Democracy and BipartisanThink

As usual, Jonathan Chait has the definitive takedown of the recent David Brooks column. Using awkward dance metaphors, Brooks blames both sides equally for the current impasse over sequestration. This is classic Brooks, but one thing I found interesting is how he presents the two parties' strategies. Here are the Democrats:

Under the Permanent Campaign Shimmy, the president identifies a problem. Then he declines to come up with a proposal to address the problem. Then he comes up with a vague-but-politically-convenient concept that doesn’t address the problem (let’s raise taxes on the rich). Then he goes around the country blasting the opposition for not having as politically popular a concept. Then he returns to Washington and congratulates himself for being the only serious and substantive person in town. 

Here are the Republicans:

In this dance, the Republicans mount the stage and roar that they are about to courageously cut spending. In this anthem they carefully emphasize cuts to programs the country sympathizes with, such as special education, while sparing programs that actually created the debt problem, like Medicare.

Then, when they have worked themselves up into a frenzy of self-admiration, they sprint across the stage and leap into what they imagine is the loving arms of their adoring fans. When they are 4 feet off the ground, they realize the voters have left the building in disgust and they land with a thud on the floor. 

Now, as Chait points out, Obama actually does have a plan. So substantively this critique is incorrect. 

But there is another aspect of Brooks' analysis that is problematic. He is suggesting that proposing a plan that citizens favor is not any more responsible than proposing a plan that citizens hate. There is a certain centrist thirst for pain, and the need to make "tough choices". And government decisions shouldn't be made by taking polls. But, deciding how to deal with the long-term debt sitution is a political decision--not a technocratic one. Different plans distribute the "pain" of deficit reduction differently, and in a democracy the way government decides to distribute the benefits and costs of a course of action should resemble the preferences of the body politic. 

This isn't an outright call for populism in place of technocracy. But the Democrats should be given credit for crafting a political platform that deals with challenges in a way that citizens would like them to be dealt with. They even ran for election on these ideas and won! 

Now democracy can't thrive unless different parties put forward different ideas. But the Republicans have been putting forward the same ones for a while now, and they haven't caught on. At some point, peoples' preference for the Democrats' approach should matter in terms of how we think about setting policy.

Capital Requirements and Transparency

A good article by Douglas J. Elliot on some of the (often ignored) costs of higher capital requirements for banks. Matt Yglesias has an interesting response. One thing in the Elliot piece caught my attention:

The “black box” nature of banks is a related problem. Investors must rely on the quality of lending, securities, and derivatives transactions that are difficult to understand from the outside. There is likely to be a limit as to how safe investors are willing to assume banks will be, at least in the proposed range of capital requirements. This may change in the long-term, if banks end up proving themselves to be very safe.

At the end of the day, the stability of the financial system is going to depend on how well lenders, regulators, and shareholders can evaluate the risks being taken on by large financial institutions. Its often very difficult to tell from annual reports how much risk a bank has taken on. This is the result of complex financial products and accounting standards that aren't able to keep up with them. As Elliot is pointing out, having higher capital requirements only works if banks don't offset the higher costs of added capital with riskier assets. It's a bad sign that he thinks investors will assume that the banks will do exactly that.

This is a hard problem to solve, but as I mentioned yesterday one of the goals of financial stabilization policy should be to encourage banks to hold assets that are widely traded, and thus priced more reliably.

The GOP's Political Problem

Josh Barro has a great piece discussing some recent efforts by conservative writers to chart a way forward for the GOP. As Barro notes, these efforts are a step in the right direction, but:

I don't think that math can add up. If you're going to expand the child credit or use some other approach to fulfill Ponnuru's goal of providing payroll-tax relief to the middle class; and you're going to avoid gutting the entitlement programs that working- and middle-class Americans depend on to support their standards of living; and you're going to run only a sustainable budget deficit; then you're going to need tax rates on high incomes or capital gains that many conservatives will probably see as "unreasonable" -- for example, in the ballpark of a 40 percent top rate on ordinary income, where we are today.

This seems correct to me, but I think the same critique could be made of Democrats. President Obama is committed to not raising taxes on those making under 250,000, which is likely not enough revenue to pay for many of the social programs he endorses. That being said, many liberals endorse more revenue than Obama asked for in the fiscal cliff negotiations, so I don't want to draw a false equivalency here.

