What John Oliver Can Tell Us about Foreclosure Fraud, Sweat Boxes and the Profit Motive

Mar 26, 2015Mike Konczal

John Oliver dedicated his main segment on last Sunday’s episode to the epidemic of municipal fees. He walks through several stories about tickets and citations that are overpriced and end up being more expensive for poor people because of a series of burdensome fees. This was one of the conclusions of the Justice Department’s report on Ferguson, which argued that “law enforcement practices are shaped by the City’s focus on revenue rather than by public safety needs.”

Oliver had a memorable phrase to describe how this system catches people and won’t let them go: he called it a “f*** barrel,” and started a NSFW hashtag on Twitter to draw attention to it.

But I had actually heard a similar (and safe-for-work) phrase for this years ago: the “sweat box.” Law professor Ronald Mann coined it in 2006 to describe how the 2005 Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) would affect consumer debt, and it applies to the criminal justice system now. The problems with this system also sound like the problems in mortgage debt servicing, which has been a focus here. It turns out that these issues are generalizable, and they illustrate some of the real dilemmas with privatization and introducing the profit-motive into the public realm.

The Sweat Box

First, the barrel/box. Credit card companies and other creditors really wanted BAPCPA to become law. But why? Mann argued that the act wouldn’t reduce risky borrowing, reduce the number of bankruptcies, or increase the recoveries these companies got in bankruptcy.

But what it would do is make it harder to start a bankruptcy, thanks to a wide variety of delaying tactics. The act did this “by raising filing fees, but also by lengthening the period between permitted filings and by imposing administrative hurdles related to credit counseling, debt relief agencies, and attorney certifications.” This kept distressed debtors in a period where they faced high fees and high interest payments, which would allow the credit card companies to collect additional revenue. Instead of trying to alter bankruptcy on the front or back ends, what it really did was give consumers fewer options and more confusion in the middle. It trapped them in a box (or over a barrel, if you will).

Mortgage Servicing

But this also sounds familiar to those watching the scandals taking place in servicer fraud as the foreclosure crisis unfolded over the past seven years. Servicers are the delegated, third-party managers of debts, particularly mortgage securitizations but also student debt. They sound disturbingly similar to the companies Oliver describes as managing municipal fees.

As Adam Levitin and Tara Twomey have argued, third-party servicing introduces three major agency problems. The first is that servicers are incentivized to pad costs, as costs are their revenues, even at the expense of everyone else. The second is that they will often pursue their own goals and objectives as the expense of other options, especially when they don’t ultimately care about the overall goals of those who hire them. And a third problem is that when problems do occur, they are often incentivized to drag them out rather than resolve them the best way possible.

Among other heart-breaking stories, Oliver walks through the story of Harriet Cleveland, who had unpaid parking tickets with Montgomery, Alabama. Montgomery, however, outsourced the management of this debt to Judicial Correction Services (JCS). JCS followed this script perfectly.

JCS had every reason to increase its fees and keep them at a burdensome rate, as it was to be paid first. It was completely indifferent to public notions of the county that hired it, such as proportional justice or the cost-benefit ratio of incarceration, such that they threw Cleveland in jail once she couldn’t handle the box anymore. And it economically benefited from keeping Cleveland in the sweat box as long as possible, rather than trying to find some way to actually resolve the tickets.

For those watching the mortgage servicing industry during the foreclosure crisis, this is a very similar story. Mortgage servicers can pyramid nuisance fees knowing that, even if the loan goes into foreclosure when the debtor can’t handle the box, they will be paid first. They are ultimately indifferent to the private notion of maximizing the value of the loan for investors, so much so that, compared to traditional banks that hold loans directly, servicers are less likely to do modifications and do them in a way that will work out. And servicers will often refuse to make good modifications that would get the mortgage current, because doing so can reduce the principal that forms the basis of their fees.

The Perils of the Profit Motive

There are three elements to draw out here. The first is that these problems are significantly worse for vulnerable populations, particularly those whose exit options are limited by background economic institutions like backruptcy or legal defense. The second is that many of our favorite buzzword policy goals, be they privatization of public services or the market-mediation of credit, involve piling on more and more of these third-party agents whose interests and powers aren’t necessarily aligned with what those who originally hired them expected. Assuming good faith for a second, privatization of these carceral services by municipalities requires a level of control of third-party agents that even the geniuses on Wall Street haven’t been able to pull off.

But we see the sweat box when it comes to purely public mechanisms too, as we see in Ferguson. So the third takeaway is that this is what happens when the profit motive is introduced in places where it normally doesn’t exist. Introducing the profit motive requires delegation and coordination, and it can often cause far more chaos than whatever efficiencies it is meant to produce. Traditional banking serviced mortgage debts as part of the everyday functions within the firm. Putting that function outside the firm, where the profit-motive was meant to increase efficiency, also created profit-driven incentives to find ways to abuse that gap in accountability.

The same dynamics come into play with the profit motive is reintroduced into the municipal level. Our government ran under the profit motive through the 1800s, and it was a major political struggle to change that. Municipal fees are very much part of the reintroduction of the profit motive into city services. As libertarian scholar and Reason Foundation co-founder Robert Poole wrote in 1980 regarding municipal court costs, “Make the users (i.e., the criminals) pay the costs, wherever possible.” As Sarah Stillman found, this is what an “offender-funded” justice system, one that aims “to shift the financial burden of probation directly onto probationers,” looks like now as for-profit carceral service providers shift their businesses to probation and parole. Catherine Rampell reports this as a total shift away from taxes and towards fees for public revenues, and the data shows it.

This is the model of the state as a business providing services, one in which those who use or abuse its functions should fund it directly. And it’s a system that can’t shake the conflicts inherent whenever the profit motive appear.

