Category: Financial Crisis

Categories
Financial Crisis

Theories of the Financial Crisis: Goldman Sachs Did It! (cont.)

[digg-reddit-me]To follow up on my initial piece: Joe Hagan in New York magazine addressed the various accusations and news stories about Goldman Sachs’ role in the economic crisis and its aftermath – and he had inside access to the top honchos at Goldman Sachs as they attempted damage control. Hagan seems to have gone into the piece fair-minded and, unlike Taibbi and other polemicists, tried to give the pro-Goldman side its due – but he still ended up summarizing the two takes on Goldman Sachs’s business model thus:

On Wall Street, there are two interpretations of this business model: Either the firm is so brilliant at making near-riskless bets that it continually attracts more clients, who don’t mind being used for the golden database if it means more profits for them—or it’s a giant casino in which the house has gamed the system by knowing every hand at the table and using that information to enrich itself at the expense of others.

Read Hagan’s whole piece – it’s quite good. It’s hard to see how these two models are different – except that on one hand, Goldman is seen as good for its clients; and in the other bad. Either way, for the market and country as a whole, what do they contribute? And how is it that a company can make so much money making “near-riskless bets”? In a real market, one couldn’t – because everyone else would be providing the same “near-riskless bets.” But Hagan provides an expanation – the presumption that Goldman Sachs uses its access to its clients portfolios and finances to become more knowledgeable about the market than almost any other participant. Which is why they saw the subprime mortgage fiasco coming and while still providing these mortgages, bet that they would lead to a disaster. Hagan quotes Peter Solomon – “chairman and founder of the investment bank Peter J. Solomon Company” – explaining how Goldman Sachs along with other Wall Street firms has an interest in creating unfree markets – all the better to profit from if one already has advantages:

The interest of the Street, dominated by Goldman Sachs, has been to have markets that are opaque, inefficient, and unregulated. And that’s been the policy for twenty years. That’s what the world is reacting to.

Hagan explains  Goldman Sachs is able to make money because it exploits the inefficiencies in the market – it profits not from free markets but from unfree ones. Hagan also quotes Joseph Stiglitz deriding the business model of Wall Street firms in general, and Goldman in particular:

“Much of their recent profits seemed to be derived from ‘trading,’ which typically means gambling—not lending,” says Joseph Stiglitz, the Nobel Prize–winning economist who teaches at Columbia University. “It is lending which is required if our economy is to be revived; it was gambling that got our financial system into trouble.”

Goldman Sachs’s outrageous recent success proves once again that it is a proud beneficiary of gambling and unfree markets – with the government taking any losses. No wonder people people are losing faith in the financial system.

Categories
Economics Financial Crisis

Theories of the Financial Crisis: Goldman Sachs Did It!

[digg-reddit-me]Matt Taibbi most famously posited that the financial crisis was the result of Goldman Sachs’ self-interested manipulations. He saw this single investment bank as the malevolent force behind the latest financial crisis – as well as speculative bubbles throughout history:

The world’s most powerful investment bank is a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money…The bank’s unprecedented reach and power have enabled it to turn all of America into a giant pump-and-dump scam, manipulating whole economic sectors for years at a time, moving the dice game as this or that market collapses, and all the time gorging itself on the unseen costs that are breaking families everywhere – high gas prices, rising consumer-credit rates, half-eaten pension funds, mass layoffs, future taxes to pay off bail-outs. All that money that you’re losing, it’s going somewhere, and in both a literal and figurative sense, Goldman Sachs is where it’s going: The bank is a huge, highly sophisticated engine for converting the useful, deployed wealth of society into the least useful, most wasteful and insoluble substance on Earth – pure profit for rich individuals.

As over-the-top as Taibbi’s description might be, it wasn’t wholly inaccurate. Putting aside the exaggerated, macho, Hunter Thompson-esque prose, and even Felix Salmon, a mainstream blogger and financial writer for Reuters, finds a great deal of truth in this portrait of Goldman Sachs:

I don’t agree with all of Taibbi’s article, but I’m surprised at how much of it I do agree with…

Adding credence to this portrait of a massive bubble-making machine were the recent best-ever quarterly profits by Goldman in the midst of a recession for the rest of the country. Graham Bowley and Jenny Anderson of the New York Times summarized this state of affair simply in their piece:

Most of Wall Street, and America, is still waiting for an economic recovery. Then there is Goldman Sachs.

