Natalie Foster: Reimagine the Safety Net for the New Economy

May 21, 2015Laurie Ignacio

In the final installment of our "Good Economy of 2040" video series, we hear from Natalie Foster, co-founder of Peers.org and Rebuild the Dream.

In the final installment of our "Good Economy of 2040" video series, we hear from Natalie Foster, co-founder of Peers.org and Rebuild the Dream.

In order to ensure a good economy in 25 years, Foster would reimagine the safety net for the 21st century. “It’s important that we stop thinking about jobs and start talking about livelihoods as people will derive their income from a variety of different sources,” says Foster. She adds that we need a safety net that is designed not for the “old industrial economy where everyone had 9-to-5 jobs," but "for people who live much more fluid and free lives but who also have a greater level of economic instability."

To learn more about the future of the safety net, check out the links below

“Two Leaders in Labor Rethink The Safety Net For A Freelance Economy” (NationSwell)

“Safety Nets for Freelancers” (NY Times)

“George Takei and Michael Buckley on the Sharing Economy” (YouTube/AARP)

Natalie Foster has spent the last 15 years at the crossroads of social movements and technology. She’s transformed and run some of the largest digital teams in the country, including President Obama’s successful effort to pass health reform, and built two organizations from scratch. Most recently, Foster co-founded Peers.org, the world’s largest independent sharing economy community. Prior to Peers, she was the CEO and co-founder of Rebuild the Dream, a platform for people–driven economic change, with Van Jones. 

 

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Better Community Investment Will Pay Dividends for Colleges

May 19, 2015Emma Copeland

We need to start holding colleges accountable as anchor institutions that provide economic growth and stability to their communities.

We need to start holding colleges accountable as anchor institutions that provide economic growth and stability to their communities.

In recent weeks, the debate about holding colleges accountable has focused on schools’ responsibilities toward failing students, continuously rising tuition, and increasing student debt. What’s been overlooked is the role of colleges as a potential force for good within their more immediate communities. Indeed, one of the most profound ways a university can improve the holistic experience of its students is to invest more in the surrounding community.

Presently, many four-year institutions entrust the bulk of their money to low-risk funds or national banks like Bank of America. The money that flows into a school never directly returns to the community, and it is often the case that low-income residents near a college must battle gentrification, stagnation, or both. For example, New York University’s $3.5 billion endowment is currently invested in national banks such as Bank of America, Chase, and Citibank, none of which are directly involved in developing the community around NYU.

Outside of investment, universities and colleges spend a huge amount of money that has the potential to directly affect the communities around them. Big schools like Michigan State University, which purchases nearly $87 million worth of goods and services annually, could spend mere fractions of this number on local small businesses, causing them to flourish like never before.

As a student at a four-year public university in Northern Virginia, I know a few things about debt and personal economic stagnation. To say “the United States can’t afford the status quo in higher education” might be the understatement of the decade. So how can we shake up the status quo?

We need to start holding colleges accountable not just to the government but to their communities. As anchor institutions, they have the power to provide economic growth and stability and serve as cornerstones of their communities due to their role as large permanent employers with significant investment capabilities. They are also permanent physical landmarks that serve as points of pride for their members as well as nearby residents.

Colleges and universities tend to be huge anchor institutions due to their extensive reach in a variety of commercial activities, immense diversity of employment throughout their numerous departments, and the vital exchange of wealth between students, alumni, trustees, fans, and neighbors to the school. It is time for these institutions to begin making a concerted effort to develop and invest locally for the long term.

The first way we can hold colleges accountable as anchor institutions is by encouraging and facilitating responsible purchasing from locally owned and operated businesses for anything from food to office supplies. This would allow small businesses to leap into the big leagues, and colleges have a responsibility to support the entrepreneurial efforts of graduates who choose to settle nearby as well as the local business owners who employ their students and alumni. Even 10 percent of the funds earmarked for paper products for a large public institution such as the University of Michigan would be the number one account for a local business struggling to compete with national suppliers. Working with these businesses to help increase their production capacity and streamline various processes would ultimately result in a symbiotic exchange of tailored quality for vital business development. Colleges have too long relied on one-size-fits-all corporations to supply their food, office supplies, cleaning services, and more. In the long-run, establishing relationships with local providers enables both the institution and the businesses to thrive as each respects and relies on the other.

Second, universities should be responsible for investing locally. Universities often have access to far more capital than the cities and towns that surround them, but they invest in distant fossil fuel companies, huge national banks, or even Israeli military efforts.  As anchor institutions, colleges should invest in their communities through community development financial institutions (CDFIs). By promising to invest a majority of its cash-on-hand in the surrounding community, a CDFI is able to safely give loans to small businesses, prospective college students and families, and new homeowners. These kinds of investments improve the lives and livelihoods of community members not directly affiliated with the anchor institutions. This is particularly vital because non-anchor institutions like large-scale banks are often unwilling to invest in these low-income communities because of the economic risk.

Colleges are institutions that can help a struggling or non-competitive community find its feet. If we hold them accountable in the right way, as institutions of economic growth for the long-term, colleges can begin to boast many more achievements and far fewer failures.

Emma Copeland is a junior at George Mason University, a 10 Ideas author, and a member of the Campus Network's Braintrust.

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Beyond Divestment: How NYU Can Still Invest in the Public Good

May 12, 2015Eugenia Kim

The fossil fuel divestment movement on college campuses highlights two distinct aspects of the problem of climate change. The first and most obvious is that climate change and environmental issues are drastically changing our planet and require immediate action. The second is the responsibility of our colleges and universities to be stewards of responsible social change.

The fossil fuel divestment movement on college campuses highlights two distinct aspects of the problem of climate change. The first and most obvious is that climate change and environmental issues are drastically changing our planet and require immediate action. The second is the responsibility of our colleges and universities to be stewards of responsible social change. While climate change appears to have caught the public eye in recent weeks, this question of responsibility continues to be overlooked. Both of these issues are now coming to a head at New York University (NYU).

On March 26, a working group of NYU’s University Senate voted to recommend not divesting from fossil fuels. On April 30, the larger University Senate, which encompasses both student representatives and faculty, will also vote on divestment.

The stated argument against divestment is twofold: political and fiduciary. The report released by NYU’s working group is emblematic of the faulty assumptions school administrations across the country have about divestment. The report claims that it is not in the nature of a university to take a stand on a political issue such as climate change, and that NYU would be better suited to combat climate change through increased research investments. Further, the report states that it would be financially irresponsible for the university to divest.

However, the working group’s argument is self-contradictory. The university cannot simultaneously claim to have no position on climate change and actively fund research that works to combat it. Further, the sheer existence of climate change is no longer a debate; broad consensus has been reached among independent agencies and scientists that climate change is real. The political question that does arise is what the institution is going to do about it. The working group also fails to recognize that divesting from fossil fuels and investing in research are not mutually exclusive. The administration has the power to do both while maintaining its fiduciary responsibilities.

NYU’s arguments against divestment are in no way unique; they exemplify the fundamental assumption of college administrations that an institution must choose between the social good and economic profitability. This is not the case, but the divestment movement has failed to demonstrate that university investments can be both profitable and environmentally friendly. Advocates committed to the divestment movement must provide more guidance as to how administrators can better spend their money.

