James Pethokoukis

Politics and policy from inside Washington

Does Bill Daley appointment further enshrine Too Big To Fail?

Jan 11, 2011 18:27 UTC

Cato’s Mark Calabria thinks the problem is not people but policy:

MIT Professor Simon Johnson recently argued that Bill Daley’s appointment as Obama’s Chief of Staff signals that “too big to fail”, as it relates to our largest financial institutions, is here to stay. Personally I never thought it was in doubt. With Geithner at Treasury and Dodd-Frank further codifiying “too big to fail”, its been clear for sometime that the bailout net is larger than its ever been, and is not being pulled back.

That said, Professor Johnson’s focus on Daley distracts from the real issue, which is changing our bank regulatory structure to end bailouts. The focus on Daley has the potential to lead us down that path of “if we just had the right people in government.” We shouldn’t be designing our regulatory structures with the “right” people in mind, but rather with the rule of law in mind. In fact one of the benefits of the Obama Administration is that it serves as a great test of the “right people” hypothesis of government. One is unlikely to see a more left-leaning White House than this one, so if this one gets captured by special interests, including Wall Street, than its a safe bet that any future Administration will as well.

Since I believe most of us actually want to end “too big to fail”, the real question is over how. It strikes me that we have three options: regulate the largest institutions to death (or competitive disadvantage), break them up, or credibly impose losses on their creditors. Ultimately I think the regulation approach is bound to fail, if for no other reason than regulatory capture. (Even Elizabeth Warren seems to get this: “Regulations, over time, fail. I want to see Congress focus more on a credible system for liquidating the banks that are considered too big to fail.”) The breaking them up might sound attractive in theory, but I have a hard time seeing how it truly works in practice. After all few in Washington viewed Bear Stearns as “too big to fail”. Accordingly I believe the best approach would be to force creditors to take losses, or be converted into equity. To make this credible, we must bind the hands of the regulators. As long as the Fed. Treasury or the FDIC can inject money, then bailouts are always on the table.

Sadly what the Daley appointment reminds us is that any attempt to end “too big to fail” will likely have to wait until the next Administration. Not only is this one wed to bailouts, the President would likely veto any bill that really tied the hands of the Fed.

COMMENT

Thanks for the information. As almost any financial advisor can attest, there is nothing too big to fail. From the sinking of the Titanic to the myriad of economic fluctuations that have plagued society throughout history, it seems like any endeavor is subject to potential failure no matter how much people want it to succeed.

Posted by GramJ | Report as abusive

What is tax-crazy Illinois thinking?

Jan 11, 2011 17:58 UTC

The news just gets worse and worse from my home state (via The Tax Foundation):

llinois’ legislature is currently considering an alternative to the initial tax increase proposed last week. Instead of pushing for a 75% increase in the personal income tax and a 49% increase corporate income tax, this proposal would raise the individual income tax rate to 5% and the corporate rate 9.5%. While this proposal is more modest than the first, but it still hurts the competitiveness of Illinois when it comes to maintaining and attracting new business.

If this passes, Illinois will have the third highest corporate income tax in the country behind only Minnesota and Pennsylvania. The corporate income tax has been shown to be among most damaging tax in terms of economic growth.

The individual income tax is often times ignored as a factor in business decisions. This is unfortunate because a large amount of business income is actually filed through the individual income tax. In raising the rate to 5%, Illinois would have the one of the highest flat individual income tax in the country.

In solving their budget problems, Illinois needs to do something that it has not done in a long time and that is look to the future. The governor and the legislature need to look past the next day, week and month and consider the long term effect of their policy decisions.

COMMENT

‘Friday, December 31, 2010
New pension law could force municipalities to raise property taxes 60% While most emphasis has been on Speaker Madigan’s pension reform law setting up for later retirements and less cushy pensions for new firemen and law enforcement hires, little attention has been focused on the shift in pension fund pay=in burden that local city councils argue will now suddenly fall on their already cash-strapped budgets. Chicago’s Mayor Daley blasted the reform bill Quinn signed on Thursday, predicting it will cause Chicago to hike its property taxes up to 60%.

ABC Chicago News covered the topic’

http://illinoisreview.typepad.com/illino isreview/2010/12/new-pension-law-could-f orce-municipalities-to-raise-property-ta xes-60-mayor-says.html

Posted by kostalbk | Report as abusive

Will the Fed need (gasp!) a government bailout?

Jan 11, 2011 16:06 UTC

Interesting piece from Team Reuters that examines that possibility (and what it really means) as a result of all the central bank’s asset buys (bold is mine):

But the Fed’s newfangled policy steps and the potential for credit losses raises, for some experts, the prospect that the Treasury may actually be forced to “recapitalize” the Fed — economist-speak for what others might call a bail-out. That would be a strange role reversal given the Fed’s efforts to ease monetary policy by buying the Treasury’s debt, and it could raise a political firestorm from lawmakers who believed all along the Fed was putting taxpayer money at risk. … Varadarajan Chari, an economics professor at the University of Minnesota and a consultant to the Minneapolis Fed, says that at some point during its exit from easy monetary policies, the Fed actually may go broke — at least on paper. ”The most obvious exit strategy is, when inflation starts to pick up, to stop and reverse asset purchases,” he said. “That’s likely to include requiring the Fed in an accounting sense to see a significant accounting loss.”

