The End Of The Euro: What’s Austerity Got To Do With It?

By Simon Johnson

Most of the current policy discussion concerning the euro area is about austerity. Some people – particularly in German government circles – are pushing for tighter fiscal policies in troubled countries (i.e., higher taxes and lower government spending). Others – including in the new French government — are more inclined to push for a more expansive fiscal policy where possible and to resist fiscal contraction elsewhere.

The recently concluded G20 summit is being interpreted as shifting the balance away from the “austerity now” group, at least to some extent. But both sides of this debate are missing the important issue. As a result, the euro area continues its slide towards deeper crisis and likely eventual disruptive break-up.

The underlying problem in the euro area is the exchange rate system itself – the fact that these European countries locked themselves into an initial exchange rate, i.e., the relative price of their currencies, and promised to never change that exchange rate. This amounted to a very big bet that their economies would converge in productivity – that the Greeks (and others in what we now call the “periphery”) would in effect become more like the Germans. Alternatively, if the economies did not converge, the implicit presumption was that people would move – i.e., Greek workers go to Germany and converge to German productivity levels by working in factories and offices there.

It’s hard to say which version of convergence was more unrealistic. Continue reading “The End Of The Euro: What’s Austerity Got To Do With It?” →

An Institutional Flaw At The Heart Of The Federal Reserve

By Simon Johnson. This is a long blog post, about 2,800 words.

On the “PBS NewsHour” in late May, Treasury Secretary Timothy Geithner indicated that the continued presence of Jamie Dimon, the chief executive of JPMorgan Chase, on the board on the Federal Reserve Bank of New York creates a perception problem that should be addressed. He used the diplomatic language favored by finance ministers, but the message was loud and clear: Mr. Dimon should resign from the board of the New York Fed.

Mr. Dimon has been an effective opponent of financial reform over the past four years. He remains an outspoken advocate of the view that global mega-banks can manage their own risks, and he has stated publicly that the new international and national rules on capital requirements are “Anti-American.”

Mr. Dimon now finds himself at the center of a number of official investigations into how his bank could have lost so much money so quickly in its London-based trading operation – including whether adverse material information was disclosed to regulators and to markets in a timely manner.

(The Wall Street Journal reported this week that serious concerns about the London trading operation had been raised – but not made public – two years ago; the New York Times has reported similar concerns. On Wednesday, the Senate Banking Committee interviewed Mr. Dimon; the event was inconclusive, perhaps because JPMorgan Chase is a major donor to some members of the committee.)

On Monday, Lee Bollinger, chairman of the board of the New York Federal Reserve Bank and president of Columbia University, weighed in to contradict Mr. Geithner in no uncertain terms. The Wall Street Journal reported Mr. Bollinger’s view: Mr. Dimon should stay on the New York Fed’s board, and critics attacking the Fed have a “false understanding” of how it works. (Please note the correction to the original Wall Street Journal story, with an important change to the reporting of what Mr. Bollinger said.) This is a remarkable statement in part because Mr. Geithner is himself a former president of the New York Fed, so it is hard to see how he would have a false understanding of how the Fed works. Continue reading “An Institutional Flaw At The Heart Of The Federal Reserve” →

Once More, With Feeling*

By James Kwak

Peter Orszag wrote an article for the latest Democracy** about political dysfunction and the “looming fiscal showdown” at the end of this year. A lot of it is a warmed-over description of political polarization, although Orszag ignores one of its most important causes: the growing influence of money in politics and the resulting need for politicians to go chasing after contributions from extremist billionaires. (Orszag instead subscribes to the theory that political polarization results from public polarization, which has been pretty well debunked by Fiorina and Abrams.)

Orszag’s recommendation, however, is spot-on: First let the Bush tax cuts expire; then, assuming that economic stimulus is necessary, push for a big, across-the-board, temporary tax cut. (Orszag proposes a payroll tax cut and an increase in the standard deduction; I’ve previously proposed a payroll tax cut.)