Follow or contact the Rortybomb blog:
 
  

 

John Oliver dedicated his main segment on last Sunday’s episode to the epidemic of municipal fees. He walks through several stories about tickets and citations that are overpriced and end up being more expensive for poor people because of a series of burdensome fees. This was one of the conclusions of the Justice Department’s report on Ferguson, which argued that “law enforcement practices are shaped by the City’s focus on revenue rather than by public safety needs.”

Oliver had a memorable phrase to describe how this system catches people and won’t let them go: he called it a “f*** barrel,” and started a NSFW hashtag on Twitter to draw attention to it.

But I had actually heard a similar (and safe-for-work) phrase for this years ago: the “sweat box.” Law professor Ronald Mann coined it in 2006 to describe how the 2005 Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) would affect consumer debt, and it applies to the criminal justice system now. The problems with this system also sound like the problems in mortgage debt servicing, which has been a focus here. It turns out that these issues are generalizable, and they illustrate some of the real dilemmas with privatization and introducing the profit-motive into the public realm.

The Sweat Box

First, the barrel/box. Credit card companies and other creditors really wanted BAPCPA to become law. But why? Mann argued that the act wouldn’t reduce risky borrowing, reduce the number of bankruptcies, or increase the recoveries these companies got in bankruptcy.

But what it would do is make it harder to start a bankruptcy, thanks to a wide variety of delaying tactics. The act did this “by raising filing fees, but also by lengthening the period between permitted filings and by imposing administrative hurdles related to credit counseling, debt relief agencies, and attorney certifications.” This kept distressed debtors in a period where they faced high fees and high interest payments, which would allow the credit card companies to collect additional revenue. Instead of trying to alter bankruptcy on the front or back ends, what it really did was give consumers fewer options and more confusion in the middle. It trapped them in a box (or over a barrel, if you will).

Mortgage Servicing

But this also sounds familiar to those watching the scandals taking place in servicer fraud as the foreclosure crisis unfolded over the past seven years. Servicers are the delegated, third-party managers of debts, particularly mortgage securitizations but also student debt. They sound disturbingly similar to the companies Oliver describes as managing municipal fees.

As Adam Levitin and Tara Twomey have argued, third-party servicing introduces three major agency problems. The first is that servicers are incentivized to pad costs, as costs are their revenues, even at the expense of everyone else. The second is that they will often pursue their own goals and objectives as the expense of other options, especially when they don’t ultimately care about the overall goals of those who hire them. And a third problem is that when problems do occur, they are often incentivized to drag them out rather than resolve them the best way possible.

Among other heart-breaking stories, Oliver walks through the story of Harriet Cleveland, who had unpaid parking tickets with Montgomery, Alabama. Montgomery, however, outsourced the management of this debt to Judicial Correction Services (JCS). JCS followed this script perfectly.

JCS had every reason to increase its fees and keep them at a burdensome rate, as it was to be paid first. It was completely indifferent to public notions of the county that hired it, such as proportional justice or the cost-benefit ratio of incarceration, such that they threw Cleveland in jail once she couldn’t handle the box anymore. And it economically benefited from keeping Cleveland in the sweat box as long as possible, rather than trying to find some way to actually resolve the tickets.

For those watching the mortgage servicing industry during the foreclosure crisis, this is a very similar story. Mortgage servicers can pyramid nuisance fees knowing that, even if the loan goes into foreclosure when the debtor can’t handle the box, they will be paid first. They are ultimately indifferent to the private notion of maximizing the value of the loan for investors, so much so that, compared to traditional banks that hold loans directly, servicers are less likely to do modifications and do them in a way that will work out. And servicers will often refuse to make good modifications that would get the mortgage current, because doing so can reduce the principal that forms the basis of their fees.

The Perils of the Profit Motive

There are three elements to draw out here. The first is that these problems are significantly worse for vulnerable populations, particularly those whose exit options are limited by background economic institutions like backruptcy or legal defense. The second is that many of our favorite buzzword policy goals, be they privatization of public services or the market-mediation of credit, involve piling on more and more of these third-party agents whose interests and powers aren’t necessarily aligned with what those who originally hired them expected. Assuming good faith for a second, privatization of these carceral services by municipalities requires a level of control of third-party agents that even the geniuses on Wall Street haven’t been able to pull off.

But we see the sweat box when it comes to purely public mechanisms too, as we see in Ferguson. So the third takeaway is that this is what happens when the profit motive is introduced in places where it normally doesn’t exist. Introducing the profit motive requires delegation and coordination, and it can often cause far more chaos than whatever efficiencies it is meant to produce. Traditional banking serviced mortgage debts as part of the everyday functions within the firm. Putting that function outside the firm, where the profit-motive was meant to increase efficiency, also created profit-driven incentives to find ways to abuse that gap in accountability.

The same dynamics come into play with the profit motive is reintroduced into the municipal level. Our government ran under the profit motive through the 1800s, and it was a major political struggle to change that. Municipal fees are very much part of the reintroduction of the profit motive into city services. As libertarian scholar and Reason Foundation co-founder Robert Poole wrote in 1980 regarding municipal court costs, “Make the users (i.e., the criminals) pay the costs, wherever possible.” As Sarah Stillman found, this is what an “offender-funded” justice system, one that aims “to shift the financial burden of probation directly onto probationers,” looks like now as for-profit carceral service providers shift their businesses to probation and parole. Catherine Rampell reports this as a total shift away from taxes and towards fees for public revenues, and the data shows it.

This is the model of the state as a business providing services, one in which those who use or abuse its functions should fund it directly. And it’s a system that can’t shake the conflicts inherent whenever the profit motive appear.

Follow or contact the Rortybomb blog:
 
  

 

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Seven Ways Chicago Can Put Working Families Before Wall Street

Mar 24, 2015Saqib Bhatti

The ReFund America Project released a new report this morning, “Our Kind of Town: A Financial Plan that Puts Chicago’s Communities First.” The report lays out a plan for getting Chicago’s finances back on track without painful austerity measures, which exacerbate economic inequality by forcing working families to shoulder the cost.

