Relevant and even prescient commentary on news, politics and the economy.

The WSJ editorial page slams…John McCain

by Ken Houghton

It was five degrees (C) warmer here this morning than the previous two days of taking the Eldest Daughter to her school bus.

Presumably, this is balanced out in part by record-low temperatures in Hell, as the WSJ editorial page (well, Thomas Frank, but still…) summarizes the McCain Position:

Last week, Republican presidential candidate John McCain called for a commission to “find out what went wrong” on Wall Street. It was an excellent suggestion: Public inquiries into Wall Street practices served the country well in the 1930s.

And Mr. McCain has a special advantage to bring to any such investigation — many of the relevant witnesses are friends or colleagues of his. In fact, he can probably get to the bottom of the whole mess just by cross-examining the people riding on his campaign bus. So the candidate should take a deep breath, remind himself that the country comes first, pull the Straight Talk Express over at a rest stop, whistle up his media pals, and begin.

Go read the whole thing.

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From the Horse’s [Mouth]

By Steam Fangs Palin (Tom Bozzo)

On 60 Minutes, John McCain helped resolve a couple of issues that occupied the comments last week.

Q1. Did McCain support Gramm-Leach-Bliley?

A: Yes, and he still does!

PELLEY: In 1999, you were one of the Senators who helped pass deregulation of Wall Street. Do you regret that now?

MCCAIN: No. I think the deregulation was probably helpful to the growth of our economy.

(Quote via Firedoglake.)

Q2. Is McCain going to outflank Obama with a populist volte-face on the bailout? (See also Krugman.)

A: Not as long as reporters can recall their ability to do a Google. Via the AP:

In the [60 Minutes] interview, McCain defended the Bush administration’s proposed bailout of financial firms as necessary, though he acknowledged it could get expensive.

“We’re going to take over these bad loans,” McCain said. “And we’re going to have the taxpayer help you out. But when the time comes and the economy recovers, then anything that’s gained back is going to go to the taxpayers first.

“I’m not saying this isn’t going to be messy. And I’m not saying it isn’t going to be expensive. But we have to stop the bleeding,” McCain said.

None of this is to say that McCain won’t continue his pattern of rampant flip-flopping by at least trying to stake out positions both for and against the bailout — as Obama deftly calls it, an “election-time conversion” — or running against all the fatcats except for Carly Fiorina and Phil Gramm (worth every penny!). And it stands to reason that the Republicans will run against the “horrible big-government program” of the Bush administration, though of course they’ll also run against the Democrats for obstructing the vital economic recovery program of the Bush administration as the situation presents itself.

PLUS: Mirabile dictu, could it be that congressional Democrats are getting the Administration to concede to the major features of the bailout plan a la Dodd and Frank?* With, in particular, equity dilution now part of the deal with Treasury, the revised bailout (Dodd discussion draft here) looks to be a huge substantive improvement over the DOA blank-check plan, and has garnered early favorable reviews from CR, Krugman, and (with some more specifics) Adam Levitin at Credit Slips. Bloomberg suggests that Republicans may bolt, but they won’t make things easy for McCain if they end up opposing the plan for being too tough on financial executives and too easy on stressed homeowners.

* From one perspective, this could be terrifying as it may signal that Treasury really sees itself as staring into the abyss.

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Never let an Economist use "Unintended Consequences" Again

by Ken Houghton

It’s not been a Good Weekend for me to read Berkeley-based Economists. (Though DeLong is on fire, in a good way, and has been since that initial post.)

Via Mark Thoma, this from Barry Eichengreen:

In the United States, there were two key decisions. The first, in the 1970’s, deregulated commissions paid to stockbrokers. The second, in the 1990’s, removed the Glass-Steagall Act’s restrictions on mixing commercial and investment banking. In the days of fixed commissions, investment banks could make a comfortable living booking stock trades. Deregulation meant competition and thinner margins. Elimination of Glass-Steagall then allowed commercial banks to encroach on the investment banks’ other traditional preserves.

In response, investment banks branched into new businesses like originating and distributing complex derivative securities. They borrowed money and put it to work to sustain their profitability. This gave rise to the first causes of the crisis: the originate-and-distribute model of securitization and the extensive use of leverage.

It is important to note that these were unintended consequences of basically sensible policy decisions.

Consequences? Yes. Unintended??? Not a chance in the world.

Now that the final step has been taken, can anyone deny that Phil Gramm, Jim Leach, and Tom Bliley knew exactly what they were doing?

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Not Since Mother Courage and Her Children…*

At a high level, Floyd Norris explains it all to you.

UDATED, AND PULLED TO THE FORE: For the more detailed view (h/t Barry R.), the soon to be late, not very lamented, New York Sun presents the details:

The SEC allowed five firms — the three that have collapsed plus Goldman Sachs and Morgan Stanley — to more than double the leverage they were allowed to keep on their balance sheets and remove discounts that had been applied to the assets they had been required to keep to protect them from defaults.