While divestment is an important symbolic gesture toward a university’s commitment to sustainability, meaningful investments in green energy businesses are a more tangible request, if perhaps less likely to inspire rallies. Investment alternatives offer practical solutions that enable activists to work with, rather than against, administrations. For example, Ohio’s Case Western Reserve University has not divested from fossil fuels, but it has invested in the Evergreen Cooperatives, thereby promoting economic growth in the Cleveland community, and still maintains a commitment to tackling larger questions around sustainability and climate change.

While these investment campaigns are harder to organize around, there are students who are interested in analyzing the economic responsibility of their universities, and student involvement in this process is vital. The Roosevelt Institute | Campus Network’s Rethinking Communities initiative is geared toward identifying and developing smarter economic decision-making practices for colleges and universities. The project is led by students who support divestment but offer smart and socially responsible local investment solutions.

NYU, for example, could stand to gain higher returns on its investments if it would simply move some of its funds from large banks like Chase into community development banks. By divesting just $500,000 (0.014 percent of NYU’s $3.5 billion endowment) from fossil fuels and moving it to community development banks, NYU could increase its returns while helping middle- and low-income residents get loans, promoting financial literacy, and providing secure financial services. This idea that investments can be both socially responsible and profitable holds true for universities across the nation.  

Students are important but overlooked stakeholders in university policy. They are the ones doing the research and asking the important questions about their schools’ social responsibility. Sit-ins, protests, and rallies across the country are the product of a large number of young people feeling left out of the decision-making process at institutions designed to serve them. These students want to participate and engage with their school administrations in making financial decisions and developing viable solutions, In short, these students want to be part of universities that embody the values they teach.

Eugenia Kim is student at New York University and a member of the Rethinking Communities Brain Trust.

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The Rules are What Matter for Inequality: Our New Report

May 12, 2015Mike Konczal

I’m very excited to announce the release of “Rewriting the Rules of the American Economy” (pdf report), Roosevelt Institute’s new inequality agenda report by Joe Stiglitz. I’m thrilled to be one of the co-authors, as I think this report really tells a compelling story about inequality and the challenges the economy faces.

Recently there’s been a lot of discussion about a “new” conventional wisdom (“a force to be reckoned with” according to one observer), one in which choices about the rules of the economy are a major driver of the outcomes we see. This is in contrast to the normal narrative about inequality we hear, one in which globalization, technology, or individual choices are the only important parts. I like to think this report is a major advancement in this discussion, bringing together the best recent research on this topic.

As we argue, inequality is not inevitable: it is a choice that we’ve made with the rules that structure our economy. Over the past 35 years, the rules, or the regulatory, legal and institutional frameworks, that make up the economy and condition the market have changed. These rules are a major driver of the income distribution we see, including runaway top incomes and weak or precarious income growth for most others. Crucially, however, these changes in the rules have not made our economy better off than we would be otherwise; in many cases we are weaker for these changes. We also now know that “deregulation” is, in fact, “reregulation”—that is, a new set of rules for governing the economy that favor a specific set of actors, and that there's no way out of these difficult choices. But what were these changes?

Financial deregulation exploded both the size of finance and its incomes, roughly doubling the share of finance in the top 1 percent. However, finance grew as a result of intermediating credit in a “shadow banking” sector, which led to disastrous results. It also grew from asset management, a field in which pay is often determined by luck and by fees driven by the increasing prevalence of opaque alternative investment vehicles like hedge funds. For all the resources it uses, finance is no more efficient than it was a century ago.

Corporate governance also radically changed during this period, led by public policy decisions. CEO pay fundamentally shifted toward a high pay model in the 1980s. The shareholder revolution also changed the nature of investment. We now see finance acting as a mechanism for getting money out of firms rather than into them; similarly, private firms are investing more than public firms. CEOs regularly use buybacks to hit earnings targets and say they’d rather hit accounting goals than invest long-term, indicating that short-termism is now a serious problem for investment and its positive spillovers.

High marginal tax rates were cut, but there’s no evidence that the high-end marginal tax rate has any effect on growth; cutting it does, however, raise the share of income the top 1 percent takes home. Low taxes don’t just make the equalizing effects of taxes weaker; they also mean that CEOs and other executives in the top 1 percent have more of an incentive to bargain aggressively with boards or seek opportunities for extracting rents, all zero-sum games for the economy. Lowering capital taxes showed no impact on higher investment, but a positive effect on increased capital payouts; capital income growth is one of the main drivers of inequality during this time period.

During this time, the Federal Reserve’s focus moved toward low and stable inflation at the cost of higher unemployment. Unemployment from weak Federal Reserve action rises the most for low-skilled and minority workers. Inequality generally doesn’t come down unless unemployment is below 6 percent, and this has become less of a priority.

The rules changed, or were not updated, for the labor market as well. Decreasing unionization has taken a toll on workers’ wages. Men’s inequality, in particular, has risen due to collapsing unionization rates. Women’s inequality has suffered due to a falling minimum wage, which went from 54 percent of the average hourly wage in the late 1960s to just 35 percent now. Labor market protections and institutions that give workers voice and power, in general, have not been updated for a new world of service and care work.

Though not an effective driver of lower crime rates, a dramatic turn toward mass and punitive incarceration has reduced the employment prospects for millions of Americans, especially people of color. In particular, there’s a dense web of discriminatory codes for those with a record, which pushes them toward second-class citizenship. One estimate finds 38,000 such punitive statutes, with most of them related to employment and having no end date.

Our institutions and rules haven’t been updated to fully facilitate women’s ability to participate in the labor force. As a result of gender discrimination in the workplace, lack of paid sick and family leave, and the unavailability of affordable child care, women’s participation in the U.S. labor force has declined over the past 15 years, while it increased in most other OECD countries.

Many people agree inequality is a challenge, but would say that this is all driven by technology and globalization. We discuss this at length in the report, but we don’t find these traditional stories either convincing, in the case of technology, or sufficient, in the case of globalization. Both of these forces are playing out, in quite similar ways, in other advanced countries, whose growth of inequality nowhere mirrors our own. Technology and globalization don’t fall from the sky, but instead are determined in important ways by rules and institutions. This is especially important in the era of free trade agreements, which are really managed trade agreements. These agreements are less about trade and more about the regulatory environment corporations face.

But rules matter even in these straightforward stories about supply and demand for labor. Advancements in search theory tell us that supply and demand, rather than strictly determining wages, instead place boundaries or endzones on where wages can go. What determines where wages fall within those boundaries is a whole host of economic rules, including bargaining power, institutions, and social conventions. Even in the strong version of these arguments, the rules matter.

This report describes what has happened, going far deeper than this summary here. It also has a policy agenda focused on both taming the top and growing the rest of the economy. Some may emphasize some pieces more than others; but no matter what this argument about the rules is what is missing in the current debates over the economy. I hope you get a chance to check out the report!

Follow or contact the Rortybomb blog:
 
  

 

I’m very excited to announce the release of “Rewriting the Rules of the American Economy” (pdf report), Roosevelt Institute’s new inequality agenda report by Joe Stiglitz. I’m thrilled to be one of the co-authors, as I think this report really tells a compelling story about inequality and the challenges the economy faces.