The free market digest The Economist immediately saw the significance of these profits so soon after government aid:

For a firm that probably would have collapsed without government capital, debt guarantees and fast-track approval to turn itself into a commercial bank (not to mention a multi-billion-dollar payout as a counterparty of American International Group), such largesse is cheeky at best, distasteful at worst. It has already drawn rebukes on Capitol Hill, even though Goldman has repaid the government’s $10 billion preferred-equity investment.

That Goldman Sachs was going to be a big winner in all of this was pretty evident as early as October when I included this as one of the 11 lessons I learned while trying to figure out the financial crisis: “Goldman Sachs always wins.” What was evident already was that – as Russell Roberts pointed out in the Times – Goldman Sachs had “won” the bailout game:

It is deeply disturbing that Lehman Brothers was a long-time competitor of Secretary Paulson’s former firm, Goldman Sachs. It is equally disturbing that the chief executive of CIT, Jeffrey Peek, has been a contributor to Republicans rather than Democrats. This could be mere coincidence. But the current and ad hoc bailout strategy inevitably creates suspicion and destroys faith in our economic and political system.

Aside from Taibbi – who sees Goldman’s tentacles at the root of most of America’s worst economic  moments through history – most observers do not see Goldman Sachs as the deliberate instigator of the current crisis. They see it instead as an opportunistic organization – one that navigated through the crisis with aplomb – as it saw its rivals vanquished and as it shored up its own business. It also played a significant role as the leader of the financial industry as it used political influence to push for various policies including a relaxation of regulation. The oversize influence of the financial industry should be the next Theory of the Financial Crisis I cover.

But the key point now is that Goldman Sachs – if successful in opposing most common-sense reforms – will be substantially to blame for the next crisis.

[Image by nydisccovery licensed under Creative Commons.]

Categories
Financial Crisis Foreign Policy Politics The Media The Opinionsphere

Sympathizing with AIG, Peace with Islamists, Senator Al Franken, Jay-Z, the Newest Lost Generation, and the Future of Journalism

1. Sympathizing with AIG. Michael Lewis has another piece plumbing the depths of the financial crisis. Except this time he is somewhat strangely sympathetic to AIG. His piece is a useful counter to Matt Taibbi’s angry screed on the same subject – but the lack of outrage in Lewis’s piece is discomfiting – like a writer who begins to sympathize with his serial killer subject. Still – worth reading – as Lewis concludes:

And yet the A.I.G. F.P. traders left behind, much as they despise him personally, refuse to believe Cassano was engaged in any kind of fraud. The problem is that they knew him. And they believe that his crime was not mere legal fraudulence but the deeper kind: a need for subservience in others and an unwillingness to acknowledge his own weaknesses. “When he said that he could not envision losses, that we wouldn’t lose a dime, I am positive that he believed that,” says one of the traders. The problem with Joe Cassano wasn’t that he knew he was wrong. It was that it was too important to him that he be right. More than anything, Joe Cassano wanted to be one of Wall Street’s big shots. He wound up being its perfect customer.

2. Peace With the Islamists. Amr Hamzawy and Jeffrey Christiansen have a thought-provoking, and somewhat discomfiting piece, in Foreign Policy suggesting that America make peace with non-violent Islamist groups – pointing out that many of them actually rely on America’s support for democracy for their success in a region of the world dependent on America and filled with dictatorships, and pointing out the signs that many of these groups are open to such a peace offer.

3. Senator Al Franken. John Colapinto profiles Al Franken in a typically humorous and in-depth New Yorker piece. More important than the piece is that this man is a Senator. Congratulations Senator Franken.

4. Jay-Z, Hegemon. Marc Lynch has written a few pieces this week applying principles of hegemony in international relations to Jay-Z and how he maintains power in the hip hop world – including specifically how he is responding to The Game’s recent attacks on him.

5. Europe’s Newest Lost Generation. Annie Lowrey discusses the problems that are facing Europe’s youth.

6. Shirsky on the Future of Journalism. Clay Shirsky has an excellent post over at Cato Unbound discussing without really predicting the future of journalism. As always with Shirky, thought-provoking and worth the read. He makes a point that I have been ruminating about in a number of posts recently (here and here) – that:

[J]ournalism is about more than dissemination of news; it’s about the creation of shared awareness.

