Blog Housekeeping

By James Kwak

As you may have noticed, we’ve been making some changes to the site recently. The main thing is that I decided we needed two sidebars in order to make it into the 21st century. I’ve been looking for a good theme that has three columns but doesn’t have dynamic page navigation (those links across the top), because we have pages that shouldn’t really be made so prominent, but I couldn’t find one. So I switched to this theme, which has three columns but also has dynamic page navigation. Now the problem is that the page navigation is buggy: right now it’s showing pages that no longer exist, pages whose titles have changed, etc., and it seems to change mysteriously from time to time. I’m hoping it will settle down in the next few days. I’ve generally been very happing with wordpress.com, but this is totally infuriating.

What Expanded Safety Net?

By James Kwak

In general, I think Binyamin Appelbaum and Robert Gebeloff’s article on how the same people oppose government handouts and take government handouts is very good. But I think their framing buys into a piece of conventional wisdom that just isn’t true.

Here it is, without any shortening (but emphasis is mine):

“The problem by now is familiar to most. Politicians have expanded the safety net without a commensurate increase in revenues, a primary reason for the government’s annual deficits and mushrooming debt. In 2000, federal and state governments spent about 37 cents on the safety net from every dollar they collected in revenue, according to a New York Times analysis. A decade later, after one Medicare expansion, two recessions and three rounds of tax cuts, spending on the safety net consumed nearly 66 cents of every dollar of revenue.

“The recent recession increased dependence on government, and stronger economic growth would reduce demand for programs like unemployment benefits. But the long-term trend is clear. Over the next 25 years, as the population ages and medical costs climb, the budget office projects that benefits programs will grow faster than any other part of government, driving the federal debt to dangerous heights.”

Continue reading “What Expanded Safety Net?” →

Reports of Wall Street’s Death

By James Kwak

Gabriel Sherman wrote what I would call a hopeful article last week called “The End of Wall Street As They Knew It.” The basic premise is that the end of the credit bubble and the advent of Dodd-Frank mean lower profits, more boring businesses, and smaller bonuses on Wall Street—permanently (or at least for the foreseeable future). Sherman also says that the former masters of the universe are now engaged in “soul-searching”: “many acknowledge that the bubble­-bust-bubble seesaw of the past decades isn’t the natural order of capitalism—and that the compensation arrangements just may have been a bit out of whack.”

Call me a skeptic, but I’m not convinced. For one thing, there are few people quoted in the article who actually seem to be engaged in anything that might be called soul-searching (as opposed to complaining—like the now-clichéd banker who watches his spending carefully but has a girlfriend who likes to eat out). The story’s featured voices are ones that are not on Wall Street and have been critical of it for a long time, such as Paul Volcker and John Bogle. Another example of “self-criticism” comes from Bill Gross—but’s he’s on the buy side, not Wall Street.

Continue reading “Reports of Wall Street’s Death” →

Mark Zuckerberg and Tax Policy

By James Kwak

Some people have been claiming that Marc Zuckerberg is subject to a high tax rate, with Robert Frank even claiming,

“Mr. Zuckerberg’s tax bill will also provide an important counter-point to the notion that the rich pay lower tax rates than the rest of America. That may be true for professional investors and private-equity chiefs, but not for dot-commers and many entrepreneurs.”

Continue reading “Mark Zuckerberg and Tax Policy” →

Stock or Cash?

By James Kwak

I’m sure many of you saw the article featuring David Choe, the artist who painted the walls of Facebook’s first offices and received stock that now could be worth $200 million. Nice story. I was thinking, though: why was Facebook paying its vendors with stock?

I understand what you pay your early employees with stock: (a) you have to in Silicon Valley and (b) you want their fortunes aligned with those of the company. Outside board members also will often demand stock. But in most circumstances, you should pay your vendors with cash.

Giving a vendor stock instead of cash is equivalent to raising capital from that vendor—at the existing valuation. When you’re an early-stage startup, you want to raise as little money as possible, at as high a valuation as possible—because the whole point of the startup is that it should be getting much more valuable over time. There are tactical considerations, like not letting your bank balance get too low (because then your VCs will have too much negotiating power). But in general, you want to delay raising more capital until you reach some milestone that will boost your valuation significantly.

Obviously, things turned out just fine for Facebook. But it doesn’t seem like the smartest business move.

Mean-Spirited, Bad Economics

By Simon Johnson

The principle behind unemployment insurance is simple. Since the 1930s, employers – and in some states employees — have paid insurance premiums (in the form of payroll taxes, levied on wages) to the government. If people are laid off through no fault of their own, they can claim this insurance – just like you file a claim on your homeowner’s or renter’s policy if your home burns down.

