James Pethokoukis

Politics and policy from inside Washington

Is system risk regulation even possible?

Sep 24, 2009 16:24 UTC

Arthur Levitt, former chairman of the SEC, wants a systemic risk regulator who can serve as an “early warning system” and “director appropriate regulatory agencies to implement action.” (This is his House Fin Serv testimony.) I am not sure, ultimately, even the WH thinks this kind of prescience is possible. Anyone who could do that should be running money rather than serving in government. Better to tweak capital and leverage rules and force the big banks to show how they could be unwound — the “living will” idea.

The Fed as systemic risk regulator

Sep 24, 2009 16:00 UTC

In his testimony before the House Financial  Services Committee, economist Mark Zandi draws light to a problem I have been talking about and then offers a solution:

The principal worry in making the Federal Reserve the systemic risk regulator is that its conduct of monetary policy may come under overly onerous oversight. Arguably one of the most important strengths of our financial system is the Federal Reserve’s independence in setting monetary policy; it would be counterproductive if regulatory reform were to diminish even the appearance of this independence. This will become even more important in coming years, given prospects for large federal budget deficits and rising debt loads. Global investors will want to know that the Fed will do what is necessary to ensure inflation remains low and stable. To this end, it would be helpful if oversight of the Fed’s regulatory functions were separated from oversight of its monetary policy responsibilities. One suggestion would be to establish semiannual reporting by the Fed to Congress on its regulatory activities, much like its current reporting to Congress on monetary policy.

And here is how Paul Volcker sees all this working:

I am not alone in suggesting that a Fed governor should be nominated by the President and confirmed by the Senate as a second Vice Chairman of the Board with particular responsibility for overseeing Regulation and Supervision. The point is to pinpoint responsibility, including relevant reporting to the Congress, for a review of market developments and regulatory and supervisory practices. Staff authority, independence, professionalism, experience, and size should be reinforced.

Me:  I don’t see how Zandi’s solution would solve anything. Maybe the new vice-chairman would do most of the testifying about regulation rather than Bernanke? I think the true answer is that a lessening of independence is just a risk Zandi and Volcker are willing to take.

White House taking a flexible approach to financial reform

Sep 24, 2009 13:55 UTC

It was a revealing performance that Treasury Secretary Timothy Geithner gave on Wednesday before the House Financial Services Committee. and an important one. While Geithner frequently journeys to Capitol Hill, his latest appearance comes as the administration begins a new renews a push for passage of sweeping financial regulatory reform.

Maybe “push” is the wrong word. “Scramble” might be better since Geithner stressed that time is of the essence. “We can’t let momentum for reform fade as memory of the crisis recedes,” he said. Indeed, Tthe same dynamic is at play with financial reform as it is with healthcare reform: Get a reasonable bill passed this year or, ideally, before the November gubernatorial elections in New Jersey or Virginia, where Republicans are leading.

While Geithner said the uber-practical administration favors what will work, the reality might be closer to what will pass. Take the White House proposals for various consumer reforms, including the establishment of a Consumer Financial Protection Agency. Chairman Barney Frank wants to tweak the White House proposal, eliminating a provision that would force financial companies to offer “plain vanilla” versions of financial products. Frank would also exempt a range of businesses from CFPA oversight such as accountants and lawyers.

Geithner’s response: “There’s nothing in there, at first glance, that troubles me significantly in terms of its practical value.” This is good news. Rather than having a new agency attempt to determine what plain-vanilla mortgages and credit cards are and then mandate them, better to merely improve disclosure of fees and requirements for consumers.

Here is hoping that Geithner and President Barack Obama show a similar flexibility on the issue of a super-regulator and systemic risk. The White House continues to push for an expanded Federal Reserve regulatory role despite the potential risks to its independence. The idea of a SuperFed is also likely to meet stiff congressional opposition given the Fed’s role in creating the financial bubble through errors in monetary policy and lapses in regulatory judgment. Creation of a SuperFed might also have to accompany passage of a bill to audit the central bank, another threat to its independence.

Christopher Dodd, Frank’s opposite in the U.S. Senate, favors a single regulator to oversee banks. Ideally, the Fed would then be free to focus on its core mission of conducting monetary policy, while, as an American Enterprise Institute analysis put it, a separate super-regulator could enjoy supervisory economies of scale and achieve consistency. This easily passes the Geithner “what will work” standard.

