Daily Digest - July 28: Work Shouldn't Be a Threat to Working Families

Jul 28, 2014Rachel Goldfarb

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Poor Parents Need Work-Life Balance Too (The Nation)

Michelle Chen says that without the flexibility of scheduling offered by white-collar jobs, workers in the service industries face volatile schedules that disrupt family lives.

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Poor Parents Need Work-Life Balance Too (The Nation)

Michelle Chen says that without the flexibility of scheduling offered by white-collar jobs, workers in the service industries face volatile schedules that disrupt family lives.

Fast-Food Workers Intensify Fight for $15 an Hour (NYT)

At the largest convention of fast-food workers, Steven Greenhouse reports that workers approved escalated tactics, drawing on the nonviolent civil disobedience of the Civil Rights Movement.

Close the Tax Loophole on Inversions (WaPo)

Treasury Secretary Jacob J. Lew explains the need for immediate action to reform the tax code to limit companies' ability to avoid taxes by merging with foreign companies.

Fed’s Targeting of Asset Bubbles Leads to Contradictions (AJAM)

Bubbles might be necessary to obtain full employment, writes Philip Pilkington, but limiting bubbles is among the Federal Reserve's goals. Higher deficits or lower inequality could help.

New on Next New Deal

Two Tiers of College Tuition? Not on This Campus

Mohanned Abdelhameed, Vice President of the San Bernardino Valley Community College chapter of the Campus Network, explains why students rejected two-tiered tuition pricing models.

Inequality Could Spark a Second Civil War

In his speculation for the Next American Economy initiative, Roosevelt Institute Fellow Dorian Warren imagines a future in which national cohesion has disintegrated and a one-party civil oligarchy has taken control.

Quick Thoughts on Ryan's Poverty Plan: What Are the Risks?

Roosevelt Institute Fellow Mike Konczal says that Paul Ryan's wholesale adoption of the President's plan for the Earned Income Tax Credit shows the value of pushing further to the left.

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Quick Thoughts on Ryan's Poverty Plan: What Are the Risks?

Jul 25, 2014Mike Konczal

Paul Ryan released his anti-poverty plan yesterday, and lots of people have written about it. Bob Greenstein has a great overview of the block-granting portion of the plan.

Paul Ryan released his anti-poverty plan yesterday, and lots of people have written about it. Bob Greenstein has a great overview of the block-granting portion of the plan. I'm still reading and thinking about it, but in the interest of answering the call for constructive criticism, a few points jump out that I haven't seen others make yet.

How did we get here?

Republicans obviously have an interest in branding themselves as a "party of ideas." And many liberals and Democrats also have an interest in trying to make the GOP seem like it's been devoid of any ideas in the past several years.

But it's worth noting that within a year of Democrats and liberal thinkers getting actively behind a serious increase in the minimum wage, and many activists making strides toward it on the local level, Paul Ryan just wholesale adopted President Obama's EITC expansion program. That demonstrates the value of pushing the envelope.

Complexity and the EITC

Ryan's plan, correctly, makes a big deal out of the complexity of receiving the EITC. The difficulty of navigating the system, the large number of improper payments, people not receiving what they should, people having to use tax-prep services to get the credit, and so on.

This is why I'm a huge fan of higher minimum wages as a complement to the EITC. Instead of 40 pages of rules and a dozen potential forms to fill out, you just put a sign that reads "$10.10 an hour" on the wall. Bosses and workers can't trick each other or get confused about this, and nobody has to pay a tax-prep service to figure it out. Easy peasy.

Ryan wants to "direct the Treasury Department to investigate further" how to fix this, but in practice Treasury just turns around and yells at the IRS. And if the IRS knew how to fix it, they'd probably be on it.

There is also a simpler plan to fix this issue: just have the government mail people their tax forms already filled out, for them to either sign or correct. When a trial version of this, "Ready Return," was tried in California, people immediately saw the potential for this to fix EITC delivery issues. Perhaps anti-poverty advocates can help provide momentum on this front.

Bosses and the EITC

Both Ryan and Marco Rubio have referred to putting the ETIC credit directly into workers' paychecks. Ryan: "[A]nother potential area of reform should focus upon EITC simplicity and delivery. If families received the credit with their paychecks, the link between work and the EITC would be that much clearer."

