James Pethokoukis

Politics and policy from inside Washington

Obama’s SEC war against Goldman Sachs

Apr 16, 2010 18:09 UTC

A few thoughts on the SEC charges against Goldman Sachs:

1) Goldman Sachs gave the Obama campaign $994k during the 2008 election, his biggest donor. Doesn’t this undercut the theory just a bit that Washington is under the thumb of Wall Street?Even a tiny bit? (No, say Simon Johnson and James Kwak.)

2) I can’t help but think this boosts the odds of financial reform passing and a shift it to the left, as well. You might even see more GOPers advocate for breaking up the banks, as do some Fed regional presidents.

3) Certainly under the leadership of a new chairman and enforcement director, the SEC’s Obama years have marked a hard switch from the posture of the Bush SEC. In 2009, the regulator opened twice as many investigations as in 2008, with fines up 35 percent. The new assertiveness helped cool talk the Hill that the SEC should be merged with the CFTC pushed into a giant super-regulator

4) But its aggression can also lead to unforced errors. A judge threw out a $33 million SEC fine against BofA regarding bonuses paid to Merrill Lynch employees. The SEC also failed to execute in its case against Cohmad Securities and the firm’s involvement with Bernard Madoff. In February, a federal court dismissed the SEC’s “flimsy” charges that Cohmad helped enable the notorious Ponzi schemer.

5) A failed case against Goldman for alleged securities fraud might leave the SEC in worse shape. It would also open the watchdog to charges that the timing of its charges, right in the middle of a debate over financial reform, was merely an attempt by the Obama administration to intimidate Wall Street into supporting its get-tough legislation.

6) This is exactly the sort of scenario a bank exec outlined to me a few months back. The exec worried that the longer FinReg reform dragged on, the odds increased that some bolt-from-the-blue news would change the political calculus and push the bill to the left.


How about stopping SEC employees from sitting all day viewing on-line porn at the taxpayers dime.

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5 reasons why the Tea Partiers are right on taxes

Apr 16, 2010 15:28 UTC

Here is the new Washington Consensus: American taxes must be raised dramatically to deal with exploding federal debt since spending can’t/shouldn’t be cut. Only the rubes and radicals of the Tea Party and their Contract from America movement think otherwise. And don’t worry, the economy will be just fine.

Don’t believe it. While you will never hear this in the MSM, there is plenty of academic research supporting the idea that cutting taxes and spending is the ideal economic recipe for growth, jobs incomes and fiscal soundness. (This all assumes that America’s amazing turnaround since 1980 isn’t proof enough.)  Just take a look:

1) Tax cuts boost economic growth more than increased government spending. Cutting spending is a better way to reduce budget deficits than raising taxes. “Large Changes in Fiscal Policy: Taxes Versus Spending” — Alberto Alesina and Silvia Ardagna, October 2009:

We examine the evidence on episodes of large stances in fiscal policy, both in cases of fiscal stimuli and in that of fiscal adjustments in OECD countries from 1970 to 2007. Fiscal stimuli based upon tax cuts are more likely to increase growth than those based upon spending increases. As for fiscal adjustments, those based upon spending cuts and no tax increases are more likely to reduce deficits and debt over GDP ratios than those based upon tax increases. In addition, adjustments on the spending side rather than on the tax side are less likely to create recessions.

2) Tax cuts boost growth. Tax increases hurt growth, especially if used to finance increased government spending. “The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks” — Christina Romer and David H. Romer, July 2007:

In short, tax increases appear to have a very large, sustained, and highly significant negative impact on output. Since most of our exogenous tax changes are in fact reductions, the more intuitive way to express this result is that tax cuts have very large and persistent positive output effects. … The resulting estimates indicate that tax increases are highly contractionary. The effects are strongly significant, highly robust, and much larger than those obtained using broader measures of tax changes. The large effect stems in considerable part from a powerful negative effect of tax increases on investment. We also find that legislated tax increases designed to reduce a persistent budget deficit appear to have much smaller output costs than other tax increases.