Recently there’s been a lot of discussion about a “new” conventional wisdom (“a force to be reckoned with” according to one observer), one in which choices about the rules of the economy are a major driver of the outcomes we see. This is in contrast to the normal narrative about inequality we hear, one in which globalization, technology, or individual choices are the only important parts. I like to think this report is a major advancement in this discussion, bringing together the best recent research on this topic.

As we argue, inequality is not inevitable: it is a choice that we’ve made with the rules that structure our economy. Over the past 35 years, the rules, or the regulatory, legal and institutional frameworks, that make up the economy and condition the market have changed. These rules are a major driver of the income distribution we see, including runaway top incomes and weak or precarious income growth for most others. Crucially, however, these changes in the rules have not made our economy better off than we would be otherwise; in many cases we are weaker for these changes. We also now know that “deregulation” is, in fact, “reregulation”—that is, a new set of rules for governing the economy that favor a specific set of actors, and that there's no way out of these difficult choices. But what were these changes?

Financial deregulation exploded both the size of finance and its incomes, roughly doubling the share of finance in the top 1 percent. However, finance grew as a result of intermediating credit in a “shadow banking” sector, which led to disastrous results. It also grew from asset management, a field in which pay is often determined by luck and by fees driven by the increasing prevalence of opaque alternative investment vehicles like hedge funds. For all the resources it uses, finance is no more efficient than it was a century ago.

Corporate governance also radically changed during this period, led by public policy decisions. CEO pay fundamentally shifted toward a high pay model in the 1980s. The shareholder revolution also changed the nature of investment. We now see finance acting as a mechanism for getting money out of firms rather than into them; similarly, private firms are investing more than public firms. CEOs regularly use buybacks to hit earnings targets and say they’d rather hit accounting goals than invest long-term, indicating that short-termism is now a serious problem for investment and its positive spillovers.

High marginal tax rates were cut, but there’s no evidence that the high-end marginal tax rate has any effect on growth; cutting it does, however, raise the share of income the top 1 percent takes home. Low taxes don’t just make the equalizing effects of taxes weaker; they also mean that CEOs and other executives in the top 1 percent have more of an incentive to bargain aggressively with boards or seek opportunities for extracting rents, all zero-sum games for the economy. Lowering capital taxes showed no impact on higher investment, but a positive effect on increased capital payouts; capital income growth is one of the main drivers of inequality during this time period.

During this time, the Federal Reserve’s focus moved toward low and stable inflation at the cost of higher unemployment. Unemployment from weak Federal Reserve action rises the most for low-skilled and minority workers. Inequality generally doesn’t come down unless unemployment is below 6 percent, and this has become less of a priority.

The rules changed, or were not updated, for the labor market as well. Decreasing unionization has taken a toll on workers’ wages. Men’s inequality, in particular, has risen due to collapsing unionization rates. Women’s inequality has suffered due to a falling minimum wage, which went from 54 percent of the average hourly wage in the late 1960s to just 35 percent now. Labor market protections and institutions that give workers voice and power, in general, have not been updated for a new world of service and care work.

Though not an effective driver of lower crime rates, a dramatic turn toward mass and punitive incarceration has reduced the employment prospects for millions of Americans, especially people of color. In particular, there’s a dense web of discriminatory codes for those with a record, which pushes them toward second-class citizenship. One estimate finds 38,000 such punitive statutes, with most of them related to employment and having no end date.

Our institutions and rules haven’t been updated to fully facilitate women’s ability to participate in the labor force. As a result of gender discrimination in the workplace, lack of paid sick and family leave, and the unavailability of affordable child care, women’s participation in the U.S. labor force has declined over the past 15 years, while it increased in most other OECD countries.

Many people agree inequality is a challenge, but would say that this is all driven by technology and globalization. We discuss this at length in the report, but we don’t find these traditional stories either convincing, in the case of technology, or sufficient, in the case of globalization. Both of these forces are playing out, in quite similar ways, in other advanced countries, whose growth of inequality nowhere mirrors our own. Technology and globalization don’t fall from the sky, but instead are determined in important ways by rules and institutions. This is especially important in the era of free trade agreements, which are really managed trade agreements. These agreements are less about trade and more about the regulatory environment corporations face.

But rules matter even in these straightforward stories about supply and demand for labor. Advancements in search theory tell us that supply and demand, rather than strictly determining wages, instead place boundaries or endzones on where wages can go. What determines where wages fall within those boundaries is a whole host of economic rules, including bargaining power, institutions, and social conventions. Even in the strong version of these arguments, the rules matter.

This report describes what has happened, going far deeper than this summary here. It also has a policy agenda focused on both taming the top and growing the rest of the economy. Some may emphasize some pieces more than others; but no matter what this argument about the rules is what is missing in the current debates over the economy. I hope you get a chance to check out the report!

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Besides Failing Corporate Finance 101, Holtz-Eakin's Attack on Dodd-Frank Sets a Terrible Priority

May 8, 2015Mike Konczal

The American Action Forum jumps into the financial reform debate with a letter on the growth consequences of Dodd-Frank penned by its president, Douglas Holtz-Eakin. This letter is a bad analysis, immediately violating the first thing you learn in corporate finance: capital structure doesn’t dictate funding costs. But there’s a deeper context that makes this letter reckless and a bad development, and I hope they are willing to walk back part of it.

Why reckless? It’s important to understand the role people like Holtz-Eakin play in the conservative movement. It is less about providing analysis (which is good, because this is a bad analysis), and more about signaling priorities. What should be done about Dodd-Frank if the Republicans win in 2016? This letter signals a new front I haven’t seen before on the right: one focused on going after higher capital requirements. Worse, going after them as if they were, using that conservative trigger word, a “tax.” I think that is a terrible move with serious consequences, and if they are going to do it, they need to do better than this.

A Bad Analysis

Americans for Financial Reform and David Dayen give us a solid overview of what is lacking in this analysis. It contains no benefits, confuses one-time and ongoing costs, assumes all costs derive from the cost of capital rather than profits, and so on. I’m also pretty sure there’s an error in the calculations, which would reduce the estimate by a third; I’m waiting for a response from them on that [1].

But I want to focus on capital requirements. Holtz-Eakin argues that the Solow growth model “can be used to transform the roughly 2 percentage point rise in the leverage ratio of the banking sector” into “a rise in the effective tax rate.” Wait, the tax rate? “The banking sector responded to Dodd-Frank by holding more equity capital,” writes Holtz-Eakin, “thus require it to have greater earnings to meet the market rate of return – the same impact as raising taxes.” Higher capital requirements, in this argument, function just like a tax.

He concludes that a 2 percentage point rise in capital requirements, much like what we just had, increases the cost of capital somewhere between 2 and 2.5 percent. (I believe I understand that to be the argument, though the paper itself is quick and not cited to any body of research.)

This is wrong, full stop. The Holtz-Eakin argument is predicated on the idea that capital structure directly affects funding costs. But our baseline assumption should be that there is virtually no impact of capital requirements on cost of capital. Economics long ago debunked the notion that changes in aggregate funding mixes can have an effect on the value of a business itself, much less a widespread, durable, macroeconomic effect. This is a theorem they teach you in Corporate Finance 101: the Modigliani–Miller theorem. And this has been one of the most important arguments in financial reform, with Anat Admati being a particularly influential advocate of pointing this out.