More evidence of rising trade protectionism

Sep 24, 2009 13:44 UTC

As Reuters reports it:

The United Steelworkers union, fresh from persuading President Barack Obama to restrict tire imports from China, filed a new case Wednesday asking for duties on coated paper from both China and Indonesia. The action came just one day after Chinese President Hu Jintao complained to Obama about the tires decision in a meeting on the sidelines of a United Nations summit in New York. … The steelworkers union, which represents workers in a number of industries, sees itself in a battle against what it believes are unfair foreign trade practices that have led to the loss of millions of U.S. manufacturing jobs. They are joined in their latest trade case by paper manufacturers NewPage Corp of Miamisburg, Ohio; Appleton Coated LLC of Kimberly, Wisconsin; and Sappi Fine Paper North America of Boston, Massachusetts, which together employ about 6,000 union workers at paper mills in nine states. … Unlike the steelworkers’ petition in the tires case, this complaint will not land on Obama’s desk. Instead, the U.S. International Trade Commission, a U.S. federal agency, will have the final word on whether anti-dumping and anti-subsidy duties will be imposed after an investigation by the U.S. Commerce Department.

Worried about how this sort of thing will affect the economy recovery both in the US and globally? Ed Yardeni is:

But what about Art Laffer’s warning about how rising taxes and protectionism could still cause another Great Depression?” …  He observed: “While Fed policy was undoubtedly important, it was not the primary cause of the Great Depression or the economy’s relapse in 1937. The Smoot-Hawley tariff of June 1930 was the catalyst that got the whole process going. It was the largest single increase in taxes on trade during peacetime and precipitated massive retaliation by foreign governments on U.S. products. Huge federal and state tax increases in 1932 followed the initial decline in the economy thus doubling down on the impact of Smoot-Hawley. There were additional large tax increases in 1936 and 1937 that were the proximate cause of the economy’s relapse in 1937.”

I completely agree with Art that the Smoot-Hawley tariff was the major cause of the Great Depression. So it is certainly disturbing to see the Obama Administration pander to the United Steelworkers by slapping a tariff on tires imported from China. This morning’s WSJ reports that three paper companies and the United Steelworkers filed an antidumping case Wednesday against China and Indonesia, making good on the union’s threat to protect other US industries after winning a recent trade decision against China. We’ve seen plenty of similar trade flare-ups in the past even during the Reagan and Bush Administrations. Nevertheless, they can spin out of control. More importantly, now is not a good time to resort to protectionism given that the global economic freefall earlier this year was mostly attributable to a collapse in exports as trade credits froze up.

A bigger and more likely threat to a sustainable recovery is the sun-setting of the Bush tax cuts after 2010. This will amount to a major tax increase that could send the economy back into a recession in 2011. I don’t think this will trip up the bull market any time soon. But it is likely to become a big issue by the second half of next year.


High taxes and restrictions in free trade are good for economic growth. Everybody knows that.

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Study: Income inequality in America is overstated

Sep 23, 2009 17:36 UTC

First the summary of new research from economist Robert Gordon:

The rise in American inequality has been exaggerated both in magnitude and timing. Commentators lament the large gap between the growth rates of real median household income and of private sector productivity. This paper shows that a conceptually consistent measure of this growth gap over 1979 to 2007 is only one-tenth of the conventional measure. Further, the timing of the rise of inequality is often misunderstood. By some measures inequality stopped growing after 2000 and by others inequality has not grown since 1993. This cessation of inequality’s secular rise in 2000 is evident from the growth of Census mean vs. median income, and in the income share of the top one percent of the income distribution. The income share of the 91st to 95th percentile has not increased since 1983, and the income ratio of the 90th to 10th percentile has barely increased since 1986. Further, despite a transient decline in labor’s income share in 2000-06, by mid-2009 labor’s share had returned virtually to the same value as in 1983, 1991, and 2001.

Recent contributions in the inequality literature have raised questions about previous research on skill-biased technical change and the managerial power of CEOs. Directly supporting our theme of prior exaggeration of the rise of inequality is new research showing that price indexes for the poor rise more slowly than for the rich, causing most empirical measures of inequality to overstate the growth of real income of the rich vs. the poor. Further, as much as two-thirds of the post-1980 increase in the college wage premium disappears when allowance is made for the faster rise in the cost of living in cities where the college educated congregate and for the lower quality of housing in those cities. A continuing tendency for life expectancy to increase faster among the rich than among the poor reflects the joint impact of education on both economic and health outcomes, some of which are driven by the behavioral choices of the less educated.

