James Pethokoukis

Politics and policy from inside Washington

5 EU options for Greece, inspired by Lehman

May 21, 2010 14:48 UTC

Don Rissmiller of Strategas looks at how the lessons of the US financial crisis could instruct policy responses for the EU and its Greece problem:

1) The TARP-like option: this is essentially spending government money to buy bad debt, and the European bailout packages have moved in this direction. The political challenge
was always getting money authorized to help those that appeared to be spending beyond their means. This still appears to be where we are now in the EU, despite some progress
with the German vote.

2) The PPIP-like option: the challenge with spending government money in the U.S. was that the authorization process was burdensome. Hence, the next suggestion was a ”public private investment program” (PPIP). The challenge with PPIP (it never got off the ground) was how to get banks to sell assets in an illiquid market, which presumably would not be as large an issue with government debt. But the key features of the program – including non-recourse leverage and a sharing of profits – were indeed well thought out. No European option of this sort appears on the table currently, however.

3) The Monetization option: When the Fed finally started participating with “all available tools”, including buying mortgage securities, the U.S. market stabilized. This is certainly a politically tough option for the ECB. Should it come to it, however, the option of doing nothing certainly seems like a much worse policy mistake.

4) Cutting Spending: Greece already appears to have lost some sovereignty, as the Lisbon treaty has required sharp adjustments. These cuts can be some of the most politically challenging items, though as the governor of NJ has demonstrated, they are not impossible.

5) Europe Bank Guarantees: the risk of a “run on the bank” seems to be creating additional uncertainty, though the amount of deposits that would have to be guaranteed would presumably be quite large. The FDIC guarantee plan in the U.S. could provide some guidance for Europe, however.

And Larry Kudlow also has some thoughts on that last option of Rissmiller’s:

So it’s my contention that the Europeans must now embark on a similar program. The EU/IMF rescue plan, which consists of $1 trillion in loans and loan guarantees for government sovereign debt, must be expanded to include a blanket loan guarantee for all European bank debt, short term and long term. A Europe-wide, centralized, deposit-guarantee system should also be developed. Right now bank deposits are insured by individual countries, like Greece. This is not credible. (Hat tip to investor David Kotok for this deposit-guarantee thought.)

A loan-guarantee program to backstop the banks in Europe and sovereign debt will put an end to this crazy Greek drama that is pulling down markets everywhere and threatening the economic recovery. As a free-market advocate, I don’t like this sort of government intervention. But we’re talking emergency here. Systemic global emergency. … These bank-loan guarantees would be temporary, perhaps a year in length. And they would buy time for the essential budget restructuring necessary to slash spending and curb the welfare-state excesses in southern Europe, or perhaps all of Europe. These government-shrinking steps will free up private-sector resources to spur growth.

Wall Street scores a win on financial reform … for now

May 21, 2010 14:43 UTC

A sigh of relief is due on Wall Street. The procedural finale for the U.S. Senate’s debate on financial reform came just in time for the big banks. The bill just kept getting tougher as the talk dragged on. But it could have been worse. While banks’ future activities and profitability may get pinched, their core business model appears intact. In the end, Wall Street got nicked, not nuked. Some observations:

1) Wall Street should thank the White House. Had President Barack Obama prioritized bank reform over healthcare at the height of the crisis, the biggest players might have been broken up, hard caps placed on balance sheets, and banking and investing operations separated. More recently, the Securities and Exchange Commission’s lawsuit against Goldman Sachs in April helped re-energize advocates for such changes.

2) Nothing radical here. While the Senate and House bills still need to be blended, it’s safe to say the most radical ideas have fallen by the wayside. A “systemic risk council” of federal regulators will recommend new capital and leverage rules to the Federal Reserve, which will be the most influential bank regulator. The Federal Deposit Insurance Corporation will have the power to wind down any failing large, systemically interconnected institution.

In addition, large, complex financial firms will have to submit plans for their rapid and orderly shutdown should they go under. And for the first time the derivatives that are currently traded privately will mostly be forced to go through clearing houses and in some cases trade on exchanges. Bank lobbyists have defended their corner: it’s not the regulatory reign of terror their clients’ most vociferous critics wanted. But it’s hardly a “light touch” regime, either, and it does involve real changes. Caveat: This assumes the Blanche Lincoln provision on derivatives is softened or stripped in the conference committee.

3) Too Big To Fail is still a problem. As long as regulators and politicians have vast amounts of discretion, a financial crisis will make bailouts an irresistible temptation. The way around this is either breaking up the banks or creating hard, market-based triggers for either regulatory action or a resolution process. Neither is in the bill.

