By James Kwak

“Fed Tells Big Banks to Shrink or Else,” the Wall Street Journal proclaimed in the headline of its lead story today.* If only.

What the Federal Reserve actually did is impose new, additional capital requirements for the largest banks. JPMorgan Chase, for example, will have to hold 4.5 percentage points more capital than it would have had to otherwise. This is clearly a good thing, since it means that the banks that could do the most damage to the financial system will be a little bit safer. But it is neither a complete solution, nor is it the draconian constraint that the banks and the Journal make it out to be.

For starters, the rule will have no effect on seven of the eight banks in question (JPMorgan is the exception), since they already have enough capital to meet the new requirements. That alone should let you know how significant a rule this is.

Continue reading “More Misinformation about Banking Regulation” →

By James Kwak

“We shall again take for granted the availability of a system of public relief which provides a uniform minimum for all instances of proved need, so that no member of the community need be in want of food or shelter.”

That’s from The Constitution of Liberty, “definitive edition,” p. 424. Yes, it comes as part of Hayek’s argument against mandatory state unemployment insurance. But it reflects a fundamental understanding that no one should go without food or shelter, and that it is the duty of the government to ensure this minimum level of existence. “The necessity of some such arrangement in an industrial society is unquestioned,” he wrote (p. 405).

The standard that Hayek simply assumed would exist goes beyond merely keeping poor people alive. In a wealthy society, he thought it inevitable that it would become “the recognized duty of the public to provide for the extreme needs of old age, unemployment, sickness, etc.” (p. 406). On this basis, he even endorsed the idea of compulsory insurance, such as the individual mandate of the Affordable Care Act.

I’m not claiming that Hayek would have supported Obamacare — he almost certainly would have favored less government involvement than the system of state-level exchanges. But on the questions of welfare and government intervention in insurance markets, he was to the left of the entire Republican Party today.

[Also posted on Medium.]

By James Kwak

In Capitalism and Freedom, Milton Friedman asks what types of inequality are ethically justifiable. In particular (pp. 164–66):

“Inequality resulting from differences in personal capacities, or from differences in wealth accumulated by the individual in question, are considered appropriate, or at least not so clearly inappropriate as differences resulting from inherited wealth.

“This distinction is untenable. Is there any greater ethical justification for the high returns to the individual who inherits from his parents a peculiar voice for which there is a great demand than for the high returns to the individual who inherits property? …

“Most differences of status or position or wealth can be regarded as the product of chance at a far enough remove. The man who is hard working and thrifty is to be regarded as ‘deserving’; yet these qualities owe much to the genes he was fortunate (or fortunate?) enough to inherit.”

I think Friedman is correct here. This is basically the same point that I made in my earlier post: the money that you make because you are smart and hard working is the product of good fortune just as much as the money that you inherit directly from your parents.

Read more at Medium.

By Simon Johnson

The Trans-Pacific Partnership (TPP) is a proposed free trade agreement (FTA) between the United States and 11 other countries.  It is comprised of two main parts: reductions in tariffs (and related non-tariff barriers), of the kind typically seen in trade agreements; and new rules for foreign direct investment and intellectual property rights, which have not previously been prominent in FTAs.

The new rules part has become controversial.  The case for introducing an investor-state dispute settlement seems less than compelling – this would favor foreign investors over domestic investors, not an idea that sits well with the standard idea of equality before the law (going back at least 800 years) and a direct contradiction to the usual principles of FTAs (emphasizing non-discrimination across types of investors).  As currently formulated, it would also be open to considerable abuse.  And the precise rules under consideration for patent protection appear likely to reduce access to affordable medicines in both our trading partners and potentially also in the United States.

As a result, advocates of TPP are now emphasizing the benefits of tariff reductions in terms of boosting US exports.  But the administration’s claims in this regard are greatly exaggerated and the United States Trade Representative (USTR) is unfortunately refusing to fully discuss the broader trade impact, including the precise impact of higher imports into the United States. Continue reading “What Is the Trans-Pacific Partnership (TPP) Really All About?” →

By James Kwak

Mark Buchanan — who is actually a physicist, after all — makes a compelling argument against relying on geo-engineering to deal with our climate change problem. For one thing, some of the proposed technologies simply won’t work, because they do nothing about the fact that the poles are warming faster than the rest of the planet. For another, the geo-engineering fairy is being used to lobby against other approaches — conservation and renewable energy sources — that would deal with climate change at its source.