In my posts, I labeled this “shared awareness” the “conventional wisdom.”

[Image by me.]

Categories
Economics Financial Crisis Politics

Tear down our capitalist system and replace it with a free market.

[digg-reddit-me]It’s Friday morning, finally finished with a week while living for the weekend, so I’m feeling loose.

My modest proposal for the day: Tear down our capitalist system and replace it with a free market.

The two terms are usually used synonymously – and I’m sure I am guilty of this myself. But after a long night of fevered dreams about politics and policy (yes, I really do dream about such things) I woke up realizing there is an important difference between the two ideas. (Perhaps as my unconscious mind dredged up some forgotten piece of writing from years ago.)

The free market is a commonsensical idea – as it is based on the values of competition, individual opportunity, and liberty. Adam Smith (from what I know of him) was only a proponent of this system – which he called “the system of natural liberty” – rather than a proponent of “capitalism” – a term he never actually used. Smith – arguing for this system – argued against government being used to prop up industries or to direct them. What he did not argue for though was “capitalism” as it has been understood for the past century. In many ways, the idea of capitalism evolved to defend our system from Marxist ideas – so it evolved to preserve the status quo rather than to describe an ideal system.

In this way, America’s economic system is different from its political system. The political system was created by men who held certain agreed-upon ideals and who attempted to write a governing document incorporating and protecting these ideals. This allowed later generations to try to better follow these ideas – to constantly seek “a more perfect union.” Rather than merely defending the status quo, it created an ideal to strive for. Our economic system though was created in an ad-hoc manner – and the ideology which grew up to defend it lacked any clear ideals. So, this ideology was defined then by what it opposed rather than a positive protection of certain principles. Capitalism then means less government interference, less centralized control of the means of production, less regulation. What this capitalism has created though is a rather unfree market – in which a small number of individuals own most of the capital – in which competition is thwarted by monopolistic practices, by bigger and bigger mega-corporations, by regulations proposed by the mega-corporations to keep out competitors, by bailouts.

Our capitalist system is based on valuing capital over labor, of seperating mangament and labor from ownership, of limiting the liability of individuals for their actions in corporate environments, of externalizing as much cost as possible to the public commons, of profit over all things. It is hard to see what most of these principles contribute to the creation of a free market. Indeed, many of them undermine it – creating a closed market, profitable only for a princely few who have the capital. This new feudalism is called freedom – but it is only free to an elite class of “ultracitizens” while the overwhelming majority of people get by in a “Sharecropper’s society” (to use terms introduced by David Rothkopf and Warren Buffett respectively.)

What we need is a founding economic document – that will describe the free market as it should be. A free market based on competition instead of capital; in which the government’s role is clear, predetermined, and predictable – rather than arbitrary and constantly contested; where regulation is seen as a protector of the free market rather than an encroachment upon it – as it forces externalized costs which are imposed on the society at large to be taken into account by the market; where the government’s role is in protecting and enhancing the opportunity of its citizens – rather than protecting the status quo and mega-corporations.

The fact is – capitalism as it is currently practiced has undermined the free market at every turn. While our current capitalist system has proved more productive than many other systems in the past, it has clearly fallen short of those implicit promises of what a free market should be. This economic crisis we are still going through – even as the financial crisis has passed – will offer up an opportunity to redefine the social bargain underlying our economic system if we are bold. So, we must be bold then – as soon as we figure out how to approach this.

[Image by me.]

Categories
Economics Financial Crisis

Theories of the Financial Crisis: Hubris of the Bankers

[digg-reddit-me]No list of theories of causes of the financial crisis that almost destroyed the fabric of the world economy (as opposed to the slow-motion disaster unfolding now) would be complete without listing hubris, that most Greek-mythical of faults.

Hubris clearly isn’t the only reason. There was greed – we all know that. There were various incentives that distorted the system as a whole. There was an enormous imbalance between East Asian countries and America that assisted in producing unmooring our financial industry. There was government intervention. There was a shift in the animal spirits. There was a profound miscalculation of risk. There were assets bubbles, Goldman Sachs, deregulation, new financial instruments, and a subservience of politics to finance.

