2011, Ben Bernanke gave his first press conference.  I wrote it up for the American Prospect here.  Looking back, I had flagged that more of the questions asked Bernanke whether he was doing too much, rather than too little, to stimulate the economy.  I noted:

the press conference, roughly nine questions worried about inflation, a weak dollar, the country's S&P rating, oil prices, and whether the government can fashion an appropriate response to the financial crisis or long-term unemployment at all. These all reflect the worry that government is doing too much instead of too little. Meanwhile, there were only two questions asking why the Federal Reserve wasn't doing more to lower unemployment. When Binyamin Appelbaum asked, "Is it in the Fed's power to reduce the rate of unemployment more quickly? How would you do that? Why are you not doing it?" it was almost out of place.

That wasn't the case today.  The questions were much harder and more frequently about why Bernanke wasn't doing more to get the economy going.  They took for granted, as the first questioner pointed out, that "unemployment is still high, the economy is slowing, inflation is subdued" and Bernanke and the FOMC is, to their critics, "still being too cautious."  I count, on a quick scan, five questions related to the idea that the Federal Reserve has the ability to do more and is choosing not to do it, with only two more related to concerns of inflation hawks or a "bond bubble."

There's a lot of reasons for this: the wasted year of 2011 for the economy, the continued low interest rates of the United States even after a ratings downgrade, growing fears of a permanent decrease in the labor force participation rate and hysteresis, and more.  But part of this change is the result of the economics blogosphere pushing the debate about monetary policy at the zero-lower bound into the mainstream of financial and economics journalism.  The econoblogsphere should be proud of itself, and I will try to do more to advance this important conversation to whatever extent I can.

A year ago I held an event for the Roosevelt Institute on the Future of the Federal Reserve.  It was the same day as the Bernanke press conference, and as such we asked each of the participants to ask Bernanke a question, and we put them online.  Matt Yglesias' question was:  "I would ask him about his own paper on self-induced paralysis in Japan and what he has changed his mind about since then."  This change from Ben Bernanke the professor who called for aggressive monetary action to the Ben Bernanke we see now must have been on the minds of all the reporters in the room, as it is the subject of a great Krugman New York Times Magazine article this upcoming weekend.  The question finally got asked by Binyamin Appelbaum, who, as we note above, asked the hardest question about the Fed not doing enough a year ago at the first conference.  Bernanke's full answer:

Binyamin Appelbaum: Unemployment is too high and you said you expect it to remain too high for years to come, inflation is under control and you expect it to remain under control. You said you have additional tools available for you to use, but you're not using them right now. Under these circumstances, it's really hard for a lot of people to understand why you are not using those tools right now. Could you address that? And specifically, could you  address whether your current views are inconsistent with the views on that subject you held as an academic.
 
Ben Bernanke: Yeah, let me tackle that second part first. So there's this, uh, view circulating that the views I expressed about 15 years ago on the Bank of Japan are somehow inconsistent with our current policies. That is absolutely incorrect. My views and our policies today are completely consistent with the views that I held at that time. I made two points at that time. To the Bank of Japan, the first was that I believe a determined central bank could, and should, work to eliminate deflation, that it's falling prices. The second point that I made was that, um, when short-term interest rates hit zero, the tools of a central bank are no longer, are not exhausted there, are still other things that, um, that the central bank can do to create additional accommodation.
 
Now looking at the current situation in the United States, we are not in deflation. When deflation became a significant risk in late 2010 or at least a moderate risk in late 2010, we used additional balance sheet tools to return inflation close to the 2% target. Likewise, we've been aggressive and creative in using nonfederal funds rate centered tools to achieve additional accommodation for the U.S. economy. So the, the very critical difference between the Japanese situation 15 years ago and the U.S. situation today is that, Japan was in deflation and clearly, when you're in deflation and in recession, then both sides of your mandate, so to speak, are demanding additional deflation. 
 
