What happened to the global economy and what we can do about it
Category: Commentary
By James Kwak
In an otherwise unobjectionable article about The Piketty, the generally excellent David Leonhardt wrote this sentence: “In the 1950s, the top rate exceeded 90 percent. Today, it is 39.6 percent, and only because President Obama finally won a yearslong battle with Republicans in early 2013 to increase it from 35 percent.”
Is “yearslong” really a word?
But that’s not what I mean to quibble with. It’s that “yearslong battle with Republicans.”
By James Kwak
Update: See notes in bold below.
The only “Wall Street” “executive” to go to jail for the financial crisis was Kareem Serageldin, the head of a trading desk at Credit Suisse, according to Jesse Eisinger in a recent article. Serageldin pleaded guilty to—get this—holding mortgage-backed securities at artificially high marks in order to minimize reported losses on his trading portfolio.
Now if that’s a crime, there are a lot of other people who are guilty of it. In fact, a major premise of the federal government’s crisis response strategy was exactly that: allowing banks to keep assets at inflated marks in order to pretend they were solvent when they weren’t. FASB changed its rules in April 2009 in order to make it easier for banks to inflate their marks. And the Obama administration’s “homeowner relief program” was designed to allow banks to delay realizing losses on their mortgage loans by dragging out—but generally not preventing—foreclosures. (Remember “foam the runway”?)
Combine Serageldin’s story with the story of the vigorous prosecution of Abacus Federal Savings Bank—a little Chinatown bank that, if anything, was probably allowing its borrowers to underreport their income on loan applications—which Matt Taibbi tells in the first chapter of his latest book, and the picture you get isn’t pretty. It’s a picture of the immense resources of the American criminal justice system being deployed against bit players, with no consequences for the people responsible for the financial crisis. The judge in Serageldin’s case even called his conduct “a small piece of an overall evil climate within the bank and with many other banks.”
By James Kwak
Some very clever people deep in the bowels of Bank of America’s accounting and regulatory compliance departments came up with a clever strategy to show, once and for all, that their bank is too big to manage. On Monday, the bank admitted that it had misplaced $4 billion in regulatory capital because of an error in accounting for changes in the value of its own debts. Coming less than two months after Citigroup misplaced $400 million in cold, hard cash in its Mexican subsidiary, this latest mixup is clearly part of a concerted campaign by employees of the big banks to definitively prove that their top executives have no idea what is going on.
This shadow lobbying campaign can be traced back to its origins in the LIBOR scandal (“Let’s rig the world’s largest market and see if Vikram Pandit notices.”) and the London Whale trade (“Let’s make a colossal bet on the relative values of different corporate bond indexes and see if Jamie Dimon notices.”). The only possible explanation for this seemingly never-ending stream of embarrassing disclosures is the existence of a conspiracy, orchestrated by some of the smartest bankers in the world, designed to broadcast to the world the message that regulators and politicians somehow failed to take from the financial crisis: the Masters of the Universe can’t even figure out what’s going on four floors down in their own buildings. The Bank of America accomplices even managed to miscalculate the bank’s regulatory capital for five full years before tipping off their bosses, showing the premeditation behind their scheme.
Or, the other possibility is that the banks are both incompetent and unmanageable. But that can’t be true, can it?
By James Kwak
Technology-land is abuzz these days about net neutrality: the idea, supported by President Obama, (until recently) the Federal Communications Commission, and most of the technology industry, that all traffic should be able to travel across the Internet and into people’s homes on equal terms. In other words, broadband providers like Comcast shouldn’t be able to block (or charge a toll to, or degrade the quality of), say, Netflix, even if Netflix competes with Comcast’s own video-on-demand services.*
Yesterday, the Wall Street Journal reported that the FCC is about to release proposed regulations that would allow broadband providers to charge additional fees to content providers (like Netflix) in exchange for access to a faster tier of service, so long as those fees are “commercially reasonable.” To continue our example, since Comcast is certainly going to give its own video services the highest speed possible, Netflix would have to pay up to ensure equivalent video quality.