4) Wall Street’s has an enduring PR problem. Yes, big banks are unpopular. But it has gotten so bad that they may not be able to so easily counter their image issues with campaign cash. Getting Wall Street money now has a stigma attached to it like oil and tobacco money. Candidates like Meg Whitman in California and John Kasich are getting hammered for their Wall Street ties. The industry’s continued unpopularity will no doubt spawn further attempts to tax, regulate and restrict the sector.

5) Bernanke trimphant. The Federal Reserve has to be pretty satisfied. It did not lose its role as regulator; in fact, it’s been strengthened. And the central banks was also able to fend off attempts to make it more transparent.  The downside:  The GOP (see Rand Paul)  has soured on the Fed in a big way, particularly at the grassroots. Further economic woes will lead to more calls to change its form and function.

U.S. reforms will nick, not nuke, big banks

May 20, 2010 20:52 UTC

A sigh of relief is due on Wall Street. The procedural finale for the Senate’s debate on financial reform came just in time for banks. The bill got tougher as the talk dragged on. But it could have been worse. While banks’ future activities and profitability may get pinched, their core business model appears intact.

Had President Barack Obama prioritized bank reform over healthcare at the height of the crisis, the biggest players might have been broken up, hard caps placed on balance sheets, and banking and investing operations separated. More recently, the Securities and Exchange Commission’s lawsuit against Goldman Sachs  in April helped re-energize advocates for such changes.

It’s safe to say the most radical ideas have fallen by the wayside. A “systemic risk council” of federal regulators will recommend new capital and leverage rules to the Federal Reserve, which will be the most influential bank regulator. The Federal Deposit Insurance Corp will have the power to wind down any failing large, systemically interconnected institution.

In addition, large, complex financial firms will have to submit plans for their rapid and orderly shutdown should they go under. And for the first time the derivatives that are currently traded privately will mostly be forced to go through clearing houses and in some cases trade on exchanges. Bank lobbyists have defended their corner: it’s not the regulatory reign of terror their clients’ most vociferous critics wanted. But it’s hardly a “light touch” regime, either, and it does involve real changes.

There’s still the chance that the bill’s limitations on banks’ derivatives activities could be further tightened. And the Senate’s final effort will then need to be blended with the House version, a process during which restrictions on derivatives and possibly proprietary trading — the so-called Volcker rule — will really be hammered out. So the book isn’t yet fully written.

Meanwhile, Wall Street’s continued unpopularity will no doubt spawn further attempts to tax, regulate and restrict the sector. And that’s ignoring the inevitable empty rhetorical attacks in this election year. For now, though — perhaps surprisingly — pragmatic policy has trumped punitive politics.

Paul Ryan and free-market populism

May 20, 2010 18:19 UTC

Over at RealClearPolitics, Rep. Paul Ryan of Wisconsin further fleshes out the emerging “free-market populism” meme beginning to emerge in the GOP:

From an ideological perspective, big government can combine with big business to advance a more progressivist society. For self-described “progressives,” the agenda is straightforward: expand government; co-opt big business; direct the capital markets from Washington to pursue “social justice.” Think Fannie and Freddie by much higher orders of magnitude.

Over the past decade, the thinking has been much less clear for conservatives. Being “pro-market” has been fundamentally confused with “pro-business.” Conservatives who came to Congress to defend and promote free enterprise have often been led to believe that pathway lies in bolstering established firms as they navigate the maze of government regulations and taxes. These instincts are correct, but the implementation is often flawed. All too often, the results of these efforts have been to exacerbate crony capitalism – erecting barriers to entry against potential competitors to firms that are currently on top.

For their part, companies seeking such protection have a right to pursue their narrow self-interest; but when these actions involve reducing open competition and transparency for short term gain, they do so to the detriment of the very free enterprise system that made their success possible.

Me: I can see this manifesting in a number of ways, from attacks on corporate welfare to more explicit calls to diffuse financial power. And it would seem to be in the sweet spot of folks like Marco Rubio, Rand Paul and Pat Toomey. This is also a group that would be willing to call for radical change in the U.S. entitlement system.

A ‘new’ GOP on its way?

May 20, 2010 18:10 UTC

So says Mr. Lawrence Kudlow:

A new tea party center is forming in the Republican Senate caucus. It will be the first Reagan nucleus in many years, one that will give the GOP a strong limited-government, cut-spending, low-tax-rate, stop-government-controls, and end-Bailout Nation message that will have clarity and gusto and will reverberate throughout the country.