Just step back and think about what Holtz-Eakin’s model means. If Congress passed a law requiring companies to fund themselves with half as much equity as they did before, would the economy experience a giant growth spurt from changing the aggregate funding mix? No, of course not. The price of capital would simply adjust with this new balance; funding with more equity means funding with less debt, though the business is still the same. Investors are not stupid; they respond to a changing funding mix by simply changing the prices accordingly. This is how markets are supposed to work.

Of course, the real world doesn’t work exactly like these abstract economic models. If there’s a hierarchy of financing options, which seems reasonable, then moving up or down that ladder can impose some costs. Doug Elliott from Brookings, for instance, writes quite a bit arguing that the idea that equity and higher capital requirement is costless is a dangerous “myth” of financial reform. (Here is Admati responding.)

So Elliott’s not on the costless side, but does he agree with Holtz-Eakin’s numbers? Not even remotely. According to Elliott’s estimate, the cost of the entirety of Dodd-Frank increases the cost of capital 0.28 percent, and the “low levels of economic costs found here strongly suggest that the benefits in terms of less frequent and less costly financial crisis would indeed outweigh the costs.”

As shown in the graphic above, a model of higher capital requirements by Kashyap, Stein, and Hanson put the estimate of a 2 percent capital increase at between 0.05 percent (driven by the tax effects) and 0.09 percent (driven by a large slippage of Modigliani-Miller they assume to get a high-end estimate). These are broadly in line with other estimates throughout the past several years. Even the most industry-driven estimates designed to weaken capital requirements don't remotely approach this 2.00+ percent increase.

(As a coincidence, Elliott did estimate what it would take to make the cost of capital rise Holtz-Eakin’s estimated 2 percent. In his view, it would be capital requirements on the order of 30 percent, which is the reach goal for some. But when you analyze Dodd-Frank and get numbers consistent with 30 percent capital ratios, you are probably doing it wrong.)

A Worse Priority

So the estimate is wrong in a fundamental way; but this is less about a specific analysis than it is about setting priorities for the conservative movement when it comes to Dodd-Frank. And if attacking capital requirements becomes a major priority for conservatives, that’s a worrying sign. When conservatives start calling things “taxes,” institutional forces go into play beyond the control of any specific person, and that’s dangerous for a successful reform with lots of support that is important for a better financial system.

A broad group of people has come together to argue for capital requirements. This includes important commentators across the spectrum, from Simon Johnson to John Cochrane to many others. And there’s good reason for this. The current capital requirement regime hits six birds with one stone: helping with solvency, balancing risk management, making resolution and the ending of Too Big to Fail more credible, preventing liquidity crises in shadow banking, right-sizing the scale and scope of the largest financial institutions, and macroeconomic prudential policy.

There are disagreements about specifics of what is the best way to do higher capital requirements—quite intense ones, actually. But there’s a broad consensus in favor of them. Having watched this from the beginning, this broad coalition is one of the most promising developments I’ve seen.

I’m excited to see the right go after Dodd-Frank. Is the argument that there’s too much accountability for consumers now, and we need to gut those regulators at the CFPB? Is it that derivatives regulations are too extensive, and we should build our future prosperity by letting a thousand AIGs bloom? Is it that there should be few, if any, consequences for firms that break the law or commit fraud? (As someone who is worried about over-policing, this is one area where I believe we are criminally under-policed.) Please, by all means, make these arguments.

But taking on capital requirements with this weak argument is a bad development. The financial market is not understudied, and though nobody has ever found anything like these results, and though it's clear Holtz-Eakin’s analysis doesn’t even engage with this other research, those who think the cost of capital requirements are low could be wrong. But to prove that, we’ll need an analysis far better than the one provided here. And until one has that, the responsible thing is to not unleash the conservative movement against reform that is doing good work and that should be advanced rather than dismantled.

 

[1] I’m pretty sure for “rL-C” in equation 11 he uses net income ($151.2bn) rather than EBIT ($218.7bn), though, from equation 9, “rL-C” should be pre-tax. However using the wrong number is the only way I can replicate the estimate he has. I’ll update this either way if they respond.

If I’m right this decreases Holtz-Eakins’ growth costs of regulations by about 30%, meaning that the economy will probably be skyrocketing any second now.

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The American Action Forum jumps into the financial reform debate with a letter on the growth consequences of Dodd-Frank penned by its president, Douglas Holtz-Eakin. This letter is a bad analysis, immediately violating the first thing you learn in corporate finance: capital structure doesn’t dictate funding costs. But there’s a deeper context that makes this letter reckless and a bad development, and I hope they are willing to walk back part of it.

Why reckless? It’s important to understand the role people like Holtz-Eakin play in the conservative movement. It is less about providing analysis (which is good, because this is a bad analysis), and more about signaling priorities. What should be done about Dodd-Frank if the Republicans win in 2016? This letter signals a new front I haven’t seen before on the right: one focused on going after higher capital requirements. Worse, going after them as if they were, using that conservative trigger word, a “tax.” I think that is a terrible move with serious consequences, and if they are going to do it, they need to do better than this.

A Bad Analysis

Americans for Financial Reform and David Dayen give us a solid overview of what is lacking in this analysis. It contains no benefits, confuses one-time and ongoing costs, assumes all costs derive from the cost of capital rather than profits, and so on. I’m also pretty sure there’s an error in the calculations, which would reduce the estimate by a third; I’m waiting for a response from them on that [1].

But I want to focus on capital requirements. Holtz-Eakin argues that the Solow growth model “can be used to transform the roughly 2 percentage point rise in the leverage ratio of the banking sector” into “a rise in the effective tax rate.” Wait, the tax rate? “The banking sector responded to Dodd-Frank by holding more equity capital,” writes Holtz-Eakin, “thus require it to have greater earnings to meet the market rate of return – the same impact as raising taxes.” Higher capital requirements, in this argument, function just like a tax.

He concludes that a 2 percentage point rise in capital requirements, much like what we just had, increases the cost of capital somewhere between 2 and 2.5 percent. (I believe I understand that to be the argument, though the paper itself is quick and not cited to any body of research.)

This is wrong, full stop. The Holtz-Eakin argument is predicated on the idea that capital structure directly affects funding costs. But our baseline assumption should be that there is virtually no impact of capital requirements on cost of capital. Economics long ago debunked the notion that changes in aggregate funding mixes can have an effect on the value of a business itself, much less a widespread, durable, macroeconomic effect. This is a theorem they teach you in Corporate Finance 101: the Modigliani–Miller theorem. And this has been one of the most important arguments in financial reform, with Anat Admati being a particularly influential advocate of pointing this out.

Just step back and think about what Holtz-Eakin’s model means. If Congress passed a law requiring companies to fund themselves with half as much equity as they did before, would the economy experience a giant growth spurt from changing the aggregate funding mix? No, of course not. The price of capital would simply adjust with this new balance; funding with more equity means funding with less debt, though the business is still the same. Investors are not stupid; they respond to a changing funding mix by simply changing the prices accordingly. This is how markets are supposed to work.

