Econospeak’s Peter Dorman has an excellent debate going on with Sandwichman and cian, among others, about using GDP as a main measure of a healthy economy, the components of growing the economy, and the state of mainstream political economic discourse. We have touched on related issues on Angry Bear. Our own Rusty puts the question in literal and layman’s terms. It is a theme that would be worth pursuing here I believe.
Matthew Richardson, a professor at NYU Stern School of Business, offers his thoughts on risk management and the economy.
Matthew Richardson on November 23, 2010, 12:00 AM
I am all for free markets and not mucking them up with government intervention. But the economic theory of regulation tells us that if there is a market failure, it cannot be resolved privately. The public sector must get involved.
The most illustrative examples of such failures in U.S. financial markets were the frequent financial panics from the 1850s until the Great Depression. Those episodes taught us that when illiquid, asset holdings (e.g., loans) of the financial sector are financed short-term (e.g., by deposits), and are hit by a severe macroeconomic downturn, failures of financial firms can lead to system-wide runs on deposits. This in turn leads to a massive disruption of the system that provides credit to households and corporations. When economists bandy about the term systemic risk, this is the type of event they are referring to.
The market failure here is that, although each financial institution may have been behaving optimally on an individual basis, the firm had no incentive to take into account the effect of their actions on the system as a whole. In economics, we call this a negative externality and it is analogous to an industrial firm causing pollution. In the example above, financial failure of one bank increased the possibility of runs on other banks, leading to the system-wide collapse.
The government regulation to address the market failure in this case was to insure retail depositors against losses (today’s FDIC guarantee), thus stopping the cycle of bank runs. Of course, these government guarantees came at great cost, not least the resulting moral hazard. So the government had to enact offsetting regulation and charge banks premiums for deposit insurance, restrict them from certain risky activities, and subject them to prompt corrective action.
This served financial markets well for over a half century. As time passed, however, the regulation became antiquated. Over the last two decades, deposit premiums became mispriced, some financial firms like Fannie Mae and Freddie Mac grew so large that they became too-big-to-fail, and shadow banks—banks such as off-balance sheet vehicles, money market funds, and investment banks that operate outside of the system—proliferated, performing bank-like functions albeit with little or no regulation. In fact, in this financial crisis, we faced modern day equivalent runs on most of the shadow banking sector.
One might argue that the government is not capable of effective regulation and makes matters so much worse that it would be better to accept systemic risk and deregulate. But the legislative response to the Great Depression and its success would suggest otherwise.
And in terms of the government’s latest financial reform, the Dodd-Frank Act is clearly well intended by focusing regulation for the first time on systemic risk. Moreover, the legislation plugs some obvious holes in the financial system like off-balance sheet financing, OTC derivatives, rating agencies, and mortgage underwriting, among other areas. That said, the legislation ultimately falls short in both its approach and focus.
After a recent presentation to 170 or so risk management executives on Dodd-Frank, I took a quick poll and the vast majority believed another financial crisis was going to occur within the next ten years. This should not be surprising. The legislation does not charge systemically risky firms upfront for the systemic risk imposed upon others; instead, choosing to penalize surviving firms when a crisis occurs. This creates a free rider problem which will lead to a race to the bottom. Moreover, in terms of moral hazard, the legislation leaves in place mispriced government guarantees, and, with respect to excess leverage, conditions for regulatory arbitrage persist. There is also no attempt to create a level playing field by regulating shadow banks and banks similarly
Nevertheless, while there is little doubt that regulatory failure played an important role in the crisis, the solution should not be to walk away and leave systemic risk in place. I would still take Dodd-Frank over the current system or, more extreme, a world with zero financial regulation and frequent financial panics. But we still have plenty of wood to chop on the regulatory front. This is just the middle innings of a very long game ahead.