The ReFund America Project released a new report this morning, “Our Kind of Town: A Financial Plan that Puts Chicago’s Communities First.” The report lays out a plan for getting Chicago’s finances back on track without painful austerity measures, which exacerbate economic inequality by forcing working families to shoulder the cost.

Over the last month, Moody’s Investors Service downgraded the credit ratings of the City of Chicago and Chicago Public Schools (CPS) to near junk level. Last week, Fitch Ratings followed by cutting CPS’s rating to just one notch above junk. Even though the major credit rating agencies are unreliable institutions, rife with conflicts of interest, a history of missed calls, and a reputation for using their ratings to push political agendas, these downgrades have put the issue of financial management front and center in Chicago's political debate. Questions about how best to manage the city’s money shine a spotlight on the competing interests of Chicago residents and the powerful Wall Street firms that have been profiting from the city’s financial problems.

In the developing world, the International Monetary Fund and World Bank require financially distressed governments to enact painful cuts in order to obtain financing. Moody’s and Fitch are similarly using these downgrades to push an austerity agenda in Chicago. These downgrades will benefit Wall Street firms because the city and CPS will be forced to take out more expensive products like credit enhancements and bond insurance to boost investor confidence in their bonds. Already, the city and CPS are on the hook for a combined $300 million in penalties connected to interest rate swaps as a result of these downgrades. But all of this is wholly unnecessary because none of Chicago’s governmental units are actually in any danger of defaulting on their bonds.

Moreover, this response will come at the expense of community services like education, mental health, and parks programs. Many politicians are already using the downgrades to call for austerity measures that would take a toll on Chicago’s most vulnerable residents and to justify slashing government workers’ pensions, in violation of the Illinois Constitution. State Representative Ron Sandack has even introduced a bill in the Illinois Legislature to allow municipalities to file bankruptcy in order to circumvent the state constitution’s protection of public pension funds.

The current discourse ignores the simple reality that the city is not spending too much on either public services or workers. The real problem with Chicago’s budget is that the city is hemorrhaging money on predatory financial deals with Wall Street banks and not properly taxing its wealthiest corporations and residents. Chicago needs a proactive agenda that puts the needs of communities first. In the short term, this includes measures like:

  • Recovering losses from predatory municipal finance deals. The City of Chicago, its related governmental units, and their pension funds should take all steps to recover taxpayer dollars when banks deal unfairly with them. This includes taking both legal and economic action to try get out of bad deals like interest rate swaps and recoup lost money.
  • Reducing financial fees by 20 percent across the board. The City of Chicago, its related governmental units, and their pension funds should press for negotiations demanding 20 percent reductions on all financial fees to force Wall Street firms to share in the sacrifices that Chicagoans are being forced to make every day.
  • Insourcing pension fund management. The City of Chicago and its related governmental units should bring investment management in-house for a significant portion of their pension funds’ investments, by hiring qualified staff with a proven record of effective management instead of paying Wall Street firms tens of millions of dollars each year to accomplish the same goal.
  • Ending corporate tax subsidies and tax breaks. The City of Chicago should end all corporate tax subsidies and tax breaks to major corporations, and claw back subsidies given to corporations in exchange for job creation if they did not live up to their goals of creating jobs for city residents. This includes tax subsidies from the city’s tax-increment financing (TIF) programs.

In the longer run, Chicago needs structural solutions. This includes:

  • Collective bargaining with Wall Street. The City of Chicago, its related governmental units, and their pension funds should identify financial fees that bear no reasonable relationship to the costs of providing the service and join with other cities in the region and across the country to create a new industry standard for fees and refuse to do business with any bank that does not abide by that standard.
  • Creating a public bank. The City of Chicago should establish a public bank that is owned by taxpayers and can deliver a range of services, including municipal finance, and provide capital for local economic development and affordable housing in Chicago’s neighborhoods.
  • Raising progressive revenue. The City of Chicago should work to raise progressive revenue by instituting measures like a graduated city income tax to force high earners to pay their fair share, a commuter tax on suburban residents who work in the city, and the LaSalle Street Tax on financial transactions at the Chicago Board of Trade and the Chicago Board Options Exchange. All of these likely require state approval, so the mayor would have to petition the state for authorization. California and Minnesota have both enacted progressive revenue measures in recent years that have helped solve their respective budget crises.

These steps will allow Chicago to reclaim power in its relationship with Wall Street and create a financial regime in the city that will put the interests of Chicago’s communities first.

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

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The Sweet Briar Dilemma: Will Predatory Lending Take Down More Colleges?

Mar 16, 2015Alan Smith

After 114 years of educating young women in rural Virginia, Sweet Briar College recently announced that the 2015 academic year would be its last. It’s closing its doors, administrators say, because its model is no longer sustainable.

After 114 years of educating young women in rural Virginia, Sweet Briar College recently announced that the 2015 academic year would be its last. It’s closing its doors, administrators say, because its model is no longer sustainable.

There are plenty of people coming out of the woodwork to explain Sweet Briar's problems. Dr. James F. Jones, the school’s president, claims that there are simply not enough people who want to attend an all-women's rural liberal arts school (though application numbers and some pundits disagree); he blames the discount that the school was giving to low-income students for the institutional budget shortfall. Billionaire investor Mark Cuban says that Sweet Briar has fallen victim to the student loan bubble and that students are unwilling to commit the money to attend, which sounds a lot like the blame-the-homeowner narrative that came out of the 2008 financial crisis.  Others are wringing their hands that small colleges in general are doomed.   

These takes are varied and complex, but they are all missing an important point: that predatory banking practices and bad financial deals played an important and nearly invisible role in precipitating the school’s budget crisis.  

A quick look at Sweet Briar’s audited financial reports (easily available in public records) reveals enough confusing and obfuscating financial-speak to last a lifetime, but a few days of digging did manage to unearth a series of troubling things.  