Jon Brodkin of Ars Technica has a fairly detailed yet readable explanation of why this is bad for the Internet—meaning bad for the choices available to ordinary consumers and bad for the pace of innovation in new types of content and services. Basically it’s a license to the cable providers to exploit a new revenue source, with no commitment to use those revenues to actually upgrade service. (With an effective monopoly in many metropolitan areas and speeds already faster than satellite, the local cable provider has no market pressure to upgrade service, at least not until fiber becomes more widespread.) The need to pay access fees will make it harder for new entrants on the content and services side; in the long run, these fees could actually be good for Netflix, since it won’t have to worry as much about competition. The ultimate result will be to lock in the current set of incumbents that control the Internet, ushering in the era of big, fat, incompetent monopolies.
By James Kwak
That seems like a nonsensical question. Of course, each of us born where he or she was born, and we didn’t have much choice in the matter. But, philosopher John Rawls asked, if you lived behind a veil of ignorance, not knowing what position you would occupy in the socio-economic hierarchy, what rules would you choose to govern society?
Rawls was reasoning from a situation in which people could decide on any set of rules.* In the real world, the set of existing countries gives us a limited set of options to choose from; among those, if you didn’t know if you were going to be rich or poor, where would you choose to be born? On Friday, I was discussing this question with a scholar who is in the United States for a year, and one thing we noted was the instinctive tendency of many Americans to assume that we must be the best at everything and have the best of everything in the world (best health care, best Constitution, best hockey team, etc.).
By James Kwak
I still have Nate Silver in my Twitter feed, and I used to be a pretty avid basketball fan, so when I saw this I had to click through:
Just how bad were the @DetroitPistons‘ Bad Boys? http://t.co/q7A05JunDn#Detroitpic.twitter.com/SOOkfzCqq4
— FiveThirtyEight (@FiveThirtyEight) April 15, 2014
In the article, Benjamin Morris tries to analyze how “bad”* the Detroit Pistons of the late 1980s and early 1990s (Bill Laimbeer, Rick Mahorn, Dennis Rodman, etc.) were, with full 538 gusto: “That seems like just the kind of thing a data-driven operation might want to quantify.” But the attempt falls short in some telling ways.
By James Kwak
The Wall Street Journal reports that the SEC will soon decide (well, sometime this year) whether brokers should be subject to a fiduciary standard in their dealings with clients, as registered financial advisers are today. At present, brokers only need to show that investments they recognize are “suitable” for their clients—roughly speaking, that they are in an appropriate asset class.
Not surprisingly, the brokerage industry is up in arms. They want to be able to push clients into the products for which they receive the highest commissions—a practice that (they say) could be more difficult under a fiduciary standard. According to one lobbyist,
“a universal fiduciary standard could end up hurting many investors. Lower- and middle-income investors often turn to brokers who are compensated through product commissions, he says, because such clients are less attractive to financial advisers who are compensated based on a percentage of assets under management. Higher costs could prompt some brokers to drop commission-based accounts in favor of more-lucrative accounts that charge a percentage of assets under management, leaving many lower- and middle-income investors without anyone to turn to for investment advice.”
(That’s a paraphrase by the Journal writer, not a direct quotation.)
By James Kwak
I was reading the plea deal in the SAC case, which was approved by the judge yesterday, and then I started reading the criminal indictment filed by the U.S. Attorney’s Office. What I noticed was how relatively simple it was for the prosecutors to convict SAC Capital for the insider trading committed by its employees. In short, because the firm enabled and benefited from the employees’ crimes, the firm was itself criminally liable.
Looking back at the enormous amount of effort the Southern District has put into Preet Bharara’s crusade against insider trading, you have to wonder what they might have accomplished had they instead targeted, say, fraud committed by Wall Street banks that contributed to the financial crisis. That’s the topic of my new column in The Atlantic. One of the frustrations of post-crisis legal proceedings is that it’s so hard to show that any senior executives themselves committed fraud, since they can usually plead some combination of ignorance and incompetence instead. Failing that, though, the government could have put more resources into flipping lower-level employees and then filing criminal indictments against their banks. Yesterday Bharara claimed, “when institutions flout the law in such a colossal way, they will pay a heavy price.” But only if the Department of Justice chooses to go after them.
