Guest Post: Heather Boushey on Inequality and Growth

Nov 6, 2012Mike Konczal

Mike here: Special guest post by Heather Boushey of the Center for American Progress, responding to a recent citation of her work with Adam Hersh on inequality and growth (work we discussed here). The launch of this post was delayed on my end as a result of Sandy-induced work/email chaos.

Mike here: Special guest post by Heather Boushey of the Center for American Progress, responding to a recent citation of her work with Adam Hersh on inequality and growth (work we discussed here). The launch of this post was delayed on my end as a result of Sandy-induced work/email chaos. Hope you check it out, as well as their excellent report that is discussed within.

Inequality does appear to affect economic growth

by Heather Boushey

It is now a well-known fact that the United States has the highest levels of inequality among developed countries. Increasingly, the economics profession is questioning how this affects our economy, not only in terms of what it means for those at the bottom of the income distribution, but in terms of how high inequality affects economic growth and stability.

The New York Times recently published a thoughtful piece on the relationship of rising U.S. inequality to long-term economic growth. In the wake of that article, they published a Room for Debate online forum on this topic and Scott Winship, a scholar a the Brooking’s Institution was among those participating. Mr. Winship cites our report on the topic to discuss what he argues is inadequate evidence linking inequality and growth.

We are grateful that Mr. Winship acknowledges CAP's central role in this debate, but grossly mischaracterizes our conclusions. The quote he pulled from our report gives the false impression that our research supports the conclusionthat inequality is not a problem for economic growth.

Our argument is that we need to look specifically at the channels through which inequality affects economic growth, specifically in the U.S. context. For example, there is evidence that documents how the rich don’t spend as much of their income as the non-rich. If inequality keeps rising and the rich pull in a larger and larger share of national income, this stunts demand, the lifeblood of the economy.

Another mechanism is through entrepreneurship, which is often portrayed as the dynamic force in a capitalist economy. Yet, most entrepreneurs come from the middle class. The middle class provides both the economic security and access to education and credit that entrepreneursneed.

If inequality is due to the top pulling far away from the rest of the economy,which creates a very wealthy elite, this is often associated with a well-known economic phenomenon of “rent-seeking.” The wealthy will tend to use their outsized resources to garner a bigger piece of the pie, rather than on investments that will increase productivity and make the whole pie bigger. And, there is growing evidence that this is exactly what is happening to our economy, threatening long-term growth. For example, economists have been finding that as money has flowed into the financial sector, that industry has increasingly used its resources to promote policies that benefit itself only.

In opposition to Mr. Winship’s claim, the preponderance of evidence does supports the conclusion that inequality can hamper economic growth. We conducted a thorough review of the literature and in the quote he took, we were highlighting methodological limitations in a specific class of empirical studies. We also pointed out that cross-country panel data studies look at reduced form equations for growth and we argue that we should be thinking instead about a structural model.

Others have found our report to be data-driven. Jim Tankersley, journalist with the National Journal encouraged his readers to consume the report “in its entirety,” describing is as a “The bulk of Boushey and Hersh's sources aren't partisan in any way - just detailed, data-driven analysis from top economists.” This blog called it “the best up-to-date arguments that progressives discussing inequality should understand inside out.” And in a lengthy discussion on the subject last month by Jared Bernstein, former chief economist to the vice president, our work was used to frame a summary of the latest research on this topic. 

We are typically pleased to have our research cited in the paper of record, the New York Times. However, it is no fun to have our work grossly misrepresented.

 

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A Post-Debate Interview with Glenn Hubbard on Housing Policy

Oct 22, 2012Mike Konczal

There were no serious housing questions at any of the presidental debates. Given how important the housing market is for both voters and the economy, this is surprising and disappointing. As Zachary Goldfarb noted, "here are a few words that surprisingly have not shown up through much of this debate: housing, mortgage, refinance, underwater." 

There were no serious housing questions at any of the presidental debates. Given how important the housing market is for both voters and the economy, this is surprising and disappointing. As Zachary Goldfarb noted, "here are a few words that surprisingly have not shown up through much of this debate: housing, mortgage, refinance, underwater." 