Continue reading “Once More, With Feeling*” →

Why Raise Taxes on Poor People?

By James Kwak

My Atlantic column today is on the bizarre fixation that some conservatives have with taxing poor people, pointed out by Bruce Bartlett in his latest column. Here’s one explanation:

The other, even-more-disturbing explanation, is that Republicans see the rich as worthy members of society (the “producers”) and the poor as a drain on society (the “takers”). In this warped moral universe, it isn’t enough that someone with a gross income of $10 million takes home $8.1 million while someone with a gross income of $20,000 takes home $19,000. That’s called “punishing success,” so we should really increase taxes on the poor person so we can “reward success” by letting the rich person take home even more. This is why today’s conservatives have gone beyond the typical libertarian and supply-side arguments for lower taxes on the rich, and the campaign to transfer wealth from the poor to the rich has taken on such self-righteous tones.

Also, in some housekeeping news, I’ve switched to a personal Twitter account, @JamesYKwak. My blog posts should generate tweets in that account; Simon’s should generate tweets in the old account, @baselinescene. I’ll try to aggregate all the stuff I write in various places in my new Twitter stream.

The Baseline Scenario Facebook page should be aggregating both of our Twitter streams, but I had a little difficulty with it on Monday, so who knows. It seems like Facebook changes the way everything works every other Tuesday, so you never know when something will break.

Does Lindsey Graham Think Before He Opens His Mouth?

By James Kwak

“The debate on the debt is an opportunity to send the world a signal that we are going to remain the strongest military force in the world. We’re saying, ‘We’re going to keep it, and we’re going to make it the No. 1 priority of a broke nation.’ ”

That’s Lindsey Graham, as reported in the Times today (emphasis added).

Graham is trying to make the case that we should undo the automatic reductions in defense spending mandated by the Budget Control Act of 2011 (last summer’s the debt ceiling compromise). But as a conservative Republican, he is also wedded to the notion that the United States is “broke.” (Which, of course, is nonsense. If you’re not sure why, see chapter 5 of White House Burning.) Graham has also signed the Taxpayer Protection Pledge, meaning that the federal government can only solve its fiscal problems by cutting spending, not increasing tax revenues.

To make this balancing act work, Graham makes the claim that a country that is “broke” (again, his word) should continue to make military spending its top priority—including military intervention in both Syria and Iran. Does he really think that, under that assumption, we should continue slashing domestic spending so we can continue paying for expensive overseas adventures? Yet this is the unavoidable, nonsensical conclusion of today’s Republican orthodoxy.

Facebook’s Long-Term Problem

By James Kwak

Facebook went public a week ago, to great embarrassment. NASDAQ creaked under the strain and, more important, the price dropped from an offer price of $38 to as low as $27 over the next week as investors decided that Facebook wasn’t so exciting now that anyone off the street could buy it.

In the long run, this could become a footnote. (Remember all the criticism of Google’s IPO?) With over $200 million in profits per quarter, Facebook’s P/E ratio is still less than 100, which isn’t bad for an Internet company that dominates its market and hasn’t fully opened the advertising spigot yet.

In the long term, Facebook’s ambition is to succeed Google (or Apple, depending on how you see it) as the dominant company on the Internet. And that’s where its real problems lie.

Continue reading “Facebook’s Long-Term Problem” →

Jamie Dimon And The Fall Of Nations

By Simon Johnson

“Why Nations Fail: The Origins of Power, Prosperity, and Poverty,” by Daron Acemoglu and James Robinson, is a brilliant and sometimes breathtaking survey of country-level governance over history and around the world. Professors Acemoglu and Robinson discern a simple pattern – when elites are held in check, typically by effective legal mechanisms, everyone else in society does much better and sustained economic growth becomes possible. But powerful people – kings, barons, industrialists, bankers – work long and hard to relax the constraints on their actions. And when they succeed, the effects are not just redistribution toward themselves but also an undermining of economic growth and often a tearing at the fabric of society. (I’ve worked with the authors on related issues, but I was not involved in writing the book.)