Matthew Richardson is a professor of finance at NYU Stern School of Business.
by Tom aka Rusty Rustbelt
Consumer Finance: Let Wal-Mart be a Bank
One of the side effects of the “great recession” is damage to credit records and banking relationships for many people who get in financial trouble. Many of them will have trouble reestablishing banking relationship (that the banks caused the recession is irrelevant, of course) because the bank computers have them on a reject list, even for a savings account.
Several years ago Wal-Mart starting actively talking about becoming a bank, and the banking industry and their lobbyists went all postal insane on Congress (some Wal-Marts have a Wood Forest bank branch).
Truth is, for many people, the customer service counter at WM is already their de facto bank. They use it to pay bills, transfer money, cash checks, and use prepaid debit cards and gift cards for many purposes.
So, since Wal-Mart is already a de facto bank for millions, why not let it be a bank? The other banks do not want the business anyway.
(PS: some academic research I did a few years ago leads me to believe WM plays a major role in transferring money from undocumented workers to Mexico, although WM denied in writing the possibility of such transfers, while running a discount special on transfers to Mexico!)
by Linda Beale
WaPo (inaccurately?) reports consensus forming on deficit
crossposted with Ataxingmatter
The buildup in the corporate media supporting the corporatist wishlist on budgeting is growing. First there was the clamor about the Bowles-Simpson road map to conquering the deficit–depicted as a reasonable, middle-of-the-road approach. Bowles-Simpson is a neo-liberal/neo-conservative group of people with little understanding of the predicament of the vulnerable middle class in this economy, and apparently as little creativeness for moving the economy out of the stagnation from the four decades of Reaganomics and into a new era of broad-based growth that lifts all boats, rather than just the yachts of the already rich and famous.
Then there was even more clamor about the more “radical” plan put forward by Alice Rivlin and cohorts. Rivlin is another neo-liberal Clintonite who is perfectly willing to sacrifice the New Deal to get the neo-deal.
Obama doesn’t seem willing to fight any fight. He quits before he starts, disgusting liberals who understand that a democracy cannot survive based on the kind of “free market capitalism” espoused by the oligarchs who benefit from it. So there is already talk of extending the Bush tax cuts for the wealthy, which have nothing at all to do with jobs, entrepreneurship, innovation, or growth of the US economy and everything imaginable to do with elitism, power, and hording of productivity gains for the G.W. Bush fan club of have-mores.
So it is perhaps not so surprising that the WaPo is already declaring that a “consensus is forming on what steps to take in cutting the deficit.” Story by Lori Montgomery, WaPo, Nov. 22, 2010. Ms. Montgomery takes the pundits and neo-con/neo-lib descriptions as god’s truth as she describes “a surprising consensus” around “the sacrifices necessary to achieve those goals [of less debt and smaller government]” being “Big cuts at the Pentagon. Higher taxes, including those on home ownership and health care. Smaller Social Security checks and higher Medicare premiums.” Once again, the neo-con faction has used its corporate-owned media to hone its message that there is no choice (false note of sadness) but to cut those deficit-causing “entitlements” like Social Security and Medicare.
The awful deed is required, she suggests, to avoid a “European-style debt crisis.” No real analysis is there. Once again we see the proof in the pudding: the corporate media has discovered that it can deliver press releases and paid interpretations of events much more cheaply than it can do investigative journalism with smart journalists paid a decent salary and provided decent benefits. Infotainment, not news; opinion, not facts; rehashing of partisan positions, not analysis.
- No mention of the fact that the Euro zone nations do not have monetary sovereignty. The story ends with the scare-tactice line (from a Republican strategist, so part of the framing intended to make it acceptable to cut Medicare and Social Security while providing more tax cuts to the wealthy) “if we don’t act [to cut the deficit], we will be Greece.” That’s simply not true. We are not in the same position as Greece. We need to do some things, but we have many more choices than Greece (though the Republican path of tax cuts for the wealthy and spending increases on programs that benefit big corporate interests tend to reduce those choices). While I don’t entirely agree with the monetarists who want us to print our way out of debt and deficits, there is some basis for printing more dollars to meet national needs, stimulate the economy, and avoid more borrowing. That is not an option for Greece.