I attended last Tuesday's presidential debate at Hofstra University as press for Al-Jazeera English, providing TV commentary on economic issues. It was my first debate, so I took some time to wander around. While exploring after the debate was over, I found the Spin Alley area, which is the area where politicians and campaign people stand by to give quick media responses. Handlers held large signs advertising the people in question. I saw a "Hubbard, Glenn" sign in the air, and the Columbia economist and Romney economic advisor standing by to give spin on the debate.

I decided to get some housing questions on the table. When some people, notably Josh Barro, argue Romney has a secret economic plan, and in particular a secret housing plan, they cite Hubbard, who has been very vocal on boosting demand through interventions in the housing market. I've noted that his plans might not be that different from what Obama is currently doing.

Below is a transcript of what I got a chance to ask him:

Mike Konczal: In 2008 you co-wrote a plan with Chris Mayer on the housing market that called for mass refinancing and principal reduction through the GSE. In 2011 you released another plan with Mayer that just featured the mass refinancing. Why was there the change?

Glenn Hubbard: It wasn't principal reduction; it was setting up a Home Owners' Loan Corporation model.

There was a debt-to-equity swap in your proposal.

Right. What we focused on in 2011 was trying to give direction to the Obama administration, which was bungling the mass refinancing so badly. That's why we focused on that. I still think it would be a good idea to have a Home Owners' Loan Corporation. But the point of that piece was that the Obama administration had bungled every housing plan, so we were trying to provide some guidance.

Earlier this year, HARP, the Home Affordable Refinancing Program, was relaunched as HARP 2.0.

It's still a failure.

After the relaunch, we are seeing a large increase in refinancing on very underwater homes, particularly those with loan-to-value over 125 percent.

It's still a failure. If you compare it to the number that Chris Mayer and I had argued, it's trivial.

Compared to the number of possible refinancing?

Yes. The reason is the GSEs have stood in the way, and the Obama Treasury has not managed the GSEs in such a way as to facilitate its own policies. It's really quite sad.

But that's an FHFA problem, is it not?

I'm sorry, but you can't duck the FHFA.

So you think President Obama should have done a recess appointment [to replace Ed DeMarco] at the FHFA?

I don't manage the Obama appointments, but I do know that the FHFA has mismanaged the president's own plan.

What would a President Romney put forward in the housing market?

What Governor Romney wisely is focused on is the long term in housing. We need to wind down the portfolios of the GSEs and reassess the government's role in such a way to get more private capital back into housing.

In 2008 you argued that cramdown, or some sort of bankruptcy reform, was a bad idea because it could impact long-term growth. In retrospect, do you still think that?

Yes. I still believe that. I absolutely think that was the correct call.

Thank you for your time.

==========

Mike here, with a few notes. According to the latest data from FHFA, there have been 118,470 refinances of mortgages with an LTV over 125 percent between February, when HARP 2.0 allows for these seriously underwater refinancings, and now. Here's a graph from Dan Green's Mortgage report:

Matt Zeitlin has more on the initial successes of HARP 2.0 at the Daily Beast. Rather than the legal issues at FHFA, it seems that the next big blockages in turning record low mortgage rates into increased consumer demand through refinancing are applications overwhelming banks, the financial sector collecting oligopolistic rents from not passing along low rates to consumers via their pricing power, and lack of competition on HARP refinances.

Hubbard is correct that Ed DeMarco is blocking principal reduction at FHFA, preventing the adminstration from pursuing their own plans. I was surprised to see Hubbard pushing for a a Home Owners' Loan Corporation (HOLC) structure now, and I wonder if he'd fight for what Senator Merkley is currently proposing. An HOLC model could bypass some of these new blockage problems we are seeing on record low interest rates, benefiting homeowners.

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Despite a Strong Debate, Obama Remains Vulnerable on the Economy

Oct 18, 2012Jeff Madrick

The president found his voice in the second debate, but he still needs to make a clearer case for the progress he's made.

There has been entirely too much celebrating about President Obama’s debate performance on Tuesday. He did very well, without a doubt. He won hands down. He didn’t get into the ring cold, and he showed that he knew his stuff—and that Romney really didn’t.

The president found his voice in the second debate, but he still needs to make a clearer case for the progress he's made.

There has been entirely too much celebrating about President Obama’s debate performance on Tuesday. He did very well, without a doubt. He won hands down. He didn’t get into the ring cold, and he showed that he knew his stuff—and that Romney really didn’t.

