Wednesday, September 29, 2010

The Amorality of Economics

Paul Krugman blogs on the fundamental absence of morality in economic theory.
I understand from the Times that whenever I mention in my column that WWII ended the Great Depression, the paper gets a lot of mail accusing me of being a warmonger. Amazing.

But maybe this is an opportunity to reiterate a point I try to make now and then: economics is not a morality play. It’s not a happy story in which virtue is rewarded and vice punished. The market economy is a system for organizing activity — a pretty good system most of the time, though not always — with no special moral significance. The rich don’t necessarily deserve their wealth, and the poor certainly don’t deserve their poverty; nonetheless, we accept a system with considerable inequality because systems without any inequality don’t work. And before the trolls jump in to say aha, Krugman concedes the truth of supply-side economics, that’s not an argument against progressive taxation and the welfare state; it’s just an argument that says that there are limits. Cuba doesn’t work; Sweden works pretty well.

And when we’re experiencing depression economics, by which I mean a situation in which it’s hard to create sufficient demand to achieve full employment — mainly because short-term interest rates are up against the zero lower bound — the essentially amoral nature of economics becomes even more acute. As I’ve said repeatedly, this is a situation in which virtue becomes vice and prudence is folly; what we need above all is for someone to spend more, even if the spending isn’t particularly wise.

The trouble in practice is that conventional modes of thought tend to prevail even when they shouldn’t; in particular, public spending on the scale needed never seems to happen. That’s why Keynes facetiously proposed burying bottles full of cash in coal mines, so people could dig them up again: since any proposal to spend money on things we need got shot down on grounds of prudence and efficiency, he proposed completely pointless spending instead.

And what actually ended up doing the trick was spending that was beyond pointless, it was actually destructive – a sort of cruel joke on the part of the gods of economics.

Friday, September 24, 2010

The Democrat's Tax Strategy

Jonathan Zasloff explains the political logic behind the decision to defer a vote on the expiring tax cuts until after the elections (h/t Kevin Drum).
Josh Marshall and Jonathan Chait are fighting back aneurysms upon hearing the news that Capitol Hill Democrats will not put forth a bill maintaining middle-class tax cuts.

But Nancy Pelosi and Harry Reid aren’t stupid.  They did what they had to do.  This was the best of a bad series of choices.

Here were their options:
1)  Bring up the middle-class tax cut bill free-standing in the House.  The Republicans would offer a “Motion to Recommit” to the Ways and Means Committee with instructions to include the tax cuts for the rich.  With Blue Dog support, it would have won.  No go.

2)  Bring up the middle-class tax cut bill freestanding in the Senate.  The Republicans would offer an amendment to include the tax cuts for the rich.  It could have won:  41 Republicans plus Lieberman, Lincoln, Pryor, Landrieu, Ben Nelson, Bayh, Hagan, Dorgan, Baucus, Conrad, and then maybe Bill Nelson, Webb, or Warner.  Then where would you be?
3)  Bring up the middle-class tax cut bill free-standing in the House under a “Suspension of the Rules,” which requires a two-thirds vote and is not subject to the Motion to Recommit.  My favorite option, because theoretically, the Republicans would be in a bind.  Either they would vote no, in which case they would have voted no on a tax cut, or they would have voted yes, in which case the Dems win and they tick off their base.  BUT — they probably would have split, meaning that the Dems would not have not gotten a win AND the partisan difference would have been muddied.
In other words, there was no way to get an actual win under these circumstances.  You could only get a loss that would muddy the partisan split.

Under these circumstances, Pelosi and Reid decided not to have the vote.  Why?  Because you can still make the issue about it being the “Republicans holding the bill hostage.”  You can still say that the Republicans won’t vote for a middle-class tax cut unless they borrow $700 billion dollars to give to millionaires and billionaires.  President Obama still has the biggest megaphone in the country, and to his great credit, he is using it.  Just an hour or so after the decision was announced, he was blaming the Republicans for holding middle-class tax cuts hostage.

In other words, you can go to the country with a clear message, and without the picture of Democrats reprising the circular-firing squad.  It’s not perfect, but it’s the best of all possible situations given the unprecedented plutocratic obstructionism of the GOP.

Ironically, though, critics like Marshall and Chait could undermine the strategy if the meme becomes “Democrats cave.”  If instead the meme becomes, “Democrats refuse to borrow $700 billion to pay off billi0naires,” then it looks like they are stronger, not weaker.  Marshall and Chait are calling it like they see it, and I take their points, but they are creating some bad spin here: let’s not let the complaints become a self-fulfilling prophecy.

Wednesday, September 22, 2010

The Liberal Disadvantage Looms Large

Kevin Drum looks at the political ideology polling and concludes that it is much harder for the Left to craft political strategy that appeals to its base than it is for the Right.