The historical evidence is overwhelming. Many societies have done well for a while – until powerful people get out of hand. This is an easy pattern to see at a distance and in other cultures. It is typically much harder to recognize when your own society now has an elite less subject to effective constraints and more able to exert power in an abusive fashion. And given the long history of strong institutions in the United States, it appears particularly difficult for some people to acknowledge that we have serious governance issues that need to be addressed.

The governance issue of the season is Jamie Dimon’s seat on the board of the Federal Reserve Bank of New York. Mr. Dimon is the chief executive of JPMorgan Chase, currently the largest bank in the United States. This bank is “too big to fail” – meaning that if it were to get into difficulties, substantial financial support would be provided by the Federal Reserve System (and perhaps other parts of government) to prevent it from collapsing. Continue reading “Jamie Dimon And The Fall Of Nations” →

The End Of The Euro: A Survivor’s Guide

By Peter Boone and Simon Johnson

In every economic crisis there comes a moment of clarity. In Europe soon, millions of people will wake up to realize that the euro-as-we-know-it is gone. Economic chaos awaits them.

To understand why, first strip away your illusions. Europe’s crisis to date is a series of supposedly “decisive” turning points that each turned out to be just another step down a steep hill. Greece’s upcoming election on June 17 is another such moment. While the so-called “pro-bailout” forces may prevail in terms of parliamentary seats, some form of new currency will soon flood the streets of Athens. It is already nearly impossible to save Greek membership in the euro area: depositors flee banks, taxpayers delay tax payments, and companies postpone paying their suppliers – either because they can’t pay or because they expect soon to be able to pay in cheap drachma.

The troika of the European Commission (EC), European Central Bank (ECB), and International Monetary Fund (IMF) has proved unable to restore the prospect of recovery in Greece, and any new lending program would run into the same difficulties. In apparent frustration, the head of the IMF, Christine Lagarde, remarked last week, “As far as Athens is concerned, I also think about all those people who are trying to escape tax all the time.” Continue reading “The End Of The Euro: A Survivor’s Guide” →

Jamie Dimon And The Legitimacy Of The Federal Reserve System

By Simon Johnson

There are two diametrically opposed views of how the largest financial companies in our economy operate. On the one hand, there are those like Charles Ferguson, director of the Academy Award-winning documentary “Inside Job” and author of the new book, “Predator Nation.” Mr. Ferguson takes the view that greed and immorality now prevail to an excessive degree at the heart of Wall Street.

Academics and other experts have become corrupted, the responsible regulators have been intellectually captured, and law enforcement officials refuse to act – despite the accumulation of evidence before their eyes.

“Inside Job” was gripping and emotional; “Predator Nation” contains many more specific details and evidence, as this excerpt dealing with academics (one Republican and one Democrat) makes clear.

The second view is that the people in charge of large banks and bank holding companies have done nothing wrong. To see this view in action, look no further than this week’s debate about whether Jamie Dimon, chief executive of JPMorgan Chase, should resign from the board of the Federal Reserve Bank of New York. The New York Fed oversees his organization, including assessing whether it is taking dangerous risks, so there are reasonable questions about whether this creates a potential conflict of interest. Continue reading “Jamie Dimon And The Legitimacy Of The Federal Reserve System” →

Jamie Dimon Should Resign From the Board Of The New York Fed

By Simon Johnson

Jamie Dimon, CEO of JP Morgan Chase, is a member of the board of the New York Federal Reserve Bank. Mr. Dimon’s role there is sometimes presented as “advisory” but he sits on the Management and Budget Committee; here is the committee’s charter, which includes reviewing and endorsing “the framework for compensation of the Bank’s senior executives (Senior Vice President and above)”. His advice apparently extends to important aspects of how the New York Fed operates, including its personnel policies.