But how can one explain how far out on this limb all of these venerable institutions went – how they thought they would be able to leverage themselves 33 to 1 – how they took on so much risk they almost brought down the financial system built over centuries in a week. Bankers didn’t take to calling themselves “Masters of the Universe” because they were being ironic. No – at the heart of this crisis – and reasserting itself now as they try to restore “normalcy” to their profession – was hubris.

Michael Lewis – who worked on Wall Street as a young man – described this hubris brilliantly in an essay published in the immediate aftermath of the financial collapse for Portfolio. He described how countless warning signs were ignored – because the money and the success had gone to the heads of these titans of Wall Street. (He steers away from the more high profile Cassandras from Nassim Nicholas Taleb to Nouriel Roubini to Brooksley Born.) After all, how had they gotten so much money if they didn’t know what they were doing? Lewis, unable to make that “logical” leap himself, had left Wall Street in the late 1980s, expecting the whole house of cards to fall at any moment:

To this day, the willingness of a Wall Street investment bank to pay me hundreds of thousands of dollars to dispense investment advice to grownups remains a mystery to me. I was 24 years old, with no experience of, or particular interest in, guessing which stocks and bonds would rise and which would fall. The essential function of Wall Street is to allocate capital—to decide who should get it and who should not. Believe me when I tell you that I hadn’t the first clue…

In [the past two decades], I had been waiting for the end of Wall Street. The outrageous bonuses, the slender returns to shareholders, the never-ending scandals, the bursting of the internet bubble, the crisis following the collapse of Long-Term Capital Management: Over and over again, the big Wall Street investment banks would be, in some narrow way, discredited. Yet they just kept on growing, along with the sums of money that they doled out to 26-year-olds to perform tasks of no obvious social utility. The rebellion by American youth against the money culture never happened. Why bother to overturn your parents’ world when you can buy it, slice it up into tranches, and sell off the pieces?

At some point, I gave up waiting for the end. There was no scandal or reversal, I assumed, that could sink the system.

Michael Osninski – who wrote programs creating derivatives – explained his rationalization for why he was able to make so much money:

[E]ven then, I was wondering why I was making more than anyone in my family, maybe as much as all my siblings combined. Hey, I had higher SAT scores. I could do all the arithmetic in my head. I was very good at programming a computer. And that computer, with my software, touched billions of dollars of the firm’s money. Every week. That justified it. When you’re close to the money, you get the first cut. Oyster farmers eat lots of oysters, don’t they?

Everyone seeks to claim credit for the successes that they benefit from – so, as the money flowed into Wall Street and all together people who didn’t quite understand what they were doing worked together and together inflated the prices of assets they didn’t know enough about to value – everyone got rich.

Contributing to this sense of unreality – and this hubris – was the culture that grew up around these people. They learned how to manipulate the programs written by the lowly programmers that created derivratives and other complex assets – and created a language that was opaque to those outside the club – of super senior risk, of CDS, CMS, and sundry other financial products. They sealed off their world from outside inspection, blocked regulation at every turn – and came to believe they understood the system. Though many must have understood their ignorance going in – as Lewis did – their success washed away their concerns. A gambler doesn’t need to know how roulette works if everyone who is playing the game is winning.

But hubris always leads to a downfall – and so, in the fall of 2008 2009, the house of cards created by these “Masters of the Universe” collapsed – and with it, the life savings of millions who trusted the brash bankers.

In the end it seems, no rational analysis or argumentation could convince these titans of Wall Street that their success was based on luck rather than knowledge or skill. And they ignored or marginalized who demonstrated otherwise – until it was too late. Too many seemed to have believed their own hype. It was as if they truly thought they were “Masters of the Universe.”

And now that the financial system has gotten back on its feet – and as the rest of the economy is still suffering – this hubris, which seemed to have fallen with the stock market, has reinflated. As a top Goldman Sachs official said commenting on the high levels of risk the firm was taking on – and the best-ever profits they were generating from that:

Our model really never changed, we’ve said very consistently that our business model remained the same.

The near-collapse of the financial industry is apparently no match for the hubris of bankers.