Of course, the real world doesn’t work exactly like these abstract economic models. If there’s a hierarchy of financing options, which seems reasonable, then moving up or down that ladder can impose some costs. Doug Elliott from Brookings, for instance, writes quite a bit arguing that the idea that equity and higher capital requirement is costless is a dangerous “myth” of financial reform. (Here is Admati responding.)

So Elliott’s not on the costless side, but does he agree with Holtz-Eakin’s numbers? Not even remotely. According to Elliott’s estimate, the cost of the entirety of Dodd-Frank increases the cost of capital 0.28 percent, and the “low levels of economic costs found here strongly suggest that the benefits in terms of less frequent and less costly financial crisis would indeed outweigh the costs.”

As shown in the graphic above, a model of higher capital requirements by Kashyap, Stein, and Hanson put the estimate of a 2 percent capital increase at between 0.05 percent (driven by the tax effects) and 0.09 percent (driven by a large slippage of Modigliani-Miller they assume to get a high-end estimate). These are broadly in line with other estimates throughout the past several years. Even the most industry-driven estimates designed to weaken capital requirements don't remotely approach this 2.00+ percent increase.

(As a coincidence, Elliott did estimate what it would take to make the cost of capital rise Holtz-Eakin’s estimated 2 percent. In his view, it would be capital requirements on the order of 30 percent, which is the reach goal for some. But when you analyze Dodd-Frank and get numbers consistent with 30 percent capital ratios, you are probably doing it wrong.)

A Worse Priority

So the estimate is wrong in a fundamental way; but this is less about a specific analysis than it is about setting priorities for the conservative movement when it comes to Dodd-Frank. And if attacking capital requirements becomes a major priority for conservatives, that’s a worrying sign. When conservatives start calling things “taxes,” institutional forces go into play beyond the control of any specific person, and that’s dangerous for a successful reform with lots of support that is important for a better financial system.

A broad group of people has come together to argue for capital requirements. This includes important commentators across the spectrum, from Simon Johnson to John Cochrane to many others. And there’s good reason for this. The current capital requirement regime hits six birds with one stone: helping with solvency, balancing risk management, making resolution and the ending of Too Big to Fail more credible, preventing liquidity crises in shadow banking, right-sizing the scale and scope of the largest financial institutions, and macroeconomic prudential policy.

There are disagreements about specifics of what is the best way to do higher capital requirements—quite intense ones, actually. But there’s a broad consensus in favor of them. Having watched this from the beginning, this broad coalition is one of the most promising developments I’ve seen.

I’m excited to see the right go after Dodd-Frank. Is the argument that there’s too much accountability for consumers now, and we need to gut those regulators at the CFPB? Is it that derivatives regulations are too extensive, and we should build our future prosperity by letting a thousand AIGs bloom? Is it that there should be few, if any, consequences for firms that break the law or commit fraud? (As someone who is worried about over-policing, this is one area where I believe we are criminally under-policed.) Please, by all means, make these arguments.

But taking on capital requirements with this weak argument is a bad development. The financial market is not understudied, and though nobody has ever found anything like these results, and though it's clear Holtz-Eakin’s analysis doesn’t even engage with this other research, those who think the cost of capital requirements are low could be wrong. But to prove that, we’ll need an analysis far better than the one provided here. And until one has that, the responsible thing is to not unleash the conservative movement against reform that is doing good work and that should be advanced rather than dismantled.

 

[1] I’m pretty sure for “rL-C” in equation 11 he uses net income ($151.2bn) rather than EBIT ($218.7bn), though, from equation 9, “rL-C” should be pre-tax. However using the wrong number is the only way I can replicate the estimate he has. I’ll update this either way if they respond.

If I’m right this decreases Holtz-Eakins’ growth costs of regulations by about 30%, meaning that the economy will probably be skyrocketing any second now.

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Marina Gorbis: Get Money Out of Politics to Make Room for Rational Decision-Making

May 7, 2015Laurie Ignacio

This week, Marina Gorbis from the Institute for the Future presents her idea on the best way to ensure a good economy in 25 years: Let’s get money out of politics.

This week, Marina Gorbis from the Institute for the Future presents her idea on the best way to ensure a good economy in 25 years: Let’s get money out of politics.

“We need to get money out of politics. Unless we do that, it will be hard to work on any other issue. It’s a fundamental issue that needs to be fixed,” and we must “limit election season to make space for rational decision-making to improve lives of everyday people and not big monied groups and lobbyists."

To learn more about money in politics, check out the following articles:

"The Top 10 Things Every Voter Should Know About Money in Politics, Center for Responsive Politics" (OpenSecrets)

"40 charts that explain money in politics" (Vox)

Marina Gorbis is Executive Director of the Institute for the Future, a nonprofit research and consulting organization based in Silicon Valley. She has brought a futures perspective to hundreds of organizations in business, education, government, and philanthropy.

Gorbis has blogged and written for BoingBoing.net, Fast Company and major media outlets, and is a frequent speaker on future organizational, technology, and social issues. Marina’s current research focus is social production and how it is changing the face of major industries, a topic explored in detail in her 2013 book The Nature of the Future: Dispatches from the Socialstructed World

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Why Democrats Should Worry About Republicans' Newfound Economic Populism

May 7, 2015Richard Kirsch

It would be a huge mistake for Democrats to dismiss the newfound economic populism of Republican presidential candidates as obviously laughable given Republicans’ deep alliance with corporate America. Republicans are aiming to pull off a populist jiu jitsu, using anger at corporate influence over government to justify even more dismantling of government. It could work.

It would be a huge mistake for Democrats to dismiss the newfound economic populism of Republican presidential candidates as obviously laughable given Republicans’ deep alliance with corporate America. Republicans are aiming to pull off a populist jiu jitsu, using anger at corporate influence over government to justify even more dismantling of government. It could work.

The good news for progressives is that attention to the squeeze on the middle class and the capture of government by corporations is finally taking center stage in American politics. Pollsters for both political parties are advising candidates to recognize the struggle of families to meet the basics, and the cynicism about government being able to do anything about their problems because it's under the control of the rich and powerful corporations.

This should be a huge opening for Democrats who are aggressive in assigning blame to corporations and pushing for what should be the obvious solution: stand up to those powerful forces with tough measures. If the banks are screwing homeowners, government should enact regulations that stop bank rip-offs and make housing affordable. If corporations and the rich are profiting from huge loopholes in the tax code, close those loopholes and raise their taxes.

But Republicans on the campaign trail are offering a different solution: if government is captured, then shrink government. Marco Rubio laid it out most clearly in an interview on NPR:

And so I hope the Republican Party can become the champion of the working class because I think our policy proposals of limited government and free enterprise are better for the people who are trying to make it than big government is. The fact is that big government helps the people who have made it. If you can afford to hire an army of lawyers, lobbyists and others to help you navigate and sometimes influence the law, you'll benefit. And so that's why you see big banks, big companies, keep winning. And everybody else is stuck and being left behind.

Rand Paul, who champions free-market, anti-regulatory economics, began his announcement speech for president by declaring, "We have come to take our country back from the special interests that use Washington as their personal piggy bank, the special interests that are more concerned with their personal welfare than the general welfare."