The Fed now holds just over $1 trillion in Treasuries, Chari noted, and if inflation rose by a couple of percentage points, it would dent the value of those holdings by about 10 percent, leaving the Fed with a $100 billion loss. “I’m sure it will have some negative political fallout,” Chari said. “But not economic consequences. Their ability to print money means it (insolvency) doesn’t mean anything.”

The problem lies in the basic workings of fixed income. By definition, bond prices decline when their yields or interest rates go up. That means that as the economy recovers and pushes inflation higher, the Fed will move to increase interest rates, pushing down the value of its giant bond portfolio. “What would the international reaction be if the Fed suddenly had to go and be recapitalized?” said Bob Eisenbeis, chief monetary economist at Cumberland Advisors and a former head of research at the Atlanta Fed. “I don’t think that would bode well for Treasuries, or for the dollar, or anything else. It would be embarrassing.”

Eisenbeis is right. If and when this happens, the financial nuances will certainly get lost and give plenty of additional ammo (not that they need it) to the anti-Fed movement.


COMMENT

Maybe the IRS could use a bail-in in the form of a voluntary tax that repays if the economy improved to a level that protects national security – ability to transfer debts to a guarantee note to share risk and reward specific shared goals if attained where downside simply confirms a more aggressive natural devaluation.

Posted by phyvyn | Report as abusive

The Great Wage Drop and wage insurance

Jan 11, 2011 15:58 UTC

Big WSJ story on how the Great Recession has reduced wage growth. When the unemployed do return to work, it is often with markedly lower salaries. Here is the money graf:

Between 2007 and 2009, more than half the full-time workers who lost jobs that they had held for at least three years and then found new full-time work by early last year reported wage declines, according to the Labor Department. Thirty-six percent reported the new job paid at least 20% less than the one they lost The severity of the latest downturn makes it likely that many of the unemployed who get rehired will take wage cuts, and that it will be years, if ever, before many of their wages return to pre-recession levels, says Columbia University labor economist Till von Wachter. “The deeper the recession, the lower the wage you’re going to get in the next job and the lower the quality of your next job,” he said.

And here is the money chart:

wsj2

I am always a bit dubious of these sorts of charts since they depend on accurately measuring inflation.  Some liberal economists, for instance, claim wages have been falling since the Golden Era of the 1970s. More likely that they actually went up by at leasts 20 percent in real terms, according to researchers at the Fed.  But I have no doubt that wage growth slowed during the downturn and many folks have suffered a real and permanent loss of income. I think you will hear Democrats talk more and more about wage insurance — having government temporarily make up the shortfall between old and new jobs — especially with Gene Sperling back in the White House. He is a big proponent of the policy.  And we shouldn’t forget that John McCain proposed something like this back in 2008 during the campaign. Here is what I said back then:

This is an idea that Democrats have been inching toward: a move to a Danish-style “flexicurity” system. In that country, workers who lose their jobs have almost their entire salary replaced by the government but are also required by the government to aggressively look for new employment or accept retraining in a new field.

It’s very expensive. For the United States, completely copying the Danish model—lauded by many as a response to globalization-inspired worker angst—could cost some $400 billion to $500 billion a year if it is as expensive for us as it is for the Danes.

Now what McCain seems to be proposing is a more modest “wage insurance” idea. Under a plan originally put forward by Brookings Institution economist Robert Litan and University of California-Santa Cruz economics Prof. Lori Kletzer, a laid-off worker who once earned $40,000 and found a new job paying just $30,000 would receive $5,000 a year–broken down into quarterly payments–for two years after the initial layoff. Such a plan might cost $4 billion a year.

Yale political scientist Jacob Hacker would up the ante considerably with a $34 billion-a-year “universal insurance” program. If a family experienced catastrophic medical costs or a large drop in income—say, more than 20 percent—owing to a variety of common risks (unemployment, loss of wages because of sickness or childbirth, temporary disability, or the death of a spouse), Hacker’s universal insurance plan would make up a portion of the loss ranging from 20 percent to 50 percent of all losses or costs in excess of a fifth of that family’s income. And House Ways and Means Chairman Charles Rangel has a $1 billion-a-year plan to expand Trade Adjustment Assistance, a benefit and training program for manufacturing workers who lose jobs to trade, to include service workers.

Of course, there are downsides here. First, it could make U.S. labor markets less mobile and dynamic as there would be less incentive for workers to get back into the workforce or start a new business because of Uncle Sam’s largess—especially if the carrot isn’t accompanied by a stick. Second, the program might grow ever bigger, becoming a massive new entitlement.

COMMENT

We’re in need of a “fairness” index in regards to public vs private sector wages-including legacy/pension costs! Also, why shouldn’t 20% of the FED & State jobs be PT and Temp like they are in the private sector? Ask what your country can do for you?

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