links for 2009-12-29
In Which Clive Crook Carries Water for the Republican Hyenas...

Ten Economic Pieces Worth Reading: December 29, 2009

1) Randall Smith and Sarah Lynch: Derivatives Overhaul Has Failed:

Lobbying by Wall Street has blunted efforts to step up regulation on derivatives trading by carving out exceptions or leaving the status quo in place. Derivatives took blame for some of the worst debacles of the financial crisis. But a year after regulators and critics began calling for an overhaul in the way they are traded, some efforts have been shelved and others have been watered down. The two main issues concerning regulators were trading and clearing of swaps, which allow investors to bet on or hedge movements in currencies, interest rates and many other things. Swaps generally trade privately, leaving competitors and regulators in the dark about the scope of their risks. In November 2008, the chairman of the Senate Agriculture Committee proposed forcing all derivatives trading onto exchanges, where their prices could be publicly disclosed and margin requirements imposed to insure that participants could make good on their market bets.

But a financial-overhaul bill passed by the House of Representatives on Dec. 11 watered down or eliminated these requirements. The measure still allows for voice brokering and allows dealers to use alternatives to public exchanges. A lawyer for one big Wall Street dealer said in an interview that the rollback from the first proposals in Congress was the result of an "educational" process by dealers and customers that resulted in "a grudging recognition" that many uses of derivatives didn't fit such a strict approach. At one point, House agriculture chairman Collin Peterson (D., Minn.) said he suspected dealers had dispatched their customers to lobby Capital Hill.

For Wall Street, switching to exchanges would have cut their profits in a lucrative business. "Exchanges are anathema to the dealers," because the resulting added price disclosure "would lower the profits on each trade they handle, and they would handle many fewer trades," said Darrell Duffie, a finance professor at Stanford business school...

2) Arvind Subramanian: How economics managed to make amends:

Here, one year on, we can say that economics stands vindicated. How so? Recall that the recession of the late 1920s in the US became the Great Depression, owing to a combination of three factors: overly tight monetary policy; overly cautious fiscal policy (especially under FDR in 1936, when tightening led to another sharp downturn in the US economy); and dramatic recourse to beggar-thy-neighbour policies.... The impact of this global financial crisis has been significantly limited because on each of these scores, the policy mistakes of the past were strenuously and knowingly avoided. On monetary policy, Mr Bernanke was true to the word he gave to Milton Friedman on the occasion of his 90th birthday: “Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”... On the fiscal side, policymakers enacted huge stimulus packages. They took their cue from Keynes.... Most surprisingly, despite the unprecedented collapse in trade, few countries resorted to beggar-thy-neighbour policies....

What is striking about the influence of economics is that similar policy responses in the fiscal and monetary areas, and non-responses in relation to competitive devaluations and protectionism, were crafted across the globe... in emerging market economies and developing countries as much as in the industrial world; in red-blooded capitalist countries as well as in communist China and still-dirigiste India. If ever there was a Great Consensus, this was it. If the Great Depression had not happened 80 years before, there may not have been a “natural experiment” to draw upon, and perhaps 2009 might have turned out differently. But the fact of the Great Depression was only a necessary condition. We were not condemned to repeat the mistakes of history because the economics profession had learnt and distilled the right lessons from that event...

3) >Mark Thoma Defends Ben Bernanke: Is Criticism of the Bernanke Fed Justified?:

[T]he Fed is largely flying blind right now. It does not have the models it needs to truly understand what policy approach is best in the present environment. I have not been a strong advocate of quantitative easing, i.e. targeting, say, a 3 percent inflation rate, but I cannot claim that my view is informed by a theoretical model of the crisis I believe in, [for] such a model does not yet exist. My view is based on empirical evidence suggesting the relative impotency of monetary policy in recessions, but that evidence comes from regular recessions, not a severe recession like we are having now and the evidence may not apply. Because of this, i.e. because of the considerable uncertainty over what policy is best, I have emphasized a portfolio approach involving both monetary and fiscal policy in the hopes that one or the other will get the job done. My concern lately is that all the talk about Bernanke and the Fed has distracted our attention away from fiscal policy, but perhaps another stimulus package isn’t politically viable.... But as I’ve said before, that doesn’t mean I will give up pushing this point... fiscal, not monetary policy, is the best response right now. For those who are making strong statements about what policy should be, and beating up Bernanke and the Fed for not following those policies, I ask you to do one thing: Produce a theoretical model that can explain the crisis and justify your policy response...

4) Megan McArdle: Heroes of the Health Care Bill, First Class - :

I would like to point out that there is one group that is especially deserving of a holiday:  the CBO analysts who have been scoring this bill.  They've been working flat out literally all year, and by this point, they have long ago exhausted any reserves of energy they might once have had.  They've been doing this because we wanted to have some sort of reasonable model of how much this was all going to cost, and what it was going to do--and whatever my arguments with the CBO model, they have fulfilled their mandate superbly.  In return they get modest government salaries, and absolutely no recognition by anyone except the three people who might recognize a CBO analyst on the street. 

