Politics: Another Way To Waste Shareholder Money

By James Kwak

I don’t often go to academic conferences. My general opinion is that at their best, sitting in a windowless room all day listening to people talk about their papers is mildly boring—even when the papers themselves are good. And it takes a lot to justify my spending a night away from my family.

Despite that, a little over a year ago I attended a conference at George Washington University on The Political Economy of Financial Regulation. I went partly because my school’s Insurance Law Center was one of the organizers, partly because there was a star-studded lineup (Staney Sporkin, Frank Partnoy, Michael Barr, Anat Admati, Robert Jenkins, Robert Frank, Joe Stiglitz (who ended up not showing), James Cox, and others, not to mention Simon), and partly because I have friends in family in DC whom I could see. It was one of the best conferences I’ve been to, both for the quality of the ideas and the relatively non-soporific nature of the proceedings.

Many of the papers and presentations from the conference are now available in an issue of the North Carolina Banking Institute Journal (not yet on their website), which should be of interest to financial regulation junkies. My own modest contribution was a paper on the issue of corporate political activity. (In a moment of unwarranted self-confidence, I told one of the organizers I could be on any of three different panels, and they put me on the panel on “political accountability, campaign finance, and regulatory reform.”)

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Software Is Great; Software Has Bugs

By James Kwak

I’m not qualified to comment on the internals of Bitcoin; I’m neither a programmer (OK, Alex, not much of a programmer) nor a computer scientist. But I do know that Bitcoin exists because of software that people wrote, and every means by which we use Bitcoin also operates because of software that people wrote. The problem here is the “people” part—people make mistakes under the best of circumstances, and especially when they have an economic incentive to rush out products. That’s why, while we love what software can do for us, we also like having a safety net—like, say, the human pilots who can take over a plane if its computers crash. This is the subject of my latest column over at The Atlantic. Enjoy.

The Costs of Bad 401(k) Plans

By James Kwak

Mixed in with blogging about this, that, and the other thing, it’s nice to occasionally write on a topic I actually know something about. 401(k) plans and the law surrounding them were the subject of my first law review article (blog post). They have also been in the crosshairs of Ian Ayres (who simultaneously works on something like nineteen different topics) and Quinn Curtis, who have written two papers based on their empirical analysis of 401(k) plan investment choices. The first, which I discussed here, analyzed the losses that 401(k) plans—or, rather, their administrators and managers—impose on plan participants by inflicting high-cost mutual funds on them. The second, “Beyond Diversification: The Pervasive Problem of Excessive Fees and ‘Dominated Funds’ in 401(k) Plans,” discusses what we should do about this problem. To recap, the empirical results are eye-opening. Screen shot 2014-02-25 at 3.21.48 PM This table shows that 401(k) plan participants lose about 1.56 percentage points in risk-adjusted annual returns relative to the after-fee performance available from low-cost, well-diversified plans. The first line indicates that participants only lost 6 basis points because their employers failed to allow them to diversify their investments sufficiently. The big losses are in the other three categories:

  • Employers forcing participants to invest in high-cost funds by not making low-cost alternatives available
  • Investors failing to diversify their investments, even when the plan makes it possible
  • Investors choosing high-cost funds when lower-cost alternatives are available

Now you could say that the latter two sources of losses are the fault of individual plan participants, but that is cutting the employers (and the plan administrators they hire) too much slack. In particular, administrators should know that, if you offer both an S&P 500 index fund and an actively managed fund that closet-indexes the S&P 500 for 120 basis points more, some people will put their money in the latter. Continue reading “The Costs of Bad 401(k) Plans” →

Rich People Save; Poor People Don’t

By James Kwak

It seems obvious. Yet it’s often lost, both by the scolds who lecture Americans for not saving enough and by the self-appointed personal finance gurus who claim that anyone can become rich simply ye saving more (and following their dodgy investment advice). Saving is sometimes seen as some kind of moral virtue, but from another perspective it’s just the ultimate consumption good: saving now buys you a sense of security, insurance against misfortune, and free time in the future, which are all things that ordinary people don’t have enough of.

Real Time Economics (WSJ) links to a new survey being pushed by America Saves (which appears to be a marketing campaign run by the Consumer Federation of America, which seems not to be evil*). According to the survey, there are significant differences in savings rates and accumulated savings between lower-middle- and middle-income households. And that’s treating all households in the same income bracket as being alike, leaving aside differences in family structure, cost of living, etc.

I’m all for living within your means and saving for retirement and all that. But it’s a myth to say, as America Saves does on its home page, “Once you start saving, it gets easier and easier and before you know it, you’re on your way to making your dreams a reality.” The underlying problems are stagnant real incomes for most people, rising costs (in real terms) for education and health care, increasing financial risk due to the withdrawal of the safety net, and increased longevity (good in some ways, but bad if incomes aren’t rising and you want to retire at 65). That’s why households are showing up at age 64 with less in retirement savings than they had just last decade. And why, if you feel like you’re not saving enough, it’s probably not your fault.