Making matters worse, according to Mr. Pickard, who helped write the original rule in 1975 as director of the SEC’s trading and markets division, is a move by the SEC this month to further erode the restraints on surviving broker-dealers by withdrawing requirements that they maintain a certain level of rating from the ratings agencies.

and the solution going forward (that is, after you give these guys $700 billion) will be an even weaker form:

The SEC said it has no plans to re-examine the impact of the 2004 changes to the net capital rule, and last week, it put out a proposal to revise the rule once again. This time, it is looking to remove the requirement that broker dealers maintain a certain rating from the ratings agencies.

Because nothing says “faith in the institution” like a non-investment grade rating.

*Title explanation: Mother Courage at the beginning of the play has two (2) children. By the end, she has two less than that. The play closes with her “silent scream” as she drags her cart along.

If you had only seen that final scene, you would think it is a tragedy of Mother Courage, not one caused by her. Working from memory: One of her children dies because she sends him(?) something that might be salable—in the middle of a battlefield. The other is similarly sacrificed. It is the reverse of the “because he’s an orphan” joke.

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Let’s Play a Game: Connect the Dots

Let us assume:

  1. That there is an equity premium ([PDF] UPDATE: Link modified to Brad De Long posting in which the PDF is embedded. Hat tip: Don Lloyd in comments.)
  2. That the equity premium can be derived from a linear relationship (y = ax(1) + bx(2) + ….) of the most significant variables.
  3. That equity premia are, to some not-insignificant extent, based on Wealth Inequality [PDF].
  4. That one of the primary variables contributing to the premium is the reliability and quality of the information provided

Given the above, should we expect the imminent weakening of U.S. accounting rules, discussed here and here, to produce a higher equity premium?*

If so, there are two possibilities. Either,

  1. the firms are perceived to have a higher present value, despite the change being one of accounting, not business flows or
  2. the stock prices decline in the face of greater uncertainty, leading to an increase in the premium due to a lowering of the price.

My instinctive answer—which I can probably be convinced is wrong, but it would take some effort**—is that the second would be the result. Leaving only one question:

Why does Christopher Cox (R-CA) hate the Securities Markets?

*Following from [3] above, we can assume that greater information tends to result in more optimal investment practices, and therefore a lower equity premium.

**The argument would have to show that the loosening of accounting practices will result in improvements to the company’s business processes that would not otherwise occur.

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All Economic Analysis is Counterfactual

In partial response to Cactus’s post, Megan McArdle offers the “look at those low air fares” defense of airline deregulation, going so far as to suggest:

I think it’s telling that complaints about deregulation of the airlines come almost entirely from three groups of people:

1) People who have no idea what they are talking about
2) Affluent people
3) People who fly a lot for work

The story being that (2) and (3) aren’t price-sensitive and other critics of deregulation are just know-nothings or whiners (or both).

Not so fast.

The conceptually correct comparison is not with 1978 airfares, but rather with whatever current airfares would be under a reasonable forecast of airfares absent deregulation but with whatever other changes would have happened anyway. Recall, Robert William Fogel was given his share of the Bank of Sweden prize in significant part for cementing this “counterfactual” (or ceteris paribus) analysis as the standard methodology of economic history.

This is a non-trivial matter for airfares as deregulation was implemented during an oil price spike, and its subsequent golden age to roughly 9/11/01 was a period marked by a very long decline in the real price of oil — not to mention cost-reducing technological change from sources such as cockpit automation and the deployment of high-bypass-ratio turbofans to the single-aisle airliners that are the workhorses of the U.S. domestic fleet. So not all of the secular airfare decline (or what’s left of it) is properly attributed to deregulation.

One source [PDF] suggests that deregulation accounted for around 60% of the observed fare-level decline to 1993 using the old CAB pricing formula as the benchmark, and that 30% of flyers paid higher fares under deregulation. Don’t get me wrong, this isn’t bad, and the liberal in me can’t help but say that taking money from airline investors and corporate travel budgets and turning it into air transportation for the middle- to upper-middle classes beats many other deregulatory outcomes (at until the system blows up). Still, it isn’t Pareto-improving, and by the standards of, say, repeal of the upper-income Bush tax cuts, the disaffected class is pretty big, though. We aren’t just talking about the “affluent” and ultra-frequent flyers.

Moreover, would-be Fogels looking for an icon-smashing result that may also be true could try to figure out whether modern systems of rate regulation would perform better than the late CAB. So once we consider what Barry Ritholtz amusingly calls “dedonics” (*) issues like service levels and qualities, the need to keep the industry somewhat stable until alternative modes of fast intercity travel are (re)developed, and so on, I submit that the true benefits of deregulation are at least a matter for careful study.

(*) It’s amusing even though it isn’t true that all quality adjustments in CPI are for quality improvements.