Continue reading “Theories of the Financial Crisis: Hubris of the Bankers”
Categories
Financial Crisis Politics The Opinionsphere

The People’s Rage At A System That Had Failed Them

Frank Rich uses the new film Public Enemies and the saga of Bernie Madoff to try to get at the momentous forces rippling through our society as this financial crisis reveals the rifts and trade-offs and makes explicit the social bargain that is submerged during prosperity:

“Dillinger did not rob poor people,” wrote one correspondent to The Indianapolis Star. “He robbed those who became rich by robbing the poor.”

Gorn writes that the current economic crisis helped him understand better why Americans could root for a homicidal bank robber: “As our own day’s story of stupid policies and lax regulations, of greedy moneymen, free-market hucksters, white-collar thieves, and self-serving politicians unfolds, and as banks foreclose on millions of families’ homes, workers lose their jobs, and life savings disappear, it becomes clear why Dillinger’s wild ride so fascinated America during the 1930s.” An outlaw could channel a people’s “sense of rage at the system that had failed them.”

As Gorn reminds us, Americans who felt betrayed didn’t just take to cheering Dillinger; some turned to the populism of Huey Long, or to right-wing and anti-Semitic demagogues like Father Coughlin, or to the Communist Party. The passions unleashed by economic inequities are explosive because those inequities violate the fundamental capitalist faith. It’s the bedrock American dream that virtues like hard work and playing by the rules are rewarded with prosperity.

In 2009, too many who worked hard and played by the rules are still suffering, while too many who bent or broke the rules with little or no accountability are back reaping a disproportionate share of what scant prosperity there is.

Categories
Barack Obama Conservativism Domestic issues Economics Financial Crisis History Liberalism Libertarianism Political Philosophy The Opinionsphere

A Generational Bargain (in which we are getting screwed)

[digg-reddit-me]Back when California’s looming bankruptcy was in the news, George Will wrote:

California’s perennial boast — that it is the incubator of America’s future — now has an increasingly dark urgency…California has become liberalism’s laboratory, in which the case for fiscal conservatism is being confirmed.

Will may be right about fiscal conservatism – but he’s wrong in laying the blame for California’s problems on liberalism. The fault in California, like the fault in America, is deeper – a refusal by the Baby Boom generation to make tough choices to create a sustainable world, economy, or government. Bill Maher summarized California’s trap best:

We govern by ballot initiative – and we only write two kinds of those: spend money on things I like and don’t raise my taxes.

California’s initiative system aggravated a tendency that has been dominant in American politics for some time now. The problem with California – and America – is a combination of two factors:

  1. a kind of accidental unholy alliance between liberals who push for more government spending to alleviate poverty and better the nation and conservatives who want to cut taxes – with neither group having the power or political will to be fiscally responsible at the same time as they push for their pet projects ((This is a bit unfair on the national level – as George H. W. Bush and Bill Clinton – with opposition Congresses checking them – proved to be exceedingly responsible, putting America on a sustainable course after the tax-cutting, free-spending Ronald Reagan and before the tax-cutting, free-spending George W. Bush.))
  2. the deliberate plan of the right-wingers who want to “starve the beast” – by which they mean encouraging the irresponsible system above of  increasing spending while cutting taxes (and these right-wingers do this knowing that the system is unsustainable and will crash, which is the only way they see to get rid of popular programs.)

This is a story of the cowardice of politicians and the idiocy of people.

This idiocy – in almost all of its forms – can be traced to the ascent of the Baby Boom generation as they took power with the Reagan administration. By increasing spending exponentially while cutting taxes – creating enormous deficits – Reagan supercharged (stimulated) the economy out of the stagflation of the 1970s. At the same time, he began the American government’s practice of becoming dependent on East Asia – relying on Japan to lend vast amounts of its money as our trade deficit with them grew. Reagan also began the trend of deregulation of industries – allowing them to take greater risks and reap greater profits if they succeeded – which also allowed companies to kick off a merger boom, leading more and more companies becoming too big to fail while they were regulated less and less. All of these steps led to an economy focused more on finance than industry – leading, along with factors due to globalization, to America’s industrial decline. The dominance of the financial sector in the economy, which is well known for its boom and bust cycle, led to a series of economic bubbles – and in fact, an economy in which growth was maintained through bubbles rather than real worth.