I'd be worried if employers were the ones responsible for adding this wage subsidy. I don't think there's a convincing argument that the EITC or food stamps lower wages directly (though there is one indirectly for the EITC), but if employers got a wage subsidy themselves to pass to their workers, it's easy to imagine them pocketing part of it through lower wages, especially in the monopsony of low-wage labor markets.

A discussion of welfare reform

Rather than a "welfare reform -- yay or nay?" conversation, it would be really useful if people arguing for the block-granting of the entire anti-poverty agenda would point out what they do and do not like about what happened in the 1990s. Especially as proponents hold up welfare reform as the model.

As Matt Bruenig notes, the work requirements and other restrictions go against the concept of subsidiarity. Greenstein writes, "the block grant would afford state and local officials tantalizing opportunities to use some block grant funds to replace state and local funds now going for similar services...That’s what happened under the Temporary Assistance for Needy Families (TANF) block grant." In retrospect, TANF didn't survive the business cycle, and it clearly has cut spending by cutting the rolls. Is that what people want to accomplish with food stamps, which have done wonders to boost childhood life outcomes? If not, what can be done other than assert that this time will be different?

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Daily Digest - July 16: Flawed Models for Understanding the Wage Fight

Jul 16, 2014Rachel Goldfarb

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A Biased Report on the Minimum Wage? (East Bay Express)

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A Biased Report on the Minimum Wage? (East Bay Express)

Darwin BondGraham speaks to Roosevelt Institute Fellow Annette Bernhardt, who says a study criticizing plans for a $12.25 minimum wage in Oakland used bad methodology.

Obama Administration Urges Immediate Action on 'Inversions' (WSJ)

The administration has asked Congress to put an end to these reincorporations abroad for tax purposes, and called instead for "economic patriotism," reports John D. McKinnon.

House Votes to Pay for Roads With Underfunded Pensions (The Wire)

Arit John explains the latest short-term plan for funding the Highway Trust Fund, which he says involves spending future tax revenue now and will lead to more shortfalls in the long run.

Hobby Lobby: A New Tool for Crushing Workplace Unionization? (MSNBC)

Ned Resnikoff explains how the Hobby Lobby decision could play out if an employer claims religious opposition to collective bargaining, as is already permitted for religious schools.

A Push to Give Steadier Shifts to Part-Timers (NYT)

Steven Greenhouse looks at the momentum behind laws that aid part-time workers by requiring further advance notice, extra pay for on-call work, and preference for more hours.

New on Next New Deal

Search Models, Mass Unemployment, and the Minimum Wage

Roosevelt Institute Fellow Mike Konczal looks at what's wrong with the models some economists are using to understand high unemployment and prolonged job vacancies.

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Detroit's Revitalization Funds Could Re-Empower Residents, Too

Jul 9, 2014Dominic Russel

Through participatory budgeting, Detroit could bring its resident's hyper-local expertise to the revitalization process.

Through participatory budgeting, Detroit could bring its resident's hyper-local expertise to the revitalization process.

The city of Detroit is suffering. It has the highest unemployment rate of the nation’s largest cities at 23 percent, the highest poverty rate at 36.4 percent, and has been listed by Forbes as America’s most dangerous city for five years in a row. As a result of its shrinking population, the city needs $850 million worth of blight removal and cleanup. On top of this, Detroit had an estimated $18 billion in debt in 2013, which caused the state of Michigan to essentially force the city to declare bankruptcy in a desperate attempt to save it.

Detroit urgently needs funding for any revitalization efforts. One source that the city receives each year is in Community Development Block Grants (CDBG) from the federal government. The grant is one part of the funding that the federal department of Housing and Urban Development (HUD) distributes to metropolitan cities. The CDBG is the portion that must go to community development projects, including the rehabilitation of residential and non-residential buildings, the construction of public facilities and improvements, and more. CDBG budgeting also must include a mechanism for citizen participation.