And Carly Fiorina bounced off the scourge of Wall Street abuses, Elizabeth Warren, to turn around Warren’s argument: “Crony capitalism is alive and well. Elizabeth Warren, of course, is wrong about what to do about it. She claims that the way to solve crony capitalism is more complexity, more regulations, more legislation, worse tax codes. And of course the more complicated government gets — and it's really complicated now — the less the small and the powerless can deal with it."

It’s easy to laugh at their argument, which can be reduced to “if the fox is getting into the hen house, tear down the hen house.” But it would be foolish to do so. It starts where people are at, as one Republican message guru wrote after the election last fall: “[F]rom the reddest rural towns to the bluest big cities, the sentiment is the same. People say Washington is broken and on the decline, that government no longer works for them — only for the rich and powerful.”

The argument takes advantage of the record-high public distrust of government, reached in no small part because of decades of Republicans stripping government’s effectiveness at tackling problems and championing shrinking government and cutting taxes as the solutions for everything.

Having said that, the current political environment should still be winning turf for Democrats who are willing to tell their own version of the problem and solution. After all, building a hen house that keeps out the foxes is clearly a better way to be sure you get fresh eggs for breakfast. But winning the debate will take something Democrats are not always willing to do: naming villains and pushing solutions that will really address the problems facing American families.

As I wrote in a column analyzing the messages that Democrats who won used last fall, naming specific villains is essential to demonstrating that the candidate understands who is responsible for the problem and is willing to stand up to those powerful forces. Because of our campaign finance system, this is more of a challenge for Democrats. If they actually take on the rich and powerful, it will result in less campaign cash. Republicans don’t have to worry about that, since their patrons understand the game.

Having named the villains, Democrats then need to propose bold solutions that demonstrate that they understand the depth of the problems people face, solutions that people can imagine might actually help. Naming bold solutions is another way to demonstrate to people that you are willing to take on the status quo.

In a debate—whether real or the virtual debates of ad campaigns—Democrats will win if they point out that what Republicans want to do is tear down the hen house, and then name the foxes and describe the fortified, fox-slaying house.

Of course, that’s the biggest question for Hillary Rodham Clinton. Will she name the villains and keep naming them, even though many of them will supply her campaign with funds? Will she advance bold solutions or try to duck tough issues? We know one thing: Vermont Senator Bernie Sanders and the Draft Warren campaign will be making it tough for her to hide.

It’s a question not just for Clinton, but for every Democrat. Will Democrats be bold enough to advance a politics that meets the despair and cynicism of Americans with directness, honesty, and hope for a better future?

Richard Kirsch is a Senior Fellow at the Roosevelt Institute, a Senior Adviser to USAction, and the author of Fighting for Our Health. He was National Campaign Manager of Health Care for America Now during the legislative battle to pass reform.

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Message to Mayor Emanuel: Play Hardball with Wall Street

May 6, 2015Saqib Bhatti

Last week, Mayor Rahm Emanuel announced that he plans to preemptively terminate a large portion of the City of Chicago’s remaining interest rate swaps, which will cost taxpayers $200 million in penalties. He is trying to sell this as a shrewd move that will protect Chicago from future risk and help return the city to financial health. Nothing could be further from the truth.

Last week, Mayor Rahm Emanuel announced that he plans to preemptively terminate a large portion of the City of Chicago’s remaining interest rate swaps, which will cost taxpayers $200 million in penalties. He is trying to sell this as a shrewd move that will protect Chicago from future risk and help return the city to financial health. Nothing could be further from the truth. In reality, this is little more than a capitulation to Wall Street that will guarantee maximum profits for banks at taxpayers’ expense. This is the moment for the mayor to play hardball and force the banks to take significant concessions to protect the interests of the city’s communities and its bondholders alike. He can do this by suing the banks for misrepresenting risks associated with these deals, in violation of their duty to deal fairly with municipal borrowers, and by initiating a debt strike against the swap counterparties by strategically defaulting on the swap payments.

Emanuel’s decision to pay the banks the full face value of the swap penalties is indefensible. When the termination clauses on Detroit’s swaps were triggered, a federal judge pushed the city to drive a hard bargain with the banks and forced them to take a 75 percent haircut on the penalties. The judge made clear that he believed the city had a strong argument to declare the swaps invalid and said the city would be “reasonably likely” to prevail if it took legal action to get out of the deals. The judge encouraged the city to stop making payments on the swaps and to sue the banks instead. As a result of these negotiations, the city paid just $85 million in penalties instead of $347 million.

Emanuel similarly has a strong argument that the banks that sold toxic swaps to both the City of Chicago and Chicago Public Schools (CPS) did so illegally, and he should use both the legal and financial options at his disposal to get a better deal from the banks. Instead of giving away $200 million to banks, the mayor should launch a debt strike against the swap counterparties. He should refuse to pay them another dime on the city and school district’s swaps. Corporations often use this tactic, which they call a debt moratorium, to increase their leverage in negotiations with creditors. Emanuel should also sue the banks to recover $1.3 billion in past and future payments on these deals. This would give the city and CPS tremendous leverage to extract major concessions from the banks and renegotiate these toxic deals.

The course that Emanuel has instead chosen, to preemptively pay the banks $200 million in penalties to terminate the swaps, will actually serve to maximize taxpayer losses rather than save the city money. The penalties are calculated based on the interest rate environment, and because variable interest rates are still at record lows, it means that paying the banks now guarantees that the city will pay a higher amount than if it has to terminate the swaps later. There is a growing consensus that the Federal Reserve will start raising interest rates soon, which will drive these penalties down. Now is the worst possible time to voluntarily pay these penalties, especially because the mayor actually has a lot of leverage to get a better deal for Chicagoans, if he chooses to exercise it.

Playing Hardball with Wall Street

The amount of the termination penalties is not set in stone. When a swap termination event occurs, municipal borrowers and banks typically enter into negotiations with each other, during which cities can use legal and financial leverage to get a better deal. The reality is that Chicago has a lot more leverage in these negotiations than its swap counterparties. For one, the city has a very strong legal argument that the banks that pitched its swap deals violated their legal duty to deal fairly with the city by downplaying and misrepresenting risks and failing to mention that many of them were rigging the interest rates that the swaps were based on. The city should take legal action to get out of these deals. But beyond that, the city also has tremendous financial leverage vis-à-vis the banks, because it could simply stop making its swap payments, which would actually free up money for the city’s residents, pensioners, and bondholders. In Detroit, a federal judge advocated both of these strategies, and the city was able to save $262 million on its termination penalties as a result.

Suing the Banks

When the City of Detroit was placed under an emergency manager in 2013 and then filed bankruptcy, it triggered termination clauses on its interest rate swaps, which came with hefty penalties that stood at $347 million according to the city’s bankruptcy filing. Through negotiations, the banks agreed to settle for just $250 million. The bankruptcy judge rejected this settlement, and urged the city to either negotiate a better deal or file a legal challenge against the swaps. The city and banks went back to the bargaining table and came back with an offer to settle for $165 million. The judge again rejected the proposal, saying that, “In the absence of this settlement, the city might pursue an underlying claim challenging the swaps themselves,” and adding that the city would be “reasonably likely” to be successful in such a challenge. Ultimately, the judge approved an $85 million settlement, a 75 percent discount on the original figure of $347 million.