But the economy remains the ace in the hole for Romney and Ryan. We haven’t nearly recovered in terms of jobs, and that’s a tough fact to slide by. The unemployment rate rose rapidly in Bush’s last term to around 8 percent, then peaked in 2009 at 10 percent and slowly came down to its current level. So we are only back to the start of the Obama term. No one ever won the presidency with a 7.8 percent unemployment rate. And we know, as Romney keeps reminding us, that median family income is awful and that poverty is up.

Everyone knows this, and yet Obama did not have a good enough explanation of how much progress has been made. He sounded defensive. So Obama needs a strong, non-defensive explanation of his achievements, and one way to put it is what would have happened had Romney won the presidency in 2008. You’d have a 10 percent unemployment rate with Romney as president. Poverty would be way up. He’d be blaming Social Security and Medicare for all his problems, and he’s find economists to claim he was right. They might already be cutting these programs forever “in order to save them.” It’s triage -- throw the elderly out of the boat and let everyone else eat the rations. People would be poorer. They would get less health care. Those in poverty would have fewer benefits. Is that the kind of America you want?

Odds are that Romney, if he put the Romney-Ryan plan into effect, would create a bigger deficit, too. That’s actually what we need, but a deficit based on tax cuts will create few jobs. (EPI ran some numbers based on Mark Zandi's multipliers.) And if Romney did close the many tax holes he promises to, recession is almost guaranteed even as your taxes rise.

This concept is tough to communicate in a credible way. It just sounds like economists bickering. But there is a record out there: George W. Bush’s. His central economic policy was tax cuts for the rich, and he produced the slowest job growth of any president since the Depression. Romney will do that again. Promise.

Obama has to be clear: He stopped a depression. He is getting the housing market to come back after the worst devastation since the early 1930s. Employment stopped falling. But he shows hesitation in critical areas. Will he protect Social Security and Medicare? If so, then say so. The other guys will cut it, even gut it. But is he vacillating too much here. The talk about Dodd-Frank doesn’t win him many points because most of America thinks the banks got away with murder. He needs a better way of talking about that. As for Obamacare, he is talking about its good points, but he needs to be bolder still. List them all, and list them fast.

And when he says Romney is lying, which is a deliberate motif of the Republican game plan, don’t say he lied with a smile. Say, "It makes me very sad and disheartened when the governor misleads the American people. It is unfair to you voters. And when challenged, my opponent will come back and tell you again, that’s not what his program is, or he never said that. Be proud of your claims, Governor Romney; don’t back off them to win over some in the middle of the pack. Tell them where you really stand."

Finally, it is critical to be constructive about the uses of government. Tell America the only way the country will succeed and the economy will remain prosperous is if we bring everyone with us. Every American must be able to contribute to the economy with a good education and good health. Every region must have good, dependable transportation. Every part of America must breathe clean air. Government can do that.

Unfortunately, there is no third debate about domestic matters since the next one is on international events. But I bet we get back to the economy in the third debate. I hope so. Democrats have to realize that every time Romney says "just look at the record," they are behind the eight ball. Obama needs a very clear, persuasive statement about how bad the economy was in 2009 and how much he did. He stopped the bleeding. The patient was in the hospital. Who put him there? The Republicans, with the same plan Romney is offering today. The patient is resuscitated. Jobs are coming back. The housing market has turned the corner. Everyone is still getting Social Security and Medicare. And now 30 million more will have health insurance. 

Oops, I've already said all this. Sorry, readers. But why do I have to keep repeating it?

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

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Obama Failed to Defend Government from Romney's Bluster

Oct 4, 2012Jeff Madrick

Obama failed to defend his policies or the positive role of government. But next time he'll be ready.

President Obama lost the dabate. A night’s bad sleep did not change my mind about that. But let’s be clear that, if more relaxed and clear, Romney was the same as ever. There is no new Romney. He dissimulated, did not address details, and refused to answer what few charges Obama brought up.

Obama failed to defend his policies or the positive role of government. But next time he'll be ready.

President Obama lost the dabate. A night’s bad sleep did not change my mind about that. But let’s be clear that, if more relaxed and clear, Romney was the same as ever. There is no new Romney. He dissimulated, did not address details, and refused to answer what few charges Obama brought up.