A single swap on a bond issued in June 2008 cost Sweet Briar more then a million dollars in payments to Wachovia before the school exited the swap in September 2011. While it is unclear exactly why they chose 2011 to pay off the remainder of the bond early, they paid a $730,119 termination fee. For a school that was sorely strapped for cash, these fines and the fees that accrued around this deal (which are hard to definitively pick out from financial documents) couldn't have come at a worse time.  

Just how big a deal are these numbers? The school has a relatively small endowment even among small liberal arts colleges: currently valued at about $88 million, with less then a quarter of that total completely unrestricted and free to spend. But in 2014, the financial year that appears to have been the final straw for Sweet Briar, total operating revenues were $34.8 million and total operating expenditures were $35.4 million, which means that the deficit the school is running is actually smaller than the cost of any of the bad deals it’s gotten itself into with banks. 

All of this puts in a very stark light the fact that the early retirement of debt (in other words, the losses the school suffered on the overall value of the bonds it had taken out because it decided to pay them back early) cost the school over $9 million in 2011 and more than $13 million in 2012. Why did the school accrue these costs? We have no way of knowing if it was bad advice from bankers, negligent trustee members covering a mistake, or a well-intentioned plan that hit at the wrong time.  

What we can say, though, is that a million dollars here and a million dollars there adds up to real money that was desperately needed as Sweet Briar fought to stay afloat.  

We know that Wall Street collects higher fees on risky and complicated deals involving variable rate debt and hedging instruments, like the ones found in Sweet Briar's last few decades of financials, than from fixed rate debt deals. We know that they add on things like credit enhancements, further driving up the costs. We know that those higher fees mean that there is a clear financial incentive to sell schools, municipalities, and pension funds on these risky deals. And we know that it works in Wall Street's favor that someone like me can spend days digging into this stuff and still not be totally sure what the exact costs of these deals are.  

What we don't know is how all these things were allowed to happen at this particular school in this particular timeframe.  

Sweet Briar appears slated to close because it is a small organization without the resources to counter the huge information imbalance that has helped precipitate the financialization crisis. It is closing because it signed some terrible deals to get what must have felt like "needed" money at the time. You can see the reasons: a $14 million bond (with swaps) in 2001 for campus improvements. A $10 million bond in 2006 to pay off other bonds that had revealed their ugly side and were costing the school too much to be allowed to fully mature. But, as has so often been the case in everything from municipal finance to personal home loans, there was a problem in the small print. Like many other colleges, what appeared to be vital and even beneficial deals turned out to be nothing of the sort. Unlike many others, Sweet Briar was already close enough to the financial brink that these ongoing debts made the difference between staying open and closing its doors.  

There are, of course, other very real pressures on Sweet Briar. Lower enrollment numbers do really hurt a school, and there are real questions about how to keep small, rural liberal arts institutions competitive in a higher education economy. None of these issues, however, compare to the fees, fines, penalties, and other losses that are all over Sweet Briar’s books. 

Is Sweet Briar the canary in the coalmine? Banks are certainly making obscene profits on the backs of the swap deals in the UC system, at the University of Michigan, and at American University — and those are the places that we’ve found in our first month of looking. While those schools are solvent enough that these swaps are not pushing them to the brink of closing, they are exacerbating budget shortfalls and passing debt on to students through increased costs. These deals are also clearly making money for many school trustees whose day jobs happen to be with the giant banks. Here I find myself agreeing with Mark Cuban, at least in part: these trends are a part of a vicious cycle of borrowing that is wholly unsustainable, and will eventually lead to a crisis.  

This is why the Roosevelt Institute | Campus Network is working to track the ways in which financial institutions are extracting wealth from our colleges and universities, and make a clear case for demanding our money back. I hope that the storied institution of Sweet Briar can find a way to keep its doors open in 2016, but even if it fails, that failure should wake us up to predatory practices at colleges and universities around the country.   

Questions? Concerns? Interested in my math? Drop me a line.

Alan Smith is the Roosevelt Institute | Campus Network's Associate Director of Networked Initiatives.

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Daily Digest - February 27: We're Missing the Mark on Monetary Policy, and a Goodbye

Feb 27, 2015Rachel Goldfarb

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The Roosevelt Institute has produced the Daily Digest five days a week since 2009, but its time has now come to an end. Today will be the final Daily Digest; however, we hope you'll subscribe to our weekly e-mail updates to stay in the loop with all the exciting work we're doing here at the Roosevelt Institute. You can also stay in touch with us on Facebook and Twitter. Thank you for reading!

Corporate Borrowing Now Flows To Shareholders, Not Productive Investment: Study (IB Times)

Owen Davis reports on J.W. Mason's new white paper, "Disgorge the Cash," explaining how the paper fits into a growing body of research that suggests flaws in our basic understanding of economics.

Students Question Own Role in Participatory Budgeting (Columbia Spectator)

Sasha Zeints reports on a Campus Network event discussing students' role in participatory budgeting. Chapter president Brit Byrd says students are well-suited to participate as volunteers.

The Federal Reserve Speaks in Mumbo Jumbo. Here's How to Fix That. (The Week)

Referencing Roosevelt Institute Fellow Mike Konczal, Jeff Sprots argues that the opacity of Federal Reserve statements could be solved by mandating a numerical target for the Fed.

The Real Meaning of $9 an Hour (Time)

Rana Foroohar says that Walmart's wage hike might not make a dramatic impact on the real economy, but it shows that workers can still get the largest companies in the world to change.

What Is ‘Middle-Class Economics’? (NYT)

Josh Barro points out that government policies that help the middle class are only able to produce small shifts. He says the best option might be to step back and hope positive trends continue.

The FCC Approves Strong Net Neutrality Rules (WaPo)

Cecilia Kang and Brian Fung report on the Federal Communications Commission's vote yesterday, which classified the Internet as a public utility to protect access for all.