Why don't we do more? I would reiterate, we're doing a great deal of policies extraordinarily accommodative. You know all the things we've done to try to provide support to the economy. I guess the, uh, the question is, um, does it make sense to actively seek a higher inflation rate in order to, uh, achieve a slightly increased pace of reduction in the unemployment rate? The view of the committee is that that would be very, uh, uh, reckless. We have, uh, we, the Federal Reserve, have spent 30 years building up credibility for low and stable inflation, which has proved extremely valuable, in that we've been able to take strong accommodative actions in the last four or five years to support the economy without leading to a, [indiscernible] expectations or destabilization of inflation. To risk that asset, for, what I think would be quite tentative and, uh, perhaps doubtful gains, on the real side would be an unwise thing to do.
Watch the video - Bernanke gets really agitated answering this question.  That's the argument to deal with.  I need to think this through more, but on its face it seems like they think they need to maintain their credability in order to keep rates at or below their target.  There's no tradeoff here - the credibility at best has allowed Bernanke to fight off opportunistic disinflation from becoming a goal (which may, in fact, be a victory).  
 
Meanwhile if the Bernanke wants to maintain credibility the best way to do it isn't by keeping the economy in a permanent quasi-recession but instead annoucing an NGDP target or announcing what he wants and what he is willing to tolerate to get it - say 3% inflation until unemployment is below 7%, like Chicago Fed President Charles Evans has suggested.
 
Important other notes: In response to a question about the dropping labor force participation, Bernanke noted that the rate was dropping because they are "no longer getting increased participation from women... society ages and also, for other reasons, male participation has been declining over time."  However a lot of it "represent cyclical factors, much of it is young people, for example, who presumably are not out of the labor force indefinitely, but given the, uh, weak job market, they are going to school or doing something else, rather than, than working."  As such "the unemployment rate may not fall as quickly going forward," because when the economy picks up "many of these folks are going to come back into the labor force looking for work."
 
Bernanke notes that in the absense of a zero lower bound the interest rate would be negative but that they've done other things to counteract this.  "We, we see monetary policy as being approximately in the right place at this point. Based on the analysis that we've been doing of the economy and the outlook."
 
All in all, the media has gotten a lot better pushing the Federal Reserve to account for its role in the weak economy over the past year.  Let's take victories where we can get them.
 

Follow or contact the Rortybomb blog:

  

Share This

Our Brave New Service Economy

Apr 23, 2012Bryce Covert

More low-wage, dead-end jobs might sound good to business owners, but is that what we want for our country?

More low-wage, dead-end jobs might sound good to business owners, but is that what we want for our country?

One of Romney’s big selling points is that he knows the “real economy” (much like some conservatives know “real America,” I guess) because he has experience as a businessman. Conservatives have started substituting business acumen for political acumen, making the mistake of comparing what’s required to run a country to what’s required to run a company. At first blush it almost makes sense: both oversee groups of people, both deal with budgets, both make decisions. But not only does that experience not necessarily translate to the White House, it also belies a deeper problem about the kind of economy we’re trying to recreate in the aftermath of the Great Recession. Viewing the country, and its economy, as a private business isn’t likely to create solid middle-class jobs.

“This American Life” had a recent episode called “What Kind of Country” that explored what kind of country Americans want this to be, but parts of it had more to do with what kind of economy we want. Take the example they give in act three: Colorado Springs. With a stretched city budget, local businessman Steve Bartolin, CEO of the Broadmoor Hotel, decided to look and compare it to running his hotel. After all, he tells the reporter on the story, “We have the same number of employees as the city… I look at us as a service delivery organization,” just like the city, apparently. They are both concerned with “how do you deliver the highest quality of service in the most efficient, cost effective manner.”

His main focus became how much both entities spend on their employees. “They’re running a 70 percent labor cost and we’ll run a 35 percent labor cost,” he says. “Any business person can look at that and say, ‘Jesus, we’re going to be out of business by 2014 at this pace.’” He writes a manifesto to the city council that ends up being circulated all over town: the city should lower starting wages for its employees, require them to pay more for their health insurance, and start contracting out anything it can to private businesses.

A city councilwoman explains that payrolls for the city government are higher than the hotel’s because it doesn’t control its own pension costs, which are mandated by the state. But she also makes a very important point: it has to hire people with more training and experience. City engineers and police officers can’t be hired on the cheap like the service industry workers at the Broadmoor.

And herein lies a big problem. What Bartolin proposed, basically, is to make government employees more like service employees. This is highly problematic, particularly for the black Americans and women who have long relied on public employment because it paid decently, offered good benefits and stability, and enabled them to move up the economic ladder. Public employment has been credited with helping to create the black middle class. If we make these jobs as unstable and low-benefit as service jobs, we’ll be taking away a huge boon from groups who have historically benefitted from it.

