Alice Rivlin on Financial Reform and Deficits

by Linda Beale

Alice Rivlin spoke at Wayne State University’s FOCIS forum today on the economic crisis. Rivlin is an economist who served as the first director of the Congressional Budget Office (1975-83, when she was a critic of “reaganomics”), director under Clinton of the Office of Management and Budget (OMB) (deputy 1993-94, director 1994-96) and a governor and vice chair of the Federal Reserve (1996-1999). She is currently associated with the Brookings Institution. She is slated to play a role in the policy decisions made on important economic and tax matters: As of January 2010, she has assumed a role as co-chair (with Pete Domenici–who was an avid supporter of the Bush budget-busting tax cuts) of a “Debt Reduction Task Force” sponsored by the Bipartisan Policy Center”. See Bipartisan Policy Center, press release, Bipartisan Policy Center Launches Debt Reduction Task Force, Jan. 25, 2010. In addition, she was recently appointed by Obama to serve on the “National Commission on Fiscal Responsibility Commission” he established by executive order on Feb. 18, 2010, with co-chairs Erskine Bowles and Alan Simpson, with the charge of proposing ways to improve the long-term fiscal outlook and specifically to address the growth in “entitlement” spending. See the description by Peter Orszag, OMB director, on The White House Blog.

I can’t help that note that Pete Domenici– in spite of claiming to spend his career seeking “deficit reduction” (along with other things such as “a strong military,” which is a substantial reason for our spending-heavy budget), see Does John McCain get mad? Ask Pete Domenici, New Mexico Independent, Apr. 21, 2008 — was an avid supporter of the Bush tax cuts, with a cost of $1.6 trillion over the first decade, even after it was clear that the Bush budget was in negative territory. See, e.g., 2 Moderate Republicans Oppose Bush Tax Plan As Democrats Offer Their Own, NY Times, Feb. 16, 2001 (the two were Jeffords and Chafee, not Domenici); Votes Database on HR4297, Washington Post, May 11, 2006 (extending the capital gains rate reduction and the application of capital gains rates to dividends, against the argunent that it primarily benefited the wealthy and added to long-term deficit and debt problems).

Update:(Rdan here…formatting has been corrected)

Both the commission and task force start out already adopting strongly urged positions of the right (military spending off the menu, tax increases sufficient to address the real problems can’t be considered, and reduction in benefits under the entitlement programs is a given). Like most of the talk of “bipartisanship” under the Obama administration, this has meant ceding key foundational principles to the right before discussion even begins of where compromises are necessary. It is why there is no public option in the deficient health care bill and why there is talk under a supposedly progressive Democratic administration of enacting a regressive national sales tax or VAT instead of letting the Bush taxes revert as scheduled at the end of 2010 back to the more sensible paradigm before the measures were enacted.]

Now, Alice Rivlin is a smart and accomplished woman. I was curious what she would say about the economic crisis and what needs to be done to get out of it. I’ll summarize (very sketchily) what she had to say and point out where I think she has gone wrong in her focus and prescriptions.

She repeated the current media story about the cause of the financial crisis–irresponsible borrowers, overleveraged lenders, lax regulators.

“It’s no one cause” she said” –you can’t blame it on Fannie Mae or any of those current whipping posts”. “Everybody got burned.” [exact quote]


“we are coming out of the problem and, as various economists predicted, 2010 will be the year of the upswing.”

[paraphrase] She pointed out, of course, the fact that unemployment numbers look better, that Wall STreet is doing better. And she indicated her great optimism for Michigan’s economy, because of the new realism in leaders’ recognizing that the solution isn’t a return to the same old manufacturing base.

This last, which actually came towards the end and in response to a question asking for more specifics on her optimism for Michigan, was very vague and had the feel of puffery. She needed to say something good because this was a program on Michigan’s hope in Michigan and the media were watching.

Then she named the two central issues to ensuring growth (she didn’t say “broad-based growth” regretably)–financial reform and deficit reduction. And her solution to these?