Detroit’s current method for allocating CDBG funds is broken, as evidenced by both their inability to completely distribute funding and the lack of citizen involvement in the process. Each year from 2010 to 2012 the city failed to spend a portion of their CDBGs, nearly causing the federal government to recapture money and diminish future grants. Again in 2014, the city is making a last-minute amendment to their CBDG plan, reallocating $12 million to avoid a recapture. This was necessary, in part, because the city allocated funds to programs that no longer exist. The main citizen participation program is the Neighborhood Opportunity Fund (NOF), in which service organizations apply for funding from the CDBG. This process, however, is limited to organizations and leaves no outlet for individual residents. In fact, individuals have only one public hearing annually for the entire HUD program. The interests of residents are not effectively being channeled into spending. All of this adds up to a system in need of reform.

Detroit has the opportunity to use CDBGs to develop a more citizen-involved allocation process. This can be achieved by creating a participatory budgeting (PB) program, which empowers citizens to allocate a portion of their own government resources and has been recognized by the United Nations as a “best practice” for local governance. A Detroit model could be based off programs in Chicago and New York City. These programs include a series of workshops where residents brainstorm ideas and elect community representatives who turn the ideas into full proposals. Residents then vote on the proposals, and the winning projects are put into action.

In Detroit, the city’s Planning and Development Department can ensure projects conform to HUD guidelines and lead outreach. The department would target traditionally underrepresented viewpoints by aiming outreach at neighborhoods with low- and moderate-income residents, using public schools for outreach to students and parents, and locating meetings and voting stations in areas that are accessible for underrepresented groups. A PB process has the potential to engage Detroit residents and better utilize their hyper-local knowledge to allocate CDBG funding.

On the night Detroit Mayor Mike Duggan was elected in 2013 he said, “Detroit’s turnaround will not occur until everyday Detroiters are involved in this effort.” He has the opportunity to create a clear path to this community involvement for all Detroiters by using participatory budgeting to determine how to spend a portion of the city’s federal grants. Not only would this make Duggan’s dream a reality, but it would reform an antiquated allocation process that has nearly cost the city millions of dollars.

Dominic Russel, a Michigan native, is a rising sophomore at the University of Michigan and is a Summer Academy Fellow interning at the Roosevelt Institute | Campus Network as the Leadership Strategy Intern.  

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Where Does $2 Trillion in Subsidies for the Wealthiest Hide in Plain Sight? Capital Gains Tax Breaks.

Jul 6, 2014Harry Stein

Research shows that government subsidies for the 1 percent are creating greater inequality. A new white paper by Roosevelt Institute Chief Economist Joseph Stiglitz offers solutions.

Research shows that government subsidies for the 1 percent are creating greater inequality. A new white paper by Roosevelt Institute Chief Economist Joseph Stiglitz offers solutions.

“What’s the effective rate I’ve been paying? It’s probably closer to the 15 percent rate than anything.” Mitt Romney made national news with that statement during the 2012 presidential election, since it meant he paid a lower effective tax rate than many middle-class Americans. The simple reason for his low tax bill?  The tax code’s special treatment of investment income.

In a recent report published by the Center for American Progress, I examine how government subsidies for investment income are making economic inequality worse. The merits of subsidizing investment income are particularly questionable in light of new research published by renowned French economist Thomas Piketty in Capital in the Twenty-First Century. Piketty finds that economic inequality has increased dramatically in recent decades, and will get even worse as the rate of return on capital from investments largely owned by the wealthy exceeds the overall growth rate of the economy.

Nobel-winning economist Joseph Stiglitz, Chief Economist at the Roosevelt Institute, takes a hard look at subsidies for investment income in a new white paper on tax reform. Stiglitz advocates taxing capital gains and dividends at the same rates as ordinary income. Under current law, the federal government will deliver an estimated $1.34 trillion in subsidies to investors over the next 10 years in the form of reduced tax rates for capital gains and dividends. Sixty-eight percent of that money will go to the top 1 percent. Stiglitz argues that there is “no justification for taxing those who work hard to earn a living at a higher rate than those who derive their income from speculation.”