He opened with a brilliant debating tactic—really a war tactic: open a second front and retreat on the first one. Romney tacked to the middle. No, he won’t cut any taxes he can’t pay for. No, it isn’t a $5 trillion plan. Obama wasn't ready and didn't seem able to adjust. But what is the Romney policy? He never said. More upsettingly, Obama noticed but never truly pressed him on it. 
 
In fact, Romney's is the same old George W. Bush policy, and it didn’t work then. Obama got to this point, too, but didn’t bring it home strongly enough. Job growth was the slowest under Bush of any other postwar president. Obama said it. Doesn’t anyone remember his saying it? But Romney dissimulated again, because he can’t pull this grand four or five point strategy off, just like he couldn't pay off his original tax cut program. Obama could have asked him how much he plans to cut tax rates. He would have dodged it, but in dodging it he would have looked more like the old Romney than the new, bold Romney. Obama could have pressed harder on the details of closing loopholes. He didn’t.
 
Romney ignored the facts time and again, a tried and true debating technique. Obama pointed out that in a Medicare voucher program with choice, the insurance companies will steal the elderly who are healthy and raise costs for Medicare, jeopardizing its future. Romney simply ignored the point and went on to say, as if Obama said nothing, that Medicare would still be there under his voucher program and if it worked better, it would stand. 
 
In his attacks on the role of government, he persistently said the private sector can do better. But private sector health care costs have risen faster than Medicare. Why is that? He pushed the old ideological sticking points. Government is bad, private enterprise good. No facts, mind you. Just shibboleths. Keep the federal government out of health care. Give it to the states. Should we keep the federal government out of Social Security and Medicare, too—both very popular programs?
 
But if Romney’s bluster was strong, Obama lost the debate more than Romney won it. He seemed incapable of defending Obamacare. He couldn’t even counter the alleged Medicare theft of $716 billion well. He didn’t defend his green investments. Ninety billion dollars is not much when you consider Japan will probably spend nearly $500 billion on renewables. He only passingly defended his stimulus bill, repeating the error of neglect he has made for most of his administration. In fact, he hardly defended his record at all, for fear it reminds people that unemployment is stil high, as is the deficit. The point is they'd both be higher under a Romney plan.  
 
And what of the policies for 2013? Where was talk of Obama's American Jobs Act? Why not say that Romney’s policies will bring you a recession, sure as you’re sitting there?
 
And what about bipartisanship, of which Romney bragged during his governorship in Massachusetts? Could Obama have pointed out that he couldn't deal with Republicans who proclaim their first priority is to stop his reelection? Did any prominent Massachusetts Democrats threaten Romney that way?
 
Now, the media will start analyzing the Romney promises, and therein will lie some justice. He won’t be able to defend them except in the same general, non-detailed ways. The Democrats have to counter-attack. There will be plenty of room to do so. 
 
And one other point: I think Obama will be ready next time. He went into the ring cold. Every boxer knows you have to warm up and break a sweat before the first bell. I think he learned. He almost got knocked out in the first round. Not again, I don't think. 
 

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

 

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State and Local Education Funding Declined (Again) in 2011

Sep 28, 2012Mike Konczal

Here's something that might put larger trends into perspective. Earlier this month, the Bureau of Economic Analysis released data on state and local spending for the 2011 year. Here's how spending looks for state and local spending on elementary and secondary education:

Here's something that might put larger trends into perspective. Earlier this month, the Bureau of Economic Analysis released data on state and local spending for the 2011 year. Here's how spending looks for state and local spending on elementary and secondary education:

This isn't adjusted for inflation, so the decline is even worse. The dotted line is the seven-year pre-recession average projected forward. I'm pretty cynical about these things and knew that spending had declined in 2010, but I had expected it to even out or go up in 2011. Instead, it has declined further.

There's been yearly increases in spending on elementary and secondary education going back decades. We didn't develop some sort of technology that made educating young people cheaper in 2009 - instead, states were hit hard by a housing crash and liquidity issues that come with having to maintain a balanced budget in light of the worst downturn since the Great Depression. This also comes on top of the mass layoffs of teachers, some 200,000 during this recession. Rather than firing teachers while spending more elsewhere, we are just spending less educating our children, period. This is the worst kind of disinvestment, made at the worst possible time.