This should be a lesson for Emanuel. Of course Detroit, unlike Chicago, got its swap termination penalties reduced during the course of bankruptcy proceedings. The judge’s legal rationale, however, was not tied to the specifics of the bankruptcy process. He believed the swaps themselves were likely invalid based on the facts of the underlying deals and that the city would have been on strong legal footing if it had stopped making payments altogether.

Similarly, Emanuel should challenge the legality of the city’s swap deals and those of CPS and use that legal leverage to try to get a better deal. Whereas Detroit was able to make the banks take a 75 percent haircut on its penalties, Emanuel is proposing to pay the banks 100 cents on the dollar. That is financially irresponsible.

Although city officials often worry that they will get cut off from the credit markets if they sue banks, these concerns are unfounded because the interests of bondholders and swap counterparties are actually at odds with each other. In Detroit, bondholders were actually advocating for the city to take an even harder line against the banks because the swap penalties would have left less money for the bondholders. Many of the city’s creditors objected even to the final $85 million settlement. In fact, taking legal action against the banks should theoretically improve Chicago’s standing among bondholders, because it would free up money for payments to bondholders.

Instead of preemptively paying Wall Street $200 million in penalties to terminate the swaps, Emanuel should sue the banks to recover nearly $800 million in past and future payments on the deals for the city and $500 million for CPS. The banks that pitched these deals like violated the fair dealing rule of the Municipal Securities Rulemaking Board by misrepresenting or omitting “the facts, risks, potential benefits, or other material information” with respect to these deals. Emanuel has several legal options at its disposal to recover that money, including filing a lawsuit in state court for breach of contract.

Launching a Debt Strike

In addition to suing the banks, Emanuel should also follow the Detroit bankruptcy judge’s advice and refuse to make any more payments on the swaps. The banks have little leverage to compel the city to pay. The worst they can do is terminate the swaps and demand the city pay $200 million in penalties, but since Emanuel already stands ready to pay them that, the city really doesn’t have much to lose. In fact, Emanuel should coordinate with the city’s other governmental units that also have interest rate swaps and launch a coordinated debt strike against their swap counterparties. Corporations routinely use this tactic, which they call a debt moratorium, to increase their leverage in negotiations with creditors and compel them to write down debt.

Chicago Public Schools is already facing more than $260 million in penalties because the termination clauses on its swaps have already been triggered. The city’s enterprise funds also have swaps tied to their debt that could carry penalties of more than $200 million if the funds’ ratings are downgraded. Between the city, its enterprise funds, and CPS, Emanuel controls more than $660 million that the banks want. This represents money that is pure profit for the banks—they have not lent the city or CPS any money against this amount. Instead, interest rate swaps are side deals that simply involve an interest rate exchange between two parties—an exchange that has turned into an unexpected windfall for banks as a result of the financial crash that they caused.

If Emanuel were simply to withhold this money, the banks would be at a loss. Banks cannot compel municipalities to file bankruptcy to try to recover this money (and in Illinois in particular, municipalities are not allowed to file bankruptcy anyway). They could seek a court order, but if Emanuel were also to take legal action against the banks, the judge could very well grant a stay on any payments until the court case was resolved, which could take years and would involve a discovery process that would likely be embarrassing for the banks. That would leave the banks with two options: strike a cheaper negotiated settlement like Detroit’s counterparties did, or risk an adverse court ruling through which they could actually be forced to pay back the city and CPS all the money they have already made on these deals—up to $1.3 billion.

Some may have concerns that strategically defaulting on the swaps would cause the city’s credit ratings to slide further. However, the city’s bonds are already trading at junk levels. Moreover, the rating agencies have already made clear that they intend to further downgrade Chicago’s credit rating anyway when the state’s blatantly unconstitutional “pension reform” bill is overturned by the Illinois Supreme Court. Ironically, a strategical default on  swap payments could actually improve the city’s credit rating, since it would free up more cash for payments to bondholders, as mentioned above.

The Termination Penalties Maximize Bank Profits

Instead of using the city’s leverage to drive a hard bargain with the banks, Emanuel is proposing to preemptively terminate the swaps and pay $200 million in penalties. The mayor’s contention that doing this will protect the city against future termination risk is illogical. In effect, his argument is that he is eliminating the risk that the city could be forced to pay banks $200 million in the future by paying them $200 million now. He isn’t eliminating the risk; he is realizing it by voluntarily signing a $200 million check to Wall Street. This may be proactive, but that’s cold comfort to the Chicagoans who need that $200 million to fund essential services in their communities like mental health clinics and libraries. This $200 million payment isn’t just bad for communities, it is also bad finance.

The standard interest rate swap contract has termination clauses built in. If any “termination events” take place, then the bank has the right to terminate the swap and collect termination penalties. These termination events include credit rating downgrades below a certain threshold, among other things. In the case of Chicago, further downgrades in the city’s credit rating could trigger termination clauses on the its swaps. Conversely, if a municipal borrower wishes to terminate a swap, it may do so at any time by paying the termination penalty to the bank. This is what Emanuel has decided to do.

These termination penalties are equal to the fair value of the swap at the time that it is terminated, which is calculated as the net present value of all future payments on the swap over its remaining life, based on the current interest rate curve. What that means is that these penalties guarantee the banks all of their future profits on the swaps. The standard way the penalties are calculated does not change regardless of which party terminates the swap or for what reason. Emanuel is not saving Chicago any money by terminating the swaps, but instead is simply choosing to absorb those losses now, so he can claim he was proactive.

In reality, the city is actually likely to save money if he waits. Variable interest rates have been stuck at historic lows since 2008, when the Federal Reserve slashed rates to near zero in response to the financial crisis. This has caused taxpayer payments on all traditional interest rate swaps in the country to balloon. Chicago now pays approximately $70 million a year on its swaps, and CPS pays another $36 million a year. Because the termination penalties represent future payments based on the current interest rate curve, this has also caused the penalties to skyrocket. As the Federal Reserve gradually increases interest rates, which it is widely expected to do, these penalties will come down. By paying the banks $200 million now, while rates are still at historic lows, Emanuel will guarantee that the banks get a larger payment than they would if the swaps were terminated six months or a year from now.

Furthermore, the mayor plans to issue new debt to pay off the $200 million. What that means is that Chicago taxpayers will also be stuck paying interest on this $200 million for the next 30 years or so. On traditional 30-year bonds, the interest ends up being roughly equal to the principal, which means these termination penalties could end up costing taxpayers around $400 million.

* * * *

Emanuel is trying to spin his decision to pay the banks $200 million to terminate the city’s swaps as a bold move that will save the city money in the long run. This is untrue. Paying the banks now would amount to little more than a handout to Wall Street that would maximize their profits at taxpayers’ expense. First of all, there is no financial benefit to paying the banks early since interest rates are expected to rise, which would cause the penalties to decline. Secondly and more importantly, the city has tremendous legal and financial leverage to get a better deal from the banks and could likely bring the $200 million penalty down to a fraction of itself if Emanuel played hardball. If he sued the banks, the city could win nearly $800 million in past and future payments and CPS could win $500 million. If he launched a debt strike against the swaps, the banks would have limited recourse. Instead of paying the banks $200 million in a feeble attempt to put the swap fiasco behind him, the mayor should take legal action against these toxic swaps and immediately cease all payments on these deals. That would be the bold thing to do.