Stiglitz would also eliminate an expensive, but little-known, provision called “step-up in basis,” which subsidizes inherited wealth. By taking a step-up in basis, heirs selling inherited assets only have to pay taxes on the capital gain that took place since they received the asset – gains that accrued during the previous owner’s lifetime are never subject to income taxes. This tax break will cost about $644 billion over 10 years, with 21 percent of that subsidy going to the top 1 percent. For the wealthiest families, the benefits are staggering: 55 percent of the wealth in estates worth over $100 million is in the form of unrealized capital gains, meaning that these families will never pay income taxes on the majority of their earnings since the heirs will benefit from step-up in basis.

Defenders of tax breaks for investment income argue that these subsidies encourage savings and grow the economy, but over the past 60 years there has been no obvious relationship between economic growth and the top capital gains tax rate. Our economic problems are rooted in a lack of aggregate demand, but tax subsidies for investment income reduce demand even further for two reasons. First, they encourage investors to hold onto their wealth and consume less. Second, these subsidies increase economic inequality by primarily benefiting the rich, who tend to consume a much smaller share of their income than poor or middle-class individuals.

The assumption underlying subsidies for investment income is that wealthy investors are “job creators,” but Stiglitz points out that “much of the income of the top arises from rent seeking (wealth appropriation) – and thus impedes growth and efficiency.” Stiglitz is using the term “rent seeking” in a broad sense to mean income from ownership, monopolies, or special treatment from the government. Rent seeking does not grow the economy; it only redistributes wealth from within the economy to rent seekers. For example, landowners get their income from rents paid by tenants. Stiglitz points out that land is an ideal target for taxation, since taxes cannot possibly reduce the supply of land. Yet the United States is taking the opposite approach by allowing landowners to fully benefit from step-up in basis and reduced tax rates for capital gains.

Tax breaks for investment income are massive in scope, but often overlooked in discussions about the proper size and role of the federal government. These subsidies are part of what Suzanne Mettler calls the “submerged state,” government programs that deliver benefits indirectly, with recipients often not even recognizing that they are benefitting from public assistance.

But government programs administered through the tax code are still government programs. It makes no meaningful difference to the government or to beneficiaries whether a subsidy is delivered in the form of a check from the government, or as a reduction in taxes the beneficiary would otherwise owe (which often takes the form of a higher tax refund check from the government). The nonpartisan Joint Committee on Taxation explains that tax breaks “are similar to direct spending programs that function as entitlements to those who meet the established statutory criteria.”

The reaction Mitt Romney’s comments may be the best example of just how invisible government subsidies for investment income are for most Americans. Watching Romney deliver the full statement and explain that most of his income comes from investments, it was clear that he did not think he was making news. And he was right – Romney’s statement that day should not have been news. We already knew that he made most of his money from earlier investments, and the tax rate at the time on capital gains and dividends was 15 percent. The only reason Romney’s statement made headlines was that most Americans were either unaware of preferential tax rates for investment income, or did not realize the staggering benefits this subsidy delivers to extremely wealthy individuals.

It is no coincidence that government subsidies for investment income are delivered through the submerged state. These programs are not popular when the American people can clearly see their impact, and they add to the sense that the economic game is rigged for those at the top.

Harry Stein is the Associate Director for Fiscal Policy at the Center for American Progress. Follow him on Twitter @HarrySteinDC.

Image via Thinkstock

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Daily Digest - July 3: America's Workforce is Still Segregated After All These Years

Jul 3, 2014Tim Price

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On the Civil Rights Act's 50th, Workplaces Remain Segregated (Colorlines)

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On the Civil Rights Act's 50th, Workplaces Remain Segregated (Colorlines)

Though the Civil Rights Act brought legal segregation to an end decades ago, people of color are still being pushed into lower-paying occupations, writes Rinku Sen.

  • Roosevelt Take: A new infographic from the Roosevelt Institute's Future of Work initiative outlines five policy proposals that would promote an inclusive workforce.

Domestic Care for Family Members Isn't Valued If Its Givers Are Exploited (Truthout)

In a book excerpt, Sheila Bapat cites research from Roosevelt Fellow Annette Bernhardt and others to show how domestic workers are shut out from standard labor protections.

We Know We Work Too Much. Now How Do We Stop It? (New Republic)

Bryce Covert looks at paid leave and vacation laws, health care reform, work-sharing programs, and other potential statutory solutions to America's oversized workweek.