On financial reform, she listed three key reforms:

1. Re-instituting better standards/controls on lending and establishment of anindepedent consumer protection agency
2. Instituting controls on leverage through the Fed
3. Finding a way to deal with the “too big to fail” problem so that big financial institutions can be disbanded when necessary without disrupting the entire financial system.On deficit reduction, she claimed that the “budget scolds” have to be listened too, and that health care and social security entitlements have to be reduced. “Taxes aren’t enough, and cannot be the whole solution.” [close to exact quote]

Now, this has always been the right’s response when a progressive (or thought-to-be-progressive) is in office, as a way to constrain to the max any actually beneficial programs targeted at ordinary Americans and to lay claim to “fiscal responsibility” by noting how they pointed out when so and so was in office that deficit reduction should take priority. Remember Greenspan–when Clinton was president, Greenspan scolded about deficit reduction; then when Bush proposed huge deficit-creating tax cuts, Greenspan suddenly found himself not worried about deficits. (Remember too that the Clinton presidency left a budget in surplus, and by the time of the 2001 Bush tax cuts, we were already back in negative territory. So that Greenspan’s logic (if anything other than ideology) was hard to fathom.

So it is discouraging to see someone with Rivlin’s experience pushing deficit reduction in ways eerily reminiscent of the right’s focus. (I don’t think high debt is a good situation to be in, by the way. But I don’t think talking about cutting health care benefits is the right approach –certainly not til you’ve reduced military spending and raised taxes.)

So what are the solutions she envisions?

To summarize…decreasing Social Security, Medicare and Medicaid benefits–in the form of small changes now that will take effect and lead to significant reductions later, such as raising the retirement age and indexing for longevity for Social Security or working to ensure that we just “pay for the good stuff” through Medicare/Medicaid increasing taxes–in the form of a national sales tax or VAT which “will be pro growth” and will require the federal government to share some of the revenues with the states.

So what didn’t I like about this?

1. Undue Influence of Financial Institutions

On the causes of the crisis, her account glosses over the deeply embedded role of financial institutions in setting the laws and standards for their own accountability, from the fact that financial institutions were in bed with the ratings agencies, to the pervasive influence of the biggest banks (and especially Goldman Sachs through placement of its alumns in key positions) over Congress and over its own regulators, and the resultingly frustratingly toothless controls that those alumns put on the use of federal money to bail out the banks. Until that reality is acknowledged and dealt with transparently, there will be no workable long-term solution.

2. Lack of focused attention on the needs of ordinary Americans related to the crisis

While Rivlin acknowledges that the problems exist in Wall Street and in the regulators, there is, as with so many trained economists, almost no discussion of the impact of the crisis on ordinary Americans and the kinds of remedies that directly address their needs. Rivlin did acknowledge the high rate of unemployment, but primarily in emphasizing her view that the economic stimulus may have lessened to 10% the peak unemployment rate that could otherwise have been at 12%.

This vastly undervalues the harm done to ordinary society
by this crisis. The pockets of extraordinarily high unemployment create
devastating societal harms that returns to average levels don’t cure.

And we could do much more. One step, early on (and even now), would have a direct, palpable impact on the lives of the ordinary Americans who have been targeted by predatory Wall Street practices and in most cases who have worked hard but lost almost everything. That’s the change of the bankruptcy laws to permit modification of home loans in bankruptcy. The Obama administration (and of course the Bush administration before it) has not taken the kind of action it could to press for these changes. Why? Because that change would force banks to acknowledge losses that they can currently hide with “level 3” mark-to-market valuations and admit deeper losses than they want to acknowledge. This is an ostrich-hiding-its-head-in-the-sand solution that, like the way the TARP program has been administered, looks to the banks and makes them whole through socialization of losses while letting ordinary Americans continue to suffer through loss of their homes as well as their jobs. Many of those who are losing their homes were tconsidered prey by predatory mortgage brokers and predatory investment bank bond traders. There is no rational logic in not pushing through a program that allows modification of home loans for primary residences in bankruptcy. The picayune programs for interest rate reductions (mostly temporary) that have been the primary effort in this regard so far are laughable. The recently announced new effort by the Obama Adminstration doesn’t
sound much better. A change to the bankruptcy laws is necessary.

