Category Archives: Commentary

Party of Higher Debts

Posted on February 24, 2012 by | 17 Comments

By James Kwak

The Committee for a Responsible Budget recently released an analysis of the budgetary proposals of the four remaining Republican presidential candidates (hat tip Ezra Klein, who shows the key graph). In short, all of the candidates propose to increase the national debt by massive amounts relative to current law, which includes the expiration of the Bush tax cuts at the end of this year.

CFRB compares the candidates’ plans to a “realistic” baseline that assumes the Bush tax cuts are made permanent and the automatic sequesters required by the Budget Control Act of 2011 are waived, among other things. Relative to that extremely pessimistic baseline, Santorum and Gingrich still want huge increases to the national debt; only Paul’s proposals would reduce it. Romney’s proposals would have little impact, but that was before his latest attempt to pander to the base: an across-the-board, 20 percent reduction in income tax rates.

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Why Won’t The Federal Reserve Board Talk To Financial Reform Advocates?

Posted on February 23, 2012 by | 28 Comments

By Simon Johnson

The Federal Reserve has great power in modern American society, including the ability to move the economy and, at least indirectly, to create or destroy fortunes. Its powers operate in two ways: through control over monetary policy, meaning interest rates and credit conditions more broadly, and through its influence over how the financial system is regulated generally and how specific large banks are treated.

The secrecy of our central bank has long been a source of controversy. In line with changes at central banks in other countries over recent decades, the Fed’s chairman, Ben Bernanke, has pushed for more transparency regarding how individual members of the Federal Open Market Committee view the economy – and thus how they are thinking about the future course of interest rates (and the Fed keeps us posted). This is a commendable change, helping people throughout the economy understand what the Fed is trying to do and why.

Under pressure from both left and right – for example, in the unlikely alliance of Senator Bernie Sanders of Vermont and Representative Ron Paul of Texas – the Fed has also, after the fact, disclosed more of its actions during the recent financial crisis.

But in terms of its process for determining financial-sector regulation, the Federal Reserve – at least at the level of the Board of Governors in Washington – is moving in the wrong direction. Continue reading →

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Facebook’s Targeted Advertising

Posted on February 18, 2012 by | 23 Comments

By James Kwak

This is the best Facebook can do with the information it has about me?

Admittedly, I don’t use Facebook that much—but in that respect I’m probably like the vast majority of Facebook users.

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Health-Care Costs and Climate Change

Posted on February 17, 2012 by | 48 Comments

By James Kwak

That’s the average global temperature from 1998 through 2008, according to NASA. This, of course, is what enabled George Will to write, in 2009, “according to the U.N. World Meteorological Organization, there has been no recorded global warming for more than a decade.”

Of course, George Will is just a run-of-the-mill climate change denier with a gift for mis-using statistics. In this case, he was probably citing a World Meteorological Organization study that said, “The long-term upward trend of global warming, mostly driven by greenhouse gas emissions, is continuing. . . . The decade from 1998 to 2007 has been the warmest on record.” And here’s the long-term picture, also from NASA:

You all know this, so why am I bringing it up?

Well, look at this, from J. D. Kleinke of AEI in The Wall Street Journal:

Those are annual percentage changes in nominal terms, so his point is that annual increases are going down. But what does the long term look like?

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Denial or Principle?

Posted on February 17, 2012 by | 37 Comments

By James Kwak

I wanted to make a belated return to Binyamin Appelbaum and Robert Gebeloff’s article on reluctant safety net beneficiaries.  Earlier this week I argued that their framing of an expanding safety net that has spread from the poor to the middle class is wrong, but otherwise the themes they discuss are very important.

Many liberals like to point out the apparent hypocrisy of the people featured in the article, who rail against big government, demand lower spending, and simultaneously rake in benefits from the federal government that they hate. The central figure in the article, Ki Gulbranson, works hard yet has barely enough money to support his family, even with the earned income tax credit* and reduced-price school lunches for his kids. His conclusion: the country is going bankrupt, but people don’t make enough money to pay more taxes, so we should have smaller government. He would rather go without his current benefits—but he can’t imagine retiring without Medicare and Social Security.

I don’t think Gulbranson is a hypocrite at all. I don’t think taking a benefit you don’t think should exist makes you a hypocrite, just like I don’t think Warren Buffett should voluntarily pay higher taxes. I think his position is one part magical thinking and one part principle.

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What Expanded Safety Net?

Posted on February 13, 2012 by | 48 Comments

By James Kwak

In general, I think Binyamin Appelbaum and Robert Gebeloff’s article on how the same people oppose government handouts and take government handouts is very good. But I think their framing buys into a piece of conventional wisdom that just isn’t true.