By James Kwak
No, I’m not talking about the fact that a major bank is named Fifth Third Bank. (As a friend said, why would you trust your money to a bank that seems not to understand fractions?) I’m talking about Fifth Third Bancorp. v. Dudenhoeffer, which was heard by the Supreme Court last week.
The plaintiffs in Fifth Third were former employees who were participants in the company’s defined contribution retirement plan. One of the plan’s investment options was company stock, and the employees put some of their money in company stock. (Most important lesson here: don’t invest a significant portion of your retirement assets in your company’s stock. Remember Enron? Anyway, back to our story.) As you probably guessed, Fifth Third’s stock price fell by 74% from 2007 to 2009—this is a bank, you know—so the plaintiffs lost money in their retirement accounts.
The claim (I’m looking at the 6th Circuit opinion) is that the people running the retirement plan knew or should have known that Fifth Third stock was overvalued in 2007, and they breached their fiduciary duty to plan participants by continuing to offer company stock as an investment option and by failing to sell the company stock that was owned by the plan. The suit was dismissed in the district court for failure to state a claim, so on review the courts are supposed to accept all the plaintiffs’ allegations as correct.
By James Kwak
A while back I wrote a post critical of a Planet Money/This American Life episode on disability insurance. Among other things, I thought that the episode made too much of the fact that the number of people on federal disability insurance (SSDI or SSI) has gone up since the financial crisis.
The book I’m currently reading with my daughter at family reading time (she just finished a fictional book about a Polish immigrant girl in a mining community in the late nineteenth century) is Social Insurance: America’s Neglected Heritage and Contested Future, by Theodore Marmor, Jerry Mashaw, and John Pakutka. It’s a pretty good overview of the programs that are typically thought of (at least by the left and center-left) as social insurance in this country. Here’s what they say about recent trends in disability insurance (pp. 166–67):
“It has long been understood by those who study disability insurance that during times of economic distress, the incidence of claimed disability increases. Impairments that might have been overcome during times of economic growth and high rates of employment become the basis for claims of disability. . . . As a recession drags on and jobs are not plentiful, many no doubt make the choice to see if a musculoskeletal malady or a mood disorder qualifies them for disability insurance benefits.”
In the longer term—meaning before the financial crisis—disability rates have been creeping upward. The main reasons are: (1) an aging population; (2) the slow increase in the full retirement age for Social Security, which keeps people on SSDI (as opposed to OASI) longer; and (3) the increasing frequency of musculoskeletal and mood disorder claims (e.g., depression). These are all completely normal things, unless you want to go back to the bad old days when mental illnesses like depression were not considered on pair with physical illnesses. At the margin, there is certainly fraud in the system, but in fact it’s quite hard to get disability benefits, and the standards aren’t getting any more lenient.
Sometimes the real story isn’t all that mysterious.
By Simon Johnson
No doubt there is still a lot of shouting to come, but this week a team at the International Monetary Fund completely nailed the issue of whether large global banks receive an implicit subsidy courtesy of the American government. Is there a subsidy, is it large, and how much damage could it end up causing to the broader economy?
The answers, in order, are: yes, there is an implicit subsidy that lowers the funding costs for very large banks; the subsidy is big, with costs of borrowing for these banks lowered by as much as 100 basis points, i.e., 1 percentage point; and yet this large scale of implicit support is small relative to the macroeconomic damage that is likely to be caused by the high leverage and incautious risk-taking that the subsidy encourages.
If anything the IMF’s work provides a conservative (i.e., low) set of estimates.
Still, as I explain in my NYT.com Economix column, I’m a big fan of this work because the Fund’s report is very good on how to handle and reconcile the main alternative methodologies for getting at the issue.