I think the problem for the GOP and conservatives runs deeper. Conservatives and the GOP establishment instinctively oppose any domestic initiative endorsed by Barack Obama and the Democrats. As the Democratic party has moved to the right, this has crowded out the GOP's policy space. Policy proposals that were once endorsed by Republicans--cap-and-trade and Romney's healthcare plan-- have become anathema. This process has left them with very little room to create policies that address the problems facing middle-class Americans.

You can see this in Matt Yglesias' discussion of Holtz-Eakin and Roy's piece on healthcare. The basic premise is that if the Republicans had been willing to compromise, they could have gotten a version of Obamacare that was more to their liking. Even now, many Republican Governors are unwilling to set up the new ACA health care exchanges, and use the leeway they are given to relax regulations. This symbolic opposition means the federal government will be setting up the exchanges for them.

It is the same factor behind Marco Rubio's public rebuke of Obama's immigration plan. Rubio is trying to thread a very tiny needle here: pass immigration reform, while simultaneously claiming Obama is the enemy.

Basically, the willingness of Democrats to move to the center on initiatives, combined with the Republicans anti-Obama posture, has left very little space for a GOP policy that appeals to a wide array of voters.

Derivatives and Capital Requirements

I really enjoyed Jesse Eisinger and Frank Partnoy's Atlantic piece "What's Inside America's Banks?" The article makes the case that both banks, and the regulatory apparatus in which they operate, are astonishingly complex. As an example, they read Wells Fargo's annual report, which is a maze of confusing language and obfuscates more than it enlightens.

Eisinger and Partnoy argue that simpler regulations based on materiality standards would suffice. Regulation should be as simple as the CEO of a company certifying that they have disclosed material information to their shareholders. Prosecutors would be free to bring criminal charges against CEO's who didn't do their due diligence in this regard. The problem, they say, with complex regulations is that it allows lawyered-up companies to meet the letter of the law without actually providing transparency.

I think they make a good case. But seeing as we live in a world of complex regulations, one thing struck me as important:

Like other banks, Wells Fargo uses a three-level hierarchy to report the fair value of its securities. Level 1 includes securities traded in active, public markets; it isn’t too scary. At Level 1, fair value simply means the reported price of a security. If Wells Fargo owned a stock or bond traded on the New York Stock Exchange, fair value would be the closing price each day.

Level 2 is more worrisome. It includes some shadier characters, such as derivatives and mortgage-backed securities. There are no active, public markets for these investments—they are bought and sold privately, if at all, and are not listed on exchanges—so Wells Fargo uses other methods to figure out fair value, including what it calls “model-based valuation techniques, such as matrix pricing.” At Level 2, fair value is what accountants would charitably describe as an “estimate,” based on statistical computer models and what they call “observable” inputs, such as the prices of similar assets or other market data. At Level 2, fair value is more like an educated guess.

Many banks’ stocks are below “book value” today. This indicates that investors don’t believe the stated value of the assets on banks’ books, or don’t believe banks will be profitable in the future—or both. 

Level 3 is hair-raising. The bank’s Level 3 estimates are “generated primarily from model-based techniques that use significant assumptions not observable in the market.” In other words, not only are there no data about the prices at which these types of assets have recently traded, but there are no observable data to inform the assumptions one might use to generate prices. Level 3 contains the most-esoteric financial instruments—including the credit-default swaps and synthetic collateralized debt obligations that became so popular and prevalent at the height of the housing boom, filling the balance sheets of Bear Stearns, Merrill Lynch, Citigroup, and many other banks.

Regulation should account for the fact that the pricing of Level 2 and Level 3 assets is imprecise and has a greater margin of error than Level 1. To compensate for this, Level 2 and Level 3 assets should require greater capital ratios as a security. This will do two things: First, the higher capital ratios will provide safety in case the assets were overvalued. Second, it will push banks to do more of their business in securities that are traded on public markets. Currently banks are incentivized to deal in over-the-counter, boutique securities because they can charge higher prices to their customers for these unique assets.

In a sense, the "problem" with derivatives isn't that they exist, rather they are too complex for shareholders to determine if they are being priced accurately. Creating incentives to reduce the number of assets banks are holding for which there is no public market would add transparency.