So in the spirit of harmony with our fellow men that ought to fill this holiday season, let's offer a very special thank you, and a huge "Happy Holidays!" to the Doug Elmendorf and team at the CBO.  I don't know what superhuman powers have allowed them to survive the last six months, but they richly deserve the praise of a grateful nation.

Unfortunately, one budget geek of a blogger is all they're likely to get.  It's not enough, and indeed, it's doubtful that anyone at the CBO will see it.  But I'm afraid it's the best I can do.

5) Jonathan Gruber: 'Cadillac' tax isn't a tax -- it's a plan to finance real health reform:

The Senate assessment on high-cost insurance plans has much to recommend it, which is why it is almost universally favored by health policy experts. It would reduce the incentives for employers to provide excessively generous insurance, leading to more cost-conscious use of health care and, ultimately, lower spending. In other words, it "bends the curve." It would also be progressive, in that it would take from those with the most generous insurance to finance the expansion of coverage to those without insurance. But there have been numerous criticisms of the Senate financing. Perhaps the strongest is that some insurance plans will be "unfairly" burdened. For example, firms with older employees may have higher insurance costs not because their plans are more generous but because the employees themselves are more expensive to insure. Thus, many claim that this is a tax not on excessively generous insurance plans but on those who happen to have high insurance costs.

But this argument misses an important point: The assessment proposed in the Senate is not a new tax; it is the elimination of an existing tax break that is provided to exactly these firms. Under current law, if workers are paid in wages, they are taxed on those wages. But if they receive the same amount of compensation in the form of health insurance, they are not taxed. As a result, the tax code has for years provided a large subsidy to the most expensive health plans -- at a cost to the U.S. taxpayer of more than $250 billion a year. To put this in proportion, the cost of this tax subsidy to employer-sponsored insurance is more than twice what it will cost to provide universal health coverage to our citizens. The excise tax on generous insurance plans would simply offset this bias for the most expensive health insurance plans -- and only on a partial basis.

6) David Warsh: The Hidden History of the Health Care Bill:

[A] bipartisan approach devised by middle-of-the-road technocrats for an entrepreneurial Republican became a winning issue for the Democrats and provoked a crisis in the Republican Party.... [Romney] returned to Massachusetts in 2002 and was promptly elected governor.... In November 2004, on the op-ed page of The Boston Globe, Romney announced "My plan for Massachusetts health insurance reform"... a bipartisan approach. His plan would require no employer mandate or “single-payer” government takeover of the system. Nor would any new taxes be required. But by restraining medical expenses, the measure would lower the cost of health insurance for all.... Two men had worked hard to devise the plan. Timothy R. Murphy... Jonathan Gruber.... The two took advantage of a considerable head start, relative to all other states: Massachusetts already put aside as much as $1 billion annually for emergency care of the uninsured. The state had relatively few non-elderly insured – about half the national average of 18 percent. And Romney persuaded the Bush Administration to preserve $400 million in annual Medicare funding.... Eighteen months later, Romney declared that the problem had been solved. A combination of a series of new no-frills insurance plans and a requirement that even healthy young adults purchase one, plus government subsidies for those unable to afford those basic policies, and increased emphasis on Medicaid for those who qualified under current law would accomplish the goal with no new taxes.... He didn’t like to call it a plan for “universal coverage,” Romney told Time’s Joe Klein; to him it was a “personal responsibility system;” but the net effect would be the same....

So a contagious Republican proposal which quickly spread to the Democratic primaries proved to be the proximate cause of landmark legislation... by extending somewhat the principle of federal regulation, it changes the geometry of the medical industrial complex in fundamental ways. As Chait puts it, the proposed statute “prods the system” in myriad ways.... [T]he current bill is not the kind of plan that liberals wish they could design from scratch. “Rather, it is a centrist compromise of the best variety, combining the ideas of the now nearly extinct moderate wing of the Republican Party with the smartest bipartisan technocratic reforms.”

Is there a crisis in the Republican Party? The best evidence of it is the lone Republican congressman from Louisiana who voted for the health bill, Anh (Joseph) Cao. All the others who might have obtained some benefit from the bill refrained for fear of being ostracized.... The Wall Street Journal fulminated... the editors wrote. “A popular president might have crafted a durable compromise that blended the best ideas from both parties.” That, of course, is exactly what Romney attempted and Obama accomplished. Sufficiently clouded by defeat is the editors’ judgment, however,  that they no longer seem to recall that they themselves showcased Romney’s “Healthcare for Everyone? We’ve Found a Way” proposal in 2006...

7) Paul Krugman: The Big Zero:

Let me quote from a speech that Lawrence Summers, then deputy Treasury secretary (and now the Obama administration’s top economist), gave in 1999. “If you ask why the American financial system succeeds,” he said, “at least my reading of the history would be that there is no innovation more important than that of generally accepted accounting principles: it means that every investor gets to see information presented on a comparable basis; that there is discipline on company managements in the way they report and monitor their activities.” And he went on to declare that there is “an ongoing process that really is what makes our capital market work and work as stably as it does.” So here’s what Mr. Summers — and, to be fair, just about everyone in a policy-making position at the time — believed in 1999: America has honest corporate accounting; this lets investors make good decisions, and also forces management to behave responsibly; and the result is a stable, well-functioning financial system.