But we’re not just dragging public employees down to the level of service workers. In fact, the jobs our economy is best at producing these days are service jobs. As Harper’s recently tweeted, the chances that an employed American works in the service industry are six in seven. Those jobs have been growing very quickly: from 2010 to 2011, occupations like salespersons, cashiers, and food preparation workers grew by 3.2 percent. As Nona Willis Aronowitz recently reported, one in 10 employed Americans works in food service, making up 9.6 million people. And young people are taking a lot of those jobs: a quarter of people ages 16 to 29 who have a job work in hospitality, meaning travel, leisure, and food service. “A study of 4 million Facebook profiles found that, after the military, the top four employers listed by twentysomethings were Walmart, Starbucks, Target, and Best Buy,” she writes.

These are low-wage, low-benefit jobs that rarely pay much more than minimum wage (if even that) and offer schedules that can change on a whim. A report from the Retail Action Project in New York found that over half of retail workers made under $10 an hour – and 12 percent earn the minimum wage. Less than a third get health benefits through their employer. The Restaurant Opportunity Centers United reported that the average yearly income for restaurant workers in 2009 was $15,092, and less than a third make a livable wage. And what about those hotel workers who might be under the employ of Batolin? Non-managers make less than $12 an hour on average.

And unlike government work, these jobs offer little training and room for advancement. The sector relies on employee churn to keep labor costs lower. (Just ask Barbara Ehrenreich.) Service careers aren’t designed to advance much farther than flipping burgers.

Is this what we want our economy to look like? Do we want most jobs to offer wages that don’t cover basic expenses and to deny workers the benefits they need to stay healthy? Businesspeople would call this cost effective. I call this unsustainable.

Bryce Covert is Editor of Next New Deal.

 

http://www.shutterstock.com/Image courtesy of Shutterstock.com.

Share This

What the Tax Code Says About Our Values: The Good, the Bad, and the Unclear

Apr 17, 2012Lydia Austin

tax-chalkboard-150Our tax code represents more than just how we choose to collect revenue. It affects everyday decisions and embodies who we are as a society.

tax-chalkboard-150Our tax code represents more than just how we choose to collect revenue. It affects everyday decisions and embodies who we are as a society.

We’re all familiar with filling out tax returns – choosing deductions and organizing earned income in a way that won’t (fingers crossed) get us audited. But what do those boxes we check reflect about our societal structure and values? More than you might think.

The tax code affects more than just our pocketbooks. It’s well known that taxes shift incentives; that’s their purpose and why they (usually) work well. But careful consideration should be paid to these incentives, as they affect everyday decisions and what we, as a society, value.

Some tax provisions, like the Earned Income Tax Credit (EITC), are undoubtedly good for society. The EITC is a tax credit for low-income households with children, and the beauty of it is that it actually incentivizes work. Up to a certain income level, it subsidizes working more: the greater income a family receives, the greater their tax credit from the government. While this is only true up to a point, it’s hard to argue with a tax provision for low-income families that helps to decrease unemployment. Likewise, the ability to deduct charitable donations provides added incentive to support our favorite charities.

On the other hand, the United States’ treatment of earned foreign income is depressing – by which I mean depressing our economy. Americans are taxed on their worldwide incomes, regardless of where that income was earned. Most countries exempt foreign income from taxation, but not us. Instead, the government provides tax credits for taxes paid to other governments (because if you earn money in Germany, the German government wants a part of it). This does not completely erase companies' desire to locate outside of the United States; many countries have cheaper labor costs or other incentives to locate there, which offset the tax trouble.

Most troublingly, our taxation of foreign income discourages companies from being American. Since other countries do not treat foreign income the way the U.S. does, corporations and companies that do a lot of business overseas have an incentive to either start out as a non-American company or sell their operations to their overseas affiliate, thus reducing their overall tax burden.

Then there are the areas where the effects of our tax code are more ambiguous. For instance, depending on the dynamics of a relationship (meaning income dynamics, not which side of the bed you prefer), the tax system can either incentivize or discourage marriage. If one partner earns significantly more than the other, then after marriage when both partners split the income, they will likely be in a lower tax bracket. Conversely, if two partners both earn moderate to high incomes, combining their income after marriage can penalize them by pushing them into a higher tax bracket. As noted in William Statsky's Family Law, some couples divorce on December 31 and remarry on January 1 in an effort to dodge the marriage penalty, since your marital status at the turn of the New Year determines how you can file. But don’t get any ideas – most of these couples are stopped from breaking up and getting back together for tax reasons (and it’s usually pretty evident).

