Who Cares About the Clinton Foundation?

By James Kwak

Imagine that while George W. Bush was governor of Texas and president of the United States, various people and companies decided to write him checks for hundreds of thousands of dollars, just because they thought he was a great guy. Those people and companies, just coincidentally, happened to have interests that were affected by the policies of Texas and the United States. But when he thanked them for their money, Bush never promised to do anything in particular for them. You would be suspicious, right?

Now, that’s roughly what has been happening with the Clinton Foundation. Various people and companies have been writing checks for millions of dollars to the Foundation during the same time that Hillary Clinton was secretary of state and, following that, the most likely next president of the United States—a title she has held since the day Barack Obama’s second term began. (The Clintons finally decided to scale back the Foundation earlier this week.)

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That “Massive New Study” Says Nothing About Economic Anxiety

By James Kwak

Last week, the Washington Post summarized a draft paper by Jonathan Rothwell of Gallup on the demographic correlates of support for Donald Trump. As various people have noted, the headline was a bit over-the-top:

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The “widespread theory,” of course, is the idea that Trump supporters are, at least in part, motivated by economic anxiety—an idea that sophisticated columnists like Matt Yglesias like to make fun of, as I discussed recently.

The article itself, as many people have noted, is considerably more circumspect than its headline. (Note to those who don’t know: Headlines are written by editors, not the people on the byline.) This is the summary near the top of the article:

According to this new analysis, those who view Trump favorably have not been disproportionately affected by foreign trade or immigration, compared with people with unfavorable views of the Republican presidential nominee. The results suggest that his supporters, on average, do not have lower incomes than other Americans, nor are they more likely to be unemployed. [Actually, according to the paper, they are more likely to be unemployed, but that’s not particularly important.]

Yet while Trump’s supporters might be comparatively well off themselves, they come from places where their neighbors endure other forms of hardship. In their communities, white residents are dying younger, and it is harder for young people who grow up poor to get ahead.

The paper itself is more circumspect still. Here’s an excerpt:

Higher household income predicts a greater likelihood of Trump support overall and among whites, though not among white non-Hispanic Republicans. In other words, compared to all non-supporters or even other whites, Trump supporters earn more than non-supporters, conditional on these factors, but this is partly because Republicans, in general, earn higher incomes, and the difference is no longer significant when restricted to this group. …

On the other hand, workers in blue collar occupations (defined as production, construction, installation, maintenance, and repair, or transportation) are far more likely to support Trump, as are those with less education. … Since blue collar and less educated workers have faced greater economic distress in recent years, this provides some evidence that economic hardship and lower-socio- economic status boost Trump’s popularity.

Before we go further, let’s make sure we understand exactly what this paper does and does not show. For the most part, it’s based on a probit regression of the likelihood a person will support Trump (that’s the dependent, or left-side variable) on a long list of variables for that person (employment status, religion, etc.) and a long list of variables measured for the area in which that person lives (share with BA degree, share of manufacturing jobs, etc.). For each variable, there is a regression coefficient that shows the impact of that variable on the likelihood of supporting Trump, and then an indication of whether that variable is statistically significant. For example, in model 1, looking at all people, being unemployed increases the chances that someone will support Trump by about 5%, which is significant at the 99% level.

There are two reasons why this paper says less than readers might think. The first is that many of the right-side (explanatory) variables are highly correlated. When you have highly correlated explanatory variables, you can get wildly inaccurate results. Let’s say you are trying to figure out what factors determine the number of words in a child’s vocabulary. In your model, you include age, since kids learn more words as they get older. You also include grade in school, since they learn more words the longer they spend in school. Do you see the problem? Age and grade are almost perfectly correlated; you’re basically using two variables when there is only one in real life—so the actual results of your model will be highly volatile. You might find that age is significant but not grade; or vice-versa; or that both are significant. If both are significant, you might conclude that both have a positive impact on vocabulary: that is, fourth graders know more words than third graders, but within any grade, older kids know more words than younger kids. That sounds plausible—but it would be a mistake. When explanatory variables are highly correlated, results are extremely sensitive to outliers. If you have one older kid in fourth grade who knows lots of words, you could get a positive coefficient on age; but if that one kid doesn’t know very many words, you could get a negative coefficient.