What percentage of all this turned out to be true? Zero.

What was truly impressive about the decade past, however, was our unwillingness, as a nation, to learn from our mistakes...


Yesterday, when I wrote about 34 Obama Nominees Not Named Dawn Johnsen being confirmed by the Senate on the heels of the healthcare vote, and before they left town, I was not aware, in addition (h/t earlofhuntingdon), the nomination was now completely dead. From Main Justice: "The Senate approved a unanimous consent request today to hold over several nominees for the second session of the 111th Congress, which begins in January. But nominees to head three DOJ offices: Dawn Johnsen, for the Office of Legal Counsel, Mary L. Smith, for the Tax Division, and Christopher Schroeder, for the Office of Legal Policy, were returned to the White House before the Senate recessed for the holidays..." The nomination of Dawn Johnsen to be the head of the Office of Legal Counsel at DOJ, a critical post, is now truly dead. If Ms. Johnsen is to serve, she will have to be renominated by Barack Obama and start over. She never got the up or down vote promised as soon as the Senate had done healthcare, she never got an ounce of support from the Administration that nominated her, and a year of her life was taken in what certainly appears to be a cowardly and demeaning political ploy.... Dawn Johnsen’s nomination had languished, twisting in the wind, for 280 days.... The only notable recent support for Johnsen from the White House came in a statement by White House Counsel Greg Craig on October 11, 2009, a weak statement saying only that the White House “would not withdraw” her nomination. Craig was subsequently fired and, hilariously, attempted to be scapegoated by Rahm Emanuel for – wait for it – not getting nominations like Johnsen’s confirmed...

9) STUPIDEST THING I'VE SEEN TODAY: Clive Crook: The real missed opportunity in Obama’s first year:

Independents have much the most reason to be disappointed... a broken political system. Congress is polarised to its roots. The country’s wide political centre is largely unrepresented on Capitol Hill. Committed Democrats and Republicans can hardly bear to be in the same room, let alone talk to each other. Mr Obama promised to strive for consensus. On issues such as energy policy, healthcare, education and immigration, there is no reason why moderates on both sides cannot make common cause.... It was the great hope independents had of Mr Obama. In his first year, he rarely even tried. He simply chose not to exercise this kind of leadership. To be sure, moderate Republicans (an endangered breed) offered no encouragement, content to oppose for opposition’s sake. But Mr Obama made no stand against this. Instead he went with the flow, deferring to the implacably partisan Democratic majorities... [What world does Clive Crook live in? Whatever moderate Republicans in the senate want in a bill, they can have: look at the stimulus package. Whatever moderate Republicans wanted in health care, they could have had. And whatever they want in cap-and-trade or financial reform they can have--but they would rather just say "no" to everything. Obama cannot change that.]

10) HOISTED FROM THE ARCHIVES: DeLong: Liquidity, Default, Risk:

I think that what Larry White has written misses the big point about what really has happened. So let me try to lay out what the situation looks like to me.... [T]wo years ago we lived in a world in which the wealth of global owners of capital was some $80 trillion.... Now over time the wealth of global capital fluctuates, and it fluctuates for five reasons: (1) Savings and Investment.... (2) News.... (3) Default Discount.... (4)Liquidity Discount.... (5) Risk Discount.... In the past two years the wealth that is the global capital stock has fallen in value from $80 trillion to $60 trillion. Savings has not fallen through the floor. We have had little or no bad news about resource constraints, technological opportunities, or political arrangements. Thus (1) and (2) have not been operating. The action has all been in (3), (4), and (5).

As far as (3) is concerned, the recognition that a lot of people are not going to pay their mortgages and thus that a lot of holders of CDOs, MBSs, and counterparties, creditors, and shareholders of financial institutions with mortgage-related assets has increased the default discount by $2 trillion. And the fact that the financial crisis has brought on a recession has further increased the default discount — bond coupons that won’t be paid and stock dividends that won’t live up to firm promises — by a further $4 trillion. So we have a $6 trillion increase in the magnitude of (3) the default discount.... (4), the Federal Reserve, the European Central Bank, and the Bank of England have flooded the market with massive amounts of high-quality liquid claims on governments’ treasuries, and so have reduced the liquidity discount — not increased it — by an amount that I estimate to be roughly $3 trillion. Thus (3) and (4) together can only account for a $3 trillion decrease in market value.

The rest of that decline in the value of global capital — all $17 trillion of it — thus comes by arithmetic from (5): a rise in the risk discount. There has been a massive crash in the risk tolerance of the globe’s investors. Thus we have an impulse — a $2 trillion increase in the default discount from the problems in the mortgage market — but the thing deserving attention is the extraordinary financial accelerator that amplified $2 trillion in actual on-the-ground losses in terms of mortgage payments that will not be made into an extra $17 trillion of lost value because global investors now want to hold less risky portfolios than they wanted two years ago...