To bring in teachers' unions, the anti-teacher's union agitprop film "Won't Back Down" is getting negative reviews, including Liza Featherstone in Dissent and Dana Goldstein in The Nation. When you see examples of parents filling in for a failing school system, notice that this will increasingly be the case with declining funding for education. That gap in the graph above is being filled by parents and teachers for free or with children getting less education. Megan Erickson wrote about this trend in Jacobin, noting, "parents and kids are increasingly being asked to pitch in and paint the building or hawk candy bars to fill budget gaps. That’s because the values of freedom, autonomy, and choice are in perfect accordance with market-based 'reforms,' and with the neoliberal vision of society on which they’re based."

And this graph is why you need some organization at the front lines fighting for better spending on education, which is part of what teachers' unions do. There's been some great write-ups of the successes of the teachers' union strike in Chicago, including Richard D. Kahlenberg at The New Republic, Hamiltion Nolan at Gawker, and Josh Eidelson at Salon. A significant part of the strike was over broader and better educational outcome and more resources for schools. As this graph shows, it is a battle that will continue to be important.

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New Article on QE3, Plus the Kocherlakota Move

Sep 24, 2012Mike Konczal

I have a new article on understanding QE3 at The American Prospect which I hope you check out.

Several people have commented on it already, but I want to note that Narayana Kocherlakota is now in favor of more monetary action.

I have a new article on understanding QE3 at The American Prospect which I hope you check out.

Several people have commented on it already, but I want to note that Narayana Kocherlakota is now in favor of more monetary action.

To put this in perspective, here's the September 21st 2011 FOMC statement: "Voting against the action were Richard W. Fisher, Narayana Kocherlakota, and Charles I. Plosser, who did not support additional policy accommodation at this time." Kocherlakota also voted against this action in August.

At this time, he was making arguments that since "the U.S. economy has experienced large increases in the federal budget deficits, contributing substantially to the overall federal debt" and "In response to the recession, the federal government extended the duration of unemployment insurance benefits," this could have caused the natural rate of unemployment to shift so that "the implied u* is 8.7 percent." That the natural rate of unemployment was incredibly high was an argument Kocherlakota had been pushing for some time: here he is in August 2010 arguing mismatch had pushed the NAIRU up 3 percentage points in this recession.

A month later, in the November 2nd, 2011 FOMC statement, there was the first dissent on behalf of the unemployed and in favor of more easing during the entire Great Recession. "Voting against the action was Charles L. Evans, who supported additional policy accommodation at this time."

Now, almost a year later, Kocherlakota is arguing a version of the Evans rule: "As long as the FOMC satisfies its price stability mandate, it should keep the fed funds rate extraordinarily low until the unemployment rate has fallen below 5.5 percent." He explicitly credits Evans with this rule, noting "President Charles Evans of the Federal Reserve Bank of Chicago has also proposed what I’m calling a liftoff plan...Those familiar with his plan will see that my thinking has been greatly influenced by his. This is perhaps hardly surprising, since he sits next to me at every FOMC meeting!"

Even though this is a relatively conservative version of the Evans rule, there are two important consequences. The first is that dissent is now taking place on Evans' terms. During 2010-2011 the debate, especially on the hawks side, was about "structural unemployment" and whether or not the Federal Reserve should accept that unemployment should remain well above 8%. Now it is about what the Fed is willing to tolerate to get unemployment below 6%. This is a major sea change.

This also takes away the intellectual firepower of the monetary hawks. Kocherlakota is an academic's academic, and his arguments were always based in the dense mathematics of job search models and job-opening ratios. Now that he's moved over to Evans' framework on tradeoffs, it isn't clear that there will be anyone at the regional levels of the Federal Reserve producing numbers arguing that we should focus mainly on how to match workers to job openings. That's a major victory towards a more sensible monetary policy going forward.

 

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The Recession Ends. Then What?

Sep 24, 2012

It may be hard to imagine, but (we all hope, anyway) some day the recession and meager recovery period will come to an end. At that point, will the debates we're having now about the economy become completely irrelevant? What will we have to fight about?