Here’s how it’s going to work: Rand Paul will grab the Senate seat in Kentucky. Marco Rubio will take Florida. Mike Lee will win in Utah. Pat Toomey will finally prevail in Pennsylvania. And Carly Fiorina will knock off Barbara Boxer in California.

Yup. That’s how I see it. And this new tea-party Senate nucleus will join free-market stalwarts like Jim DeMint, Tom Coburn, Jon Kyl, Richard Shelby, Jeff Sessions, and John Thune. I’m probably leaving somebody out in the Senate, and I apologize in advance. But that’s what I’m thinking. It’s a pity Judd Gregg is retiring; he could be part of that group also.

This will be a reformist nucleus, tackling spending, taxes, and even monetary and currency policy. It will unabashedly propose free-market reforms to replace the Obama welfare state and to finally curb the avalanche of debt creation.

COMMENT

It’s interesting that anybody might see virtue in coalescing with the likes of Jim de Mint who is one of biggest scenery-chewing scam artists in political history.

If that’s the best the GOP has going for it, then they’d better be stocking up on industrial-strength deodorant.

Posted by HBC | Report as abusive

Best of the blogosphere

May 11, 2010 19:50 UTC

The best bits of the best stuff I have read today:
Larry Kudlow, CNBC, on the European bailout:

And in addition to Western Europe’s failure to enforce real welfare-state reductions, there really is no flat-tax reform — such as adopted in Eastern Europe — to promote growth. Ironically, the countries of Western Europe, including the southern tier of Greece, Spain, Portugal, and Italy, have a lower corporate tax rate than the United States. That is good. But they could build on that with real flat-tax reform, rather than jacking up value-added taxes.

So there are no enforced spending cuts, there is no flat tax, and there is plenty of political upheaval. (Angela Merkel just lost an important regional election.) So right now, on the day after a big relief rally in stock and bond markets, a sober assessment of the so-called rescue package doesn’t look so great. Actually, the real winner looks to be gold, which is up $20 this morning and is almost at its all-time high of $1,226. That’s a sign of no confidence in the European story. The euro currency has been compromised and the European welfare state continues. Not good.

Josh Barro, RealClearMarkets, on California debt problems:

California’s permanent budget crisis stems from institutional failures. Ballot measures have made it nearly impossible to raise taxes or cut spending, and have cemented the idea in voters’ minds that they can get government services without paying for them. The state has repeatedly failed to reform its inefficient tax code (which relies too much on highly volatile taxes on high-income people, and not enough on property taxes) or to tackle the problem of runaway public employee compensation. … The trouble with California is that it has a Mediterranean budget to match its Mediterranean climate. April’s numbers show that rosy tax receipts aren’t likely to improve matters any time soon. Like any Mediterranean EU member, California desperately needs an aggressive fiscal adjustment if it is to remain solvent.

Veronique de Rugy, Reason, on inflation:

The Federal Reserve is unwilling to take the inflationary route today. But investors know that other central banks have done so in the past and that the scenario could happen again. … If these growing deficits aren’t addressed by immediately and dramatically slashing spending—and there’s zero indication that such a shift will happen anytime soon—we are about to embark on the most massive transfer of wealth from younger taxpayers to older ones in American history. It will be not just unprecedented but unfair: Our children will have to pay for the decisions we make today.

Eileen Norcross, NY Post, on Chris Christie and NJ:

The governor is also directly challenging the monopoly hold of the NJEA. He backs a bipartisan bill to create a voucher program for students in the worst-school districts, and he supports the expansion of charter schools. Each reform would expose the teachers unions to competition, bringing down the cost of public schools while releasing students from some of New Jersey’s highest-spending and worst-performing schools. Christie inherited an unenviable budgetary framework, strangled with court-ordered school-spending formulas. He’s responding to voter anger over property taxes, but he knows that capping one source of revenue without capping total state spending only shifts the bill. Most important, he understands that New Jersey doesn’t have a revenue problem — it has a spending problem.

COMMENT

Gaius, you must be a true believer! Sorry, though, your facts are false. Since a picture is worth a thousand words, here’s a picture for you to study closely before repeating your lie about “Bush…running up greater deficits than Obama….”
http://blog.heritage.org/2010/02/05/past -deficits-vs-obamas-deficits-in-pictures  /
Not that I actually think you’ll repent, but there’s always hope for redemption.