3. Lack of any sense of the significance of creating laws that hold the guilty culpable

It is sad that policy makers like Rivlin never even mention the lack of
accountability in a system that, sense the Central Bank of Denver case, has let accountants, brokers, and lawyers off the hook when they design financial instruments for their own benefit that rip off their customers and/or rip off regulatory and tax authorities, keep information as hidden as possible through complex derivatives, and rely on “quants” to develop computer models to tell them how to make money without regard to the impact of their schemes on society or on individuals. Wall STreet bond traders, their lawyers, the ratings agencies, accountants and the various hedge funds that exist below any accountability radar screen bear the lion’s share of the blame for the financial crisis, and most of them are back to making millions without a qualm. Their predatory culture has to be dealt with, in order to protect all of us from a recurrence of this in the future.

Ultimately, the people who were treated as prey and got pushed into subprime mortgages that they couldn’t afford should be able to sue the broker, the traders, the rating agencies, and the lawyers that made that possible, in class-action lawsuits. (I know–the rating agencies convinced the courts that the rating that they are paid to provide and that are required for various legal purposes are “just opinions” and therefore
protected by the First Amendment. That’s seems like more of the corporatist agenda that lets corporations have all the benefits of being persons but none of the liability. Some way around it needs to be developed.)

4. Regulatory tightening for transparency and discouragement of risk-taking is essential.

1. Transparency is needed, but that won’t be achieved without SEC-like disclosure requirements on all financial innovations and FASB accounting rules that
minimize the amount of manipulation possible.
2. The changes that Congress forced in mark-to-market accounting (letting institutions decide to move to “level 3” mark-to-model valuations when there is a “market disruption” ) appear harmful, not beneficial. Mark-to-model needs to be revised drastically to require complete openness about individual positions being marked to model (not just aggregate information) and complete transparency or even standardization of the models used. [See my tome on mark-to-market for tax on SSRN and the problems of manipulating income or losses to suit the financial statement needs or tax needs of the institutions]
3. Financial innovations generally need to be discouraged, not encouraged–perhapsthrough a combination of patent law changes (proprietary financial institution models should not be patent-eligible in the first place), regulatory hurdles, and new regulatory regimes.

5. Starting out with a deficit concern that is set forth as justifying reduction in programs for the common welfare is problematic.

No we want quality health care for all? Then are there ways to achieve that to be considered? The answer is yes and yes. This country never really considered single-payer health care, the successful model in the developed world most likely because of the power of the big insurers and the unwillingness of those like Rivlin operating under the centrist economic legacy of Clinton (Rubin, Rivlin, Summers, etc.) to put people first and make the arguments needed to help Americans understand that democratic capitalism cannot be sustained under the corporatist empire to which we are so rapidly moving.
By setting the charge of his “commission” to be reducing entitlements, Obama has regretably fallen into the pit dug by the rights efforts to treat programs that provide benefits for the poor or ordinary Americans as worrisome items while letting the programs for the Big Banks and other similar corporate welfare continue unabated.

6. Supporting a national sales tax or VAT as the tax solution is similarly problematic

Those tax systems are highly regressive, which is the wrong direction for us to move after the Bush tax cuts led to a less progressive system. We have various better alternatives, including at least the following:

a. eliminating the capital gains preference

b. increasing the progressivity of the income tax through both base broadening (eliminating or reducing the provisions that primarily provide redistribution upwards to the wealthy because they are the only ones able to take advantage of them, such as the charitable contribution for value of stock with low basis) and rate increases (adding more finely tuned rate brackets, so that those with millions are taxed higher than those with half a million and those with billions are taxed considerably higher than those with millions)

c. letting the Bush tax cuts lapse as they are scheduled to do by law as enacted by the GOP-dominated Congress that passed them

d. instituting a financial institution leverage tax that charges the financial institutions for the cost-of-funding advantage they receive due to the implicit federal guarantee

e. reinstituting the estate tax at a vigorously progressive rate (which will tax individuals when they are at a point where they don’t feel it and will help to slow the development of oligarchy)