3) Cutting corporate taxes boosts growth. “The Effect of Corporate Taxes on Investment and Entrepreneurship” — Simeon Djankov, Tim Ganser, Caralee McLiesh, Rita Ramalho, Andrei Shleifer, January 2008:

We present new data on effective corporate income tax rates in 85 countries in 2004. The data come from a survey, conducted jointly with PricewaterhouseCoopers, of all taxes imposed on “the same” standardized mid-size domestic firm. In a cross-section of countries, our estimates of the effective corporate tax rate have a large adverse impact on aggregate investment, FDI, and entrepreneurial activity. For example, a 10 percent increase in the effective corporate tax rate reduces aggregate investment to GDP ratio by 2 percentage points. Corporate tax rates are also negatively correlated with growth, and positively correlated with the size of the informal economy.

4) Tax rates are reaching dangerous levels where higher rates bring in less money. “The Elasticity of Taxable Income with Respect to Marginal Tax Rates” — Emmanuel Saez, Joel Slemrod and Seth Giertz, May 2009:

Following the supply-side debates of the early 1980s, much attention has been focused on the revenue-maximizing tax rate. A top tax rate above [X] is inefficient because decreasing the tax rate would both increase the utility of the affected taxpayers with income above [Y] and increase government revenue, which can in principle be used to benefit other taxpayers. Using our previous example … the revenue maximizing tax rate would be 55.6%, not much higher than the combined maximum federal, state, Medicare, and typical sales tax rate in the United States of 2008.

5) Cutting corporate taxes boosts wages. “Taxes and Wages” — Kevin Hassett and Aparna Mathur, June 2006:

Corporate taxes are significantly related to wage rates across countries. Our coefficient estimates are large, ranging from 0.83 to almost 1-thus a 1 percent increase in corporate tax rates leads to an almost equivalent decrease in wage rates (in percentage terms). … Higher corporate taxes lead to lower wages. A 1 percent increase in corporate tax rates is associated with nearly a 1 percent drop in wage rates.

There are plenty more, of course. The Tax Foundation lists a dozen recent studies how harmful business taxes are to growth, jobs and wages. Economist Greg Mankiw has determined America is far from a low tax nation. More like in the middle. And let me add this from economist Scott Sumner:

When I started studying economics the US was much richer than Western Europe and Japan, but was also growing more slowly than other developed countries. They were still in the catch-up growth phase from the ravages of WWII. But since Reagan took office the US has been growing faster than most other big developed economies, and at least as fast in per capita terms. They’ve plateaued at about 25% below US levels, when you adjust for PPP. This is the steady state.  …   Why is per capita GDP in Western Europe so much lower than in the US? Mankiw seems to imply that high tax rates may be one of the reasons. … So I think Mankiw is saying that if we adopt the European model, there really isn’t a lot of evidence that we’d end up with any more revenue than we have right now. … Of course the progressives’ great hope is that we’ll end up like France. But Brazil also has high tax rates, how do they know we won’t end up like Brazil?


This guy seems to be confusing economic growth with creating an economic bubble.

The simple reality is that tax increases lead to higher GDP growth and lower unemployment. And cutting taxes lead to lower GDP growth and higher unemployment.

Take a look at the stark reality yourself.

http://img27.imageshack.us/img27/3633/ta xrates.jpg

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A few thoughts on Tax Day

Apr 15, 2010 13:45 UTC

1) Dems have ripped the Bush tax cuts yet want to keep 95 percent of them.

2) Even the middle class ones may only be extended through the 2012 election by Congress. That will make for a nice presidential campaign issue!

3) New research shows that raising taxes on rich may now cost more revenue than it produces. We are on the wrong side of the Laffer Curve, people.

4) If WH thinks Americans consume too much and save too little, why do they want to raise taxes on savings and investment?

5) Why raise taxes on capital when the first quarter of 2010 saw the lowest commitments to venture capital since 1993.

6) These tax hikes (letting the Bush tax hikes expire on the so-called wealthy) would hit the bulk of small biz profits.


I like your 6 points, and add my own.

7) Only cutting spending is not sufficient to cut the national debt, despite Senator Ryan’s nice looking plan.

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Is McConnell right about TBTF?