How does this apply to this paper? The individual explanatory variables include, among other things: employment status (e.g., self-employed); religion; “works for government”; sex; marital status; “works in blue collar occupation”; union member, non-government; race and ethnicity; highest degree; and household income. The regional explanatory variables include: share of college graduates; share of manufacturing jobs; median income; share of white people; and white mortality rate. All of those variables are obviously correlated with income, particularly highest degree. So we have the same problem described above—too many variables for the amount of variance in our sample—which produces arbitrary results. (One way to think about this is that you could use a bunch of those variables to predict household income pretty accurately, at which point the household income variable itself becomes unnecessary.)

The Washington Post writeup remained blissfully unaware of this problem:

After statistically controlling factors such as education, age and gender, Rothwell was able to determine which traits distinguished those who favored Trump from those who did not, even among people who appeared to be similar in other respects.

This is the argument that the statistical significance of the income coefficient means that, among people who are otherwise identical, higher income does have an effect (pro-Trump, in this case). But as explained above, that’s a fallacy. Multicollinearity, as this statistical problem is called, means that individual coefficients are unreliable. The model as a whole may predict support for Trump pretty well, but you have no way of knowing which variables are doing the predicting.

That’s the first problem with this paper: we can’t trust the coefficients. The second problem is one of interpretation. Even if we accept for a moment the coefficients on the explanatory variables, the paper says nothing about why people actually support Trump; it’s just a long list of correlations.

So imagine this simple world. There are 100 people. 50 are poor and 50 are rich. In each group, one half (25 people) vote based on their feelings, such as economic anxiety. The other half vote based on their interests. So the electorate looks something like this:

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Of the people who vote their feelings, let’s say economic anxiety does increase support for Trump. So Trump gets 15 of the people in the Feelings/Poor box but only 10 people in the Feelings/Rich box. For people who vote their interests, however, income is positively correlated with Trump support, since he has promised to cut their taxes. So Trump gets 20 of the people in the Interests/Rich box but only 5 people in the Interests/Poor box (because the other 20 realize that Hillary Clinton’s policies will be better for them).

Now our exit poll looks like this:

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Trump gets only 40% of the poor voters, but 60% of the rich voters.

That’s what the Gallup paper shows, and that’s what the Washington Post editors used as their headline: rich people prefer Trump, so economic anxiety is a myth. But I constructed this outcome using a model that explicitly incorporated economic anxiety as a factor (in the Feelings row, Trump does better with poor people). In other words, the economic anxiety story is consistent with a study showing that, on average, rich people prefer Trump.

The lesson is very simple, and it’s one that everyone knows before becoming a poll-reading pundit: People make decisions for different reasons. Something can be an important factor—here, it gives Trump a 20-point advantage among half the population—but get outweighed by some other important factor. Or, to put it in sophisticated language, you can’t use income as an instrument for economic anxiety, because income affects Trump support through other channels (in this example, because some rich people realize that Trump’s tax cuts will be good for them). This is really just the same mistake that Matt Yglesias made yesterday with race and age.

As should be obvious, I think that economic anxiety is a reason why some people support Donald Trump. I can’t prove it from poll breakouts, or from the Gallup paper, because this type of hypothesis can’t be proven or disproven with that type of data. That’s the one thing you should remember the next time someone argues that some demographic statistics show why some politician is popular.

A Cute Joke Gone Too Far

By James Kwak

For weeks now, Vox columnist Matt Yglesias has been mocking the idea that “economic anxiety” is a substantial factor in the Rise of Trump. Here’s one of dozens of examples:

It’s understandable where this particularly highbrow putdown (also used by other twitterers) came from. Belittling the economic anxiety explanation has two understandable if not entirely pure motivations. One is the idea that chalking up Trump’s success to economic factors minimizes the central role of racism in his campaign; pointing out other reasons people might have for voting Trump distracts from the main issue or can even be seen (in an illogical sort of way) as an apology for Trump’s racism. The second motivation is that, since Hillary Clinton decided to run on the poorly worded “America is already great” theme, talking about economic insecurity only plays into the hands of the enemy; instead, we should just pretend everything is hunky-dory. (Yglesias does not share this second motivation.) But to many people, including me, it seems bizarre to insist that economic anxiety has nothing to do with Trump’s success, and much simpler to simply acknowledge that some of his voters are racists, some are worried about their economic prospects, and some are both.