Me: Indeed, part of this is the Wal-Mart factor where lower-income households have been able to substitute less expensive goods, giving their real spending power a big boost.


Despicable and ignorant. Maybe it’s not alright that people HAVE TO shop at Walmart just to stretch their dollars… using that kind of barometer to say everything is alright for people who have to spend every dollar they make to make ends meet, I think that says a lot about the author. I would love to propose to anyone who thinks that people are better off today than, say, ten years ago try this simple test: try to only spend what you could make working 50hrs a week (ie two part time jobs) at Walmart or MacDonald’s (after taxes, so roughly $300/wk) for a whole month. That’s food, utilities, gasoline. Let’s see how you feel about the economy after that exercise. Maybe, if you live alone, you’re ok, but try it with 2 or more dependants (kids). If you don’t starve first, comeback afterwards and write a commentary in this blog.

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Sarah Palin speaks! Some thoughts on her speech in Hong Kong

Sep 23, 2009 16:34 UTC

So Sarah Palin gave her big speech in Hong Kong. She talked about eliminating cap gains and estate taxes, giving people tax breaks to buy their own health insurance, and took a few shots at the Fed. That section was particularly interesting. (A bit of video here.) Here is the WSJ’s take:

“How can we discuss reform without addressing the government policies at the root of the problems? The root of the collapse? And how can we think that setting up the Fed as the monitor of systemic risk in the financial sector will result in meaningful reform?” she said. “The words ‘fox’ and ‘henhouse’ come to mind. The Fed’s decisions helped create the bubble. Look at the root cause of most asset bubbles, and you’ll see the Fed somewhere in the background.”

“Lack of government wasn’t the problem, government policies were the problem. The marketplace didn’t fail. It became exactly as common sense would expect it to,” she said. “The government ordered the loosening of lending standards. The Federal Reserve kept interest rates low. The government forced lending institutions to give loans to people who as I say, couldn’t afford them. Speculators spotted new investment vehicles, jumped on board and rating agencies underestimated risks. So many to be blamed on so many different levels, but the fact remains that these people were responding to a market solution created by government policies that ran contrary to common sense,” she said.

Me: I will  alsopredict that she’ll also come out strong against TARP, which may be a big dividing line among 2012 candidates.


OK, here are my thoughts on the substance of the speech. Palin fundamentally doesn’t understand the causes of the economic crisis (this should come as no surprise to anybody that has ever seen her interviewed).
Government was not the root cause of the crisis and it is simply untrue to say that financial markets didn’t fail. If anything, INSUFFICIENT regulation (a lack of sensible constraints on leverage, etc) was a larger part of the problem. Saying this does not make one a socialist.
You can have a sensible discussion about such matters with an intelligent conservative like Mitt Romney, but Palin has absolutely nothing to offer to the debate.

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Geithner on the Hill (live blogging)

Sep 23, 2009 14:34 UTC

Treasury Secretary Timothy Geithner speaks before the House Financial Services Committee on financial regulatory reform this morning and I am there.

9:33 It begins

9:35 Barney Frank says financial regulatory reform is not dead for 2009.

9:37 Frank says a busy schedule, including working on Fridays.

9:38 Frank says Senate counterparts tell him its full-speed ahead for them, too.

9:39 Frank talks about TBTF and how America hates it, doesn’t like that incompetence is “immunized.” “There will be death panels enacted by this Congress.”

9:41 Says Bush White House felt it had no options other than pay all creditors or none of the creditors. This will change.

9:42 Is against a “pre-ordained” list fo systemically important institutions. Like porno, “You’ll know it when you see it.”

9:44 Sees a future regulator who would tell an AIG to get out of CDS business and unwind portfolio

9:45 Ranking GOPer Spencer Bachus starts to speak. Doesn’t want to rescue firms but liquidate and resolve them. Bad mouths the Fed’s ability to identify systemic risk. Also rips into consumer finance piece.

9:46 Now we are going around the horn as other committee members give their two (minute) cents.

9:50 Jeb Hensarling (R) is going after bailouts and saying they are making economy worse, mentions jobsless recovery. He seems unaware that Frank is already going to tone down some Obama proposals like consumer finance.

