Category: Commentary

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” →

The Elusive Quest For Gold

By Simon Johnson. As prepared for the NYT’s Room for Debate – for the context and the whole discussion, see this link.

In a world with so many instabilities, there is an understandable search for something that offers a stable value – preferably something that cannot be affected by the whim of government or the latest scheme of a central bank. Unfortunately, this search proves just as illusory as the pursuits of alchemists in pre-modern times; there is no magic to gold.

For international economic transactions, proposing any kind of return to the gold standard is equivalent to wanting more fixed exchange rates, i.e., moving away from market-determined rates and returning to the system, at least in part, to how it operated before 1971.

But it is hard to imagine how this would help with regard to the major currencies, which are again the subject of controversy today. The main issues in the US are high unemployment, an unstable financial system, and longer-term issues around the budget. How exactly would gold help on any dimension? Advocates of a modified gold standard argue that this would serve as a form of anchor to the system – but in the 1930s it proved to be an anchor tied around the neck of some countries, including the United States. Nobody needs the kind of “stability” associated with the Great Depression. Continue reading “The Elusive Quest For Gold” →

Making The Volcker Rule Work

By Simon Johnson. This is the text of a letter (about 2,000 words) submitted on Friday to the Financial Stability Oversight Council, in response to their request for comments on the Volcker Rule. The full letter is here and on regulations.gov. If you would like more background on the Volcker Rule and its political importance, please see this post and the links it provides.

Dear Members of the Financial Stability Oversight Council:

Thank you for the opportunity to submit these comments on the study regarding implementation of Section 619 of the Dodd-Frank Act, also known as the Merkley-Levin provisions on proprietary trading and conflicts of interest or as the Volcker Rule.

Summary

I would like to offer three main comments.

Mismanagement of risks that involved effectively betting the banks’ own capital was central to the financial crisis of 2008; this is why our largest banks failed or almost failed. The Merkley-Levin Volcker Rule, properly defined, would significantly reduce systemic financial risks looking forward. Congressman Bachus’s comment to contrary (as submitted to the FSOC, as part of the Public Input for this Study, dated November 3, 2010) is completely at odds with the facts.
Trades need to be scrutinized in a detailed and high frequency fashion. It is not enough to rely on relatively infrequent and “high level” inspections – or the established supervisory process. The comments provided to you in this regard by Senator Harkin (dated October 20, 2010) – and also by Senators Merkley and Levin (dated November 4, 2010) – are exactly on target.
The separation between banks and the funds they sponsor, in any fashion, needs to be complete. The argument offered by State Street and other “Custodian Banks” in their comment to you (dated October 27, 2010) is worrying and potentially dangerous, because it ignores the basic economics that leads to bank failure.

The remainder of this letter expands on these points. Continue reading “Making The Volcker Rule Work” →

B of A Doublespeak

By James Kwak

Investors are claiming that Bank of America’s servicing operations are milking delinquent mortgages to earn fees rather than either foreclosing or modifying the mortgages. Bank of America’s defense?

“We have no financial incentive to keep mortgages on the books longer. Isn’t it better to modify the loan and keep people in their homes rather than foreclosing?”

I’m glad you feel that way. Then why do you have the second-lowest permanent modification rate of the seventeen servicers and two other servicer categories whose data have been released by Treasury?

Is This What You Voted For?

By James Kwak

In What’s the Matter with Kansas? Thomas Frank described how the Republican Party was able to take advantage of the conservative, values-focused, evangelical-driven movement to come to power–and then paid lip service to the priorities of the “base,” instead pursuing policies that helped established business interests and the rich. On a national scale, this was one major reason why conservatives became so disillusioned with George W. Bush.

It’s no surprise to anyone that this is happening again, only substituting “Tea Party” for “evangelical conservatives” and “United States” for “Kansas.”

Spencer Bachus, the likely new chair of the House Financial Services Committee, has announced that he is planning to use whatever powers he can to gut the Dodd-Frank financial reform bill. Why? According to the Financial Times, Bachus “expressed concern that shareholders of Goldman Sachs and JPMorgan Chase will be hurt because the banks will be less profitable.”

So one major effect of the Tea Party movement will be to further enrich Wall Street banks and the bankers who work there. (Which, I guess, is consistent with the common Tea Party insistence on reducing taxes for the rich.)