New on Next New Deal

Make the Stop Overdose Stat Act a Priority for 2015

Roosevelt Institute | Campus Network Senior Fellow for Health Care Emily Cerciello explains why this bill targeting opioid overdose prevention should be on both parties' agendas this year.

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Daily Digest - February 26: Where Is All the Corporate Cash Going?

Feb 26, 2015Rachel Goldfarb

Click here to subscribe to Roosevelt First, our weekday morning email featuring the Daily Digest.

Why Companies are Rewarding Shareholders Instead of Investing in the Real Economy (WaPo)

Click here to subscribe to Roosevelt First, our weekday morning email featuring the Daily Digest.

Why Companies are Rewarding Shareholders Instead of Investing in the Real Economy (WaPo)

Lydia DePillis looks at Roosevelt Institute Fellow J.W. Mason's new white paper on how the shift towards increased shareholder payouts since the 1980s has decreased corporate investment.

  • Roosevelt Take: Read J.W. Mason's paper, "Disgorge the Cash: The Disconnect Between Corporate Borrowing and Investment," here.

Hewlett-Packard Shows How to Fatten Shareholders While Firing Workers (LA Times)

Referencing J.W. Mason's paper for context on the impact of shareholder payouts on the larger economy, Michael Hiltzik explains how H-P has managed to fire workers and increase payouts at once.

Don't Wait Until 2016 to Make Political Change (HuffPo)

Roosevelt Institute | Campus Network National Director Joelle Gamble argues for the need for young people to participate in governance, not just elections.

The Push for Net Neutrality Arose From Lack of Choice (NYT)

Steve Lohr speaks to Roosevelt Institute Fellow Susan Crawford, who agrees that the current approach to net neutrality makes sense while cable is most people's only option for high-speed Internet.

The Lawyer Who Went from Fighting for Guantánamo Bay Inmates to Going After Shady Banks (Vice)

David Dayen profiles Josh Denbeaux, a lawyer who is fighting back against foreclosure abuse in the courts and trying to develop class-action suits for homeowners facing illegal foreclosures.

New on Next New Deal

Launching Our Financialization Project with "Disgorge the Cash"

Roosevelt Institute Fellow Mike Konczal introduces our Financialization Project, which aims to define and explain the topic, as well as J.W. Mason's paper. Learn more about the project here.

Millennials Want More Than Obama’s Keystone Veto

Roosevelt Institute | Campus Network Senior Fellow for Energy and Environment Torre Lavelle says the veto isn't good enough, because Millennials are seeking a real commitment to transforming energy usage.

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Launching Our Financialization Project with "Disgorge the Cash"

Feb 25, 2015Mike Konczal

So excited to be launching our new Financialization Project. Check out the website here. Part of the goal of the project is to define financialization, and we've focused on the changes to savings, power, wealth, and society that have occured over the past 35 years. We'll have more there soon, but for now check out the general idea here.

We're also releasing our first paper, "Disgorge the Cash: The Disconnect Between Corporate Borrowing and Investment," by Roosevelt fellow J.W. Mason. There's a great writeup of the paper by Lydia DePillis – "Why companies are rewarding shareholders instead of investing in the real economy" – at the Washington Post.

There's a ton in there, from the key intellectual, ideological, legal, and institutional changes that brought about the shareholder revolution, to reasons to doubt a credit crunch has played any kind of role in the Great Recession. But the core of it is told in these two graphs, dug out from detailed Compustat data:

The first figure shows that a firm borrowing $1 would correlate with an additional 40 cents of investment before the 1980s. Since the 1980s that has collapsed. Today, there is a strong correlation between shareholder payouts and borrowing that did not exist before the mid-1980s. Since the 1980s, shareholder payouts have nearly doubled; in the second half of 2007, aggregate payouts actually exceeded aggregate investment.

This next figure, a little harder to follow, uses flow-of-funds data to make the same point more dramatically.

These graphs plot corporate investment and shareholder payouts against cash flow from operations and net borrowing, respectively. Here the series are broken into three periods: 1952–1984; 1985 to the business-cycle trough in 2001; and 2002–2013. As the paper notes, the upper two panels show a strong relationship between corporate sources of funds and investment in the 1950s through the early 1980s: the points of the scatterplots fall clearly along an upward-sloping diagonal, indicating that periods of high corporate earnings and high corporate borrowing were consistently also periods of high corporate investment. The relationship between investment and the two sources of funds is still present, though weaker, in the 1985–2001 period.
 
But in the most recent business cycle and recovery, the correlations appear to have vanished entirely. The rise, fall, and recovery of corporate cash flow over the past dozen years is not associated with any similar shifts in corporate investment, which seems stuck at a low level of 1–2 percent of total assets. Similarly, the very large swings in credit flows to the corporate sector do not correspond to any similar shifts in aggregate investment. Turning to the lower two panels of Figure 6, which show shareholder payouts, we see at most a weak relationship with the two sources of funds in the earlier period. In the earlier period, it is payments to shareholders that are stable at 1–2 percent of corporate assets. In the most recent period, by contrast, payouts to shareholders vary much more, and appear more strongly associated with variation in cash flow and borrowing. The transitional period of 1985–2001 is intermediate between the two.
 
I hope you check out the full paper. Here's the executive summary:
 
This paper provides evidence that the strong empirical relationship of corporate cash flow and borrowing to productive corporate investment has disappeared in the last 30 years and has been replaced with corporate funds and shareholder payouts. Whereas firms once borrowed to invest and improve their long-term performance, they now borrow to enrich their investors in the short-run. This is the result of legal, managerial, and structural changes that resulted from the shareholder revolution of the 1980s. Under the older, managerial, model, more money coming into a firm – from sales or from borrowing – typically meant more money spent on fixed investment. In the new rentier-dominated model, more money coming in means more money flowing out to shareholders in the form of dividends and stock buybacks.
 