Today, instead of letting the by-now-stale joke simply fade away, Yglesias decided to double down with a column arguing that Trump is all about “white grievance politics,” not economic anxiety.

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And the Award for Best Financial Crisis Book …

… goes to Chain of Title, by David Dayen (with apologies to Jennifer Taub, Alyssa Katz, Michael Lewis, and many others, including my co-author, Simon Johnson).

Chain of Title isn’t primarily about the grand narrative of the financial crisis: subprime lending, mortgage-backed securities, collateralized debt obligations, credit default swaps, synthetic CDOs, the collapse of the global financial system in 2008, and the frenzied bailout that followed. Instead, it’s about foreclosure fraud: how mortgage servicers, banks, and the law firms they hired systematically broke the law to force people out of their homes. At the same time, it’s about securitization fraud: the fact that an untold number of securitizations were not properly executed, meaning that they violated the terms of their underlying agreements, meaning that their investors should have been able to force rescission of the entire deal.

The substance of the argument has been well known for years, so I’ll try to pack it into one sentence: The banks creating mortgage-backed securities failed to properly transfer notes (the documents proving a borrower’s obligation) to the trusts that issued the MBS, so not only was the securitization itself faulty, but the trust did not have legal standing to foreclose on homeowners—so the banks paid third-party companies to forge the required paper trail, and lawyers knowingly submitted fraudulent evidence to courts, who usually accepted it.

This has been common knowledge on the Internet since 2009 or 2010. But Dayen does what good writers do: he tells the story of a few real human beings figuring out the workings of this vast fraudulent system on their own, fighting against it … and ultimately, for the most part, losing. The book makes you feel the anger, disbelief, hope, and disappointment of those days over again. Even though I knew how the story ended—in a whimper of liability-eliminating settlements and self-congratulatory back-patting by politicians—it was still painful to read. Continue reading

The Value of Connections in 2008

By James Kwak

These days, some papers get more attention when they are in draft form than when they are published, in part because of the length of the review and publication cycle. Recall the Romer and Romer paper on the impact of tax changes, or the Philippon and Reshef paper on the financial sector, both of which made huge splashes years before they were finally published. My best-known paper also falls in that category. “The Value of Connections in Turbulent Times” began knocking around the Internet in 2013, and is only now being published by the Journal of Financial Economics—nine years after we began working on it, and at a time when the world seems to have completely moved on from its subject. (Note: that link will allow you to download the published version of the paper for free, but only until September 4, 2016. Thanks Elsevier, I guess.)

The paper, as you may have heard years back, shows that financial institutions with connections to Tim Geithner experienced abnormal positive market returns when his nomination to be treasury secretary was leaked and then announced in November 2008, and suffered abnormal negative returns when the news of his tax issues threatened to undermine his confirmation in January 2009. The interesting thing is that this is not ordinarily supposed to happen in the United States. Having connections to important government officials is not supposed to provide financial benefits to a company, and therefore nominations of those officials do not usually produce stock market bumps. The evidence is not completely one-sided, but in one representative example, researchers found that companies with connections to Dick Cheney did not experience abnormal returns in response to unexpected news about Cheney. This is in contrast to developing countries, where numerous studies have found that connections to important politicians are reflected in stock market valuations.

But it’s less clear why the markets (which, remember, are made up of at least some supposedly rational investors) thought that having connections to Geithner would pay off. Our main argument—after testing and discarding a bunch of other possibilities, like the effect was due to Citigroup, or to very large banks—is that, in the confusion of the time, it seemed likely that the treasury secretary would be given a large amount of discretion; and the more discretion that is available to an official, the more valuable it is simply to be able to get a meeting with him, or get him to return your phone call. You don’t have to think that Tim Geithner would consciously help out someone he served on a board with, or someone he had spent time with as president of the New York Fed; you just have to think that people are influenced by the people they spend time with, and so access matters.