Another reason to be skeptical of geo-engineering is the effect it has on the risk profile of humanity’s future. Technology has produced some amazing things in the past century. But, with zero exceptions that I can think of, they weren’t things that our species needed to survive, or to prevent widespread natural and societal devastation. If we’re talking about technologies that can make our lives better in all sorts of ways, like the Internet or DNA sequencing or quantum computing, then risk is good: we want to place lots of bets that have a high chance of failure but high potential returns.

Read more at Medium.

By James Kwak

One of the central dramas of the early seasons of The Wire is the cat-and-mouse game between Avon Barksdale’s drug operation and the detectives of the Major Crimes Unit. The drug dealers started off using pagers and pay phones. When the police tapped the pagers and the phones, Barksdale’s people switched to “burner” cell phones that they threw away before the police could tap them. By Season 4, Proposition Joe advised Marlo Stanfield not to use phones at all.

Well, apparently, Wall Street currency traders don’t watch The Wire. I don’t think anyone was surprised to learn that major banks including JPMorgan, Citigroup, Barclays, RBS, and UBS conspired to manipulate currency prices — something that regulators have been investigating for over a year and a half. One common strategy was cooperating to time large transactions in order to manipulate daily benchmark rates at which other client transactions are executed.

Read more at Medium.

By Simon Johnson

At today’s daily briefing, White House spokesman Josh Earnest communicated the president’s threat to veto any trade promotion authority (TPA) that “could undermine the independence or ability of the Federal Reserve to make monetary policy decisions”.  (The question was posed at minute 42:50, Mr. Earnest’s answer starts at 43:31, and the lead up to this quote starts around 45:20.)

Mr. Earnest’s statement seems clear enough, but what potential TPA is he talking about?  Either the White House is confused or some other communications strategy is at work here.  Either way, Mr. Earnest is describing some imaginary version of TPA that is simply not on the congressional table.

He most certainly cannot be accurately describing the bipartisan Portman-Stabenow amendment, currently before the Senate.  This amendment specifically goes out of its way to state that it would not “restrict the exercise of domestic monetary policy.” Continue reading “Why Is The White House Threatening To Veto An Imaginary Trade Promotion Authority (TPA)?” →

By James Kwak

“In my many years of experience working in compliance, do you know how many fixed and variable annuities I’ve seen being invested in IRAs??? Countless.

“Investing a tax deferred investment within a tax deferred account simply does not make sense, except for very very few exceptions. … And when brokers answered me honestly as to why they picked annuities over mutual funds or even plain vanilla stocks??? Payout baby!!!”

That’s a compliance officer at Wells Fargo talking about the kinds of abuses that brokers — who advise clients about where to put their money, even if they aren’t “registered investment advisers” — inflict on their customers. For context: The benefit of an annuity is that taxes on earnings are deferred until withdrawals — but you get that benefit in any IRA, so there’s no point in putting an annuity (which has higher costs than an ordinary mutual fund) in an IRA. Yet in this case the brokers were pushing annuities because of the (legal) kickbacks they were getting from the annuity providers.

Read more at Medium.

By Simon Johnson and Andrei Levchenko

The Obama administration is lobbying hard for Congress to pass a trade promotion authority (TPA) and to quickly approve the Trans-Pacific Partnership (TPP), a free trade agreement that is on the verge of being finalized.

The administration and its supporters on this issue, including leading Republicans, argue that the case for TPP rests on basic economic principles and is only strengthened by the findings of modern research.  On both counts their claims are greatly exaggerated – particularly with regard to the notion that more trade, on these terms, is necessarily better for the United States.

There is a strong theoretical and empirical case – dating back to David Ricardo in 1817 – that freer trade should make countries better off. However, modern-day trade agreements, including those currently being negotiated, are very different from earlier experiences with trade liberalization. Continue reading “The Trans-Pacific Partnership (TPP): This Is Not About Ricardo” →

By Simon Johnson

As Congress debates the trade promotion authority, TPA, the issue of currency manipulation remains firmly on the table.  The administration and Republican leadership insist that language discouraging currency manipulation should not be included in the TPA (and also not in the Trans-Pacific Partnership, TPP, a trade agreement currently under negotiation).  Many Democrats and Republicans continue to argue in favor of prohibiting currency manipulation.