These results have important implications for macroeconomic policy. The shareholder revolution – and its implications for corporate financing decisions – may help explain why higher corporate profits in recent business cycles have generally failed to lead to high levels of investment. And under this new system, cheaper money from lower interest rates will fail to stimulate investment, growth, and wages because, as we show here, additional funds are funneled to shareholders through buybacks and dividends.
 
Follow or contact the Rortybomb blog:
 
  

 

So excited to be launching our new Financialization Project. Check out the website here. Part of the goal of the project is to define financialization, and we've focused on the changes to savings, power, wealth, and society that have occured over the past 35 years. We'll have more there soon, but for now check out the general idea here.

We're also releasing our first paper, "Disgorge the Cash: The Disconnect Between Corporate Borrowing and Investment," by Roosevelt fellow J.W. Mason. There's a great writeup of the paper by Lydia DePillis – "Why companies are rewarding shareholders instead of investing in the real economy" – at the Washington Post.

There's a ton in there, from the key intellectual, ideological, legal, and institutional changes that brought about the shareholder revolution, to reasons to doubt a credit crunch has played any kind of role in the Great Recession. But the core of it is told in these two graphs, dug out from detailed Compustat data:

The first figure shows that a firm borrowing $1 would correlate with an additional 40 cents of investment before the 1980s. Since the 1980s that has collapsed. Today, there is a strong correlation between shareholder payouts and borrowing that did not exist before the mid-1980s. Since the 1980s, shareholder payouts have nearly doubled; in the second half of 2007, aggregate payouts actually exceeded aggregate investment.

This next figure, a little harder to follow, uses flow-of-funds data to make the same point more dramatically.

These graphs plot corporate investment and shareholder payouts against cash flow from operations and net borrowing, respectively. Here the series are broken into three periods: 1952–1984; 1985 to the business-cycle trough in 2001; and 2002–2013. As the paper notes, the upper two panels show a strong relationship between corporate sources of funds and investment in the 1950s through the early 1980s: the points of the scatterplots fall clearly along an upward-sloping diagonal, indicating that periods of high corporate earnings and high corporate borrowing were consistently also periods of high corporate investment. The relationship between investment and the two sources of funds is still present, though weaker, in the 1985–2001 period.
 
But in the most recent business cycle and recovery, the correlations appear to have vanished entirely. The rise, fall, and recovery of corporate cash flow over the past dozen years is not associated with any similar shifts in corporate investment, which seems stuck at a low level of 1–2 percent of total assets. Similarly, the very large swings in credit flows to the corporate sector do not correspond to any similar shifts in aggregate investment. Turning to the lower two panels of Figure 6, which show shareholder payouts, we see at most a weak relationship with the two sources of funds in the earlier period. In the earlier period, it is payments to shareholders that are stable at 1–2 percent of corporate assets. In the most recent period, by contrast, payouts to shareholders vary much more, and appear more strongly associated with variation in cash flow and borrowing. The transitional period of 1985–2001 is intermediate between the two.
 
I hope you check out the full paper. Here's the executive summary:
 
This paper provides evidence that the strong empirical relationship of corporate cash flow and borrowing to productive corporate investment has disappeared in the last 30 years and has been replaced with corporate funds and shareholder payouts. Whereas firms once borrowed to invest and improve their long-term performance, they now borrow to enrich their investors in the short-run. This is the result of legal, managerial, and structural changes that resulted from the shareholder revolution of the 1980s. Under the older, managerial, model, more money coming into a firm – from sales or from borrowing – typically meant more money spent on fixed investment. In the new rentier-dominated model, more money coming in means more money flowing out to shareholders in the form of dividends and stock buybacks.
 
These results have important implications for macroeconomic policy. The shareholder revolution – and its implications for corporate financing decisions – may help explain why higher corporate profits in recent business cycles have generally failed to lead to high levels of investment. And under this new system, cheaper money from lower interest rates will fail to stimulate investment, growth, and wages because, as we show here, additional funds are funneled to shareholders through buybacks and dividends.
 
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Daily Digest - February 25: The Big Banks Had a Bad Year

Feb 25, 2015Rachel Goldfarb

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Annual Bank Profit Falls for First Time in Five Years (WSJ)

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Annual Bank Profit Falls for First Time in Five Years (WSJ)

Victoria McGrane says the trend is primarily because seven of the 10 largest banks posted lower earnings, while other parts of the banking sector, like community banks, are thriving.

The White House Has No Back-Up Plan if SCOTUS Rules Against Obamacare (Vox)

Sarah Kliff reports on the announcement that the Department of Health and Human Services has been unable to find an administrative fix in case they lose in King v. Burwell.

State Orders Minimum Wage Increase for Tipped Workers (Capital New York)

The New York State Labor Department has ordered an increase in the minimum wage for tipped workers from $5.00 to $7.50 per hour, writes Jimmy Vielkind.

Labor Takes Final Stand as Wisconsin Prepares Way for Anti-Union Law (AJAM)

Ned Resnikoff says Wisconson labor leaders see the governor's new support for right-to-work legislation as proof that he's already focused on appealing to donors for a 2016 presidential run.

Obama Proposal Recognizes How Retirement Saving Has Changed (NYT)

Neil Irwin argues that by requiring those who manage retirement savings to put their clients' best interests first, Obama is bringing back some of the protections of old-school pensions.

One Sign Americans Won't See Big Raises Anytime Soon (Bloomberg Business)

An increasing share of hires are workers who are just entering or re-entering the workforce, writes Jeanna Smialek, which is good for labor force participation but keeps salaries down.

New on Next New Deal

Guns on Campus: Not an Agenda for Women's Safety

Roosevelt Institute Fellow Andrea Flynn breaks down the data that proves allowing guns on campus will only increase the safety risks women face, not reduce sexual assault.