Posted by OldBull | Report as abusive

State capitalism, crony capitalism

May 11, 2010 18:42 UTC

When Ian Bremmer offers to tell you “what comes next, it is wise to pay attention:

I believe that things are going to get worse for free markets before they get better. China might be sitting on a bubble, but it’s not the one that James Chanos is pointing toward, one that will pop as soon as China’s real estate boom goes bust. Nor is it the scenario described by Gordon Chang in which the Chinese people rise up to challenge the Chinese government. I could mention the labor bubble (200 million Chinese men with no hope of finding spouses), the environmental bubble (no water, no arable land, no breathable air), or any of the dozens of other bubbles floating ominously across the Chinese landscape. All of them are serious. None are certain to threaten China’s state capitalist system anytime soon. I’d bet confidently on strong state-led Chinese growth over the next decade. Intensified national pride will only strengthen the system in the near term.

Second, the situation will get much worse for free markets because anemic growth and high unemployment in the developed world will feed a backlash against free market sentiment. We’re already seeing more support for protectionism and a tougher stance on immigration in both Europe and the United States. In America, Goldman Sachs is today’s scapegoat, but China is next in line, whether the subject is currency policy, cyber-security, trade imbalances, product safety, or something else.

All of that makes the recommendation that you and I share — strong government support of basic free market principles — one that looks increasingly vulnerable to populist politics within free market democracies. The problem is even larger in Europe and Japan than in America.

COMMENT

Dear editor friend,
Well and wish to hear the same from you.
You have already a email for my new theory on world economics.
About this article, you have given more spaces on world trade and commerce, currency values, European nations different approach to tackle their economic mess and economic uncertainty.
Which economic theory holds good on now a days.
Only Mixed economy,that is, capitalism,capital growth, more wealth generations, a correct corporate taxes on industrialists, business men, and from new enterprises for more capital, more revenue to government treasuries,government governance, national security and more save and investment on permanent returns by mutual funds, government bonds, post office savings-more popular in Asian nations had saved this world economic crisis.
Indians are prospering day by day on account of some free liberal economy, more IT industries, more outsourcing, more labor in selected fields, more rural and urban growth on many sects had made India and state capitalist country China are created a new milestones to entire world.
Whereas, in many western countries, America,England, Germany are mainly depending stock markets, artificial creation for demand in real sectors, no proper auditing mechanism, election gimmicks on social welfare, less productivity in major industries had contributed a strong negative results and they are facing the past mistakes with terrible financial problems, social inequalities,frustrations, tensions and conflicts, a sudden reemergences of single nation identities,some law and order problems, huge cry on migrants, who asked them to allow more migrants for manual labors, ego on super thinking on other nations are to be corrected at the earliest.
Previously Dollar was talk of the town.
Now Euro is talk of the town.
Now, clashes had happened to these super,world currencies.

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The false choice of higher taxes and less spending

May 11, 2010 17:41 UTC

Over at NRO, Kevin Williamson tries to figure out how to reduce the US budget deficit:

I am not, in general, in favor of tax increases, but I think that Chait is correct that conservatives would do better to support a budget plan that combines real spending cuts with tax increases than to support a budget that does nothing to reduce spending but leaves taxes where they are or reduces them. The point being, from my point of view: Reducing government spending is paramount, and it is a much more important agenda item than tax cuts that will only defer the financial reckoning that our spending inevitably entails.

Closing the gap from revenues that equal 15 percent of GDP and spending that equals 25 percent of GDP still looks pretty hard to me. To repeat yesterday’s thought-experiment, say we construct a point-by-point trade-off, equalizing spending and revenue at 20 percent of GDP. I don’t see Republicans supporting a 33 percent tax increase or Democrats supporting a 20 percent spending cut. Lots of readers have made clever suggestions about how we get there, but none of them seem convincing to me. The trade-offs would have to be pretty significant, like collecting that 20 percent of GDP via a flat tax and enacting deep entitlement reform.
Me: First of all, let’s keep in mind that all the scary long-term deficit forecasts assume long-term US growth will be about a third slower than its historical average.  Smart tax policy, along with other pro-growth initiatives, could keep the US economy humming along.  Second, the higher-tax/less-spending austerity policy formulation has a poor track record. It brings weak growth and grumpy voters. More likely countries try to grow or inflate their way out of trouble.
COMMENT

Historical average is meaningless, sorry. One can’t assume the past will repeat itself in these matters. America was industrialized only up to the Mississippi as little as 100 years ago, and the growth that ensued up to the Korean War was based on building up the west and the industry to support that build up. After that followed a lull in economic growth as there was no more easy organic growth. It wasn’t until Nixon relieved the USD from the gold standard and then the policies of Reaganomics that growth approached the numbers from the days of yore – and those numbers were skewed by the growth of debt! In my opinion a fully developed economy like America should really only expect 1% growth + population growth (in America’s case a total of 2%.) For most of the rest of developed nations, that means 0-1%. Forcing up those numbers into 2-4% range in effect really only creates bubbles because the support isn’t there for those growth valuations. And so we’ve seen in the last 15 years… well, really since ’86-87, but I’ll limit to the dot-com build up to be fair