For more bold solutions that Mayor Rahm Emanuel can pursue to bring new, progressive revenue into Chicago’s coffers, see the ReFund America Project’s report, Our Kind of Town: A Financial Plan that Puts Chicago’s Communities First.

Saqib Bhatti is a Roosevelt Institute Fellow and Director of the ReFund America Project.

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Bo Cutter: Universal Pre-K Is the First Step Toward the Next American Economy

Apr 29, 2015Laurie Ignacio

Our series on “The Good Economy of 2040” continues this week with Next American Economy Director and Roosevelt Senior Fellow Bo Cutter.

Our series on “The Good Economy of 2040” continues this week with Next American Economy Director and Roosevelt Senior Fellow Bo Cutter.

If Cutter could pick one policy solution to ensure a good economy in the future, he’d call for universal pre-K through secondary school to "bring up children from low-income households" and teach all children "the element of imagination, creativity, and innovation to make their way in the world that's coming."

Read more about the case for universal pre-K here:

"Pre-K for All" (US News & World Report)

"Arne Duncan: High-quality preschool is a sure path to the middle class" (WashPost)

Bowman Cutter is a Senior Fellow at the Roosevelt Institute and Director of the Next American Economy Project. He was a managing director of Warburg Pincus, a major global private equity firm headquartered in New York City, between 1996 and 2009, where he served both as the firm’s economist and as a leader in its international business, with particular reference to Asia. He has served with distinction during two Democratic presidencies: as director of the National Economic Council and Deputy Assistant to the President during the Clinton presidency; and as Executive Director for Budget during the Carter presidency. He also served as leader of the OMB transition team after the election of President Obama.

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Senator Baldwin is Asking the SEC Questions About "Disgorge the Cash"

Apr 23, 2015Mike Konczal

A lot of people were surprised last month when the investment giant BlackRock flagged the rise in stock buybacks and dividend payments as a major economic concern. Its CEO argued that the “effects of the short-termist phenomenon are troubling both to those seeking to save for long-term goals such as retirement and for our broader economy,” and that this was being done at the expense of “innovation, skilled work forces or essential capital expenditures necessary to sustain long-term growth.”

They are right to be concerned. The cash handed back to shareholders in the form of buybacks and dividends was 95 percent of corporate profits in 2014, climbing from 88 percent the year before and 72 percent in 2010 and expected to go even higher in the future. These numbers are far above historical norms, but they are the culmination of a long process starting in the 1980s. Private investment remains a weak part of the recovery, and it is necessary to investigate the connection between corporate governance and those decisions.

With that in mind, Senator Tammy Baldwin (D-WI) has sent a letter to the SEC looking for answers on these issues. In particular, she flags whether the SEC’s mission to “foster capital formation and prevent fraud" is jeopardized by short-termism in the market. It will be good to see how the SEC responds, and which other senators and organizations join in with their concerns.

Personally, I’m happy that it quotes J.W. Mason’s work on profits and borrowing shifting from investment in a previous era to cash leaving the firm now. This issue is a major piece of our Financialization Project here at Roosevelt, and we will continue to develop it in the future.

I think there are two additional things of interest. One is that this relationship is becoming more of an interest for academic and popular scrutiny. Recent, high-level research is showing that as a result of short-termist pressures, “public firms invest substantially less and are less responsive to changes in investment opportunities, especially in industries in which stock prices are most sensitive to earnings news” compared to private firms before the Great Recession.

Second, this looks like a centerpiece agenda item for liberals going into 2016. Larry Summers’s Inclusive Prosperity report for the Center for American Progress discusses concerns over short-termism, noting, “it is essential that markets work in the public interest and for the long term rather than focusing only on short-term returns. Corporate governance issues, therefore, remain critical.”

The problem of short-termism was also in Senator Elizabeth Warren’s big speech on the future of the financial reform agenda, in which she noted we need to change the rules of the economy because we “too often reward short-term risk-taking instead of sustained, long-term growth” and allow CEOs to “manipulate prices in the short-term, rather than investing in the long-term health of their companies.”

And it will be central to work from the Roosevelt Institute about inequality coming next month. (Get excited!)

I’m not sure if the right has a response to this issue. One of their core policy goals, removing all taxes on capital, will certainly make the situation worse, as the Bush dividend tax cuts increased dividends payouts without encouraging any real investment or wage growth. If the Republicans want to have real answers about inequality and stagnation, it’s important that they tackle real questions. And short-termism is one of those essential questions.

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A lot of people were surprised last month when the investment giant BlackRock flagged the rise in stock buybacks and dividend payments as a major economic concern. Its CEO argued that the “effects of the short-termist phenomenon are troubling both to those seeking to save for long-term goals such as retirement and for our broader economy,” and that this was being done at the expense of “innovation, skilled work forces or essential capital expenditures necessary to sustain long-term growth.”

They are right to be concerned. The cash handed back to shareholders in the form of buybacks and dividends was 95 percent of corporate profits in 2014, climbing from 88 percent the year before and 72 percent in 2010 and expected to go even higher in the future. These numbers are far above historical norms, but they are the culmination of a long process starting in the 1980s. Private investment remains a weak part of the recovery, and it is necessary to investigate the connection between corporate governance and those decisions.

With that in mind, Senator Tammy Baldwin (D-WI) has sent a letter to the SEC looking for answers on these issues. In particular, she flags whether the SEC’s mission to “foster capital formation and prevent fraud" is jeopardized by short-termism in the market. It will be good to see how the SEC responds, and which other senators and organizations join in with their concerns.

Personally, I’m happy that it quotes J.W. Mason’s work on profits and borrowing shifting from investment in a previous era to cash leaving the firm now. This issue is a major piece of our Financialization Project here at Roosevelt, and we will continue to develop it in the future.

I think there are two additional things of interest. One is that this relationship is becoming more of an interest for academic and popular scrutiny. Recent, high-level research is showing that as a result of short-termist pressures, “public firms invest substantially less and are less responsive to changes in investment opportunities, especially in industries in which stock prices are most sensitive to earnings news” compared to private firms before the Great Recession.

Second, this looks like a centerpiece agenda item for liberals going into 2016. Larry Summers’s Inclusive Prosperity report for the Center for American Progress discusses concerns over short-termism, noting, “it is essential that markets work in the public interest and for the long term rather than focusing only on short-term returns. Corporate governance issues, therefore, remain critical.”

The problem of short-termism was also in Senator Elizabeth Warren’s big speech on the future of the financial reform agenda, in which she noted we need to change the rules of the economy because we “too often reward short-term risk-taking instead of sustained, long-term growth” and allow CEOs to “manipulate prices in the short-term, rather than investing in the long-term health of their companies.”

And it will be central to work from the Roosevelt Institute about inequality coming next month. (Get excited!)

I’m not sure if the right has a response to this issue. One of their core policy goals, removing all taxes on capital, will certainly make the situation worse, as the Bush dividend tax cuts increased dividends payouts without encouraging any real investment or wage growth. If the Republicans want to have real answers about inequality and stagnation, it’s important that they tackle real questions. And short-termism is one of those essential questions.

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