The Baseline Scenario

By James Kwak

A couple of weeks ago, Yves Smith picked up on the story that the TARP Special Inspector General is investigating suspicious trades in connection with the Public-Private Investment Program. When PPIP was announced almost a year ago, there was widespread speculation about how banks and other private investors could take advantage of the program to unload toxic securities onto taxpayers (technically speaking, onto investment funds containing some private money, some public money, and a lot of non-recourse financing from the government). That story more or less faded away because PPIP never really amounted to much; banks apparently decided they were better off sitting on their toxic assets, counting on favorable accounting rules and regulatory forbearance, instead of selling them.

Here’s the relevant section from the SIG-TARP report (p. 141):

“The PPIF management company in question operates both a PPIF and one or more non-PPIF funds that invest in similar securities (i.e., mortgage-backed securities (‘MBS’)). In the case of this fund management company, the same person is the portfolio manager for both the PPIF and the non-PPIF fund. In late October, the portfolio manager directed that a particular MBS from the non-PPIF fund be sold after the security — in this case a residential MBS — had been downgraded by a rating agency. According to the company, multiple bids were received, and a quantity of the security was sold to a dealer. Within minutes of the sale, however, the same portfolio manager purchased, for the PPIF, the same amount of the same security from the dealer at a slightly higher price. Later in the day, the portfolio manager bought more of the security for the PPIF from the dealer at the original price.

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American Banker is running an article by Bill Wade (subscription required, but free trial available), a former banker . . . explaining why the banking industry should be in favor of a Consumer Financial Protection Agency. Wade repeats many of the arguments made by consumer advocates such as Elizabeth Warren:

“A Consumer Financial Protection Agency can be the vehicle that restores consumer confidence in our products, our services and our institutions. The customers we serve will always need credit and other banking products . . . What they want is simple, clearly explained products and the comfort that someone is looking out for their best interests when financial products are developed and marketed. . . .

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By James Kwak

Ted K. points out (and comments on) Stephanie Fitch’s article in Forbes on Wal-Mart’s 401(k) plan. The crux of the matter is that Wal-Mart seems to have done a lousy job creating a good 401(k) plan for its employees. Until recently, it had ten funds, only two of which were index funds; the other, actively managed funds all had high expense ratios (the ones Fitch quotes are above 1 percent).* More shockingly, the expense ratios paid by plan participants were the same as the expense ratios paid by individual investors in those mutual funds. It didn’t even pool its employees’ money together to get institutional investor rates. The irony, of course, is that Wal-Mart is the world’s best, most powerful negotiator when it comes to getting low prices for the stuff it sells, yet it exercised no negotiating power in getting low prices for its employees — even though it had $10 billion in assets to swing like a club.

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By James Kwak

Ezra Klein focuses on this passage from  John Judis’s review of regulatory policy in the Bush and Obama years:

“Bush stopped weighing the costs and benefits of deregulation and issued an executive order allowing OIRA to intercede before agencies made their initial proposals, thereby providing industry lobbyists with a back door to block regulations. OIRA also instructed agencies to discount the value of future lives in constructing cost-benefit analyses by 7 percent a year, so that 100 lives in 50 years would only be worth 3.39 current lives. (Such logic can be used by conservatives to argue that the present cost of regulating greenhouse gases outweighs the future benefits of stopping climate change.)”

There is a normative argument against valuing lives in cost-benefit analysis; some people think it’s just wrong. I don’t agree with that; I think that in practice, you either value lives implicitly or you do it explicitly, and so you might as well do it explicitly. And for what it’s worth, the practice of valuing lives is firmly entrenched in our legal system; the amount you pay in damages if you kill someone negligently depends primarily on that person’s future earning potential, and also on the monetary value of the benefits that other people gained from his or her life.

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By James Kwak

Not the day they launched Google Buzz, but the day that Google Buzz product manager Todd Jackson responded to legitimate privacy concerns by writing this piece of meaningless corporate PR spin worthy of, well, any other company out there: “Google remains completely committed to freedom of expression and to privacy, and we have a strong track record of protecting both.”

By James Kwak

Broken record alert: Another post on the deficit ahead. Wouldn’t you rather look at funny pictures of cats? Why do I keep writing these? (Hint: The other side keeps writing them.) You have been warned.

Greg Mankiw, noted economics textbook author and former chair of Bush 43′s Council of Economic Advisers, has an op-ed on the deficit that is relatively sensible by the standards of recent debate. He points out that modest deficits can be sustainable, that taxes will probably need to go up, and that a value-added tax is a plausible option. He also points out that Obama’s projections are based on optimistic economic forecasts that very plausibly may not pan out, and that Obama’s main deficit-reduction strategy is to kick the problem over to a deficit-reduction commission, which are valid criticisms.