* But America Saves itself is supported by a bunch of financial institutions and trade associations like the Investment Company Institute, which have a vested interest in getting people to entrust more money to them.

Résumé Put Hall of Fame

By James Kwak

Before 2006, people used to talk about the Greenspan put: the idea that, should the going get rough in the markets, Chairman Al would bail everybody out. But there’s something even better than having the Federal Reserve watching your back. It’s the résumé put.

The Wall Street Journal reported that Vikram Pandit, former CEO of Citigroup, is starting a new firm called TGG which will . . . well, it’s not entirely clear. In one email, they claim “a novel approach to address the challenges that large complex organizations face in compliance, fraud, corruption, and culture and reputation.” (That’s the standard marketing tactic of describing what benefits you will provide without mentioning what you actually do.) Now, Pandit certainly has experience in a large, complex organization with compliance, fraud, corruption, culture, and reputation problems. Citigroup checks pretty much every box. But is it experience you would want to pay for?

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$100M for Eric Schmidt?

By James Kwak

Over on Twitter, Matt O’Brien wrote:

That inspired me to take a look at the article O’Brien referred to: a column by Steven Davidoff asking why JPMorgan gets pilloried for giving CEO Jamie Dimon $20 million while Google can give Chairman Eric Schmidt $106 million without incurring the wrath of the public.

I went into it thinking I would agree with O’Brien—that there is something worse about lavish Wall Street pay packages than lavish Silicon Valley pay packages. Part of that was home team bias: I spent most of my business career working for companies based in Mountain View, Sunnyvale, Menlo Park, San Mateo, and Foster City (that’s two companies and five office moves). But I ended up mainly agreeing with Davidoff.

I think O’Brien is right on the narrow question of why people are mad: JPMorgan has done a lot of bad things in recent years, while Google’s role in the world is more ambiguous. But at the end of the day, voting the chairman of the board enough money to buy a Gulfstream 650 and an entourage of 550s is not a good use of shareholder money. And it’s shockingly tone-deaf in this age of rising inequality and cuts to food stamps. That’s the topic of my latest Atlantic column.

Random Variation

By James Kwak

As I previously wrote on this blog, one of my professors at Yale, Ian Ayres, asked his class on empirical law and economics if we could think of any issue on which we had changed our mind because of an empirical study. For most people, it’s hard. We like to think that we form our views based on evidence, but in fact we view the evidence selectively to confirm our preexisting views.

I used to believe that no one could beat the market: in other words, that anyone who did beat the market was solely the beneficiary of random variation (a winner in Burton Malkiel’s coin-tossing tournament). I no longer believe this. I’ve seen too many studies that indicate that the distribution of risk-adjusted returns cannot be explained by dumb luck alone; most of the unexplained outcomes are at the negative end of the distribution, but there are also too many at the positive end. Besides, it makes sense: the idea that markets perfectly incorporate all available information sounds too much like magic to be true.

But that doesn’t mean that everyone who beats the market is actually good at what he does, even if that person gets a $100 million annual bonus. That person would be Andy Hall, the commodities trader who stirred up controversy when he apparently earned a $100 million bonus at Citigroup—in 2008, of all years. (That was a year with huge volatility in the commodities markets.)

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“Telling a lie does not make you guilty of a federal crime”

By James Kwak

That’s what Jesse Litvak’s lawyer said at the start of his trial earlier today. And technically speaking, it’s true. If you’re trying to sell a bond to a client, and during the course of the conversation you say you can bench press 250 pounds when you can only bench 150, that’s not a federal crime. But if you lie about a material aspect of the bond and the client relies on your lie in buying the bond, that’s another story.

Litvak’s case is (barely) in the news because it has a financial crisis connection; some of the buy-side clients he is alleged to have defrauded were investment funds financed by the infamous Public-Private Investment Program (PPIP) set up in 2009 using TARP money, and hence one of the counts against Litvak is TARP-related fraud. But it bears on a much more widespread, and much more important feature of over-the-counter (OTC) securities markets.

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Not the Problem

By James Kwak

Nicholas Kristof’s ill-conceived diatribe against the supposed self-marginalization of academics has come in for a fair amount of criticism, notably from Corey Robin. The most obvious problem with Kristof’s argument assertion is that anywhere you look in the policy sphere, you can’t help stumbling over academics left and right. Macroeconomics is an obvious one, but there many others. Take education, for example, where anyone pushing for any conceivable policy change can wave a fistful of academic papers in your face.

It’s easy to multiply examples of academics doing policy work or even occupying policy positions. The bigger question, and the less obvious problem with Kristof’s opinion, is whether more of us would do any good for the world.