It may be hard to imagine, but (we all hope, anyway) some day the recession and meager recovery period will come to an end. At that point, will the debates we're having now about the economy become completely irrelevant? What will we have to fight about? Roosevelt Institute Fellow Mike Konczal and EPI's Josh Bivens took this question on in the latest Fireside Chats episode on Bloggingheads:

As Mike points out, "Right now the debates seem very focused on things very specific to this recession," such as what the Federal Reserve could do to make things better or whether we should reduce mortgage burdens to boost consumption. Those are "very technical and very important debates to be having," he points out, "but they’re very narrow to the moment we’re in right now." Once we one day leave these issues behind, what will liberals decide to promote? And will we all be able to get on board?

The first issue Josh sees rearing its head is what we consider the "natural" rate of unemployment to be. Right now it's pretty obvious that unemployment is too high. At what point does it fall so much that some people, including the Fed, start to say it shouldn't go any lower? This question will have larger implications as well. As Mike says, "You see policy experts running around trying to figure out how to boost the wages of the lower quintile, but we know what has done it in the past 30 years, and it’s when unemployment is below 5 percent for a sustainable period of time." In fact, he says, a low unemployment rate "is the ultimate jobs program, it is the ultimate policy solution," and boosts wages for everyone -- not just those at the bottom.

What else will we squabble over when the economy once again booms? Bivens predicts social insurance programs -- Social Security, Medicaid, and Medicare -- will have to be on the agenda. And related to that will be just how high we can go with tax rates on the rich. "Obviously you can have a fairness argument and a just deserts argument, but the economic case is pretty clear that [tax] rates [on the wealthier] could go much higher," Mike says. "But we’re seeing resistence to just getting to near 40 percent at this point." Brace yourself, political battles are coming.

Watch the full episode below, in which Mike and Josh discuss how little we all take home and whether inequality and the social safety net have anything to do with it:

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The Recession Ends. Then What?

Sep 24, 2012

It may be hard to imagine, but (we all hope, anyway) some day the recession and meager recovery period will come to an end. At that point, will the debates we're having now about the economy become completely irrelevant? What will we have to fight about? Roosevelt Institute Fellow Mike Konczal and EPI's Josh Bivens took this question on in the latest Fireside Chats episode on Bloggingheads:

It may be hard to imagine, but (we all hope, anyway) some day the recession and meager recovery period will come to an end. At that point, will the debates we're having now about the economy become completely irrelevant? What will we have to fight about? Roosevelt Institute Fellow Mike Konczal and EPI's Josh Bivens took this question on in the latest Fireside Chats episode on Bloggingheads:

As Mike points out, "Right now the debates seem very focused on things very specific to this recession," such as what the Federal Reserve could do to make things better or whether we should reduce mortgage burdens to boost consumption. Those are "very technical and very important debates to be having," he points out, "but they’re very narrow to the moment we’re in right now." Once we one day leave these issues behind, what will liberals decide to promote? And will we all be able to get on board?

The first issue Josh sees rearing its head is what we consider the "natural" rate of unemployment to be. Right now it's pretty obvious that unemployment is too high. At what point does it fall so much that some people, including the Fed, start to say it shouldn't go any lower? This question will have larger implications as well. As Mike says, "You see policy experts running around trying to figure out how to boost the wages of the lower quintile, but we know what has done it in the past 30 years, and it’s when unemployment is below 5 percent for a sustainable period of time." In fact, he says, a low unemployment rate "is the ultimate jobs program, it is the ultimate policy solution," and boosts wages for everyone -- not just those at the bottom.

What else will we squabble over when the economy once again booms? Bivens predicts social insurance programs -- Social Security, Medicaid, and Medicare -- will have to be on the agenda. And related to that will be just how high we can go with tax rates on the rich. "Obviously you can have a fairness argument and a just deserts argument, but the economic case is pretty clear that [tax] rates [on the wealthier] could go much higher," Mike says. "But we’re seeing resistence to just getting to near 40 percent at this point." Brace yourself, political battles are coming.

Watch the full episode below, in which Mike and Josh discuss how little we all take home and whether inequality and the social safety net have anything to do with it:

 

Crossroads image via Shutterstock.com.

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The GOP's Zombie Dodd-Frank Would Lose the Core Logic of Financial Reform

Sep 20, 2012Mike Konczal

Republicans might not repeal Dodd-Frank outright, but they'd eliminate the system of rules that make it work.

Republicans might not repeal Dodd-Frank outright, but they'd eliminate the system of rules that make it work.