Here it is, without any shortening (but emphasis is mine):

“The problem by now is familiar to most. Politicians have expanded the safety net without a commensurate increase in revenues, a primary reason for the government’s annual deficits and mushrooming debt. In 2000, federal and state governments spent about 37 cents on the safety net from every dollar they collected in revenue, according to a New York Times analysis. A decade later, after one Medicare expansion, two recessions and three rounds of tax cuts, spending on the safety net consumed nearly 66 cents of every dollar of revenue.

“The recent recession increased dependence on government, and stronger economic growth would reduce demand for programs like unemployment benefits. But the long-term trend is clear. Over the next 25 years, as the population ages and medical costs climb, the budget office projects that benefits programs will grow faster than any other part of government, driving the federal debt to dangerous heights.”

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Reports of Wall Street’s Death

Posted on February 13, 2012 by | 23 Comments

By James Kwak

Gabriel Sherman wrote what I would call a hopeful article last week called “The End of Wall Street As They Knew It.” The basic premise is that the end of the credit bubble and the advent of Dodd-Frank mean lower profits, more boring businesses, and smaller bonuses on Wall Street—permanently (or at least for the foreseeable future). Sherman also says that the former masters of the universe are now engaged in “soul-searching”: “many acknowledge that the bubble­-bust-bubble seesaw of the past decades isn’t the natural order of capitalism—and that the compensation arrangements just may have been a bit out of whack.”

Call me a skeptic, but I’m not convinced. For one thing, there are few people quoted in the article who actually seem to be engaged in anything that might be called soul-searching (as opposed to complaining—like the now-clichéd banker who watches his spending carefully but has a girlfriend who likes to eat out). The story’s featured voices are ones that are not on Wall Street and have been critical of it for a long time, such as Paul Volcker and John Bogle. Another example of “self-criticism” comes from Bill Gross—but’s he’s on the buy side, not Wall Street.

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Why Do Investors Pay Lower Taxes Than Workers?

Posted on February 10, 2012 by | 22 Comments

By James Kwak

I don’t know, but we do it anyway. Yesterday’s Atlantic column discusses the arguments for and against.

Of course, the last word on our capital gains tax policy comes from Peter Steiner.

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Mark Zuckerberg and Tax Policy

Posted on February 9, 2012 by | 15 Comments

By James Kwak

Some people have been claiming that Marc Zuckerberg is subject to a high tax rate, with Robert Frank even claiming,

“Mr. Zuckerberg’s tax bill will also provide an important counter-point to the notion that the rich pay lower tax rates than the rest of America. That may be true for professional investors and private-equity chiefs, but not for dot-commers and many entrepreneurs.”

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Stock or Cash?

Posted on February 9, 2012 by | 6 Comments

By James Kwak

I’m sure many of you saw the article featuring David Choe, the artist who painted the walls of Facebook’s first offices and received stock that now could be worth $200 million. Nice story. I was thinking, though: why was Facebook paying its vendors with stock?

I understand what you pay your early employees with stock: (a) you have to in Silicon Valley and (b) you want their fortunes aligned with those of the company. Outside board members also will often demand stock. But in most circumstances, you should pay your vendors with cash.

Giving a vendor stock instead of cash is equivalent to raising capital from that vendor—at the existing valuation. When you’re an early-stage startup, you want to raise as little money as possible, at as high a valuation as possible—because the whole point of the startup is that it should be getting much more valuable over time. There are tactical considerations, like not letting your bank balance get too low (because then your VCs will have too much negotiating power). But in general, you want to delay raising more capital until you reach some milestone that will boost your valuation significantly.

Obviously, things turned out just fine for Facebook. But it doesn’t seem like the smartest business move.

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Mean-Spirited, Bad Economics

Posted on February 9, 2012 by | 32 Comments

By Simon Johnson

The principle behind unemployment insurance is simple. Since the 1930s, employers – and in some states employees — have paid insurance premiums (in the form of payroll taxes, levied on wages) to the government. If people are laid off through no fault of their own, they can claim this insurance – just like you file a claim on your homeowner’s or renter’s policy if your home burns down.

Fire insurance is mostly sold by the private sector; unemployment insurance is “sold” by the government – because the private sector never performed this role adequately. The original legislative intent, reaffirmed over the years, is clear: Help people to help themselves in the face of shocks beyond their control.

But the severity and depth of our current recession raise an issue on a scale that we have literally not had to confront since the 1930s. What should we do when large numbers of people run out of standard unemployment benefits, much of which are provided at the state level, but still cannot find a job? At the moment, the federal government steps in to provide extended benefits.