Beginning with Reagan, president after president stimulated the economy constantly – to avoid having to take the fall. But this system was unsustainable. As the Baby Boomers “surfed on a growing wave of debt” – both public and private – they sought to use debt to meet their rising expectations in the absence of creating real value. This was the generational bargain at the heart of the Reagan presidency – a bargain that allowed America to spend the Soviet Union into the ground and jumpstart the economy from the stagflation of the 1970s – but that, unchecked, thirty years later, now threatens our future.

The Baby Boomers pissed away the prosperity their parents bequeathed them and squandered the opportunities presented to them – and now are busy using their children’s future earnings (our future earnings) to buy their way out of the mess they have created. They avoided the challenges of their times and found people to blame. They focused on OJ Simpson, Britney Spears, Madonna, and Monica Lewinsky – on abortion, Vietnam, gays, and religion – and not on global warming, on campaign finance, on the corruption of our political process, on an overleveraged economy.

After decades of avoiding systematic problems – as the solutions became embroiled in the ongoing culture war – we now must face them. With two wars in the Mid-East, a failing world economy, a growing threat of catastrophic terrorism, and whatever else may come our way, procrastination is impossible. Now it’s time for us to try to salvage this wreck. It remains to be seen if we’re up to it.

David Brooks explained this grave situation facing Obama and the difficult tasks ahead (focusing especially on the growing deficit). Brooks concludes with reasons for hope and despair:

The members of the Obama administration fully understand this and are brimming with good ideas about how to move from a bubble economy to an investment economy. Finding a political strategy to accomplish this, however, is proving to be very difficult. And getting Congress to move in this direction might be impossible.

Your cards do not improve if you complain about the hand you have been dealt. But it is essential to understand how we got here. We also must not be complacent now that a leader who we admire has been given power. Individuals are empowered to a greater extent than ever before in history – for good or ill. Which is why it is never enough to get the right man or woman into public office – even if this is a useful initial step. What we must do – as individuals – is to see the world around us clearly and take steps to effect what changes we can, to live the values we hold in our hearts, to reach out to those affected by our actions.

[Image by orangejack licensed under Creative Commons.]

Categories
Barack Obama Domestic issues Economics Financial Crisis Health care Iran Politics The Opinionsphere

Mirror Neurons, Iran’s Fissures, Yglesian Insights, The Deficit Crisis, Rare Minerals

Once again, it’s Friday, so it’s time for my weekend reading recommendations.

1. Mirror Neurons. Daniel Lametti explains the importance of mirror neurons in the Scientific American.

2. Iran’s Fissures. Roger Cohen has been prominently writing about Iran for the past year or so – predicting and pushing for a thaw in relations. Now, on the cusp of an important election, Roger Cohen discusses Iran:

Iran, its internal fissures exposed as never before, is teetering again on the brink of change. For months now, I’ve been urging another look at Iran, beyond dangerous demonization of it as a totalitarian state. Seldom has the country looked less like one than in these giddy June days.

3. Yglesian insights. Matt Yglesias’s blog has long been on my must-read list – but he’s offered some especially insightful observations in various contexts about the free market in recent weeks. Here Yglesias speculates about the advantages of non-profit-maximizing corporations in a free market:

After all, profit-maximization is not a natural form of human behavior. I think it’s best understood as a very idiosyncratic kind of pursuit. It happens to be one that’s economically rewarded because with money to invest tend to want to invest it with would-be profit-maximizers. Thus, in fields of endeavor where the ability to raise large sums of capital on reasonable terms is a huge advantage, a profit-maximization impulse winds up being a huge advantage.

In a later post about health care, Yglesias makes a related point:

[P]art of what’s wrong with the world is that the very same people who spend a lot of time cheerleading for free markets and donating money to institutions that cheerlead for free markets—businessmen, in other words—are the very people who have the most to gain from markets being totally dysfunctional. The absolute worst place on earth you can find yourself as a businessman is in the kind of free market you find in an Economics 101 textbook. As a market approaches textbook conditions—perfect competition, perfect information, etc.—real profits trend toward zero. You make your money by ensuring that textbook conditions don’t apply; that there are huge barriers to entry, massive problems with inattention, monopolistic corners to exploit, etc.