Apr 14, 2010 12:26 UTC

Senate Republican leader Mitch McConnell charges that the Dodd financial reform bill supported by the WH fails to end Too Big To Fail. Is he correct. Well, this bit from Reuters highlights one problem area:

Seeking a middle ground between bailout and bankruptcy, the Senate bill sets up a new process for “orderly liquidation” of large firms that get into trouble. Authorities could seize distressed firms and dismantle them. The Senate bill creates a $50 billion fund to finance such actions. Large firms with assets above $50 billion would pay into the fund. Republicans object to a part of the bill that would let the fund borrow additional money from the Treasury — that means taxpayers — if the liquidation fund runs short. This provision smells like “backdoor bailouts,” say Republicans. … The House bill, like the Senate’s, sets up a new liquidation process, but it would be simpler to invoke and and it would come with a higher price-tag. The House proposes a $200-billion fund. Firms with assets over $50 billion would pay up to $150 billion into the fund, which could borrow another $50 billion from the Treasury.

Me: Then there is the issue of confidence in regulators and politicians to resist the temptation to bail/rescue in a crisis.

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.

Imagining a V-shaped recovery and the 2010 midterms

Apr 12, 2010 17:39 UTC

Those who argue that Democrats might lose one or both houses of Congress are making an economic argument. Slow growth/high unemployment = angry, anti-incumbent voters. But what if the economy really perks up? First some analysis by Larry Kudlow:

Sometimes you have to take your political lenses out and look at the actual economic statistics in order to gauge whether we’re on the road to recovery or not. … No one has written more about the future tax-and-regulatory threats from the big-government assault of Obamanomics. But most of that is in the future. The current reality is that a strong rebound in corporate profits (the greatest and truest stimulus of all), ultra-easy money from the Fed, and some very small stimuli from government spending are all working to generate a cyclical recovery in a basically free-market economy that is a lot more resilient than capitalist critics would have us believe. So conservatives should not lose their cool and blow their credibility over a cyclical rebound that is backed by the statistics.

And now the econ team of Wesbury and Stein at First Trust Advisors:

Unfortunately, there is a group of people who still haven’t arrived at the station – mostly because they confuse politics with economic forecasting. Many Republicans and quite a few conservative television commentators are still trying to use the Clinton/Carville method of winning elections – “It’s the Economy, Stupid.” As a result, they keep telling anyone who will listen that the Obama agenda is going to kill the economy – RIGHT NOW.

But they will be wrong. It is true that more government spending and regulation, higher taxes, and government mandates will erode growth in the future. And it is true that recent growth in government will make it less likely the US will be the home of the next Apple iPad-type device. The fact of the matter is that big government and high tax rates hurt the entrepreneurial spirit and slow economic activity (see growth in Europe versus the U.S.).

But arguing that this recovery is not happening is a losing proposition. It is happening; And it’s V-shaped. We expected a V-shaped recovery as the panic ended, as monetary velocity returned and because Fed policy was easy.

Me: I think the key here is to see what happens with unemployment, incomes, housing and gas prices.  Certainly the economic consensus is for unemployment to stay above 9 percent. And my own analysis shows a big lag between an economic turn around and public perception. Perhaps the jobless rate will outperform on the upside as it has underperformed on the downside. One thing to keep an eye on is Obama’s approval rating which is now 45-48, according to Gallup.


zzzzzzz…bed time

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After FDR’s New Deal …

Apr 12, 2010 17:20 UTC

The death of FDR in 1944 meant no New Deal, The Sequel. What did happen? This (via the WSJ):

Instead, Congress reduced taxes. Income tax rates were cut across the board. FDR’s top marginal rate, 94% on all income over $200,000, was cut to 86.45%. The lowest rate was cut to 19% from 23%, and with a change in the amount of income exempt from taxation an estimated 12 million Americans were eliminated from the tax rolls entirely.

Corporate tax rates were trimmed and FDR’s “excess profits” tax was repealed, which meant that top marginal corporate tax rates effectively went to 38% from 90% after 1945.

Georgia Sen. Walter George, chairman of the Senate Finance Committee, defended the Revenue Act of 1945 with arguments that today we would call “supply-side economics.” If the tax bill “has the effect which it is hoped it will have,” George said, “it will so stimulate the expansion of business as to bring in a greater total revenue.”

Me: Research indicates that top U.S. tax rates are already on the wrong side of the Laffer Curve. And our corporate tax rates are highly uncompetitive internationally. All play into a New Normal thesis over the long term.