James Pethokoukis

Politics and policy from inside Washington

Imagining a new consumer finance regulator

Apr 13, 2010 17:38 UTC

Alex Pollock does, and the results are not pretty:

Consider a new, independent regulatory bureaucracy filled with ambitious officers and staffers who are interventionist by ideology, believers that people need to be guided for their own good according to the tenets of “behavioral economics,” social democratic by faith, and closely aligned to numerous “consumer advocates.” They will hardly be content with the project of “improving disclosure,” important as that is.

They will ineluctably embark instead on allocating credit in terms of “improved access” and “fairness.” In other words, they will promote expanding riskier loans, in spite of the fact that making people loans they can’t afford is the opposite of protecting them.

This is why, if such an organization is to be created, it is absolutely essential that it be truly part of, and subordinate to, a regulatory body also charged with financial prudence, safety and soundness, and balancing risks. Better would be not to create it at all, but rather to centralize the responsibility for clear, straightforward key information in a relevant existing regulator—the Federal Trade Commission, for example.

The Looting Scenario for America

Apr 13, 2010 17:25 UTC

The Great Arnold Kling thinks there is a high probability of a two-decade economic fiasco, outlined below.

In the Looting Scenario, what is going to be rewarded is what we call rent-seeking. Basically, over the next twenty years, wealth transfer by government will be much more important than wealth creation–and the amount available for transfer could actually decline. For example, I expect that benefits for the elderly will become increasingly means-tested and savings will be increasingly taxed, to the point where the marginal return to saving will approach zero. If the marginal return to saving is low, and government deficits are high, then capital formation is going to be low. It’s hard to see how you get rapid innovation in that kind of world.

The Looting Scenario is one in which public employees and pensioners have the incentive to just take as much as they can while they can get it. It is a scenario in which people talk about the deficit, and wise heads say we must do something about it, but the only politically feasible approach is to raise taxes. Even so, it turns out that higher tax rates bring in less revenue than projected, because of the incentives to consume leisure and engage in black-market activity.

Seven years ago, it would not have occurred to me that our ruling class would be so bad that the Looting Scenario would be likely. My guess is that, even among libertarians, just about everyone else still has faith that our ruling class will not let the Looting Scenario take place. However, I think it is one of the higher-probability scenarios out there.


Current trends in US ethnic demographics will continue to reduce the amount of wealth available for transfer.

When people say that betting against the US has always been a losing wager, they forget — or don’t want to acknowledge — that they’re not talking about the same country.

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How to really end Too Big To Fail

Apr 13, 2010 17:22 UTC

Over at the must-read e21 site, Chris Papagianis provides an excellent counter to the Dodd-Obama financial reform plan. He prefers an approach devised by Oliver Hart and Luigi Zingales. Here are the key details via Papagianis:

1) Hart and Zingales would use credit default swap (CDS) spreads as a market-based default probability metric. The “spread” or premium on a CDS contract represents the market price of providing a financial guarantee against losses from a firm’s default.

2) In the Hart and Zingales framework, once the CDS spread rises above a pre-specified “critical threshold,” the regulator would force the institution in question to issue equity (offer new stock for sale) until the CDS spread moves back below the threshold.

3) While Hart and Zingales choose the right instrument for their trigger, their proposed remedial step should be strengthened. Instead of having the regulator demand that the institution issue new equity, the debt of the institution could automatically convert into equity. Say a large bank financed $150 billion of assets with $80 billion of deposits, $40 billion of senior debt, $20 billion of so-called junior debt, and $10 billion of equity. When the CDS on this bank surpassed the critical threshold, half of the bank’s junior debt would automatically convert to equity. Instead of having 6.7% equity (15-to-1 leverage), the bank’s assets would be financed with 13.3% equity (7.5-to-1 leverage). If that failed to bring the CDS below the critical threshold, the other half of the junior debt would also convert to equity.

4) The mandatory conversion would enhance systemic stability for two reasons. First, the risk that the debt would convert to equity would be priced into the debt, raising the systemic institution’s cost of capital and leveling the playing field with smaller banks. Secondly, the automatic conversion would eliminate the potential for regulatory forbearance caused by market conditions.

Me: I like this. It doesn’t depend on the omniscience of politically captured regulators, and it doesn’t involve bank bailouts by taxpayers. This would seem to be an antidote to Crony Capitalism.

Andy Stern can now fix a problem he helped cause

Apr 13, 2010 15:10 UTC

Multiple reports suggest Andy Stern will be leaving his job as head of the politically powerful SEIU. The union, which represents healthcare and public employees, was instrumental in passing healthcare reform. In other words, he has contributed in two ways to America’s fiscal woes. First, health reform may prove a budget fiasco since its tax hikes and spending cuts  were used to expand coverage rather than cut the budget deficit. Second,  fat pay and benefit packages for public sector unions are a big reason so many states like California have long-term fiscal woes. As this David Feddoso story found:

Among states whose government workers are less than 40 percent unionized, median per capita state debt is $2,238. Among states with between 40 and 60 percent of their government workers in public sector unions, the average debt is $3,609. Among states with more than 60 percent of the government workforce unionized, the average (median) per capita debt is $6,380.

Interestingly, Stern will be a member of Obama’s deficit commission. So there are at least a couple of issues that need addressing that he will be an expert on.