The New York Fed is a key part of our regulatory and supervisory apparatus, involved in overseeing the activities of banks and bank holding companies, like JP Morgan Chase (currently the largest bank in the US). Within the Federal Reserve System, the New York Fed also has some of the deepest expertise on financial markets and complex products, such as derivatives. Almost all of the relevant supervision takes place behind closed doors, with representatives of the industry – including big banks – typically taking the position that they should be allowed to operate in a particular way or use various kinds of risk models. The staff of the New York Fed often has a decisive voice in determining what kinds of risks are acceptable for systemically important financial institutions. Continue reading “Jamie Dimon Should Resign From the Board Of The New York Fed” →

The Need For An Independent Investigation Into JP Morgan Chase

By Simon Johnson

JPMorgan Chase is too big to fail. As the largest bank-holding company in the United States, with assets approaching $2.5 trillion as reported under standard American accounting principles, it is inconceivable that JPMorgan Chase would be allowed to collapse now or in the near future. The damage to the American economy and to the world would be too great.

The company’s recent trading losses therefore call for greater public scrutiny than would be case for most private enterprise – and demand an independent investigation into exactly what happened. (Dennis Kelleher of Better Markets has already called for exactly this.) The investigation begun by the F.B.I. is unlikely to be sufficiently public. Given the strong political connections between JP Morgan and the Obama administration, it would also be better to have an investigation led by a completely independent counsel. Continue reading “The Need For An Independent Investigation Into JP Morgan Chase” →

Geithner to Dimon: Resign From The Board Of the New York Fed

By Simon Johnson

In an interview Thursday on PBS NewsHour, Jeffrey Brown and Treasury Secretary Tim Geithner had the following exchange:

“JEFFREY BROWN: Do you think Jamie Dimon should be off the board [of the New York Federal Reserve Board]?

TIMOTHY GEITHNER: Well, that’s a question he’ll have to make and the Fed will have to make. But again, on the basic point, which is it is very important, particularly given the damage caused by the crisis, that our system of oversight and safeguards and the enforcement authorities have not just the resources they need, but they are perceived to be above any political influence and have the independence and the ability to make sure these reforms are tough and effective so we protect the American people, again, from a crisis like this. And we’re going to, we’re going to do that.”

In the diplomatic language of Treasury communications, Mr. Geithner just told Jamie Dimon to resign from the New York Fed board (here is the current board composition). It looks bad – and it is bad – to have him on the board of this key part of the Federal Reserve System at a time when his bank is under investigation with regard to its large trading losses and the apparent failure of its risk management system. (Update: Mr. Dimon is on the Management and Budget Committee of the NY Fed board; here is the committee’s charter, which includes reviewing and endorsing “the framework for compensation of the Bank’s senior executives (Senior Vice President and above)”.)

Mr. Geithner’s call is a major and perhaps unprecedented development which can go in one of two ways. Continue reading “Geithner to Dimon: Resign From The Board Of the New York Fed” →

Why Markets Won’t Fix JPMorgan

By James Kwak

Jonathan Macey, a former professor of mine at Yale Law School,* recently wrote an op-ed for the Wall Street Journal (paywall; excerpts here) arguing that we shouldn’t worry about JPMorgan’s recent trading loss because market forces will ensure that the bank does a better job next time. Here’s a key paragraph:

“Thus, far from serving as a pretext to justify still more regulation of providers of capital, J.P. Morgan’s losses should be treated as further proof that markets work. J.P. Morgan and its competitors will learn from this experience and do a better job of hedging the next time. They will learn because they have to: In the long run their survival depends on it. And in the short run their jobs and bonuses depend on it.”

Macey’s central point is that companies don’t like losing money, so losing $2 billion means that they will do a better job of figuring out how not to lose money in the future. That’s obvious. But it’s also beside the point.