Unfortunately, his bottom line seems to be throwing more rocks at President Obama, under the general Republican principle that since he’s the president, everything is his fault:

“But unless the president revises his spending plans substantially, he will have no choice but to find some major source of government revenue. Ms. Pelosi’s suggestion of a VAT may be the best of a bunch of bad alternatives. Unfortunately, in this new era of responsibility, the president is not ready to face up to the long-term fiscal challenge.”

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By Simon Johnson

As controller of the euro, the European Central Bank (ECB) wields great power in Europe and has a wide global reach.  The race to become the ECB’s next president – with a term that starts next year – has been intense and hard fought.  The final selection is down to two men: the ultra hawkish Axel Weber, head of the Bundesbank, who sees inflation dangers at every turn; and the relatively more moderate Mario Draghi, head of the Bank of Italy, chair of the Financial Stability Board, and experienced international economic diplomat. 

Unfortunately for those hoping that Draghi could still prevail, he is also formerly senior management at Goldman Sachs and serious questions are emerging regarding what he knew and did during Goldman’s alleged “let’s help Greece circumvent EU budget rules” phase in the early 2000s.

Specifically, Draghi joined Goldman Sachs in January 2002, after a distinguished public service career – including 10 years in a key position (Director General) at the Italian Treasury.  His formal titles were Managing Director, Vice Chairman of Goldman Sachs International, and member of the “Group’s Commitment Committee”; his job, according to Goldman’s press release, was to “help the firm develop and execute business with major European corporations and with governments and government agencies worldwide.”

Did this involve Greece? Read the rest of this entry »

By James Kwak

Jeff Sachs:

“Policy paralysis around the US federal budget may be playing the biggest role of all in America’s incipient governance crisis. The US public is rabidly opposed to paying higher taxes, yet the trend level of taxation (at around 18% of national income) is not sufficient to pay for the core functions of government. As a result, the US government now fails to provide adequately for basic public services such as modern infrastructure (fast rail, improved waste treatment, broadband), renewable energy to fight climate change, decent schools, and health-care financing for those who cannot afford it.

“Powerful resistance to higher taxes, coupled with a growing list of urgent unmet needs, has led to chronic under-performance by the US government and an increasingly dangerous level of budget deficits and government debt.”

That’s part of a longer article, “Obama in Chains,” on the challenges presented by political polarization. Sachs seems generally sympathetic to Obama, although he criticizes him for his pledge of no new taxes on the “middle class” and ruling out a value-added tax.

Unfortunately, Sachs isn’t long on practical solutions: he prescribes an end to the Iraq and Afghanistan wars, increased taxes, and lobbying reforms. But that’s in part because the problem is hard to solve.

 By Simon Johnson

Otmar Issing, a former senior European Central Bank official, came out strongly today against any kind of rescue package for Greece (FT op ed; Bloomberg report).

He hits hard to the core of the issue:

“Financial assistance for countries that violated the terms of their participation in EMU [European Monetary Union, i.e., the eurozone] would be a major blow for the credibility of the whole framework.”

Unfortunately, Mr. Issing’s article (and the subsequent coverage) neglected to mention that he is an adviser to Goldman Sachs (see also the FT archives).  This is a major issue for three reasons. Read the rest of this entry »

There has been a lot of talk about the financial crisis over the past year and a half, and I obviously think that will remain an important subject, at least until we have a truly reformed financial system. Preventing the next financial crisis should be high on our society’s priority list. But as the months and years wear on, I suspect we will see more articles like Don Peck’s recent 8,000-word article in The Atlantic, “How a New Jobless Era Will Transform America.”

Peck’s article is not about what caused the recent crash and recession, but what its societal consequences will be. And the article is almost unremittingly bleak. Even before 2008, we had already lived through a decade of stagnant median income and sluggish job growth; the recession pushed some unemployment levels, such as the underemployment rate (people out of work, working part-time for economic reasons, or too discouraged to look for work) to levels not seen since the Great Depression. It’s not particularly clear where growth will come from, as manufacturing remains in decline, services are becoming increasingly outsourceable, and other countries take the lead in the most plausible major new industry (alternative energy). According to Nobel laureate Edmund Phelps, “the new floor for unemployment is likely to be between 6.5 percent and 7.5 percent (for several reasons, including “a financial industry that for a generation has focused its talent and resources not on funding business innovation, but on proprietary trading, regulatory arbitrage, and arcane financial engineering”).

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At 9:30pm on Sunday, September 21, 2008, Goldman Sachs was saved from imminent collapse by the announcement that the Federal Reserve would allow it to become a bank holding company – implying unfettered access to borrowing from the Fed and other forms of implicit government support, all of which subsequently proved most beneficial.  Officials allowed Goldman to make such an unprecedented conversion in the name of global financial stability.  (The blow-by-blow account is in Andrew Ross Sorkin’s Too Big To Fail; this is confirmed in all substantial detail by Hank Paulson’s memoir.)