In negotiations currently under way, House Republicans propose to cut back dramatically on these benefits, asserting that this will push people back to work and speed the recovery. Does this make sense, or is it bad economics, as well as being mean-spirited? Continue reading →

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Facebook and Mark Zuckerberg

Posted on February 2, 2012 by | 49 Comments

By James Kwak

I must admit that I find Facebook’s impending glory a bit awkward, as it touches on two themes I have written about previously. One is that I just don’t like Facebook. And, I confess, I don’t really understand it. I sort of understand why people like it, but I don’t really understand why it’s going to be the most valuable technology company on the planet in a few years. I don’t understand why anyone would ever click on an ad within Facebook (or why anyone would even see them, since you could just use AdBlock), since I don’t understand why you would want your shopping choices to be dictated by who is willing to spend the most money for your attention. (When I want to buy something, I prefer using organic Google search results, since at least they aren’t affected by ad spending.) Maybe I’m just too old.

At the same time, it’s pretty clear by now that Facebook does whatever it is that it does pretty well. $1 billion in annual profits is impressive, and it’s also considered a pretty good place to work. And who is the CEO of Facebook? A twenty-seven-year-old kid with no other work experience. So while, as a customer (“user,” in software industry parlance), I’m less than thrilled, I can’t deny that Zuckerberg is doing something right as a CEO. Which is further evidence that the myth of the experienced CEO and the cult of the generalist manager are just a myth and a cult, as I’ve written about before. According to Reuters, Zuckerberg will soon be the fourth-richest person in America, after Bill Gates, Warren Buffett, and Larry Ellison. Which means that, like Gates and Ellison, it’s a good thing he never let anyone convince him that his company needed an experienced CEO.

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Private Equity and “Job Creation”

Posted on February 2, 2012 by | 43 Comments

By James Kwak

The phrase “job creation” always makes me a little queasy. The personal computer has probably contributed to the elimination of tens of millions of clerical jobs, yet I think most of us feel that computers are a good thing: they make people more productive, meaning more goods and services for everyone . . . and hopefully the people who lost those jobs will find work doing something else. In boom periods, like the 1990s, it seems to work, at least for most people, but I doubt that there’s any proof that productivity-increasing innovation always increases employment. But this line of thinking quickly leads to questions like whether the invention of the automatic toll booth is a good thing (because it eliminates what must be a pretty unpleasant job) or a bad thing (because it results in the layoff of people who may not have good alternatives), and those questions are above my pay grade.

Anyway, job creation these days usually refers to growing companies, making stuff people want, which tend to hire new workers—leaving aside the question of whether the products they make are causing other people to lose their jobs. This is the kind of job creation that Mitt Romney (and the private equity industry, at least publicly) wants to be associated with.

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What Did the SEC Really Do in 2004?

Posted on January 30, 2012 by | 14 Comments

By James Kwak

Andrew Lo’s review of twenty-one financial crisis books has been getting a fair amount of attention, including a recent mention in The Economist. Simply reading twenty-one books about the financial crisis is a demonstration of stamina that exceeds mine. I should also say at this point that I have no arguments with Lo’s description of 13 Bankers.

Lo’s main point, which he makes near the end of his article, is that it is important to get the facts straight. Too often people accept and repeat other people’s assertions—especially when they are published in reputable sources, and especially especially when those assertions back up their preexisting beliefs. This is a sentiment with which I could not agree more. One of the things I was struck by when writing 13 Bankers was learning that nonfiction books are not routinely fact-checked (Simon and I hire and pay for fact-checkers ourselves). As technology and the Internet produce a vast increase in the amount of writing on any particular subject, the base of actual facts on which all that writing rests remains the same (or even diminishes, as newspapers cut back on their staffs of journalists).

I’m not entirely convinced by Lo’s example, however. He focuses on a 2004 rule change by the SEC. According to Lo, in 2008, Lee Pickard claimed that “a rule change by the SEC in 2004 allowed broker-dealers to greatly increase their leverage, contributing to the financial crisis” (p. 33). That is Lo’s summary, not Pickard’s original. This claim was picked up by other outlets, notably The New York Times, and combined with the observation that investment bank leverage ratios increased from 2004 to 2007, leading to the belief that the SEC’s rule change was a crucial factor behind the fragility of the financial system and hence the crisis.

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What Is Private Equity?

Posted on January 27, 2012 by | 65 Comments

By James Kwak

Recently, a lot of the political debate has been about whether private equity—and by extension Mitt Romney—is good or bad. The argument on one side is that private equity firms are vultures who destroy firms to make money; on the other, that private equity is just capitalism at work, creates value, and creates jobs.

A private equity firm is an asset management company. It creates investment funds that raise most of their money from outside investors (pension funds, insurance companies, rich people, etc.), and then manages those funds. As opposed to a mutual fund, however, instead of buying individual stocks, these funds usually make large investments either in private companies or in public companies that they “take private” (more on that in a minute). While mutual funds and most hedge funds try to make money by guessing where securities prices will go in the future, private equity funds try to make money by taking control of companies and actively managing them. (There is a bit of a spectrum here, since mutual funds and hedge funds can exercise pressure on company management and private equity funds do take minority positions, but that’s the ideal-typical distinction.)

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