Fire insurance is mostly sold by the private sector; unemployment insurance is “sold” by the government – because the private sector never performed this role adequately. The original legislative intent, reaffirmed over the years, is clear: Help people to help themselves in the face of shocks beyond their control.

But the severity and depth of our current recession raise an issue on a scale that we have literally not had to confront since the 1930s. What should we do when large numbers of people run out of standard unemployment benefits, much of which are provided at the state level, but still cannot find a job? At the moment, the federal government steps in to provide extended benefits.

In negotiations currently under way, House Republicans propose to cut back dramatically on these benefits, asserting that this will push people back to work and speed the recovery. Does this make sense, or is it bad economics, as well as being mean-spirited? Continue reading “Mean-Spirited, Bad Economics” →

Facebook and Mark Zuckerberg

By James Kwak

I must admit that I find Facebook’s impending glory a bit awkward, as it touches on two themes I have written about previously. One is that I just don’t like Facebook. And, I confess, I don’t really understand it. I sort of understand why people like it, but I don’t really understand why it’s going to be the most valuable technology company on the planet in a few years. I don’t understand why anyone would ever click on an ad within Facebook (or why anyone would even see them, since you could just use AdBlock), since I don’t understand why you would want your shopping choices to be dictated by who is willing to spend the most money for your attention. (When I want to buy something, I prefer using organic Google search results, since at least they aren’t affected by ad spending.) Maybe I’m just too old.

At the same time, it’s pretty clear by now that Facebook does whatever it is that it does pretty well. $1 billion in annual profits is impressive, and it’s also considered a pretty good place to work. And who is the CEO of Facebook? A twenty-seven-year-old kid with no other work experience. So while, as a customer (“user,” in software industry parlance), I’m less than thrilled, I can’t deny that Zuckerberg is doing something right as a CEO. Which is further evidence that the myth of the experienced CEO and the cult of the generalist manager are just a myth and a cult, as I’ve written about before. According to Reuters, Zuckerberg will soon be the fourth-richest person in America, after Bill Gates, Warren Buffett, and Larry Ellison. Which means that, like Gates and Ellison, it’s a good thing he never let anyone convince him that his company needed an experienced CEO.

Private Equity and “Job Creation”

By James Kwak

The phrase “job creation” always makes me a little queasy. The personal computer has probably contributed to the elimination of tens of millions of clerical jobs, yet I think most of us feel that computers are a good thing: they make people more productive, meaning more goods and services for everyone . . . and hopefully the people who lost those jobs will find work doing something else. In boom periods, like the 1990s, it seems to work, at least for most people, but I doubt that there’s any proof that productivity-increasing innovation always increases employment. But this line of thinking quickly leads to questions like whether the invention of the automatic toll booth is a good thing (because it eliminates what must be a pretty unpleasant job) or a bad thing (because it results in the layoff of people who may not have good alternatives), and those questions are above my pay grade.

Anyway, job creation these days usually refers to growing companies, making stuff people want, which tend to hire new workers—leaving aside the question of whether the products they make are causing other people to lose their jobs. This is the kind of job creation that Mitt Romney (and the private equity industry, at least publicly) wants to be associated with.

Continue reading “Private Equity and “Job Creation”” →

What Did the SEC Really Do in 2004?

By James Kwak

Andrew Lo’s review of twenty-one financial crisis books has been getting a fair amount of attention, including a recent mention in The Economist. Simply reading twenty-one books about the financial crisis is a demonstration of stamina that exceeds mine. I should also say at this point that I have no arguments with Lo’s description of 13 Bankers.

Lo’s main point, which he makes near the end of his article, is that it is important to get the facts straight. Too often people accept and repeat other people’s assertions—especially when they are published in reputable sources, and especially especially when those assertions back up their preexisting beliefs. This is a sentiment with which I could not agree more. One of the things I was struck by when writing 13 Bankers was learning that nonfiction books are not routinely fact-checked (Simon and I hire and pay for fact-checkers ourselves). As technology and the Internet produce a vast increase in the amount of writing on any particular subject, the base of actual facts on which all that writing rests remains the same (or even diminishes, as newspapers cut back on their staffs of journalists).