No One Remembers the Balanced Budgets

Amity Shales argues (correctly) that Reagan didn't care about balanced budgets, and that if austerity fanatics proponents need a hero they should look to Calvin Coolidge:

But Coolidge came in like a lion, determined to make austerity permanent. Coolidge met with his budget director, Gen. Herbert Lord, on his first day in office and routinely thereafter. The two men soon announced that they would deepen planned cuts in two politically sensitive areas: veterans and on District of Columbia public works. "I am for economy, and after that I am for more economy," Coolidge told voters—who gladly kept him in the White House when he ran in 1924.

I don't know much about Coolidge (except this), but neither does most Americans. Probably because balancing the budget didn't actually matter that much in the course of U.S. history. Whatever the wisdom of cutting benefits to WWI veterans, its pretty clear that from a budgetary perspective the Great Depression and WWII would totally undue these initiatives.

The fact that Republicans champion Reagan and don't discuss Coolidge should tell us something about how little importance balancing the budget has on U.S. economic history and prosperity.

Also this:

When an admirer in South Africa sent two lion cubs to the president, Coolidge named them Budget Bureau and Tax Reduction to emphasize the linked approach.

Terrible names for lions.

The Laziness of Simpson-Bowles 2.0

Ezra Klein points out that Simpson-Bowles 2.0 is right in the middle of the current Obama and House Republican bargaining positions:

This isn’t meant to be an update to Simpson-Bowles 1.0. Rather, it’s meant to be an outline for a new grand bargain. To that end, Simpson and Bowles began with Obama and Boehner’s final offers from the fiscal cliff deal. That helps explain why their tax ask has fallen so far: Obama’s final tax ask was far lower than what was in the original Simpson-Bowles plan, while Boehner’s tilt towards spending cuts was far greater than what was in the original Simpson-Bowles.

As he also describes, the actual policies used to achieve these targets haven't been revealed (other than Chained-CPI).

There is a lot to be frustrated with about this type of proposal. As Greg Sargent notes, this will be referred to as a "centrist" position even though it is far to the right of their initial "centrist" proposal. This moving of the goalposts punishes the Democrats for being more willing to compromise, while rewarding the Republicans for being less willing to. But I think one thing worth mentioning is the sheer lazyness of the proposal.

There is room in our political debate for a group that outlines a proposal that falls roughly in the middle of the two major party's bargaining positions. But the role of the group needs to be actually outlining the proposal. Simply naming the middle adds no value whatsoever. Naming actual budgetary changes is difficult work, and legislators would benefit from non-partisan groups identifying and scoring these changes. Similarly, identifying different potential budgetary changes and computing and publicizing their distributional impact would help the public recognize what these changes would actually mean. But Simpson-Bowles does none of this. They simply point out "the middle" and then go on Sunday shows and scold politicians.



 

Thomas Friedman is Uncertain About Uncertainty

Thomas Friedman thinks he knows why the economy isn't growing:

Apple is currently sitting on $137 billion of cash in the bank. There are many reasons Apple has not spent its cash horde, but I’ll bet anything that one of them is the uncertain economic and tax environment in this country.
...
Message: There is no doubt our economy is primarily being held back by the deleveraging and drop in demand that resulted from the 2008 financial crisis. But they are being reinforced today by uncertainty and worry that we do not have our political house in order and, therefore, our tax, regulatory, pension and entitlement frameworks are all in play. 

I think companies are uncertain about demand, and I think the best way to fix this would be for the federal reserve to target NGDP. But even if you thought Friedman was right, and that a big problem was regulatory uncertainty, why would this be your solution:

Therefore, [Obama] owes it to himself and to the country to make one more good shot at a Grand Bargain on spending, investment and tax reform before he opts for a strategy of trying to pummel the Republican Party, hoping that he can win the House for the Democrats in 2014 and then push through his second-term agenda unencumbered.

If you are concerned about regulatory uncertainty, a grand bargain is a terrible idea. Putting tax reform on the table would mean months and maybe a few years of bargaining over tax loopholes and rates. Right now, businesses can be fairly certain that the House and Obama won't agree on much, especially not on taxes. They can be fairly certain that taxes won't really change over the next four years. Friedman's solution isn't going to happen, and according to his logic it would make things worse.