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Dealing with debt: America needs a growth experiment

May 10, 2010 15:20 UTC
Europe’s debt problems should inspire Americans to explore just how the U.S. will solve its own fiscal woes. I mean, no one is going to cut us a check like Germany and France just did for Greece. This is a topic I tackle in a piece I just wrote for The Weekly Standard. A few key points:
1) Cutting spending and raising taxes is a risky formula. It doesn’t have a great track record:
Since 1980, some 30 debt-plagued nations have tried to reduce their indebtedness through such austerity measures. In practically all cases, according to a new study by financial giant UBS, the increase in national debt was only slowed, not reversed, by such policy pain.
2) Trying to take more from rich people has its limits. Higher and higher income taxes or even wealth taxes create incentive to find tax havens and avoid productive work or capital allocation.
3) Cutting spending is better than raising taxes. Hey, I even have a study to prove it:
A 2009 study by Harvard University’s Alberto Alesina and Silvia Ardagna. It examined 40 years of debt reduction plans by advanced economies and found that “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.” They’re also associated with higher economic growth.
4) Less spending +more growth. This is my money graf from the piece:
But what if (a) government spending tracks current projections over the next 70 years, (b) government revenue as a percentage of GDP stays at its historic average of 18 percent, and (c) the economy were somehow to grow a bit faster than its 20th-century average, about 3.5 percent. Under those conditions, according a recent study by JPMorgan Chase, a much wealthier America (generating $100 trillion in tax revenue rather than $50 trillion) would be able to afford projected spending without raising taxes. The long-term budget gap would vanish. … Indeed, that is typically how successful countries in the UBS study managed to get their books in order; they grew their economies faster than they added debt. … Easier said than done, of course. … And there is no one policy to help make that happen. It will take a full-spectrum effort: lower taxes on companies and capital, pork-free spending on infrastructure and basic research (beyond health care), an education system that teaches students rather than feathering the nests of teachers’ unions. Every aspect of U.S. public policy will need to be optimized for economic growth.
COMMENT

Chinese firms are moving manufacturing plants to the US because land is cheaper here than in Beijing. THAT is growth

http://storyburn.com

Posted by STORYBURNcom2 | Report as abusive

Are US regulators blowing it … again

May 7, 2010 19:10 UTC

Karen Shaw Petrou at Federal Financial Analytics asks a good question:

Last Friday, we outlined the systemic-risk implications of the growing EU crisis. In the days that followed, LIBOR spreads tightened, funding dried up and our fears only rose. So, we were a bit surprised to hear a senior U.S. bank regulator tell a radio audience Thursday morning not to bother their heads about any prospects that the European crisis could wash ashore. That was, of course, followed in a few hours by a classic systemic-risk crisis on the exchanges. Was the U.S. regulator keeping the game-face on so as not to scare the children? Or, more worryingly, are U.S. regulators still unprepared for another bout of systemic risk, whistling in the dark much as they did when they told us that subprime-mortgage risk couldn’t spill over?

COMMENT

A computer glitch, a fat finger is that the best analysis we can do? Though I doubt we can trace the transactions if they went through “dark pools” yesterday’s situation looks a lot like a program trading variation with sell and cancel orders to create massive liquidity then intiating buys on a variation of the following example of a gaming strategy:

Savvy traders can use information about your order to manipulate prices in their favor. Some of the most common gaming scenarios include:

Gaming by manipulating the stock price. This scenario is explained with the following sequence of actions:
Figure 3. Gaming with Fishing
How gaming happens: 1) The Information Leak (Fishing)- By selling a few small lots, a gamer determines that a passive buyer has placed a standing order in a stock 2) The Exploratory Maneuver – The gamer buys the stock rapidly in the displayed market and succeeds in moving the stock up. 3) The Hit – After moving the stock, the gamer sends a large sell order to the dark pool and sells at substantially higher prices than the price he started buying at in the displayed market. 4) The Reversion – In less then two minutes it is all over. Prices revert as the gamer stops supporting the market.

Dark pools are lucrative, and can be anonymous trades.
U.S. regulators are observers and will have a difficult time regulating what the “insiders” already know and have succesfully kept quiet. It feels like I sat down at the high stakes table in Vegas, not investing with firms that are concerned with my volatility objectives or financial goals.
See the following for a simple description of “dark pools”.
http://www.itg.com/news_events/papers/IT GResearch_Toxic_Dark_Pool_070208.pdf

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