I’m not entirely convinced by Lo’s example, however. He focuses on a 2004 rule change by the SEC. According to Lo, in 2008, Lee Pickard claimed that “a rule change by the SEC in 2004 allowed broker-dealers to greatly increase their leverage, contributing to the financial crisis” (p. 33). That is Lo’s summary, not Pickard’s original. This claim was picked up by other outlets, notably The New York Times, and combined with the observation that investment bank leverage ratios increased from 2004 to 2007, leading to the belief that the SEC’s rule change was a crucial factor behind the fragility of the financial system and hence the crisis.

Continue reading “What Did the SEC Really Do in 2004?” →

What Is Private Equity?

By James Kwak

Recently, a lot of the political debate has been about whether private equity—and by extension Mitt Romney—is good or bad. The argument on one side is that private equity firms are vultures who destroy firms to make money; on the other, that private equity is just capitalism at work, creates value, and creates jobs.

A private equity firm is an asset management company. It creates investment funds that raise most of their money from outside investors (pension funds, insurance companies, rich people, etc.), and then manages those funds. As opposed to a mutual fund, however, instead of buying individual stocks, these funds usually make large investments either in private companies or in public companies that they “take private” (more on that in a minute). While mutual funds and most hedge funds try to make money by guessing where securities prices will go in the future, private equity funds try to make money by taking control of companies and actively managing them. (There is a bit of a spectrum here, since mutual funds and hedge funds can exercise pressure on company management and private equity funds do take minority positions, but that’s the ideal-typical distinction.)

Continue reading “What Is Private Equity?” →

Breakthrough: Eric Schneiderman To Chair Mortgage Crisis Unit

By Simon Johnson

As reported first in the Huffington Post, President Obama is creating “a special unit to investigate misconduct and illegalities that contributed to both the financial collapse and the mortgage crisis”.  This will be chaired by Eric Schneiderman, the New York attorney general.

For more background on why this makes sense and could represent a major policy breakthrough, please see this column: http://www.politico.com/news/stories/0112/71788.html.

 

Should We Trust Paid Experts On The Volcker Rule?

By Simon Johnson

On Wednesday morning, two subcommittees of the House Financial Services Committee held a joint hearing on the Volcker Rule.  The Rule, named for former Fed chair Paul Volcker, is aimed at restricting certain kinds of “proprietary trading” activities by big banks – with the goal of making it harder for these institutions to blow themselves up and inflict another deep recession on the rest of us.

The Volcker Rule was passed as part of the Dodd-Frank financial reform legislation (it is Section 619) and regulators are currently in the process of requesting comments on their proposed draft rules to implement.  Part of the issue currently is claims made by some members of the financial services industry that the Volcker Rule will restrict liquidity in markets, pushing up interest rates on corporate debt in particular and therefore slowing economic growth.

This argument rests in part on a report produced by Oliver Wyman, a financial consulting company.  Oliver Wyman has a strong technical reputation and is most definitely capable of producing high quality work.  But their work on this issue is not convincing.  (The points below are adapted from my written testimony and verbal exchanges at the hearing; the testimony is available here.) Continue reading “Should We Trust Paid Experts On The Volcker Rule?” →

What Do Companies Do with Their Political Spending?

By James Kwak

Whatever they’re doing, it doesn’t seem to be good for shareholders. That’s one conclusion of a new paper by John Coates, a Harvard law professor, which I discuss in today’s Atlantic column (which originally misdated the Citizens United decision, thanks to some faulty proof-reading by me). Coates compares firm valuations with levels of lobbying and contributions by corporate PACs and finds that, outside of heavily regulated industries where everyone lobbies heavily, political activity is associated with lower firm value—implying that it’s more like a CEO perk than like a good investment from the shareholder perspective.

Department of “Duh”

By James Kwak

The Times has a story out today: Surprise, all the Republican candidates’ tax plans increase the national deficit! The numbers (reduction in 2015 tax revenues, from the Tax Policy Center):

  • Romney: $600 billion
  • Gingrich: $1.3 trillion
  • (Late lamented) Perry: $1.0 trillion
  • Santorum: $1.3 trillion

I guess that makes Romney the “fiscally responsible” choice, at least among the Republicans. But President Obama’s tax proposals would only reduce 2015 tax revenues by $222 billion. (That’s $385 billion in Table S-4 less $163 billion in Table S-3.)

Second surprise: The big winners in all of these tax plans are the rich! (That’s not just in dollars, but in percentage increase in after-tax income.)

I don’t mean to be hard on the Times reporters. This is exactly the kind of story they should be writing. Someone has to point out that the same people who are complaining about deficits are proposing to vastly increase those deficits. Especially when their fantastic claims are essentially going unchallenged on the campaign trail.