This isn’t how we think our government is supposed to operate, but of course it’s how we all realize that it does operate. That’s one reason why individuals and corporations are willing to donate huge amounts of money to super PACs—so they can get access when they need it. What was unusual about the financial crisis was that, with the financial system and economy apparently falling apart, the value of those connections was much higher than usual. It also showed how, when push came to shove, the United States’ political institutions behaved more like those of a developing country than we would care to believe—the central point of Simon’s famous Atlantic article.


More Banking Mystifications

By James Kwak

Apparently, both parties have platform planks calling for the reinstatement of the Glass-Steagall Act of 1933, the law that separated investment banking from commercial banking until it was finally repealed in 1999 (after being watered down by the Federal Reserve beginning in the late 1980s). Bringing back Glass-Steagall in some form would force megabanks like JPMorgan Chase, Citigroup, and Bank of America to split up; it would also force Goldman Sachs to get rid of the retail banking operations it started in a bid to get access to cheap deposits.

In his article discussing this possibility, Andrew Ross Sorkin of the Times slips in this:

“Whether reinstating the law is good idea or not, the short-term implications are decidedly negative: It would most likely mean a loss of jobs as part of a slowdown in lending from the biggest banks.”

I looked down to the next paragraph for the explanation, but he had already moved on to another unsubstantiated claim (that the U.S. banking industry would be at a competitive disadvantage). So, I thought, maybe it’s so obvious that Glass-Steagall would reduce lending that Sorkin didn’t think it was worth explaining. I thought about that for a while. I couldn’t see it.

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That’s So PC

By James Kwak

In an article about political correctness in contemporary politics, Amanda Hess of the Times writes:

“Politically correct” was born as a lefty in-joke, an insidery nod to the smugness of holier-than-thou liberals. As Gloria Steinem put it: “ ‘Politically correct’ was invented by people in social-justice movements to make fun of ourselves.”

As far as I can tell from publicly available sources, Amanda Hess went to college during the George W. Bush administration, so I take it she is working from sources (like Gloria Steinem) here. But she’s not far off the mark.

I went to college in the late 1980s, which is when the concept of political correctness was spreading. My first recollection of political correctness is of a friend saying, “That’s so PC,” talking about someone else who was always sure to participate in the left-wing cause of the day. “Politically correct” absolutely was a phrase that lefties came up with to make fun of themselves. And it did not have the connotation of criticizing other (politically incorrect) people that it has today. If you were PC, that just meant that you were against the Nicaraguan contras, in favor of divesting from companies that invested in South Africa, against discrimination against people with AIDS, in favor of a nuclear freeze, and so on. Those were the issues–not the vocabulary used by rich white frat boys.

In other words, being politically correct meant adopting the appropriately subversive position on every issue. It was a faintly derogatory term because it implied that you didn’t think about issues independently; you just lined up on whatever side the left was supposed to line up on. “Politically correct” was a way to describe the herding behavior of left-wing people–not a way to criticize right-wing people.

Today, political correctness has become one of the favored bogeymen of the Trump campaign and of conservatives in general. People of my generation could genuinely be either baffled or aghast: It was a JOKE! Don’t you get it? But etymology is not destiny, of course. Conservatives have changed political correctness into something it wasn’t back in the old days, and that’s just the way it is.

But in its original meaning–the idea that you have to toe the party line, to be the hardest of the hard core–it is among conservatives that political correctness reigns supreme. On virtually every issue–taxes, Obamacare, abortion, Medicaid block grants, Dodd-Frank, guns, climate change, even the theological status of Barack Obama and Hillary Clinton–every Republican falls in line for fear of offending the omnipotent Base. Do you really think that every Republican member of the House and Senate honestly believes that human activity has not had an impact on the climate? Do they honestly believe that allowing anyone to carry a gun makes the world a safer place? But they have to pretend that they are as stupid as they sound for fear of offending Exxon Mobil, the NRA, and the conservative activists who really do believe that climate change is a fantasy concocted by intellectuals and that the best solution to crime is more guns.

So yes, political correctness is a problem. It’s a problem among Republicans. As for Democrats, who can’t even figure out if we are for or against the TPP, we can’t even get our act together enough for political correctness to be an issue.