4. How to tackle the deficit crisis. Set off by David Leonhardt’s excellent look at the forthcoming deficit crisis, the Opinionsphere quickly took this up as a theme of the week. Noah Millman at The American Scene had the best take on how to tackle the deficit crisis – once we decide to get serious. One of the main ways he suggests is to reform the tax code:

We have an income tax that is riddled with deductions that undermine its purported progressivity, and we rely on increasingly steep progressivity to justify every additional change to said code. A 1986-style reform that eliminated many deductions and lowered rates would not only be a likely booster of the economy, but would probably raise revenue – certainly on the corporate side.

5. China’s Great Game. And of course, the Financial Times reported that China has almost cornered the world market in rare minerals needed for most high tech products. I’m looking forward to some analyst really following up on this and explaining what implications – if any – this has.

Categories
Barack Obama Economics Financial Crisis Politics The Bush Legacy The Opinionsphere

Obama’s Grand Bargain (as a necessary response to the deficit problem)

[digg-reddit-me]David Leonhardt has a typically excellent piece in the Times with a helpful graph explaining the deficit problem. Leonhardt tells the story of how the $800 billion surpluses left by Bill Clinton have turned into $1.2 trillion deficits – or what he calls the “$2 trillion swing.” He identifies four categories of spending accounting for the swing in descending order of significance:

the business cycle, President George W. Bush’s policies, policies from the Bush years that are scheduled to expire but that Mr. Obama has chosen to extend, and new policies proposed by Mr. Obama.

Leonhardt identifies only 10% of the current deficit as resulting from either Obama’s stimulus package or new spending (which is only 3%). 20% of the deficit is traced to Bush policies set to expire that Obama is continuing – for example, a large portion of Bush’s tax cuts and the Iraq war. 33% comes from legislation signed by Bush – like the Medicare prescription act. And Leonhardt attributes 37% of these enormous deficits – the single largest factor – to the combination of increased counter-cyclical spending (on food stamps, unemployment, etc.) and a decrease in government revenues resulting from the downturn.

This math is a large part of what made those Tea Parties – as well as so much of the Republican opposition – ridiculous. First, these Tea Parties – and most of the opposition – was silent while George W. Bush pushed through legislation account for 53% of the current deficit – but suddenly was up in arms once a Democrat proposed 10% in spending to stimulate the economy and fix some significant problems. At the same time, many of those conservatives who were strong opponents of Bush continue to propose more tax cuts. In fact, during the debate over the stimulus bill, Republicans denounced the deficits being caused by government spending while proposing a tax cut bill that would create even large deficits.

What Leonhardt describes is a nation that has been subjected to the conservative “starve the beast” strategy of cutting taxes and increasing spending. This deliberate policy has brought us to the brink of disaster – as George Will describes:

For years, many conservatives advocated a “starve the beast” approach to limiting government. They supported any tax cut, of any size, at any time, for any purpose, assuming that, deprived of revenue, government spending would stop growing. But spending continued, and government borrowing encouraged government’s growth by making big government cheap: People were given $1 worth of government but were charged less than that, the balance being shifted, through debt, to future generations. In 2003, Republicans fattened the beast with the Medicare prescription drug benefit (Cooper opposed it), which added almost $8 trillion in the present value of benefits scheduled, but unfunded, over the next 75 years.

Liberalism’s signature achievement — the welfare state’s entitlement buffet — will, unless radically reduced, starve government of resources needed for everything on liberalism’s agenda for people not elderly. Conservatives want government limited, but not this way.

Leonhardt quotes Alan Auerbach, an economist at the University of California, Berkeley,

Bush behaved incredibly irresponsibly for eight years. On the one hand, it might seem unfair for people to blame Obama for not fixing it. On the other hand, he’s not fixing it.

And not fixing it is, in a sense, making it worse.

I think Andrew Sullivan has the right tack on this:

I don’t blame Obama for failing to turn all this around in five months, and for running a debt this big right now. I willblame him if he does nothing serious to tackle this in the next year.

Leonhardt has been a reporter with good access to the White House in these early days of the presidency. Which suggests that this article is not coming out of the blue for this administration. In fact, shortly before taking office, Obama talked about the “Grand Bargain” he would need to negotiate to deal with precisely this issue. It seems to me that this piece begins to set the stage for what Obama is looking to do after cap-and-trade and health care are passed – to tackle the issues of tax reform and entitlement reform.

