Month: November 2010

The Economics and Politics of Elizabeth Warren

By Simon Johnson

Congressional Republicans are apparently intent on a big showdown with Elizabeth Warren, who is currently building up the new Consumer Financial Protection Bureau (CFPB).

This is very good news for the White House, if they use this opportunity wisely.

Some Republicans seem to think that Ms. Warren is about “big government” or “intrusive regulation”. But this is not the case – Elizabeth Warren’s approach is much more appealing and already popular with almost everyone on right and left: Transparency. Continue reading “The Economics and Politics of Elizabeth Warren” →

The Eurozone Endgame: Four Scenarios

By Peter Boone and Simon Johnson

In the aftermath of the Irish bailout, the German proposal for a future sovereign and/or senior bank debt restructuring mechanism within the eurozone makes complete political sense to the electorate in stronger European countries. They do not want to write “blank checks” to weaker countries and to out-of-control financial institutions going forward; creditors to countries that run into trouble will face likely losses.

While the details of this “burden sharing” approach remain to be hammered out (after Sunday’s announcements), there is no way for German or other politicians to backtrack on the broad strategic principles. But once this arrangement is in place, say in 2013 or thereabouts, all eurozone countries will (a) be able to sustain less debt than has recently been regarded as the norm, and (b) become vulnerable to the kinds of speculative attacks in debt markets that we have seen in recent weeks – to reduce funding rollover dangers, they will all need to lengthen the maturity of their outstanding debt.

The end point is clear. Last week the markets began to work backwards to today’s debt profiles; major disruptions still lie ahead.

Ultimately, there will be a eurozone will greater shared fiscal authority, a common cross-border resolution authority for failed banks, and likely greater economic integration. But there are four scenarios regarding who ends up in that eurozone – and how we get there. Continue reading “The Eurozone Endgame: Four Scenarios” →

Will Ireland Default? Ask Belgium

By Simon Johnson

On the face of it, Ireland seems poised on the brink of default. Its debts are very large relative to the size of its economy, most of this money is owed to foreigners and – unless there is an unexpected growth miracle – the country will struggle to pay its debts in full for many years to come.

Yet all the indications are that, as part of the historic rescue package to be introduced this week by the European Union and the International Monetary Fund, Ireland will not default on or otherwise restructure its most substantial debts. Why not?

To be clear, Ireland owes a huge amount of money to the outside world. In the best scenario, Ireland’s government debt is likely to stabilize at more than 100 percent of gross national product (G. N. P.); in the worst scenario, with greater real estate losses and a deeper recession, this level could reach 150 percent. Continue reading “Will Ireland Default? Ask Belgium” →

How Are the Kids? Unemployed, Underwater, and Sinking

This guest post is contributed by Mark Paul and Anastasia Wilson. Both are members of the class of 2011 at the University of Massachusetts-Amherst.

In some cultures asking how the kids are doing is a colloquial way of asking how the individual is faring, acknowledging that the vitality of the younger generation is a good metric for the well-being of society as a whole. In the United States, the state of the kids should be an important indicator. Young workers bear the significant burden of funding intergenerational transfer programs and maintaining the structure of payments that flow in the economy. Today, the kids’ outlook is almost as bleak as the housing market; they are unemployed, underwater on student debt, and out of luck from a reluctant political system.

Currently, even after a slight boost in jobs growth, unemployment for 18-24 year olds [correction: should be 18-19 year olds] stands at 24.7%. For 20-24 year olds, it hovers at 15.2%. These conservative estimates, using the Bureau of Labor Statistics U3 measure, do not reflect the number of marginally attached or discouraged young workers feeling the lag from a nearly moribund job market.

The U3 measure also does not count underemployment, yet with only 50% of B.A. holders able to find jobs requiring such a degree, underemployment rates are a telling index of the squeezing of the 18-30 year old Millennial generation. While it appears everyone is hurting since the financial collapse, young adults bear a disproportionate burden, constituting just 13.5% of the workforce while accounting for 26.4% of those unemployed. Even with good credentials, it is difficult for young people to find work and keep themselves afloat.

Continue reading “How Are the Kids? Unemployed, Underwater, and Sinking” →

Who Gains From The Eurozone Fiasco? China

By Simon Johnson

Ireland will get a package of support from the EU and the IMF. Will the money and the accompanying policy changes be enough to stabilize the situation in Ireland or more broadly around Europe? Does it prevent Ireland from restructuring its debt – or move the Irish (and other parts of the European periphery) further in that direction?

And who gains from the delay and mismanagement we continue to see at the highest European levels?