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OCC and Model Validation Part 2

FIRE reports:

“The securities industry is an economic powerhouse that continues to strengthen the U.S. economy,” said Securities Industry Association President Marc Lackritz. “SIA data shows that last year alone, we raised a record $3.2 trillion of capital for American business and nearly $14 trillion over the past five, underscoring our substantial contribution to overall growth in the U.S. economy.”

Also fatbear in comments earlier offers this link by Paul Krugman on the OCC and Office for Thrift Supervision.

Just go read Krugman from right before Xmas last year:
Consider the press conference held on June 3, 2003 — just about the time subprime lending was starting to go wild — to announce a new initiative aimed at reducing the regulatory burden on banks. Representatives of four of the five government agencies responsible for financial supervision used tree shears to attack a stack of paper representing bank regulations. The fifth representative, James Gilleran of the Office of Thrift Supervision, wielded a chainsaw.
Also in attendance were representatives of financial industry trade associations, which had been lobbying for deregulation. As far as I can tell from press reports, there were no representatives of consumer interests on the scene.
Two months after that event the Office of the Comptroller of the Currency, one of the tree-shears-wielding agencies, moved to exempt national banks from state regulations that protect consumers against predatory lending. If, say, New York State wanted to protect its own residents — well, sorry, that wasn’t allowed.
One thing to remember is the the state subsidiaries of the national banks, many of the them state based mortgage companies, were also exempt from state regulation.

Another thing to remember is the lack of resources to even monitor the new market, as Consumers Union points out.

Even if the OCC had a desire to effectively regulate the consumer practices of national banks, it lacks the resources to do so. According to the OCC’s own statistics, there are about 2,200 nationally chartered banks, with total assets of $3.5 trillion. The entire staff of the OCC is less than 3,000, which is less than one person per $1 billion in bank assets. Even if the OCC did vigorously develop new consumer protection regulations, which it does not, the OCC does not have enough staff to detect and prevent problems for consumers at big and small nationally chartered banks throughout the U.S. is the resources of the agency as they took on added responsibilities…”

The GAO weighed in rather obliquely on the issue.

We shall see how it all shakes out, but remember, do not exclude externalities, which our economic models exclude from serious price adjusting. But that is a different story for 19th century philosophy. It just means we do not even try to validate the model in the 21st century. Whatever happened to innovation in economic philosophy?

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Spitzer and the OCC – Who you gonna call?

OCC press release

WASHINGTON Feb. 14, 2008 — Comptroller of the Currency John C. Dugan issued the following statement today, responding to comments from New York Governor Eliot Spitzer:
Almost everyone who has paid attention to the subprime lending crisis has concluded that OCC-regulated national banks were not the problem. Instead, the worst abuses came from loans originated by state-licensed mortgage brokers and lenders that are exclusively the responsibility of state regulators.
However, comments from today assert that the OCC and national bank preemption have prevented the states from taking action against predatory or abusive lenders. That’s just plain wrong.
The OCC extensively regulates the activities of national banks, including mortgage lending. The OCC established strong protections against predatory lending practices years ago, and has applied those standards through examinations of every national bank. As a result, predatory mortgage lenders have avoided national banks like the plague. The abuses consumers have complained about most — such as loan flipping and equity stripping — are not tolerated in the national banking system. And the looser lending practices of the subprime market simply have not gravitated to national banks: They originated just 10% of subprime loans in 2006, when underwriting standards were weakest, and delinquency rates on those loans are well below the national average.
Nothing the OCC has done has prevented the states from regulating and preventing abuses among the lenders that they license – lenders that are the source of most of today’s problems. The states have ample authority – as well as clear responsibility – to set standards for these lenders and enforce them. It defies logic to argue that preemption was an impediment. National banks are bound to obey the strict standards enforced by the OCC everywhere they operate – even in states that had far less rigorous standards. The states should have applied equally rigorous standards to the non-bank lenders that were responsible for the bulk of the problems.

If a little worried while everyone passes the buck so to speak, you might want to go here to check on who is in your wallet!

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Science and regulation

The Union of Concerned Scientists has just published a paper on science and governmental regulatory bodies and policy advisory panels.

The United States has enjoyed prosperity and health in large part because of its strong and sustained commitment to independent science. As the nation facesnew challenges at home and growing competitiveness abroad, the need for a robust federal scientific enterprise remains critical. Unfortunately,an epidemic of political interference in federal science threatens this legacy, promising serious and wide-ranging consequences.Political interference in science has penetrated deeply into the culture and practices of federal agencies. These systemic problems cannot be resolved quickly or simply. Leadership and an unwavering commitment to scientific integrity from our next president, continued oversight from the legislative branch, and the persistent and energetic engagement of many different stakeholders are critical. The balance of poweramong the three branches of government should be restored, to enable each to playits part in keeping science independent.This interference in science threatens ournation’s ability to respond to complex challenges to public health, the environment, and national security. It risks demoralizing the federal scientific workforce and raises the possibility of lastingharm to the federal scientific enterprise. Most important, it betrays public trust in our government and undermines the democratic principles upon which this nation was founded.

Update: MG sends additional links here and here.

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