All this makes his continued and extraordinary attempts to woo members of the House and Senate – and his efforts to give them a role in determining policy (as described in Matt Bai’s new article) – essential. As Bai describes:

“One of the mistakes of the past is that when presidents arrive on Capitol Hill with legislation chiseled into stone, it’s not well received,” says David Axelrod, one of Obama’s most influential advisers. “You have to give people a sense of ownership.”

Obama seems to have decided early on that his model for pursuing legislation would be something closer to Ronald Reagan, a president whose political savvy he has often expressed admiration for. Partly by necessity, because he had to work with a Democratic Congress, Reagan was known for providing broad policy frameworks while delegating the details to lawmakers. In this way, he managed to fundamentally reform the tax code and shore up Social Security during his first year in office — achievements for which he gladly took credit, even if Congress didn’t give him precisely what he wanted. To this end, Obama’s chief health care adviser, Nancy-Ann DeParle, has been all over Capitol Hill, consulting with various members and soliciting their advice, but the administration has been careful not to weigh in with too much authority or to make any public pronouncements on the negotiations.

Obama may have been able to push through health care and cap-and-trade with his Democratic majorities and personal popularity. But he needs the Congress and Senate to work with him on tax reform and entitlement reform once the financial crisis has been dealt with. Or perhaps sooner – as the bond market pressures the administration to set a clear path which involves a return to fiscal sanity.

To do this, Obama needs the trust and support of a large majority of Congressmen and Senators. And he needs to mobilize public and elite opinion to support a significant change in our tax and spending policies. This article by David Leonhardt strikes me as an attempt to set the stage for this soon-to-be debate.

[Picture by Peter Souza courtesy of the White House.]

Categories
Barack Obama Economics Financial Crisis Law Politics The Bush Legacy

The Supreme Court Holds Up the Chrysler Sale

I actually decided to write a short piece stating my hope that the Supreme Court would look into Obama’s and Bush’s expansion of executive powers in tackling the financial crisis before the Supreme Court delayed the sale of Chrysler to Fiat. Now that they have, I’m relieved if a bit nervous. The key issue is the use of executive power in a crisis – as Michael J. de la Merced explained the issue:

In a broader context, such a decision would also give the justices an early opportunity to consider the scope of the wide-ranging but not unlimited authority that Congress granted the president to address the economic crisis.

I think this is a good thing – though I’m not sure how the timing of this will affect things. Generally, the strongest decisions restricting the executive’s freedom in a crisis have come after the crisis has past. With the rash of bad news on the economic front – even as most indicators seem to be levelling off – this financial crisis is not yet over. On the one hand, strong action by the Court at this time to curb the power of the president could destabilize the economy, as it is confidence in the power and determination of the executive branch and the Federal Reserve to backstop the financial system that seem to have restored confidence in the market and economy itself. At the same time, the Supreme Court is less likely to challenge the president’s authority in the middle of a crisis – making it more likely the decision will be deferential.

It is possible that all of these competing claims could be dealt with responsibly – with a Solomonic decision along the lines of Marbury v. Madison. It’s also possible that the Court may find Presidents Bush and Obama both acted constitutionally in their response. But as a matter of policy, the recent government interventions into the market are ill-advised if they extend beyond the minimum amount of time. As I wrote regarding Obama and the Rule of Law:

The power of the executive branch has grown enormously in the financial crisis – between the Stimulus Bill and the bank bailout. While in the short-term this may be necessary, if steps are not taken, this would undermine the balance of power between the federal government and the states. While this in itself is not a violation of the Rule of Law – it does weaken the system which together helps maintain the Rule of Law.

The one issue that strikes me as worth considering – on matters of constitutionality rather than policy – is whether or not Bush and then Obama acted within their powers in providing loans to Chrysler and General Motors; perhaps a Court should also look at the broad authority given by the TARP bill itself and set some standards regarding what authorities and monies can and cannot be extended to the executive branch by the legislative.

The whole process of drafting and passing the TARP bill was obviously flawed – though it’s difficult to judge legislation passed in the midst of a crisis. The only logical way out of this I’ve heard mentioned would be to “stockpile laws” as Philip Bobbitt once suggested with regards to terrorism.

But even as there is a flawed process, it’s not clear what if anything was unconstitutional.

At the same time, I’m glad to see the Court looking seriously at getting involved. I’m all for these checks and balances.