This is complicated economic chess within Ireland, across Europe, and at the international level. In my Bloomberg column this morning, I suggest we look several moves ahead, recognizing the underlying political dynamic:

There is a much more general or global phenomenon in which powerful people cooperate to build an economic model that provides growth based on a great deal of debt. When the crisis comes, those who control the state try to save their favorite oligarchs, but there aren’t enough resources to go around

…..

Here is the present problem: It’s not just the Irish elite that is under pressure and struggling to sort out who should be saved. It’s also the European bankers who funded them. Continue reading “Who Gains From The Eurozone Fiasco? China” →

“We Have Good Processes and Good Controls”

By James Kwak

One of the things I can’t stand about the corporate world is the tendency of senior executives to say things that they wish were true, without verifying whether they actually are true or not. Perhaps my favorite example of all time is Stan O’Neal’s internal memo from mid-2007:

“More than anything else, the quarter reflected the benefits of a simple but critical fact: we go about managing risk and market activity every day at this company. It’s what our clients pay us to do, and as you all know, we’re pretty good at it.”

But here’s another good one from Barbara Desoer, head of Bank of America’s home loan division (to Bloomberg):

“We believe that our assessment shows the basis for past foreclosure decisions is accurate. We have good processes and good controls.”

And apparently she’s sticking with this line. This week she told Congress, “Thus far we have confirmed the basis for our foreclosure decisions has been accurate.”

Continue reading ““We Have Good Processes and Good Controls”” →

Fixing The US Budget – Straightforward Or The Hardest Problem On Earth?

By Simon Johnson

The conventional wisdom is that we face a serious budget problem, ballooning debt and political deadlock that prevents any semblance of progress either in the short term or over the next 20 years. “The sky is falling — cut everyone’s wages, slash Social Security, buy gold!” summarizes the mood of this midterm moment.

But step back and look at American public finances from any angle — historical, comparative with other nations, from Mars — and the picture is very different. We have a simple economic problem — we need to fix our tax system, irrespective of how much revenue we want from it. And we continue to face the central American political problem of the last 200 years: how much inequality are we willing to accept as reasonable and fair? Continue reading “Fixing The US Budget – Straightforward Or The Hardest Problem On Earth?” →

The Law of Software Development

By James Kwak

I recently read a frightening 2008 post by David Pogue about the breakdown of homemade DVDs. This inspired me to back up my old DVDs of my dog to my computer (now that hard drives are so much bigger than they used to be), which led me to install HandBrake. The Handbrake web site includes this gem:

“The Law of Software Development and Envelopment at MIT:
Every program in development at MIT expands until it can read mail.”

I thought of that when I heard that Facebook is launching a (beyond) email service.

(The side benefit of this project is that now I get to watch videos of my dog sleeping whenever I want to.)

The Debt Problems of the European Periphery

By Anders Åslund, Peter Boone and Simon Johnson

Last week’s renewed anxiety over bond market collapse in Europe’s periphery should come as no surprise. Greece’s EU/IMF program heaps more public debt onto a nation that is already insolvent, and Ireland is now on the same track. Despite massive fiscal cuts and several years of deep recession Greece and Ireland will accumulate 150% of GNP in debt by 2014. A new road is necessary: The burden of financial failure should be shared with the culprits and not only born by the victims.

The fundamental flaw in these programs is the morally dubious decision to bail out the bank creditors while foisting the burden of adjustment on taxpayers. Especially the Irish government has, for no good reason, nationalized the debts of its failing private banks, passing on the burden to its increasingly poor citizens. On the donor side, German and French taxpayers are angry at the thought of having to pay for the bonanza of Irish banks and their irresponsible creditors.

Such lopsided burden-sharing is rightly angering both donors and recipients. Rising public resentment is testing German and French willingness to promise more taxpayer funds. German Chancellor Angela Merkel’s hasty and ill thought out plan to demand private sector burden sharing, but only “after mid-2013”, marks a first response to these popular demands. We should expect more. Continue reading “The Debt Problems of the European Periphery” →

Why Our Tax Code?

By James Kwak

In honor of the deficit commission, Ezra Klein is running a number of posts about the commission’s proposals and our tax code, including one about the mortgage interest tax deduction. Although this is often defended as a middle-class tax break, on a percentage-of-income basis it mainly benefits people between the 80th and 99th income percentiles; above that they make so much money that they can’t buy big enough houses to keep up. (On a dollar basis, of course, the correlation between income and tax savings is perfect.)

This should not be surprising, since like any itemized deduction (a) it’s worthless if you have a small house and take the standard deduction instead, (b) it’s proportional to the size of your mortgage, and (c) it’s proportional to your tax bracket. Klein says, “I’m not really clear why we’re giving people making hundreds of thousands a year large subsidies to buy a house, but I’m sure there’s a good reason.” I’m sure he knows the reason, but I’ll spell it out anyway.