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The Social Value of Finance

By James Kwak

It’s been more than five years since the peak of the financial crisis, and it seems clear (to me, at least) that not much has changed when it comes to the structure of the financial sector, the existence of too-big-to-fail banks, and the types of activities that they engage in. It’s also clear that the Dodd-Frank Act and its ensuing rulemakings have embodied a technocratic perspective according to which important decisions should be left to experts and made on the grounds of economic efficiency. Even the Consumer Financial Protection Bureau, the Dodd-Frank achievement most beloved of reformers, is essentially dedicated to correcting market failures, which means attempting to achieve the outcomes that would be generated by a perfect market.

The big question is why we went down this route. The traditional explanation, and one that I’ve tended to assume in the past, is that it was a question of political power. Wall Street banks and their lawyers simply want less regulation of their industry, and they feel more comfortable granting actual rulemaking power to regulatory agencies that they feel confident they can dominate through the usual mix of congressional pressure, lobbying, and the revolving door. Given that the Obama administration also wanted to avoid structural reforms and preferred to rely on supposedly expert regulators, the outcome was foreordained.

In a recent (draft) paper, Sabeel Rahman puts forward a different, though not necessarily incompatible explanation. He draws a contrast between a managerial approach to financial regulation, which relies on supposedly depoliticized, expert regulators, and a structural approach, which imposes hard constraints on financial firms. Examples of the latter include the size caps that Simon and I argued for in 13 Bankers and the strict ban on proprietary trading that has been repeatedly watered down in what is now the Volcker Rule.

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Unequal Justice

By James Kwak

If I write about a legal matter on this blog, it usually involves battalions of attorneys on each side, months of motions, briefs, and hearings, and legal fees easily mounting into the millions of dollars. That’s how our legal system works if, say, you lie to your investors about a synthetic CDO and the SEC decides to go after you—even if it’s a civil, not a criminal matter.

But most legal matters in this country don’t operate that way, even if you face the threat of prison time (or juvenile detention), and all the collateral consequences that entails (ineligibility for public housing, student loans, and many public sector jobs, to name a few). Theoretically, the Constitution guarantees you the services of an attorney if you are accused of a felony (Gideon v. Wainwright), misdemeanor that creates the risk of jail time (Argersinger v. Hamlin), or a juvenile offense that could result in confinement (In re Gault). The problem is that this requires state and counties to pay for attorneys for poor defendants, which is just about the lowest priority for many state legislatures, especially those controlled by conservatives.

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Small Steps, but Not Nearly Enough

By James Kwak

Floyd Norris says some sensible things in his column from last week on the retirement savings problem: Defined benefit pensions are dying out, killed by tighter accounting rules and the stock market crashes of the 2000s. Many Americans have no retirement savings plan (other than Social Security). And the plans that they do have tend to be 401(k) plans that impose fees, market risk, and usually a whole host of other risks on participants.

But even his cautious optimism about some new policy proposals is too optimistic. One is the MyRA announced by President Obama a couple of weeks ago. This is basically a government-administered, no-fee Roth IRA that is invested in a basket of Treasury notes and bonds, effectively providing low returns at close to zero risk. The other is a proposal by Senator Tom Harkin to create privately-managed, multi-employer pension plans that employers could opt into. The multi-employer structure would reduce the risk that employees would lose their pension benefits if their employer went bankrupt.

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That’s the Whole Point

By James Kwak

The Wall Street Journal reports that the federal financial regulators may yet again carve a  loophole in the Volcker Rule. This time, the issue is whether banks subject to the rule’s proprietary trading prohibitions can hold collateralized loan obligations (CLOs)—structured products engineered out of commercial loans, just like good old collateralized debt obligations were engineered out of residential mortgage-backed securities during the last boom.

The reason to prohibit positions in CLOs obvious: it was portfolios of similarly complex, opaque, risky, and illiquid securities that torpedoed Bear Stearns, Lehman, Citigroup, and other megabanks during the financial crisis. The counterargument is one we’ve heard many times before: If banks are forced to sell their CLOs, they will have to do so at a discount, which will “have a material negative impact to our capital base,” in the words of one banker.

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Why We Have a Debt Problem, Part 23

By James Kwak

So, we have eleven aircraft carrier groups. No other country in the world has more than one. Everyone who has looked at the issue has agreed that we could do with fewer than eleven while still achieving our national security goals: Bush/Obama Defense Secretary Robert Gates, Obama Defense Secretary Chuck Hagel, and think tanks on the left and the right.

But apparently we can’t retire even one–even though we would save not just the annual operating costs, but most of the $4.7 billion it will cost to refurbish over the next five years. Instead, the Obama Administration has promised the Pentagon that it can simply have more money and not comply with the spending limits set in the 2011 debt ceiling agreement (and modified by Murray-Ryan).

Continue reading “Why We Have a Debt Problem, Part 23” →