9:51 Luis Guitierrez (D) dismissed the regulatory abilities of Fed and FDIC, talks up consumer finance. More capital, less leverage to stop TBTF. “Only government can stop” another Lehman.

9:55 Republicans say things need to slow down.

9:56 Geithner speaks. Says WH is only focused on “what will work.”

9:57 Hits on consumer finance first. Failures were “extensive and costly.” And to fix this we need to have national standards on credit providers.

9:58 TG: We need fundamental overhaul without hurting consumer choice.

10:00 TG: We need tools to resolve TBTF firms.  We need a way to allow failure to happen with huge collateral damage to economy. “Can’t let momentum for reform fade as memory of crisis recedes.”

10:02 TG asked about BF changes to plain vanilla aspect of consumer finance proposal. TG says he is supportive of BF changes!

10:04 Doesn’t Tier One designation create a subsidy? TG says he is worried about that issue but that they will be subject to leverage limits and keep more capital and more conservative restraints on risk taking. But we need tools to intervene to be dismantled and restructured without taxpayer bearing burden. Our jobs is to make sure”system is less vulnerable.”  Can’t let financial crisis “burn itself out.” Can’t “abolish the fire station.”

10:07 Maxine Waters says she is very worried about speculative use of CDS. Also seems to want to completely ban them. No just naked CDS.

10:11 TG gives a “how did that work out for you” kind of answer to the idea of keeping consumer finance authority dispersed.

10:13 TG: Don’t want to see “a bunch of bureaucrats” limit consumer choice.

10:15 Hensarling do you favor Frank death panel for troubled companies.

10:16 TG: It could be receivership or conservatorship for TBTF companies.

10:17 Mandatory standardized products for consumers not off the table but looking at other approaches, too.

10:18 JH: Wouldnt retailers like Walmart fall under new consumer authority.

10:19 Seems to say if you offer consumer credit, you play by same rules. “It’s black and white.” If you compete with banks, you fall under new agency, he seems to say. (Hensarling sees it as a new reg regime for US retailers.)

10:21 TG: Leverage is a biggie, especially for systemically important firms. Adds that “I have not had the privilege” of working on Wall Street.

10:24: TG: How best to prevent moral hazard. Cant expect the market to constrain excess leverage or wait for crisis to burn itself out.

10:35 What about proprietary trading/ toxic assets? TG:  Won’t guarantee those activities. Also,new capital is coming into the system because of disclosure. More liquidity toxic assets markets. Govt. capital just  now being allocated.

10:37 GOP presses TG on consumer reg consolidation. TG: Other regulators are not incompetent or unprincipled but also are protecting turf. More importantly, status quo did not work.

10:42 On derivatives and hedging. TG: Some companies need to hedge risk and also need customized products.

10:44 On credit ratings agencies. TG: We need to decrease ratings dependence and a critical part of that is that people who sell securities retain some of the risk.

10:46  TG has seen Frank note on fin reform changes but only briefly “but broad thrust looks encouraging and promising” and “nothing troubles me.”

10:51 Sherman (D) and section 1204 (resolution authority) and SuperTARP.  Can we limit $ to $1 trillion in taxpayer dough or come to Congress.TG responds: I dont recognize most of your concerns and would be a mistake to harden or create an expectation that government will save you. You are fundamentally mischaracterizing the bill. (Sherman presses him on dollar limit.) I would not support proposals to put us in position we were in 2007 and 2008. Sherman: The problem with Wall Street is that Congress had to be involved.

10:57 Sherman: This creates moral hazard.

11:00 (From GOP)Will consumer energy push out smaller players, community banks and raise costs, creating bigger financial institutions. TG: This won’t increase costs for community banks. And we want to preserve capacity to use derivative markets to hedge.

11:09 Manzullo (R) Was root cause of collapse that subprime not regulated enough, people buying home they could not afford. TG: One of a number of factors.

Can Obama spend US back into prosperity?

Sep 22, 2009 18:07 UTC

Presidents, particularly Democrats it seems, love to try and attach catchy titles to their agendas. FDR’s New Deal and JFK’s New Frontier made for powerful branding. Bill Clinton’s New Covenant, not so much.

Barack Obama seems to be going with “New Foundation,” the title of a big-think economy speech from last spring. As the President said back then with biblical flair: “We cannot rebuild this economy on the same pile of sand. We must build our house upon a rock. We must lay a new foundation for growth and prosperity.”