Porsches, Potholes and Patriots (NYT)

The Fourth of July should prompt a celebration of America's great public investments -- and an acknowledgment that they depended on taxes, writes Nicholas Kristof.

Census: One-Quarter of Americans Now Live in "Poverty Areas" (Slate)

Data from 2010 shows that a growing number of Americans live in areas where more than 20 percent of the population is below the poverty line, notes Jordan Weissmann.

Yellen Drives Wedge Between Monetary Policy, Financial Bubbles (Reuters)

Fed chair Janet Yellen says monetary policy is the wrong tool to curb financial risk, report Michael Flaherty and Howard Schneider. She sees no need to raise rates at present. 

New on Next New Deal

Graduated and Living With Your Parents? You May Be Luckier Than You Think.

Millennials forced to move home may have their economic futures determined by where they were born, writes Roosevelt Campus Network Operations Director Lydia Bowers.

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Daily Digest - June 26: People Awaken to Find Wall Street is a Crooked Road

Jun 26, 2014Rachel Goldfarb

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Wall Street and Washington Want You to Believe the Stock Market isn't Rigged. Guess What? It Still Is (The Guardian)

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

Wall Street and Washington Want You to Believe the Stock Market isn't Rigged. Guess What? It Still Is (The Guardian)

Heidi Moore says investment in the stock market isn't down due to low investor confidence, but because more people are realizing the system isn't equal for all investors.

A Cure for Bloated CEO pay (Fortune)

Dean Baker proposes a "Director's Roulette" provision, which would withhold directors' compensation if a CEO pay package they approve had been voted down by a shareholder Say-on-Pay vote.

  • Roosevelt Take: Roosevelt Institute Fellow and Director of Research Susan Holmberg examines how Say-on-Pay begins to curb executive compensation.

Why did the White House Pass Up an Opportunity to Support a (Mostly) Good, Bipartisan Idea? (WaPo)

The White House rejected the proposed gas tax, needed to save the Highway Trust Fund that pays for infrastructure, but Jared Bernstein says an imperfect fix would have been better than nothing.

How the Government Subsidizes Wealth Inequality (CAP)

Harry Stein proposes that the U.S. government could reduce wealth inequality simply by changing tax policy for capital gains, since current subsidies give $2 trillion to the wealthy over 10 years.

How Connecticut’s Smart New Pension Plan Can Prevent Poverty in Retirement (The Nation)

Connecticut's new plan, which offers statewide benefits to private sector workers, will cost less than helping greater numbers of elderly poor down the line, writes Michelle Chen.

Ikea Plans to Increase Minimum Hourly Pay (NYT)

Steven Greenhouse reports on Ikea's new wage structure, which sets minimum wages on a store-by-store basis based on local cost of living, with an average minimum wage of $10.76.

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Do Taxpayers Care if Student Loans Are Paid Off Too Quickly? (On Fair Value Accounting)

Jun 11, 2014Mike Konczal

With President Obama’s student loan announcement in the news this week, an argument over whether or not taxpayers make a profit from student loans is no doubt close behind. We do make a profit using the government’s accounting tools, but there’s an argument that we should instead use “fair value accounting,” or the rate at which the private market adjusts for risk (here’s Jared Bernstein with a recent piece). By that standard, we see a much smaller profit.

Most people reference the CBO on this, though its numbers are entirely opaque. For instance, it says that it “relied mainly on data about the interest rates charged to borrowers in the private student loan market,” but there are gigantic adverse selection problems right out of the gate. The private student loan market is where the worst credit risks go, so of course they have higher rates. Is the CBO able to control for this? Nobody knows.

But beyond that, there’s a simple finance logic reason for why I don’t buy the argument for fair value accounting. I don’t believe that taxpayers face prepayment risk, and to whatever extent they do, it’s a matter of politics, not economics, that determines this.

The concept of prepayment risk might not make sense for people without some financial background, so let’s walk through it. If you lend money to a person you know, whether it’s a questionable relative or a partner who asks to hold some money until they get their check next week, you just want to get paid back in full. And, here’s the kicker, you are really happy if you get paid back sooner than you had expected. You want the money back.