It’s clear the tax code affects our lives more than inducing stress during the month of April. It can encourage or discourage labor, marriage, and philanthropy. We make decisions in part because of how the tax structure incentivizes us to act. But is the government promoting the right values?

America needs a tax system that doesn’t cater to special interests or current holders of wealth. Our tax laws and provisions need to reflect our belief in equity, equality, non-discrimination, prosperity for all, and economic growth. Unfair tax practices that push corporations’ business overseas or penalize marriage should be reconsidered or done away with, while efficient taxes that work should be promoted.

Preferential treatment should not be given to capital income over labor income, as is currently the case, and while the current income tax code is outdated and convoluted, any revision needs to bear in mind our commitment to a progressive tax structure. If the income tax were scrapped and a consumption tax implemented instead, assurances would need to be made that this system would be tempered by progressive laws, so the heaviest burden does not fall on low and middle-income earners.

A closer look at our tax system is warranted for anyone who cares about the future of this country. What seem like mundane decisions regarding money in fact have enormous social consequences. Though many find discussing taxes dull, they have important consequences on our societal value system – and our actions.

Lydia Austin is a junior at the University of Michigan Gerald R. Ford School of Public Policy, where she is studying tax policy and international economics.

Share This

E-Government Can Help Entrepreneurs Cut Through Red Tape

Mar 16, 2012Blake Falk

money-question-150As part of the 10 Ideas: New Ideas for a New Economy series, a proposal to create a one-stop resource that would ease the regulatory burden on the recovery's real job creators.

money-question-150As part of the 10 Ideas: New Ideas for a New Economy series, a proposal to create a one-stop resource that would ease the regulatory burden on the recovery's real job creators.

"We know the startup sector is important, and it is sputtering." So said Dennis Lockhart, president of the Federal Reserve Bank of Atlanta, at the Conference on Small Business and Entrepreneurship During an Economic Recovery. Although recent employment reports have signaled improvement in the labor market, with the unemployment rate falling to 8.3 percent and jobless claims tumbling, a closer inspection of underlying trends concerning new business creation is troubling. As Lockhart noted, between 1992 and 2005, the rate of new business creation outpaced the rate of exit by about two percentage points, providing a net increase in employment. However, with the onset of the Great Recession, the relationship between these two metrics was overturned. Business failures rose sharply while the rate of establishment fell from 870,000 a year in 2006 to 720,000 in 2010, signaling a reversal in new business and employment trends.

Given the current momentum in the labor market, some question if new business creation is truly vital for the recovery. With established companies currently sitting on record cash reserves worth nearly $2 trillion, it would seem that they already have the resources to reduce unemployment considerably. However, new business creation during and after the recovery must recuperate for more reasons than simply job numbers, even though businesses with fewer than 50 workers are the largest employers in the nation and have consistently led payroll gains during the recovery. Federal Reserve Chairman Ben Bernanke stated that beyond playing an "important role in fueling past recoveries," new businesses help drive innovation, provide an economic alternative to those facing income instability, and "help sustain the vitality of the neighborhoods" in which they are located. The recovery is not just clawing out of the hole created by the financial crisis of 2008, but rebuilding a new base from which sustained, dynamic, and meaningful employment and economic growth can occur. New business creation therefore remains a crucial component of the economic recovery.

But what tools are likely to affect this positive and sustained momentum? Certainly cyclical unemployment, symptomatic of the Great Recession, is the main contributing factor to the dismal employment situation. However, permanent change in the labor market in the wake of the financial crisis must come in the form of changing its structural inefficiencies. One such change that will reduce unemployment during and after the recession is reforming and simplifying the process of founding a business. Even if one has the necessary capital, the current bureaucratic obligations of formally starting a business are demanding.

Without the services of a lawyer, prospective new business owners must often navigate the red tape of permits, incentives, and regulations of multiple city, state, and federal agencies. Requiring a significant investment of time and effort on the part of the entrepreneur, the current process of establishing a new firm should be made more time efficient. The structural barrier to new businesses created by these regulatory hurdles can and should be fixed -- not only for the sake of the recovery, but for future job growth, since these restrictions will not disappear when the recovery ends.