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Daily Digest - January 30: Where Did the Manufacturing Jobs Go?

Jan 30, 2015Rachel Goldfarb

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Wal-Mart’s Manufacturing Recovery? (The Hill)

Roosevelt Institute Senior Fellow Damon Silvers says that Wal-Mart's manufacturing initiative is really just an attempt to make people forget the company's influence on offshoring jobs.

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Wal-Mart’s Manufacturing Recovery? (The Hill)

Roosevelt Institute Senior Fellow Damon Silvers says that Wal-Mart's manufacturing initiative is really just an attempt to make people forget the company's influence on offshoring jobs.

Bernie Sanders Wants to Spend $1 Trillion on Infrastruture (WaPo)

Senator Sanders' proposal calls for investment in a full range of infrastructure projects, and he says it would put 13 million people to work, writes Ashley Halsey.

What the Sharing Economy Takes (The Nation)

Doug Henwood dives deep into the so-called sharing economy, pointing out how the utopian ideals of the companies involved fail to play out in the real economy.

Obama Has a Modest Plan to Tackle One of the Most Underrated Economic Problems in America (Vox)

Timothy B. Lee praises a proposed study of state occupational licensing. There's little evidence that licensing massage therapists and funeral attendants improves quality.

Rent to Own: Wall Street’s Latest Housing Trick (ProPublica)

Jesse Eisinger says rent-to-own housing schemes, which seem to take advantage of consumers' lack of knowledge, make a case for a stronger government role in overseeing the housing market.

Stop Trying to Make Financial Literacy Happen (Slate)

Helaine Olen argues that the financial services industry pushes financial literacy because it's a way around true consumer protection models with legal backing.

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The 2003 Dividend Tax Cut Did Nothing to Help the Real Economy

Jan 20, 2015Mike Konczal

President Obama is going big on capital taxation in the State of the Union tonight, including a proposal to raise dividend taxes on the rich to 28 percent. The President is probably not going to frame this as a move away from the George W. Bush economy, but Bush’s radical cuts to capital taxes are part of his legacy that we are still living with. And it’s a part that the latest evidence tells us did a lot to help the rich without helping the overall economy at all.

In the response to Obama’s proposal, you are going to hear a lot about how lower dividend rates increase investment and help the real economy. Indeed, lowering capital tax rates has been a consistent goal of conservatives. As a result, one of the biggest capital taxation changes in history happened in 2003, when George W. Bush reduced the dividend tax rate from 38.6 percent to 15 percent as part of his rapid and expansive tax cut agenda.

There’s been a lot of research about the effect of this massive dividend tax cut on payouts to shareholders (kicked off by an important 2005 Chetty-Saez paper), but very little on its effect on the real economy. Did slashing the dividend tax rate boost corporate investments, perhaps because it made funding projects easier? We don’t know, and it’s not because economists aren’t interested; it’s because it’s very difficult to construct a control group with which to compare the results. Investments increased after 2003, but they likely would have to some degree independent of the dividend tax cut, as we were coming out of a recession. So did the tax cut make a difference?

This is where UC Berkeley economist Danny Yagan’s fantastic new paper, “Capital Tax Reform and the Real Economy: The Effects of the 2003 Dividend Tax Cut,” (pdf, slides) comes in. He uses a large amount of IRS data on corporate tax returns to compare S-corporations with C-corporations. Without getting deep into tax law, C-corporations are publicly-traded firms, while S-corporations are closely held ones without institutional investors. But they are largely comparable in the range Yagan looks at (between $1 million and $1 billion dollars in size), as they are competing in the same industries and locations.

Crucially, though, S-corporations don’t pay a dividend tax and thus didn’t benefit from the big 2003 dividend tax cut, while C-corporations do pay them and did benefit. So that allows Yagan to set up S-corporations as a control group and see what the effect of the massive dividend tax cut on C-corporations has been. Here’s what he finds:

The blue line is the C-corporations, which should diverge from the red-line if the dividend tax cut caused a real change. But there’s no statistical difference between the two paths at all. (Note how their paths are the same before the cut, so it’s a real trend in the business cycle.) There’s no difference in either investment or adjusted net investment. There’s also no difference when it comes to employee compensation. The firms that got a massive capital tax cut did not make any different choices about things that boost the real economy. This is true across a crazy-robust number of controls, measures, and coding of outliers.

The one thing that does increase for C-corporations, of course, is the disgorgement of cash to shareholders. Cutting dividend taxes leads to an increase in dividends and share buybacks. This shows that these corporations are in fact making decisions in response to the tax cut; they just happen to be decisions that benefit, well, probably not you. If right now you are worried that too much cash is leaving firms to benefit a handful of investors while the real economy stagnates, suddenly Clinton-era levels of dividend taxation don’t look so bad.

This is interesting for people interested more specifically in corporate finance theory. Because this is evidence against the theory that firms use the stock market to raise funding, and toward a “pecking order” theory that internal funds and riskless debt are far above equity in a hierarchy of corporate funding choices. In models like the latter, taxation of dividends does very little to impact the cost of capital for firms, because equity isn’t the binding constraint on marginal investment options.

President Obama will likely focus his pitch for the dividend tax increase on the future, when, in his argument, globalization and technology will cause compensation to stagnate while investor payouts skyrocket and the economy becomes more focused on the top 1 percent. But it’s worth noting that while capital taxes are a solution to that problem, the radical slashing conservatives have brought to them are also partly responsible for our current malaise.

Follow or contact the Rortybomb blog:
 
  

 

President Obama is going big on capital taxation in the State of the Union tonight, including a proposal to raise dividend taxes on the rich to 28 percent. The President is probably not going to frame this as a move away from the George W. Bush economy, but Bush’s radical cuts to capital taxes are part of his legacy that we are still living with. And it’s a part that the latest evidence tells us did a lot to help the rich without helping the overall economy at all.