Is that how private capital markets work? No. Let’s say you manage a large portfolio of private student loans. And let’s say you get a note at the office that they are being paid back more quickly than you had expected. Are you happy? No. You are not, and you might even get fired.

Why wouldn’t you be happy about getting paid back earlier?

1. You have to physically do something with the money you get paid back to get it earning more money again. No matter what you end up doing -- reinvesting it in student loans, putting it into a different set of assets, or just stuffing it in the equivalent of a mattress -- it takes time, energy, and resources, all of which cost money.

2. Often you want to set a certain time frame for repayment. Say you really want to have a cash flow at a certain date far off into the future because you are funding a pension or insurance liability. Getting paid back earlier doesn’t meet that goal, and it confuses your expectations for cash flows.

3. Crucially, you are likely to get paid back exactly when you don’t want the money. Say you locked in private student loans at a high interest rate, but then interest rates decline dramatically. At this point students will pay back their loans more quickly, which leaves you with more cash on hand at a time when interest rates are low.

This isn’t some partisan ideological point; it’s just basic finance. You can see it described in a CFA study guide under call and prepayment risk and reinvestment risk. (People more baller than I who actually did the CFA can nitpick specifics, but the general layout is correct.)

So private investors in student loans are genuinely worried that they’ll get paid back too quickly, and as a result charge a higher interest rate which leads to a larger discount rate. Because, and follow this, their goal isn’t to “get paid back.” Their goal is to achieve a consistent rate of return given a risk profile, with predictable cash flows given other institutional constraints. Getting paid back quickly is a risk to all this.

So, here’s my question: do taxpayers face this prepayment risk? If you saw a headline that said “student debtors are paying off their public student loans faster than expected,” would you be happy as a citizen, or furious?

I’d say happy. As a citizen, I’m not interested in earning a certain amount of profit consistently and with certainty over time, especially with the money paid back by student debtors, though I am as a private investor. If citizens were paid back more quickly, we could return the money to taxpayers, or use it for different purposes, or whatever. I certainly wouldn’t say “how are we going to continue to make the profit we were making?” as a citizen, though that’s exactly what I’d say if I were an investor in a private student loan portfolio. We could debate this -- perhaps you think the goal of the government here is to extract maximum financial profits no matter what. But it would be a political debate, divorced from the logic of financial market valuation.

This is not a trivial concern. Anyone with experience modeling a mortgage-backed security is very conscious of how greater prepayments impose massive risks and uncertainty. Normally the private sector goes to great lengths to imposes penalties and limitations on paying back loans early, though the government doesn’t do this for student loans. And since citizen do not face prepayment risks the way the private sector does, the discount rate for public funds, by definition, must be less than private funds when it come to student loans. Hence private sector discount rates aren’t a valid benchmark.

Note that the Financial Economist Roundtable (cited approvingly by Jason Delisle here) brings up prepayment risk specifically as something that fair value accounting is meant to capture. But the prepayment risk they specify -- which is “costly to lenders because prepayments are most likely to occur when market interest rates have decreased and loan values have appreciated,” reflecting the third issue noted above -- exists primarily because private capital has to reinvest money in a worse environment. Do taxpayers have to reinvest money they get from student loans? No, unlike private lenders, they don’t. The financial logic has broken down. (And don’t even get me started on using the private sector’s liquidity risk as a measure of the state’s.)

I have yet to see an argument addressing this head-on, much less a convincing one, but perhaps this post will change that.

Follow or contact the Rortybomb blog:
 
  

 

With President Obama’s student loan announcement in the news this week, an argument over whether or not taxpayers make a profit from student loans is no doubt close behind. We do make a profit using the government’s accounting tools, but there’s an argument that we should instead use “fair value accounting,” or the rate at which the private market adjusts for risk (here’s Jared Bernstein with a recent piece). By that standard, we see a much smaller profit.

Most people reference the CBO on this, though its numbers are entirely opaque. For instance, it says that it “relied mainly on data about the interest rates charged to borrowers in the private student loan market,” but there are gigantic adverse selection problems right out of the gate. The private student loan market is where the worst credit risks go, so of course they have higher rates. Is the CBO able to control for this? Nobody knows.

