Afternoon Must-Read: Pedro Nicolaci da Costa: The Fed’s Lopsided Inflation Target
Lunchtime Must-Read: Losing Aaron Swartz

Are There Conservative Policy Alternatives?: Friday Focus (January 3, 2014)

First health-care reform. Now financial reform. And just what is the conservative position on climate change right now, anyway?

Mike Konczal: Is there a conservative alternative to financial reform?:

The Manhattan Institute’s Nicole Gelinas recently wrote an essay that critiques the Dodd-Frank financial reform law, titled “Too Convoluted to Succeed.” It’s worth reading to get a sense for what the conservative critiques of the law actually are.... One of her biggest complaints is about the law's "resolution authority".... Gelinas says... “regulators could use Treasury funds” in these resolutions, thereby “injecting money from the Orderly Liquidation Fund into [the banks] and keeping them going.” Got that? In other words, the resolution authority allows the government to provide emergency liquidity to large banks during a crisis.

This is an odd criticism. In the aftermath of the crisis, in 2009, Gelinas wrote a book called After The Fall, with a chapter on how to fix the financial sector. (The book got a big endorsement from Ross Douthat at the time.) Here’s how Gelinas recommended fixing Too Big To Fail back then:

The FDIC was an effective solution to systemic risk, but it couldn’t stem a modern financial panic because so much of the financial world had moved beyond banking…. [Congress] must do what they should have done two decades ago: create an FDIC-style conservatorship for too-big-to-fail financial institutions…the government could provide financing to assure the institution's continued operation temporarily to maintain stability.

This is exactly what Dodd-Frank set out to do. It isn’t clear from Gelinas’ most recent article what has changed in her thinking. Is the core idea right, but the implementation gone poorly? Or is the whole idea wrong, and either nothing is needed or something radically different is needed? Gelinas notes that any losses usually get funded after the fact through additional fees on banks, implying that it should be prefunded. But Republican opposition killed off a proposal for prefunding in the Senate in 2010 (it had passed the House)....

So what would a conservative alternative to Dodd-Frank look like? Gelinas concludes her piece arguing that the “nation did not need a sweeping new financial regime"... but instead “incremental change to fix the specific things".... (1) regulating the over-the-counter derivatives market to ensure debt and reporting requirements... (2) imposing higher leverage requirements overall as well as liquidity requirements... (3) overhaul the parts about derivatives in the 2005 bankruptcy act to make runs at large financial firms less likely.

The first two items here are two of the biggest parts of Dodd-Frank (Title VII and I respectively). It would be odd to repeal Dodd-Frank just to pass most of it again.

It's also clear that the GOP wouldn’t support this. Republicans in the House have declared war on derivatives regulations....

Notice how this mimics the dilemma of conservative health-care wonks. They attack things they previously supported, while proposing reforms that the movement has made clear it has no interest in supporting. How can that possibly be a way forward?

And what about climate change?

Google RA reminds me of this, from Greg Mankiw in 2004:

**Market-Based Quantity Regulations: Cap-and-Trade:88 The main problem with an emission fee is that it is difficult to know beforehand what fee level will achieve the desired amount of pollution reduction. A cap-and-trade regulation addresses this issue and provides market incentives to reduce emissions in a cost-effective way.... Under a cap-and-trade system, a source with a high cost of reducing an additional unit of emissions would be willing to purchase a permit from a source with a lower marginal abatement cost.... One consideration for a cap-and-trade system is how to allocate the permits initially.... Grandfathering versus auctioning the permits is primarily a question of distribution, not efficiency.... The trading program has achieved its pollution-reduction goals at great cost savings.... A cap-and-trade program with a safety valve achieves the target level of emission reductions in a cost-effective manner, while protecting the regulated firms against unexpected short-term price increases in emissions reduction.... President's [Bush's] Cap-and-Trade Program...

And Greg Mankiw (2009):

The legislation making its way to [Obama's] desk could well be worse than nothing at all.... When he was still a candidate, Mr. Obama did not exactly endorse a carbon tax.... But he did come tantalizingly close. What Mr. Obama proposed was a cap-and-trade system for carbon, with all the allowances sold at auction....

The problem occurred as this sensible idea made the trip from the campaign trail through the legislative process. Rather than auctioning the carbon allowances, the bill that recently passed the House would give most of them away to powerful special interests....

The problem arises in how the climate policy interacts with the overall tax system. As the president pointed out, a cap-and-trade system is like a carbon tax.... But if most of those allowances are handed out rather than auctioned, the government won’t have the resources to cut other taxes.... The result is an increase in the effective tax rates facing most Americans, leading to lower real take-home wages, reduced work incentives and depressed economic activity.... To those not fully convinced of the enormity of global warming but deeply worried about the adverse effects of high current and prospective tax rates, the bill is a step in the wrong direction....

I hope the president refuses to sign a bill that fails to auction most of the allowances. Some might say a veto would make the best the enemy of the good. But sometimes good is not good enough.