Is this what you voted for?

(If not, Mike Konczal reminds us that tomorrow is the deadline to submit comments on the implementation of the Volcker Rule.)

Panel with Blogging Luminaries

By James Kwak

For those of you lucky enough to live in Western Massachusetts, the Political Economy Research Institute is hosting a panel tomorrow (Friday) from noon to 1:30 with not one, not two, but three prominent econobloggers: Doug Henwood of Left Business Observer, Mike Konczal of Rortybomb, and Yves Smith of naked capitalism. And your humble blogger will be moderating. It’s at the University of Massachusetts, on the third floor of Gordon Hall.

Paul Ryan Is Not A Fiscal Conservative

By Simon Johnson

Writing in the Financial Times today, Paul Ryan – the incoming chair of the House Budget Committee – presents himself as a fiscal conservative, primarily focused on bringing the budget deficit and government debt under control. He is not.

Only in American could self-styled “fiscal conservatives” say that “America is eager for an adult conversation on the threat of debt,” but then decline to discuss the first order problem that has brought us here and threatens us going forward: Dangerous systemic risk brought on by the reckless behavior of big banks. No “fiscal conservatives” showed up for the legislative fight to rein in big banks – none, and now Spencer Bachus (presumptive incoming chair of House Financial Services) says that restrictions on big banks should be further lifted (quoted in the FT today, p.15).

We can reasonably draw only one conclusion: Paul Ryan and his colleagues are not real fiscal conservatives. This is further confirmed by the following: Continue reading “Paul Ryan Is Not A Fiscal Conservative” →

Will the Volcker Rule Survive The Midterm Elections?

By Simon Johnson

The Obama administration saved the deeply troubled megabanks in the United States in early 2009 with a bundle of rescue measures that, compared with similar financial crises elsewhere, stands out as extraordinarily generous – particularly to the bankers at the epicenter of the disaster.

The banks responded to this magnanimity with – by all accounts – extraordinarily generous support for the Republicans leading up to this week’s midterm elections. Why would they do this?

The answer is straightforward: The Republicans have promised generally not to tighten restrictions on the financial sector, which means specifically that they will seek to make the recent Dodd-Frank financial regulatory legislation less effective. Continue reading “Will the Volcker Rule Survive The Midterm Elections?” →

The White House Needs Elizabeth Warren, Now More Than Ever

By Simon Johnson

The White House today is under pressure, with insiders asking: After the strong showing of the Republicans in the midterm elections, should the president move to the right or to the left?

This is entirely the wrong way to think about the problem – the administration needs to get beyond its mental framework of early 2009, which led it sadly astray with regard to the financial sector. The President needs to find people and themes capable of cutting across the political spectrum; specifically he needs to promote strongly the ideas of Elizabeth Warren – what we need in financial services, above all else, is much more transparency.

The premise – and central mistake – of the Obama administration in 2009-10 can be summed up in what the president said to leading bankers on that fateful day, March 27, 2009: “My administration is the only thing between you and the pitchforks”. Continue reading “The White House Needs Elizabeth Warren, Now More Than Ever” →

Phony “Fiscal Conservatives” – In The Midterms And Beyond

By Simon Johnson

Should we take seriously people who, in the current US political debate, argue that they are “fiscal conservatives”? No.

These self-labeled conservatives are very far from even being willing to discuss the real issues – let alone make proposals that would have significant effects. As Peter Boone and I argue on Bloomberg this morning, US “fiscal hawks” are just pretending. Perhaps this will prove effective in the midterm elections, but then they will face the music – what exactly will they put on the table that will make any difference at all?

Unless and until you are ready to really reform the financial sector, you cannot be taken seriously in the fiscal space. It’s the big banks that blew up the economy, caused a devestating recession, and pushed up debt by 40 (forty) percentage points relative to GDP.

None of today’s “fiscal conservatives” showed up to work hard on constraining global megabanks over the past 18 months. They have repeatedly and explicitly earned the right not to be taken seriously.

Here’s the full Bloomberg link: http://www.bloomberg.com/news/2010-11-01/u-s-fiscal-hawks-turning-french-commentary-by-peter-boone-simon-johnson.html