- No analysis of the tax proposals–lower rates even with closing some loopholes will generally mean more of the burden is passed to the middle class and taken from the wealthy. Merely repeats the Republican notion that lower tax rates lead to economic growth (they don’t–just look at the historic pattern of growth and tax rates–we have higher growth when we have higher rates, likely because it leads to better allocation of resources).
- No mention of the fact that the health reform bill, when it kicks in, should begin the process of reducing health care costs, or of the fact that a much more cost-effective solution–rather than cutting benefits to those vulnerable elderly and sick for whom Social Security and Medicare is a lifeline–would be to throw the rent-seeking health insurers out of the primary business of determining who gets health care and let them make their non-rentier profits on supplementing a national health care single-payersystem similar to Canada’s or Britain’s or Germany’s–anybody but our failed profits-for-financial-institutions-at-the-cost-of-care-for-ordinary-Americans system.
- No mention of the fact that Social Security is not even officially part of the deficit–that in fact we have borrowed from the funds paid in by workers who are now retiring so that we could create a tax-haven economy for the wealthy and corporate elite or the fact that whatever shortfall Social Security might (but not necessarily will) face in future years is EASILY solvable by extending the tax to full wage income of all workers (and, for this purpose at least, acknowleding that payments from hedge and equity fund partnerships to service partners in respect of their “profits” interest are compensation that is subject to payroll taxation). Social security should be off the table because it ain’t broke, any future fixing that it needs is simple and equitable, and it has been put on the table by the same monied elites that at the same time work to ensure that their favorite tax breaks and other benefits stay in the system (such as the charitable contribution deduction for the value of stock, rather than the basis that represents the owner’s actual investment in the stock). Instead, the Bowles-Simpson right-wing dominated group would reduce benefits for all retirees by redefining their cost of living needs (in spite of the fact that the current formula is probably weighted too lightly on the kinds of expenses that the elderly face, they would suggest a formula that would be even less likely to keep the elderly who depend on SS on an even keel); means-test Social Security (thus destroying the key element of the near universal support of the program); and raise the retirement age (to 69) meaning that some people who get nothing whatsoever from the years invested and many in manual labor jobs would be worn out before able to retire.
- No mention of the fact that Alan Simpson, Obama’s choice to co-chair his so-called Commission on Fiscal Reform (it should have been called–neo-lib/neo-con commission for cutting benefits under Social Security and Medicare), has consistently targeted Social Security (and other New Deal programs) as a huge unearned entitlement that should just be gotten rid of or at least whittled down to the bare bones if at all possible. See e.g., Alan Simpson Calls Social Security ‘Cow with 310 Million Tits,’ Causes Uproar, TPM Muckraker, Aug. 25, 2010. It’s no surprise that a commission made up of elitists –including nine Republicans that the Business INsider site politely calls merely “tax averse” (see Beutler, Meet the 18 People Who Could Determine the Fate of Social Security“, Aug. 30, 2010) opts for solutions that favor elites.
- No mention of the fact that Social Security funds were required to be invested in US Treasuries-(see Trust Fund FAQs,” Social Security Administration, February 18, 2010)
The SS surplus funded US debt at the same time that huge tax cuts were enacted in favor of corporate and wealthy elites, but now the neo-con/neo-lib move to decrease benefits is essentially a call to reneg on commitments made to those that funded the surplus and borrowing.