Continue reading “Why Our Tax Code?” →

It’s Not About Ireland Anymore

By Simon Johnson

On the Project Syndicate website, Peter Boone and I argue, with regard to the European situation in this coming week:

The Germans, responding to the understandable public backlash against taxpayer-financed bailouts for banks and indebted countries, are sensibly calling for mechanisms to permit “wider burden sharing” – meaning losses for creditors. Yet their new proposals, which bizarrely imply that defaults can happen only after mid-2013, defy the basic economics of debt defaults.

…

Given the vulnerability of so many eurozone countries, it appears that Merkel does not understand the immediate implications of her plan. The Germans and other Europeans insist that they will provide new official financing to insolvent countries, thus keeping current bondholders whole, while simultaneously creating a new regime after 2013 under which all this debt could be easily restructured. But, as European Central Bank President Jean-Claude Trichet likes to point out, market participants are good at thinking backwards: if they can see where a Ponzi-type scheme ends, everything unravels. Continue reading “It’s Not About Ireland Anymore” →

Dear Mr. President

By James Kwak

There have been (admittedly unclear) indications from your administration that you may accede to the Republicans’ demand to extend the Bush tax cuts for everyone. I urge you not to do this.

The question is: Is it better to extend the tax cuts for everyone or for no one? The answer is to extend them for no one.

The Bush tax cuts have always overwhelmingly benefited the rich, not the middle class, and that is no less true today than when they were enacted. They were bad policy then and they are bad policy today. Extending the tax cuts would dramatically enrich the wealthy relative to everyone else. 65.5 percent of the total benefit would go to the top quintile by income, 26.8 percent to the top 1 percent, and 14.7 percent to the top 0.1 percent.*

Leaving aside discredited, Reagan-era theories about trickle-down economics, there are two main arguments for extending the tax cuts:

Continue reading “Dear Mr. President” →

G20: Profound And Complete Disappointment For The US Treasury

By Simon Johnson

Early Friday I went through the G20 communique for the Wall Street Journal; a marked up copy is available on-line.

It is hard to imagine how the summit could have gone any worse for the US Treasury and the president. The spin machine is now working overtime – and you’ll see big efforts to get more positive stories over the coming week – but on all fronts the outcome is very bad.

There was no substantive progress on anything to do with exchange rates. The “indicative guidelines” to be agreed next year are just a way to kick the can down the road. The Chinese are digging in hard on their exchange rate; this is headed towards a mutually destructive trade war.
There was less disagreement at the summit regarding the “regulation” of global megabanks – but only because this had been gutted so effectively by the bankers’ lobby and officials who bought their specious arguments. There is nothing here that will prevent or limit the impact of another major worldwide financial crisis. Continue reading “G20: Profound And Complete Disappointment For The US Treasury” →

Vikram Pandit Has No Clothes

By Simon Johnson

Vikram Pandit heads Citigroup, one of the world’s largest and most powerful banks. Writing in the Financial Times Thursday morning, with regard to the higher capital standards proposed by the Basel III process, he claims

“There is a point beyond which more is not necessarily better. Hiking capital and liquidity requirements further could have significant negative impact on the banking system, on consumers and on the economy.”

Mr. Pandit is completely wrong. To understand this, look at the letter published in the Financial Times earlier this week by finance experts from top universities – the kind of people who trained Mr. Pandit and his generation of bank executives. Continue reading “Vikram Pandit Has No Clothes” →

Top Finance Experts To G20: The Basel III Process Is A Disaster

By Simon Johnson

The Group of 20 summit for heads of government this weekend will apparently “hail bank reform,” particularly as manifest in the Basel III process that has resulted in higher capital requirements for banks. According to leading authorities on the issue, however, the Basel process is closer to a disaster than a success.

Bank capital can be best thought of as the amount of financing of a bank’s operations (lending and investment) that is covered by equity and not by debt obligations. In other words, it describes how much of the assets of the bank are subject not to the “hard claim” of debt but rather to a residual or equity claim, which would not lead to distress or insolvency when the value of the asset goes down. For global megabanks, equity capital is thus a key element in preventing the failure of an individual institution (or a couple of banks) from bringing down the financial system.

The framing of the Basel “success,” according to officials, is that the big banks wanted to keep capital standards down — and this is definitely true — but that governments pushed for requirements that are as high as makes sense. The officials implicitly conceded the banks’ main intellectual point, that higher capital requirements would be contractionary for the economy. Continue reading “Top Finance Experts To G20: The Basel III Process Is A Disaster” →