We now learn – from Der Spiegel last week and today’s NYT – that Goldman Sachs has not only helped or encouraged some European governments to hide a large part of their debts, but it also endeavored to do so for Greece as recently as last November.  These actions are fundamentally destabilizing to the global financial system, as they undermine: the eurozone area; all attempts to bring greater transparency to government accounting; and the most basic principles that underlie well-functioning markets.  When the data are all lies, the outcomes are all bad – see the subprime mortgage crisis for further detail.

A single rogue trader can bring down a bank – remember the case of Barings.  But a single rogue bank can bring down the world’s financial system.

Goldman will dismiss this as “business as usual” and, to be sure, a few phone calls around Washington will help ensure that Goldman’s primary supervisor – now the Fed – looks the other way.

But the affair is now out of Ben Bernanke’s hands, and quite far from people who are easily swayed by the White House.  It goes immediately to the European Commission, which has jurisdiction over eurozone budget issues.  Faced with enormous pressure from those eurozone countries now on the hook for saving Greece, the Commission will surely launch a special audit of Goldman and all its European clients. Read the rest of this entry »

By Simon Johnson

Already facing serious difficulties – both internal and with regard to its EU partners (see our longer essay in Saturday’s WSJ) – Greece’s predicament just became substantially worse.

Speaking on national television this evening, the Greek Prime Minister – George Papandreou – lashed out at the European Union (presumably meaning mostly Germany) for creating a “psychology of looming collapse which could be self-fulfilling.”  He also implied that Greece was being treated, in some senses, like a “lab animal.”

Without doubt, EU engagement with Greece over the past week or three has not be well-managed – and the pseudo-announcement of support after the summit on Thursday was a complete amateur hour. Read the rest of this entry »

By James Kwak

Some law school friends and I had trouble figuring this out two nights ago when Buzz was apparently rolled out, so I thought this might be helpful. I think I got it right, but no guarantees. Note that this post is about including your profile in public search results; there is another more important privacy issue discussed here.

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By James Kwak

Here are the results of the latest New York Times/CBS News poll. (Here’s the Times article.)  A few observations:

1. When asked what the most important problem facing the country is (question 4), here are the winners:

• Jobs: 27%
• Economy: 25%
• Other: 16%
• Health Care: 13%
• Budget Deficit: 4%
• DK/NA: 4%

This shows the divide between the country, which cares about jobs, and the Washington punditocracy, which cares (or professes to care) about the deficit. Now, I’m not saying that something’s actual importance is a function of its perceived importance. Governing requires doing what’s best for the country, whether or not people realize it. But neither is it true to say that Americans are overwhelmingly concerned about the deficit. They’re not. And looking at the numbers, you would think most would favor increased spending or lower taxes to create jobs. Later on, though, when given that explicit question, we find a much smaller margin (47-45) in favor of jobs. This, of course, is largely an artifact of question design, so you can argue about which design is more relevant depending on what question you’re trying to answer.

2. On questions 6-10, Obama gets positive marks for foreign policy and terrorism, but negative marks for the economy, health care, and the deficit. This is what you would expect for a Republican president, not a Democratic one (with the possible exception of the deficit question, since Democrats are still seen as big spenders, the past two administrations notwithstanding). Probably the most likely explanation is that the last three are simply things that people are unhappy about in general; also, the economy and health care are issues where Obama faces disapproval both from the right and the left, for opposite reasons. Basically, we have a centrist president.

3. Only 8% of Americans think that “most members of Congress” deserve re-election. This, it seems to me, is one of those survey results that is inherently self-defeating. All of the Republican base should be happy with Republican Congressmen for successfully fighting off the Obama agenda. Many though not all Democrats no doubt blame the last year on the Republicans and should be reasonably happy with their Congressmen. And we know the vast majority of members of the House will be returned to office. So all this means is that people have an unfocused antipathy toward Congress as an institution.

4. When you ask if “homosexuals” should be allowed to serve in the military (page 24), people are in favor 59-29. When you ask about “gay men and lesbians,” you get 70-19. (If you follow up by asking about serving “openly,” the margin falls to 44-41 and 58-28, respectively.) Words matter.

By Simon Johnson

Yesterday’s announcement of European “support” for Greece was badly bungled. 

The Global Crisis Fighter’s Guide to the Galaxy clearly states that when “markets overreact… policy needs to overreact as well” (see Larry Summers’s 2000 Ely Lecture to the American Economic Assocation, American Economic Review, vol. 90, no. 2, p.11; no free link available – and yes, I know that the White House doesn’t always follow its own playbook). 

This definitely does not mean: Vague promises to provide some support in an unspecified fashion in return for some policy actions to be specified later.

Irrespective of your view on how much fiscal adjustment Greece needs vs. how much German taxpayer money it deserves (or can realistically expect), you need a different approach – much more concrete and detailed.  The only good news yesterday was that the IMF will play a slightly greater role than previously expected, but even this change was a nuance missed by everyone – and who knows where it will lead.

If the euro continues to depreciate as it has so far today, the G7 will need to weigh in. Read the rest of this entry »