In the response to Obama’s proposal, you are going to hear a lot about how lower dividend rates increase investment and help the real economy. Indeed, lowering capital tax rates has been a consistent goal of conservatives. As a result, one of the biggest capital taxation changes in history happened in 2003, when George W. Bush reduced the dividend tax rate from 38.6 percent to 15 percent as part of his rapid and expansive tax cut agenda.

There’s been a lot of research about the effect of this massive dividend tax cut on payouts to shareholders (kicked off by an important 2005 Chetty-Saez paper), but very little on its effect on the real economy. Did slashing the dividend tax rate boost corporate investments, perhaps because it made funding projects easier? We don’t know, and it’s not because economists aren’t interested; it’s because it’s very difficult to construct a control group with which to compare the results. Investments increased after 2003, but they likely would have to some degree independent of the dividend tax cut, as we were coming out of a recession. So did the tax cut make a difference?

This is where UC Berkeley economist Danny Yagan’s fantastic new paper, “Capital Tax Reform and the Real Economy: The Effects of the 2003 Dividend Tax Cut,” (pdf, slides) comes in. He uses a large amount of IRS data on corporate tax returns to compare S-corporations with C-corporations. Without getting deep into tax law, C-corporations are publicly-traded firms, while S-corporations are closely held ones without institutional investors. But they are largely comparable in the range Yagan looks at (between $1 million and $1 billion dollars in size), as they are competing in the same industries and locations.

Crucially, though, S-corporations don’t pay a dividend tax and thus didn’t benefit from the big 2003 dividend tax cut, while C-corporations do pay them and did benefit. So that allows Yagan to set up S-corporations as a control group and see what the effect of the massive dividend tax cut on C-corporations has been. Here’s what he finds:

The blue line is the C-corporations, which should diverge from the red-line if the dividend tax cut caused a real change. But there’s no statistical difference between the two paths at all. (Note how their paths are the same before the cut, so it’s a real trend in the business cycle.) There’s no difference in either investment or adjusted net investment. There’s also no difference when it comes to employee compensation. The firms that got a massive capital tax cut did not make any different choices about things that boost the real economy. This is true across a crazy-robust number of controls, measures, and coding of outliers.

The one thing that does increase for C-corporations, of course, is the disgorgement of cash to shareholders. Cutting dividend taxes leads to an increase in dividends and share buybacks. This shows that these corporations are in fact making decisions in response to the tax cut; they just happen to be decisions that benefit, well, probably not you. If right now you are worried that too much cash is leaving firms to benefit a handful of investors while the real economy stagnates, suddenly Clinton-era levels of dividend taxation don’t look so bad.

This is interesting for people interested more specifically in corporate finance theory. Because this is evidence against the theory that firms use the stock market to raise funding, and toward a “pecking order” theory that internal funds and riskless debt are far above equity in a hierarchy of corporate funding choices. In models like the latter, taxation of dividends does very little to impact the cost of capital for firms, because equity isn’t the binding constraint on marginal investment options.

President Obama will likely focus his pitch for the dividend tax increase on the future, when, in his argument, globalization and technology will cause compensation to stagnate while investor payouts skyrocket and the economy becomes more focused on the top 1 percent. But it’s worth noting that while capital taxes are a solution to that problem, the radical slashing conservatives have brought to them are also partly responsible for our current malaise.

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Daily Digest - January 16: Internet Access is the Next Tennessee Valley Authority

Jan 16, 2015Rachel Goldfarb

There will be no new Daily Digest on Monday, January 19 in observance of Martin Luther King, Jr. Day. The Daily Digest will return on Tuesday, January 20.

Click here to subscribe to Roosevelt First, our weekday morning email featuring the Daily Digest.

Barack Obama: The FDR of Internet Access? (Moyers & Company)

There will be no new Daily Digest on Monday, January 19 in observance of Martin Luther King, Jr. Day. The Daily Digest will return on Tuesday, January 20.

Click here to subscribe to Roosevelt First, our weekday morning email featuring the Daily Digest.

Barack Obama: The FDR of Internet Access? (Moyers & Company)

Roosevelt Institute Fellow Susan Crawford compares the president's recent push for fiber-optic Internet access to FDR's work on electricity during the New Deal.

Obama Tells Agencies to Advance Sick Leave For Feds’ New Children (WaPo)

Joe Davidson reports that the sick leave would be paired with paid administrative leave, so that federal employees with a new child could have parental leave as well as sick time to follow.

Trying to Solve the Great Wage Slowdown (NYT)

David Leonhardt looks at a new report that considers what could get wages rising again. It focuses in particular on Canada and Australia, countries similar to the U.S. that have seen wage growth.

How Elizabeth Warren Is Yanking Hillary Clinton to the Left (TIME)

Rana Foroohar says that Senator Warren is already shifting the conversation on economics, citing a new report on wages and the middle class from relatively centrist Larry Summers as proof.

Home Care Workers Denied the Right to Make Minimum Wage and Overtime (ThinkProgress)

Bryce Covert reports on a ruling that has overturned a 2013 Department of Labor rule change on the "companionship exception," which allows home care workers to be paid sub-minimum wages.

New on Next New Deal

A Battle Map for the Republican War Against Dodd-Frank

Roosevelt Institute Fellow Mike Konczal looks at the three fronts in this surprisingly sophisticated GOP war: guerilla deregulation, administrative siege, and reactionary rhetoric.

The Van Hollen Plan Takes on Soaring CEO Pay: A Debate We Need to Have

Roosevelt Institute Fellow Susan Holmberg points out that Rep. Van Hollen's plan has great political messaging around CEO pay, though it doesn't fully close the performance pay loophole.

For Now, Excitement of Free Community College Program Raises Lots of Questions

David Bevevino, a Campus Network alumnus who now researches community college best practices, poses questions about how schools will implement this program, and what extraneous costs it might have.

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