It was just announced that Tim Pawlenty will become the head of the bank lobbying group Financial Services Roundtable. The powerful financial lobbying group, which represents groups like JP Morgan and Bank of America among other big financial sector players, appears to be aligning itself more closely with the Republican Party and betting on the idea that Republicans will control at least part of Congress. But what do they want? Earlier in the year, I argued in Washington Monthly that they'd like to repeal the core parts of financial reform.

Recently, Phil Mattingly had an article at Bloomberg Businessweek about how the GOP and Mitt Romney would approach Dodd-Frank. This is with a hat-tip to Reihan Salam who notes that this article "has confirmed something I’ve heard from well-informed insiders" and makes additional arguments [1]. So it seems well-sourced.

Mattingly's argument is that it is unlikely that the Republicans will outright repeal Dodd-Frank. "Instead, President Romney would likely try to give the financial industry something it wants more: a diluted financial reform law that would relax restrictions on some of its most profitable—and riskiest—investments but maintain enough government oversight to give the banks cover."

So what would the Republicans try to dilute and remove? Mattingly:

"Wall Street wants to loosen rules governing the swaps market, which generated $7 billion in revenue in the first quarter of 2012, according to government records. The banks would also get rid of restrictions on bank investment in private equity and hedge funds, pare back the power of the new federal consumer protection agency, and block the Volcker Rule, which bars banks from trading with money from their own accounts, a practice that can put customer deposits at risk. [...]

Wall Street doesn’t oppose everything in the law. Banks support the “resolution authority” that spells out how and when the government can seize and wind down struggling banks before they catastrophically fail."

So they want to go after derivatives rules (swaps), the Volcker Rule and the related law on restrictions on hedge fund investments, and also the CFPB. It's important to understand this isn't like removing random parts of the bill, as strict as they may be, but is instead gutting the core logic of the law. It's the equivalent of Republicans saying they'd keep the Obamacare bill, but stop the exchanges, remove the individual mandate, and lose the ban on pre-existing conditions while getting rid of the means-tested subsidies and Medicaid expansion. We'd understand that all of the parts of this system are interconnected and inseparable; the ban requires everyone to be in the market, which requires subsidies and well-developed markets.

Let's make sure we understand how derivatives, the Volcker Rule, and the CFPB all work together. Imagine that we're car engineers, and we want to design a car and road system so that if the car crashes, it does so as safely as possible. There are four things we can do. We can put airbags and seatbelts in the car and other cars so that when it does crash the damage is limited and controlled. We can design the car with things like a brake override system so that if it hits a rough patch the driver can keep control of it and make it less likely to crash.  We can put some speed limits on the road, as well as clear traffic signals to guide cars from running into each other. And we can have some protection for pedestrians, like cops watching for DUIs or barriers to prevent cars from driving into crowds of people. Easy, right?

Now let's think of Dodd-Frank. There are the legal powers that deploy to resolve a firm if it fails, like an airbag, which are called resolution authority. This allows the FDIC to take down a failed financial firm as if it were a bank, subject to serious rules and restrictions.  And, like requiring certain car features, there are specific policies for large, systemically risky financial firms, like enhanced capital requirements, limits to investments in risky hedge-funds, and the Volcker Rule, which are designed to make it less likely for a firm to crash.

Dodd-Frank also introduces speed limits and rules of the road in the financial sector, designed to make the system as a whole less likely to crash or spiral out of control when a panic does happen. One primary place it does that is through derivatives regulations. And "cops on the beat" is the metaphor for the Consumer Financial Protection Bureau.

So there's Dodd-Frank law to allow a firm to fail, law to make it less likely a financial firm fails, laws to prevent the interconnected financial markets from going into crisis if a firm does fail, and law to gives consumers a representative in dealing with the regulatory field. This is like thinking of Dodd-Frank as a system of deterrance, detection, and resolutiion, a related model we've developed elsewhere.

If Wall Street and the Republicans are looking to seriously gut the Volcker Rule, derivatives, and the CFPB, then they're looking to gut the entire logic of the bill. Interestingly, they are less interested in "resolution authority," the legal process to fail a financial firm. This is evidently no problem with everything else removed, perhaps because they believe congressional bailouts will then happen. This should remind us that resolution authority is strengthened and made more credible by other strong regulations, including things not in Dodd-Frank, like size caps or Glass-Steagall. Preventing these diluations is crucial to building a regulatory system for the financial sector that works in the 21st century.