Continue reading “Why Markets Won’t Fix JPMorgan” →

Because They Can

By James Kwak

It seems as if the Republicans, meaning both John Boehner and Mitt Romney, are trying to turn the national debt back into a major political issue. Now, a visitor from Mars might wonder how this is possible. How could a party that (a) passed the massive tax cuts that were the single largest legislative contributor to today’s record deficits, (b) increased spending rapidly the last time it controlled the federal government, and (c) cannot talk in detail about anything except deficit-increasing tax cuts possibly think that calling attention to deficits could be a political winner?

Well, despite the Republican Party’s abysmal record when it comes to fiscal responsibility, it could still turn out to be smart politics, for a few reasons. One is that many Americans reflexively associate large deficits with excessive spending, even though reductions in tax revenues have played just as big a role since George W. Bush became president. (Compare, for example, receipts and outlays in 2000 and 2011 as a percentage of GDP.) Then they associate excessive spending with Democrats, although the only president to reduce spending significantly in the past forty years was Bill Clinton. It turns out that if you repeat the same tired attack lines year after year—Democrats are all tax and spend liberals, for example—people believe them.

The other, more important reason why Republicans like talking about the national debt is that Democrats don’t have a good response. Sure, Democrats have lots of policy proposals, and theirs make a good deal more sense than the Republicans’; it was President Obama who proposed trillions of dollars in spending cuts and tax increases, which is what people supposedly want (according to opinion surveys, at least).

But most Democrats just don’t like talking about deficits and the national debt. They think it’s a distraction from talking about jobs and unemployment, or they think simply broaching the subject is succumbing to a vast right-wing conspiracy to slash entitlements, or both. The result is that there is no ~~liberal~~ progressive position on the national debt. There’s the Republican one (Romney, Boehner, Ryan), which is to cut taxes (boggle); and there’s the Obama one, which is basically the Republican-Lite position of George H. W. Bush, and which many liberal Democrats run away from. On the left, all there is is a vague belief that you can balance the budget by increasing taxes on the rich, but no one really wants to come out and say it. (Also, the numbers don’t add up unless you’re willing to boost the tax rates on millionaires to very high levels; just, say, repealing the Bush tax cuts for the rich won’t cut it.) Instead, the strategy is to demonize RyanCare, which is effective as a short-term tactic, but doesn’t really amount to a coherent message on the national debt.

This is one reason why I wrote White House Burning. I say “I” because Simon probably wouldn’t call himself a liberal, but I do call myself a liberal, and I think liberals need to have a coherent message on the national debt. I think the message should be something like this: the national debt is a real problem that needs to be addressed; we need to address it in the way that’s best for the American people as a whole; that means preserving the social insurance programs that almost everyone depends on; and we can preserve those programs, while bringing the debt under control, through a set of policy changes that make sense on their own grounds (eliminating distorting subsidies, eliminating tax expenditures, introducing Pigovian taxes like a carbon tax and a financial activities tax).

You don’t have to agree with our recommendations. But as long as the liberal wing of the Democratic Party has nothing to say about the national debt, conservatives will be free to lead the debate, and the most likely outcome will be some sort of compromise between the moderate Republican Barack Obama an the now-“severe” conservative Mitt Romney. And you can expect the Republicans to bang on this drum from now until November.

Regression to the Mean, JPMorgan Edition

By James Kwak

I haven’t been writing about the JPMorgan debacle because, well, everyone else is writing about it. One theme that has stuck out for me, however, has been everyone’s reflexive surprise that this could happen at JPMorgan, supposedly the best and most competent of the big banks. For example, Lisa Pollock of Alphaville, who has provided some of the most detailed analyses of what happened, asked, “could this really happen under CEO Jamie Dimon’s watch?” Dawn Kopecki and Max Adelson at Bloomberg referred to “JPMorgan’s cultivated reputation for policing risk.” Articles about Ina Drew’s resignation are sure to point out her relative success at dealing with the financial crisis of 2007–2009.

“Highly intelligent women tend to marry men who are less intelligent than they are.” Why? Is it that intelligent men don’t want to compete with intelligent women?

Continue reading “Regression to the Mean, JPMorgan Edition” →