As a follow up, the White House’s National Economic Council, headed by Lawrence Summers, just released a new white paper that fleshes out how the administration plans to create that “new foundation.” In a post on the official White House blog, Summers says the government needs to take an active role in strengthening America’s “economic ecology.”

But let’s examine the diagnosis before we turn to the prescribed treatment. The most important statistic for analyzing a nation’s economic strength is worker productivity. And since 1995, U.S. worker productivity has increased at a terrific annual rate of about 2.6 percent.

But is that somehow a phony number, a mere derivative of the equity and housing bubbles? The White House doesn’t seem to think so. As economic adviser Jared Bernstein told me recently, “There is nothing that’s changed in the basic underlying productivity and strength of the American workforce and the American economy. [Productivity] remains in that kind of post –’95, elevated, 2 ½ percent range.”

In other words, Obama actually inherited an economy with a pretty solid foundation, though clearly one with some cracks. And don’t forget that despite the financial crisis, the World Economic Forum still recently ranked the American economy as the second-most competitive in the world, far in front of major competitors such as Germany and France.

The key, then, is to build on America’s existing strong foundation of innovation-driven productivity. Summer’s NEC makes a variety of recommendation such as increased government investment in education, infrastructure and basic research. And as long as that spending is limited to the “building blocks” of economic growth as opposed to picking winners, Uncle Sam might actually do some good here.
Unfortunately, the White House has been picking winners in a sort of an ad hoc industrial policy. Maybe the banks were too big too fail, but GM and Chrysler?

And why should the tax code continue to favor the housing sector? Is building bigger homes and vacation getaways the best use of American capital? Yet there is little evidence the White House plans on changing that sector’s privileged position.

And the President continue to favor the idea of high-speed rail, a favorite of unions and green activists, despite numerous studies questioning the economic benefit of such a system in the vast, spread-out United States.

The administration also seems to be making a bet that higher taxes on small businesses, investment and higher incomes will have limited or no negative effect on the nation’s entrepreneurial climate.

Finally, any productivity guru will tell you that perhaps the most important thing a country can do to boost innovation and economic efficiency is keeping markets open. Or to use the favorite phrase of Diana Farrell, former director of the McKinsey Global Institute and now a Summer’s deputy at the NEC, “creating maximum competitive intensity.” Obama’s tire tariff doesn’t seem to qualify as a pro-innovation measure by that standard.

So by all means, repair some bridges and spend more bucks at federal labs. But innovation and productivity involve a whole lot more.



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Social Security may be in worse trouble than we think

Sep 22, 2009 18:00 UTC

Over at Hot Air, Ed Morrissey has gotten hold of an internal CBO report distributed to Congress that  predicts Social Security will start running a cash deficit next year as opposed to 2019. And even that, apparently , is based on some pretty rosy revenue projections.  Indeed, over the span of  2017, 2018, 2019, SS will run a $126 billion deficit, according to the CBO. Gee, and you wonder why the Chinese are getting skittish about the dollar?


When people talk about debt and ar aghast at the $1.7 trillion deficit this year and national debt of $11 trillion now, just think how horrified/terrified they would be if they knew the whole picture! If you inlude gov’t pledges and underfunded liabilities – fancy naming gimmickery for what is plain old DEBT – the total is closer to $70 trillion, or roughly 375-400% GDP. When the Social Security ‘situation’ finally really comes to public attention there will be some scared people, and most of them foreign investors. I don’t like to be a doom and gloomer, but I don’t see lots of happy numbers to change my mind…

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TARP and the 2010 election

Sep 22, 2009 17:40 UTC

The following quote is from a Democrat, Rep. Peter DeFazio, but I would not be surprised to hear a lot of GOPers say a similar thing on the campaign trail (via The Hill):

The view of the Larry Summers crowd down at the White House that has the president’s ear is, ‘What a tremendous success — everyone at Goldman Sachs is getting a $700,000 bonus this year, so it’s working,’ ” said Rep. Peter DeFazio (D-Ore.), a consistent critic of the Wall Street bailouts. “If your total focus in life is enriching a few people on Wall Street and protecting their assets, it’s working. If your focus is jobs for Americans and their assets, this whole thing has been a disaster.


Would be curious to see how he voted, or if he even read it, as he was passing it into law…

This kind of political posturing is why there can never be any real debate in America, because it’s not what politicians think, it’s what they think they can win on.

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