Buy a copy of The Unfinished Revolution: Voices from the Global Fight for Women’s Rights, featuring a chapter by Roosevelt Institute Senior Fellow Ellen Chesler.

From a simple accounting perspective, "the cost disadvantage on small business in each sector is driven largely, but not entirely, by compliance with environmental regulations and with the federal tax code." Complying with these regulations is more difficult for smaller businesses because they possess reduced economies of scale relative to larger ones and consequently stretch their human capital thin. This burden is especially severe on small firms in the manufacturing sector, with the estimated cost per employee being 118 percent and 151 percent higher than medium and large-sized firms. Given that manufacturing is currently "supporting first quarter overall growth in the economy " and "driving the economy forward," this regulatory strain on new manufacturing businesses relative to larger manufacturing firms may be injuring the momentum manufacturing has provided during the recovery.

Beyond accounting costs, the time costs of setting up a new business cannot be monetized. However, given that new businesses have very limited resources with regards to legal and administrative burdens, there are indirect economic impacts of time and lost productivity due to the multiple tasks required. For instance, a new restaurant owner in New York City who "wants to serve alcohol and have a pool table [...] needs no fewer than 11 city permits and licenses." Determining which agencies he or she must contact, as well as the different permits, incentives, and certifications he or she must complete presents a legal quagmire for entrepreneurs. This difficulty is largely due to the hundreds of new and sometimes contradictory rules agencies issue each year, meaning new business owners are tasked with legal burdens on top of the stresses of establishing a new business.

So how can these structural inefficiencies be remedied? One proposed solution is to create a single location from which all permits and forms for new businesses can be obtained across all local, state, and national agencies. This singular resource will steeply reduce the time commitment of retrieving and returning the forms for entrepreneurs. Given the proliferation of web-based processes and the movement to an Internet society, this one-stop location for new business owners need not be a brick-and-mortar establishment. Instead, it can take the form of a one-stop website, accessible at all times from anywhere.

One model for a one-stop website is New York City's NYC Business Express. Spearheaded in 2006 by New York City Mayor Michael Bloomberg, NYC Business Express offers "clear, focused content where traditionally there was an overload of information." Establishing a business was compared to finding "five needles in 35 haystacks" due to the significant number of city, state, and federal regulations and agencies a business owner in New York City must interact with. However, the NYC Business Express website hosts upwards of 20 different city agencies' permits, incentives, licenses, and payments that can be retrieved online at any time. The website also walks new business owners through the process step by step in a manner customized to the entrepreneur's line of business. As a result, the previously tedious and deterrent process of establishing a new business in New York City is now compared to someone handing "you the five needles you need and they're categorized, labeled, and come in a leather-bound carrying case with clear instructions on how to use them." This time-saving service has led to more than 22,000 accounts being logged on the site as well as cities like Boston, Newark, Portland, and San Francisco, which have reached out to New York City to create similar websites of their own.

The time-based restrictions of establishing a new business are structural inhibitors to new business creation, but sites similar to the successful NYC Business Express can reduce such barriers. Since the tedium suffered by new business owners is nearly universal, these one-stop sites also need to be widespread in order to reduce structural barriers to a significant degree. NYC Business Express is a successful beginning, but time inefficiencies have not been resolved elsewhere. As these one-stop websites spread, they will reduce structural inefficiencies and permanently drive the dynamic process of new business creation that is crucial not only to the recovery, but to all future job growth.

Blake Falk is a Roosevelt Institute | Campus Network member at the University of North Carolina at Chapel Hill where he studies mathematical decision sciences and economics.

Share This

What Small Business Really Needs: A Helping Hand, Not a Tax Cut

Mar 12, 2012Joseph Shure

Entrepreneurs aren't being discouraged by high taxes. They're struggling with a lack of support and resources needed to put their ideas into action.

During the 2008 presidential campaign, an Ohio man named Samuel Joseph Wurzelbacher confronted then-candidate Barack Obama about the Democrat's plan to raise taxes on individuals in high-income brackets. Wurzelbacher, who became known as Joe the Plumber, asserted the plan would hurt small business owners like him.

Entrepreneurs aren't being discouraged by high taxes. They're struggling with a lack of support and resources needed to put their ideas into action.