But beyond that, there’s a simple finance logic reason for why I don’t buy the argument for fair value accounting. I don’t believe that taxpayers face prepayment risk, and to whatever extent they do, it’s a matter of politics, not economics, that determines this.

The concept of prepayment risk might not make sense for people without some financial background, so let’s walk through it. If you lend money to a person you know, whether it’s a questionable relative or a partner who asks to hold some money until they get their check next week, you just want to get paid back in full. And, here’s the kicker, you are really happy if you get paid back sooner than you had expected. You want the money back.

Is that how private capital markets work? No. Let’s say you manage a large portfolio of private student loans. And let’s say you get a note at the office that they are being paid back more quickly than you had expected. Are you happy? No. You are not, and you might even get fired.

Why wouldn’t you be happy about getting paid back earlier?

1. You have to physically do something with the money you get paid back to get it earning more money again. No matter what you end up doing -- reinvesting it in student loans, putting it into a different set of assets, or just stuffing it in the equivalent of a mattress -- it takes time, energy, and resources, all of which cost money.

2. Often you want to set a certain time frame for repayment. Say you really want to have a cash flow at a certain date far off into the future because you are funding a pension or insurance liability. Getting paid back earlier doesn’t meet that goal, and it confuses your expectations for cash flows.

3. Crucially, you are likely to get paid back exactly when you don’t want the money. Say you locked in private student loans at a high interest rate, but then interest rates decline dramatically. At this point students will pay back their loans more quickly, which leaves you with more cash on hand at a time when interest rates are low.

This isn’t some partisan ideological point; it’s just basic finance. You can see it described in a CFA study guide under call and prepayment risk and reinvestment risk. (People more baller than I who actually did the CFA can nitpick specifics, but the general layout is correct.)

So private investors in student loans are genuinely worried that they’ll get paid back too quickly, and as a result charge a higher interest rate which leads to a larger discount rate. Because, and follow this, their goal isn’t to “get paid back.” Their goal is to achieve a consistent rate of return given a risk profile, with predictable cash flows given other institutional constraints. Getting paid back quickly is a risk to all this.

So, here’s my question: do taxpayers face this prepayment risk? If you saw a headline that said “student debtors are paying off their public student loans faster than expected,” would you be happy as a citizen, or furious?

I’d say happy. As a citizen, I’m not interested in earning a certain amount of profit consistently and with certainty over time, especially with the money paid back by student debtors, though I am as a private investor. If citizens were paid back more quickly, we could return the money to taxpayers, or use it for different purposes, or whatever. I certainly wouldn’t say “how are we going to continue to make the profit we were making?” as a citizen, though that’s exactly what I’d say if I were an investor in a private student loan portfolio. We could debate this -- perhaps you think the goal of the government here is to extract maximum financial profits no matter what. But it would be a political debate, divorced from the logic of financial market valuation.

This is not a trivial concern. Anyone with experience modeling a mortgage-backed security is very conscious of how greater prepayments impose massive risks and uncertainty. Normally the private sector goes to great lengths to imposes penalties and limitations on paying back loans early, though the government doesn’t do this for student loans. And since citizen do not face prepayment risks the way the private sector does, the discount rate for public funds, by definition, must be less than private funds when it come to student loans. Hence private sector discount rates aren’t a valid benchmark.

Note that the Financial Economist Roundtable (cited approvingly by Jason Delisle here) brings up prepayment risk specifically as something that fair value accounting is meant to capture. But the prepayment risk they specify -- which is “costly to lenders because prepayments are most likely to occur when market interest rates have decreased and loan values have appreciated,” reflecting the third issue noted above -- exists primarily because private capital has to reinvest money in a worse environment. Do taxpayers have to reinvest money they get from student loans? No, unlike private lenders, they don’t. The financial logic has broken down. (And don’t even get me started on using the private sector’s liquidity risk as a measure of the state’s.)

I have yet to see an argument addressing this head-on, much less a convincing one, but perhaps this post will change that.