- No mention of the fact that most of the Bowles-Simpson crew held pre-determined positions that favored reducing the programs that help the poor and vulnerable (see Beutler, Meet the 18 People Who Could Determine the Fate of Social Security“, Aug. 30, 2010) :
- Bowles himself, a Wall Streeter Clintonite Dem who was not very strongly against privatization when he was chief of staff;
- Simpson, who has supported privatization and benefit cuts to Social Security for deaces,
- Rivlin, another bank-friendly Clintonite who has long argued for cutting Social Security benefits;
- Stern, a former President of the SEIU who has supported the idea of investing Social Security funds in the stock market rather than in US Treasuries;
- Cote, Republican CEO of Honeywell who has advocated cuts for military servicemen and women rather than defense contractors like Honeywell;
- Fudge, an Obama supporter who has been in business at Kraft Foods and Young & Rubicam (so is likely to support business friendly solutions whether they are good for the vulnerable or not)
- Paul Ryan, Republican advocate of austerity budgeting, Social Security privatization, and Medicare vouchers
- Jeb Hensarling, Republican advocate of austerity budgeting and privatization and cuts for Social Security and Medicare
- Dave Camp, Michigan Republican that wants tax cuts, and Social Security privatization
- Judd Gregg, Republican interested in raising retirement age to 70, privatizating Social Security, shrinking government by “starving the beast”, and yet doesn’t think tax cuts should be offset
- Tom Coburn, Republican from Oklahoma who says he’s “open to everything if it gets us where we need to go” regarding the commission’s deficit reduction aims, BUT hypocritically opposes not providing an additional tax cut for the wealthy. Coburn wants to “dismantle large segments of the federal government” and wants all options on the table except preserving current structure and benefits or increasing SS taxes (on the wealthy). He also wants to cut pay and benefits for military dependents, retirees and survivors. Funny, he doesn’t mention generals or defense contractors. Coburn has consistently worked to eliminate the New Deal programs oriented towards the ordinary and middle class folks.
- Mike Crapo, Republican who wants to privatize Social Security and reduce benefits for anyone born after Jan.1, 1950.
- John Spratt, blue-dog Democrat who has long advocated changes to Social Security, including supplementing SS with private plans
- Xavier Becerra, democrat who may actually oppose changing Social Security
- Jan Schakowsky, progressive democrat who opposes entitlement cuts and fought for the public option
- Kent Conrad, Democratic budget hawk who opposed the public option, supports passing new tax cuts that extend the Bush cuts for everybody, though arguing for tax increases eventually
- Max Baucus, Democrat who supported Bush tax cuts (imagine where we might be if he had fought instead for ordinary Americans) and has consistently supported decimating the estate tax and has supported the idea of Social Security cuts
- Dick Durbin, a progressive Democrat who nonetheless has been open to cutting Social Security
No analysis is there. What Montgomery puts forward as supporting the idea of a national consensus is the Bowles-Simpson vague statement of a roadmap; the Rivlin-Domenici panel, another neo-lib/neo-con dominated group whose prescriptions are predictable; Frank Keating, a Republican who wants lower income-tax rates and a national sales tax (perfect for the wealthy in passing the burden of taxation to the middle class); and retired military officers and national security experts who agree that the hugely bloated Pentagon budget can be reduced (can’t we ALL agree on that one?). That’s a national consensus? I don’t think so.
Regretably, she ends with a quote from Domenici (not a moderate by any means) saying that the fact that there is some common ground about cuts and tax increases among this disparate group is “‘a testament to the moderate nature’ of the ideas under discussion”. No–it is a testament to the ability of one view to dominate the media and to be presented as a growing consensus on the need to cut the welfare programs that are the backbone of the New Deal, in order to frame the discussion in a way that pushes it towards a single conclusion.
For a different perspective, see DAvid Coates, Eating the Old at Thanksgiving (nov. 22, 2010).
The International Federation of Health Plans released its 2010 report today. (PDF here.)
The good news is that the problem is clear: Americans pay too much for the same services. The bad news is (1) we’ve known that for years and (2) the factions who are gaining these excessive rents want to keep their sinecures.
But I’ve said this before. That it remains true is as true as “that which cannot go on will not go on.”