[1] Reihan notes that banks "also understand that [Dodd-Frank] favors incumbents over new entrants, particularly incumbents with the legal acumen and lobbying resources to shape the emerging regulatory regime. My strong preference, very much in line with conservative and libertarian sensibilities, would be for a financial reform that would aim to facilitate rather than stymie entry."

I'd like to see more on how Dodd-Frank as blocking new firm entry works. While this is a generic complaint of regulations in general, I'm not sure in what ways it applies to Dodd-Frank. Parts of Dodd-Frank actually are designed to scale up with size and risk, e.g. Sec. 171 requires capital requirements to scale with "concentrations in market share for any activity that would substantially disrupt financial markets if the institution is forced to unexpectedly cease the activity," which is not for new entries. The idea is to hold larger and riskier firms to tougher standards and higher capital, which is regulation that scales with size.

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Central Banks Are Saving Democracy From Itself

Sep 17, 2012Jeff Madrick

We may want more democratic control over the Federal Reserve, but its independence is allowing it to push back against austerity.

We may want more democratic control over the Federal Reserve, but its independence is allowing it to push back against austerity.

The Federal Reserve's recent announcement of aggressive new policies is more than a little welcome. It involved a new round of quantitative easing focused on mortgage-backed securities, but more importantly, a statement that the Fed would keep rates low for a long time, even if the unemployment rate begins to fall markedly. In other words, the Fed will be more tolerant of rising inflation. A couple of points are clear and have been widely discussed:
 
First, more inflation is what this economy needs. It will reduce “real” interest rates down the road. It will also reduce the level of debt, which will now be paid off in somewhat inflated dollars. Lenders will pay the price; borrowers will benefit.
 
Second, the Fed is at last accepting its dual mandate, which is not only to keep inflation in check but also to keep unemployment in check as well. Inflation got almost all the focus since Paul Volcker’s reign in the early 1980s.
 
Third, inflation targeting as almost the sole purpose of any government policy is now either not applicable to current circumstances or never really was the answer to our prayers. The main claimant on the uses of either hard or soft inflation targeting was none other than Ben Bernanke himself. He was the champion of the Great Moderation, which held that less GDP volatility and low inflation were admirable ends in themselves -- proof of a nearly perfectly managed economy.  
 
Never mind that growth in the late 1990s was supported by high-tech speculation in the stock market, or that growth in the early 2000s was supported by a housing bubble and crazy, risky practices on Wall Street. And forget that job growth was the worst of the postwar period under George W. Bush, even before the 2008 recession, and wages had been performing poorly for 30 years. It was all really great, said Bernanke, and only a few mainstream economists disagreed.
 
But there is another point that needs emphasis and is being passed over. This one is about democracy. Bernanke is acting aggressively because the American Congress and president are locked in an austerity embrace. Fiscal stimulus is now turning into de-stimulus. Even the president’s budget calls for fiscal restraint. The deficit bugaboo is strangling the world.   
 
Those who want to make the Fed more subject to democratic control – and to a degree, I am sympathetic -- should heed a lesson here. Democracy -- that is, a democratically elected Congress and president -- is choosing a damaging course of austerity. In Europe, it is far worse. 
 
Needed policies are coming from America’s central bank, which was deliberately created as an independent entity. Note that it is Romney who is saying he wants Bernanke out of there and crying wolf about inflation. Bernanke, not subject to the whims of democracy, has had the courage to change his own thinking. He knows the consequences of tight policy now.
 
So what do we do? We should be a little modest about the universal benefits of democracy. For example, I think democracy may yet work to end the severest levels of austerity in Europe. People are mad. Governments are changing for the better. Demoracy in America is the only answer to an ever-richer and more powerful oligarchic class in the U.S., which wants to lower taxes, limit regulations, and cut government into ever smaller pieces.
 
But we must also deal with the disturbing fact that one of the least democratic of our institutions, the Fed, is the only one saving the day now. The same is true in Europe, where the European Central Bank is now acting intelligently, in contrast to the fiscal hawks dominated by the German policymakers and apparently supported by a majority of the German people. This issue is not simple.
 

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

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