During the 2008 presidential campaign, an Ohio man named Samuel Joseph Wurzelbacher confronted then-candidate Barack Obama about the Democrat's plan to raise taxes on individuals in high-income brackets. Wurzelbacher, who became known as Joe the Plumber, asserted the plan would hurt small business owners like him.

At the time, it seemed as though Joe the Plumber gave a voice to the small business owner population, tired as they were of high taxes and strict regulations. But two things proved wrong with this picture: Joe the Plumber, it turns out, is not a plumber at all, he's merely worked for one. Also, he is woefully ill equipped to speak on behalf of small business owners.

The trope Wurzelbacher trotted out -- that small business owners just want the government to reduce their taxes and get out of the way -- is one we often hear coming from the mouths of conservative politicians and the press releases of right-leaning groups like the United States Chamber of Commerce.

While this stance may reflect the views of some entrepreneurs, it glosses over a reality that is becoming increasingly clear: many small business owners, most likely the majority of them, could benefit from policies that make it easier for them to do business. Small business owners need affordable healthcare, good infrastructure, and access to capital. Millions need more humane immigration laws.

I have seen this first-hand from having worked with hundreds of business owners; I'm the co-founder of the Intersect Fund, a New Jersey non-profit that provides training and loans to emerging entrepreneurs. I rarely hear my clients complain about taxes (as start-up owners, many earn low incomes). What I do notice, though, is that high health care costs hurt new businesses, and immigration related hurdles keep many from starting firms that could otherwise pay taxes and create jobs.

In addition, my clients struggle to find affordable capital with which to start or grow their businesses. Part of the reason the Intersect Fund exists is that big banks are uninterested in disbursing business loans of less than $25,000, and they balk at applicants with less-than-perfect credit.

We cater to clients at the "very small" end of the small business spectrum. The industry term for such a firm is "microbusiness," which we define as a business with five or fewer employees that needs $35,000 or less to get off the ground. The Association for Enterprise Opportunity estimates approximately 24 million of these firms operate throughout the country. If one third of them added one job each, the U.S. would enjoy full employment.

Vote by March 14 for the Roosevelt Institute | Pipeline to win a free both at Netroots Nation!

Unfortunately, these businesses face some serious obstacles. An Aspen Institute study found approximately 10 million of them lack access to basic resources, such as technical assistance or business loans.

And the resources that do exist are distributed unequally: a 2003 Dartmouth study by David Blanchflower found African American business owners are twice as likely as their white counterparts to be denied a business loan, even when controlling for factors such as creditworthiness. The perception (often correct) that capital is unavailable, the study found, makes black business owners more reluctant than others to seek out capital.

Government efforts like the Community Reinvestment Act mitigate the effects of discrimination, and agencies like the Community Development Financial Institutions Fund, part of the Treasury Department, offer much needed aid to organizations that lend to underserved populations.

The effects of the Affordable Care Act remain to be seen, but the provision enabling individuals under 26 to sign on to their parents' insurance plans has already removed a significant barrier to entrepreneurship for more than a million young adults.

Millions of entrepreneurs -- especially those of modest means and those whom the financial services industry has historically ignored -- benefit every day from policies that seek to expand access to entrepreneurial opportunity. Instead of taking the hands-off approach that Joe the Plumber and his ilk promote, the federal government and states should re-think what "pro-business" means. They should play an active role in promoting small business development.

At a time when small businesses are so important, I believe voters deserve a clear picture of which policies help them and which hurt them. To this end, I'll be working in the coming months with entrepreneurs, industry organizations, and trade groups to develop a scorecard with which to assess a candidate's or party's stance on issues that affect entrepreneurs.

To be clear, Joe the Non-Profit Microlender (me) is no better qualified than Joe the Plumber to speak on behalf all small business owners. My observations represent neither entrepreneurs at large, the views of my clients, nor the positions of my organization. But I would propose a couple of things: first, an entrepreneur's potential should hinge on her talent and drive, not on her race, gender, origin, or income bracket. Second, a business climate that tolerates inequality ends up quashing potential that our economy -- especially now -- can scarcely afford to waste. Policies that ensure equality would spur far more growth than a tax cut ever could.

Joe Shure is a Roosevelt Institute | Pipeline Fellow and co-founder and associate director of the Intersect Fund.

Share This

Pages