Follow or contact the Rortybomb blog:
 
  

 

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Daily Digest - June 10: Tax Reform Can Bring Corporate Profits Home

Jun 10, 2014Rachel Goldfarb

Today, the Roosevelt Institute, The Century Foundation, and the Academic Pediatric Association are hosting "Inequality Begins at Birth: Child Poverty in America," a conference discussing solutions to help the nation's most vulnerable. Senator Cory Booker will be the keynote speaker. Watch the livestream here.

Today, the Roosevelt Institute, The Century Foundation, and the Academic Pediatric Association are hosting "Inequality Begins at Birth: Child Poverty in America," a conference discussing solutions to help the nation's most vulnerable. Senator Cory Booker will be the keynote speaker. Watch the livestream here.

Click here to subscribe to Roosevelt First, our Monday through Friday morning email featuring the Daily Digest.

Another Voice for Formulary Apportionment (Bloomberg BNA)

Alex Parker looks at the pros and cons of Roosevelt Institute Chief Economist Joseph Stiglitz's proposal for taxing corporate profits based on a holistic view of companies.

Arm Girls Against Trafficking in Sex (Providence Journal)

Sarah Estrela, President of the Wheaton College chapter of the Roosevelt Institute | Campus Network, argues for incorporating information about sex trafficking in sex education curricula.

  • Roosevelt Take: Sarah's idea was published in the Campus Network's 10 Ideas series in the 2014 Education journal.

Obama and Sen. Warren Talk Student Loans (The Last Word with Lawrence O'Donnell)

Roosevelt Institute Fellow Dorian Warren breaks down the numbers to explain why existing student debt is cause for serious concern, but also an opportunity for organizing.

Minimum Wage: Who Makes It? (NYT)

Jared Bernstein lays out statistics about the workers who would be affected if the minimum wage were raised to $10.10 an hour; for instance, women and minorities are overrepresented.

Most Missing Workers Are Nowhere Near Retirement Age (Working Economics)

Heidi Shierholz says that 4.4 million missing workers, who are neither employed nor seeking work, are too young to be early retirees. This shows the continued weakness in the labor market.

The Economic Recovery Would Be Stronger If Companies Like Apple Paid Their Fair Share in Taxes (TNR)

Danny Vinik says the U.S. corporate tax code shares the blame for multinationals holding profits offshore, and that corporate tax reform would give the economy a major boost.

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Daily Digest - June 9: The Middle Class Needs a Better Tax Code

Jun 8, 2014Rachel Goldfarb

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How Tax Reform Can Save the Middle Class (Moyers & Company)

Click here to subscribe to Roosevelt First, our Monday through Friday morning email featuring the Daily Digest.

How Tax Reform Can Save the Middle Class (Moyers & Company)

Roosevelt Institute Chief Economist Joseph Stiglitz and Bill Moyers continue their discussion of Stiglitz's new white paper on how tax reform can reduce inequality and promote prosperity.

For Poverty Solutions, Looking Beyond Congress (The Hill)

As Rep. Paul Ryan prepares for another hearing on the War on Poverty, Roosevelt Institute Fellow Andrea Flynn and Nell Abernathy look at ways to strengthen the safety net to fight child poverty.

Lawsuit Claims Thin Red Line in Discriminatory Lending Practices (MSNBC)

Roosevelt Institute Fellow Dorian Warren speaks to the mayor of Providence, RI, who says that Satander Bank is discriminating against people of color seeking mortgages in his city.

Everything You Need to Know About Walmart, in Nine Charts (Vox)

Danielle Kurtzleben references William Lazonick's Roosevelt Institute white paper on CEO pay to explain how Walmart could give its workers raises without cutting into profits.

Taxi Driver Solidarity (NYT)

Taxi drivers across the country are seeking to form a national union, reports Steven Greenhouse. Beyond shared grievances about pay and costs, many are concerned about ride-share apps.

The Fault in our Starry-Eyed 'Recovery': 2014 Looks Like We're Going Bust Again (The Guardian)

Heidi Moore says the recovery of the last five years was only for corporations and Wall Street, and hasn't helped average Americans, who still face rising costs and high unemployment.

Wall Street Fights for Our Right to Pay 5% Fund Fees (Bloomberg News)

Wall Street is pushing back against a strong fiduciary rule that would require financial advisors to put clients' interests first, writes Ben Steverman, because it would cut into profits.

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