On Tuesday, the Treasury Department and White House claimed that the amendment proposed by Senators Rob Portman (R., Ohio) and Deborah Stabenow (D., Michigan) would actually impede the ability of the Federal Reserve to conduct monetary policy.  This is absurd.  The Portman-Stabenow amendment clearly and precisely addresses protracted one-way intervention in foreign exchange markets, i.e., large-scale purchases of foreign assets by a central bank.  The Federal Reserve does not engage in such activities – nor will it engage in this kind of intervention in the foreseeable future.  US monetary policy involves buying and selling domestic assets.  The Fed does not buy foreign assets on any significant scale.  There is nothing in this amendment that would impede the workings of US monetary policy.  To suggest otherwise is to mischaracterize the nature of this amendment.

There are instead three main issues of substance worth further consideration. Continue reading “Preventing Currency Manipulation” →

By James Kwak

“At present, when zero interest rates make capital costs as low as they have ever been but corporate profits are at record levels, there needs to be much less concern with capital costs and more concern with the distributional aspects of capital taxation.”

That’s Larry Summers — with whom I have often disagreed in the past — at a Brookings event on the tradeoff between equality and efficiency. For most of our lives, government policy in the United States and most of the developed world has been focused (at least in theory) on efficiency: colloquially speaking, making the pie bigger rather than worrying about how the pie is divided up. Rising tide, boats, you know the rest: Laffer Curve, unleashing the job creators, and so on. Inequality is something we profess to regret while doing nothing about it.

Read more at Medium.

By James Kwak

Unemployment is down to 5.4%! Yay!

That was the summary of last week’s unemployment report. Yet the two-track “recovery” — about to enter its seventh year — continues. Average hourly wages increased by only 0.1% in April and 2.2% for the past twelve months, which amounts to basically nothing when you take inflation into account.

This is what the new normal looks like. Wages barely rise during periods of economic “expansion” (you know, the opposite of recession), then fall when unemployment spikes during a recession. In the long run, that means that average real earnings actually go down, and household income can only keep up if people work more hours. Yet the number of full-time jobs is lower today than it was before the financial crisis.

Read more at Medium.

By James Kwak

I’ve written several times about what I call the Economics 101 ideology: the overuse of a few simplified concepts from an introductory course to make sweeping policy recommendations (while branding any opponents as ignorant simpletons). The most common way that first-year economics is misused in the public sphere is ignoring assumptions. For example, most arguments for financial deregulation are ultimately based on the idea that transactions between rational actors with perfect information are always good for both sides — and most of the people making those arguments have forgotten that people are not rational and do not have perfect information.

Mark Buchanan and Noah Smith have both called out Greg Mankiw for a different and more pernicious way of misusing first-year economics: simply ignoring what it teaches — or, in this case, what Mankiw himself teaches. At issue is Mankiw’s Times column claiming that all economists agree on the overall benefits of free trade, so everyone should be in favor of the Trans-Pacific Partnership, among other trade agreements.

Read more at Medium.

By James Kwak

The neolithic political ideology of Thomas and Friends is so overbearing and obvious that it’s not worth writing about (except in parody, which I won’t attempt here). Duncan Weldon has taken up the more interesting question of what Thomas, Percy, and their friends can tell us about the economy of Sodor, that strange island trapped somewhere off the coast of Great Britain and in a weird time warp that vaguely resembles the mid-twentieth century.

Like Duncan, I have watched plenty of Thomas videos, in my case in the company of my three-year-old son Henry. One thing that has often struck me about Sodor Railways is the vast amount of excess capacity. The most common plotline goes like this: Some engine has a job to do. However, said engine chooses to do something else out of vanity, unwillingness to go out in bad weather, curiosity, or something similar. Late in the episode, either the engine realizes the error of his ways and does his job, or some other engine does it for him. In either case, the original engine learns his lesson: that it is best to be Really Useful and not to cause Confusion and Delay. (Only, he never really learns the lesson — see the next episode.)

Read more at Medium.