The Fund offers an entirely reasonable approach that sets a very high quality bar. The Government Accountability Office (G.A.O.) is expected to produce a report on TBTF subsidies in the summer; their work now needs to be at least as careful and as comprehensive as that of the IMF. The same applies to the Federal Reserve and anyone in the private sector who attempts to dispute these numbers.
By James Kwak
I accidentally glanced at the link to David Brooks’s recent column and—oh my god, is it stupid. You may want to stop reading right here to avoid being exposed to it.
By James Kwak
One of the criticism’s of Michael Lewis’s book is that he gets his moral wrong. High-frequency trading doesn’t hurt the little guy, as Lewis claims; instead, it hurts the big guy. The explanation is this: people sitting at their desks buying 100 shares of Apple are getting the current ask, so mainly they care about volume and tight bid-ask spreads. Institutional investors, buy contrast, want to buy and sell huge blocks of shares, and they don’t want the price to move in the process; they are the ones being front-run by the HFTs. Felix Salmon pointed this out, and it’s the subject of an op-ed by Philip Delves Broughton today.
What this leaves out is the question of who ends up being harmed. To figure that out, you have to ask whose money we’re talking about when we say “institutional investor.” If it’s SAC Capital, meaning Steven Cohen’s money, then who cares? But most ordinary people invest—if they are lucky enough to have money to invest—through mutual funds (401(k) plans, for example, are largely invested in mutual funds), and those funds are among the “institutional investors” losing money to HFTs. Another big chunk of institutional money belongs to pension funds. In this case, if the pension fund does poorly, the money may come out of its corporate sponsor in the form of increased contributions—or it may come out of beneficiaries and taxpayers in the form of a bankrupt plan shifting its obligations to the PBGC. Then there are insurance companies: in that case, losses from trading affect shareholders, but if they are systemic across the industry they end up as higher premiums for consumers.
This is not to say that the institutional investors are warm and cuddly and are just passive victims in all of this. I’ve spilled enough ink inveighing against active asset managers, and Salmon points out that the buy side bears its share of blame for being careless with other people’s money. At the end of the day, if HFT harms other people in the markets, it’s just a fraternal spat among capital, and doesn’t affect the fundamental divide in the post-Piketty world. Until a poorly-tested algorithm goes berserk and freezes the financial system, that is.
By Simon Johnson
Just a few short days ago, it looked like Citigroup was on the ropes. The company’s proposal for redistributing capital back to shareholders was rejected by the Board of Governors of the Federal Reserve System. Given the global bank’s repeated fiascos – including most recently the theft of around $400 million from its Mexican unit – it is hardly surprising that the Fed has said “no” (and for the second time in three years).
The idea that Citigroup might now or soon have a viable “living will” now seems preposterous. If top management cannot run sensible financial projections (that’s the Fed’s view; see p.7 of the full report), what is the chance that they can lay out a plausible plan to explain how the company, operating in more than 100 countries worldwide, could be wound down through bankruptcy – without any financial assistance from the government? According to the Dodd-Frank financial reform law, failure to submit a viable living will should result in remedial action by the authorities.
Such action has now been taken: CEO Michael Corbat has been named to a top White House job, with responsibility for helping to develop “financial capability for young Americans.” Continue reading “Citigroup CEO Named To “Key Administration Post””
By Simon Johnson
International economic policy making is a contender for the title of “most boring important topic” in economics. And within the field there is nothing quite as dull as the International Monetary Fund (IMF). Try getting an article about the Fund on the front page of any newspaper.
And even for aficionados of the Fund, the issues associated with reforming its “quota” and “voting rights” seem arcane – and are fully understood by few.
Dullness in this context is not an accident – it’s a protective wrapping against political interference, particularly by the US Congress.
Now, however, the IMF needs a change in its ownership structure, and the sole remaining holdup is Congress.
The Obama administration let this issue slide for a long while, and then attempted to link it with financial aid being extended to Ukraine. That attempt failed last week.
In a column for Project Syndicate, I discuss why this matters and what comes next. Try not to fall asleep.
The Baseline Scenario 