How it ends—its eschaton, as it were—is what is being discussed. Hint to doctors: You are the farmers of the 2010s; you will lose either way. (Think 1994 all over again, this time with a vengeance.)
by Bruce Webb
Strengthen Social Security a coalition of progressive organizations determined to protect and strengthen Social Security, coordinated and hosted by Social Security Works (or maybe by now SSW is hosted by SSSC) produced the above graph. I didn’t see it on their website and so grabbed it from Ezra Klein’s post (which does credit SSSC) The Future of Social Security in One Graph
This doesn’t tell the whole story, for one thing it shows wage indexed results which would seem to discount the actual gains in real benefits under the current schedule, and for another it would be interesting to see the results on the “if nothing is done” trendline if we added in the revenue effects alone of the other plans. But however you slice it clearly the goal of ‘reform’ is not to deliver an appreciably better result for workers, at best they are being asked for a significant giveaway from the current schedule.
by Linda Beale
Irish Bailout–impact on taxes uncertain
crossposted with Ataxingmatter
As plans for the $100 billion bailout of the Irish economy and banking system by the European Commission, International Monetary Fund and European Central Bank continues, Ireland’s downtrodden prime minister (who will call elections after the budget is finalized) has said that it “will not” change its corporate tax haven status–its corporate tax rate of 12.5 percent will remain for now. At the same time, however, Daily Tax RealTime reports this evening comments today by Eurogroup President Juncker that discussions about Ireland’s low corporate tax scheme are ongoing, Both France and Germany would like to see Ireland raise its rate closer to the average 25% EU rate.
A Montreal accessories company has taken its policy of using no animal products beyond the rack and has forbidden its staff from eating meat and fish at work.
A former employee says the policy violated her rights as a non-vegetarian….
It’s an interesting experiment for many reasons, none of which deal directly with economics as it is currently taught. For one thing, it is a dictated change in a contract with workers. As a standard microeconomics problem, there is a negotiation, the worker’s preferences are examined, and the student is asked to find an economic balance that will satisfy the worker, with the implication that the employer desiring the change with provide compensation. (Note that the standard intermediate or graduate-level microeconomics problem merely teaches math, with dollars and preferences substituted for widgets and variables.)
For another, there is insufficient information to discuss externalities. (Aside to Brad DeLong: it’s not only, or even most importantly, Irving Fisher who is forgotten; Alfred Marshall appears to have been stripped from the curriculum as it transmogrified into a Libertarian Wet Dream.) Absent evidence, we cannot know if the company had a legitimate reason for banning meat eating. Perhaps chemicals used in their processes combine with some proteins and produce a marginally higher level of cancer in those exposed for long periods. Perhaps the maintenance crew has discovered multiple rat nests because the workers have not been attentive to clean-up requirements, leaving enough pieces of pork, chicken, beef, and tripe around to make the building a desirable habitat. We do not have sufficient information.
We do, however, know that bars that permit smoking produce lung, throat, and other cancers in even the non-smoking bartenders and wait staff. It may be unlikely that the aggressive hormone and radiation treatment given to meat these days produces a similar effect—radiation and drug treatment, after all, are both perfectly safe—but it is also possible that the company has seen recent research that indicates otherwise and fears for its future health-care costs.
We also do not know whether the company provides eating areas for its staff, or under what conditions it does. Is there a company cafeteria (or eating spaces on various floors) that provides napkins and utensils to those who bring their own food? Is eating at one’s desk permitted? (I have worked places where it is not.) In such a case, we cannot even model the type of microeconomics problem referenced above, because we do not know the extent to which the workers are being told to give up something. (Smokers having to leave the building has positive externalities for them, such as work breaks others do not get and social networking opportunities that provide compensation.) We cannot, in short, know the value of the widgets or the identities of the variables.
The question then becomes whether this is an economics problem at all. And, if we assume it is, what does that mean for other. more standard, problems? On the Next Rock: capital, labor, and taxation.