I'll repeat a point I made a few weeks ago: this is baked into the cake of modern American politics. Every local race has its own dynamics, but it's still worth taking a look at the Gallup chart above to get a sense of the broad national hole that liberals are in. About 40% of the electorate self-identifies as conservative and getting their votes is critical for any conservative politician. If you piss off a few moderates in the process, that's life. After all, if you win the conservative base convincingly, then on average you only need to hold on to the most conservative 10% of moderates to win an election.
But only 20% of the electorate self-IDs as liberal. So the math is exactly the opposite: you need to win nearly all the moderates in order to win an election. If you piss off centrists by playing too hard to the base, you'll lose.

This is a bummer, but it's reality, and lefties really need to suck it up and get less annoyed by the fact that politicians react to the world as it is, not as we wish it were. Like it or not, most pols just can't afford to give the liberal base too much rhetorical lip service until and unless it gets a lot bigger than it is today.

Still, there's a mystery here. Not why Obama feels the need to market himself the way he does, but why he lately seems so clumsy at it. As Krugman implies, dog whistling can be subtle but still clear. So where's the subtlety in the Obama White House these days?

Monday, September 20, 2010

Taxing Politics

Jonathan Chait on how the Democrats should handle the upcoming tax debate.
Wall Street Journal opinion columnist Kimberly Strassel has a column entitled "Why Democrats Can't Win On Taxes," purporting to show that the awesome power of (massively unpopular) tax cuts for the rich has put the Democrats into a political bind. Oddly, in the course of running down the party's alternatives in an attempt to prove her point, she winds up with this final option:
The Democrats' best shot is procedural, to somehow allow only one vote—on extending rates for just the "middle class"—and dare Republicans to vote against it. Democrats might then peel off GOP support and provide themselves cover this fall. If the majority senses fear—like what emanated from Minority Leader John Boehner this past weekend when he suggested he wouldn't take that dare—it'll take this shot.
Right! That's what you do -- hold a vote on the extremely popular proposal to extend tax cuts for income under $250,000. I highly doubt Republicans are going to want to vote that down. If they do, it's the best possible election frame for Democrats. Which is to say, the Democrats can win on taxes. Strassel continues this scenario by observing, "If Mr. Obama has such a winner tax position, it isn't clear why his leaders are ducking tax bills and his members are running for cover." I'll answer that: moderate Democrats really like tax cuts for the rich, because they and their most influential supports are rich. That doesn't mean their hand is weak.
Now, you can also hold another, subsequent vote on tax cuts exclusively for income over $250,000 if the Blue Dogs so desire. That's fine. The only way Republicans win is if the two issues are combined.

Saturday, September 11, 2010

We Are All in Kansas Now

Kevin Drum summarizes the key points from the new book by Jacob Hacker and Paul Pierson, "Winner-Take-All Politics" which analyzes how political changes led to the increase in income inequality over the past 30 years. Drum zeroes in on the reasons that middle- and lower-income voters opt to vote against their own economic interests, a phenomenon Thomas Frank first addressed in his book "What's the Matter With Kansas?".
  1. In the 60s, at the same time that labor unions begin to decline, liberal money and energy starts to flow strongly toward "postmaterialist" issues: civil rights, feminism, environmentalism, gay rights, etc. These are the famous "interest groups" that take over the Democratic Party during the subsequent decades.
  2. At about the same time, business interests take stock of the country's anti-corporate mood and begin to pool their resources to push for generic pro-business policies in a way they never had before. Conservative think tanks start to press a business-friendly agenda and organizations like the Chamber of Commerce start to fundraise on an unprecedented scale. This level of persistent, organizational energy is something new.
  3. Unions, already in decline, are the particular focus of business animus. As they decline, they leave a vacuum. There's no other nationwide organization dedicated to persistently fighting for middle class economic issues and no other nationwide organization that's able to routinely mobilize working class voters to support or oppose specific federal policies. (In both items #2 and #3, note the focus on persistent organizational pressure. This is key.)
  4. With unions in decline and political campaigns becoming ever more expensive, Democrats eventually decide they need to become more business friendly as well. This is a vicious circle: the more unions decline, the more that Democrats turn to corporate funding to survive. There is, in the end, simply no one left who's fighting for middle class economic issues in a sustained and organized way. Conversely, there are lots of extremely well-funded and determined organizations fighting for the interests of corporations and the rich.
The result is exactly what you'd expect. With liberal money and energy focused mostly on non-economic concerns, the country moves steadily leftward on social issues. With conservative money and energy focused mostly on the interests of corporations and the rich—and with no one really fighting back—the country moves steadily rightward on econonomic issues. Thomas Frank's famous working-class Kansans who vote against their own economic interests are easily explained. It's not just that conservatives appeal to them on social grounds, it's that there's no one left to really make the economic case to them in the first place. And even if anyone did, they have little reason to believe that Democrats would actually follow through in concrete ways. So why not vote on abortion and gay rights instead?

Tuesday, September 7, 2010

More on the Republicans

Sully takes a comment by David Frum and extends it into a stark indictment of the Right.
Without the housing claim, it would have been hard to depict the Bush economic record as very much of a success. Employment was up, the Dow was up, but median incomes still lagged behind 2000 levels. It was the rise in home prices that represented the administration’s main argument that its economic policies had helped the American middle class. No way was the administration going to act to slow – let alone halt – that rise. To the extent that political appointees regulated the lending industry, the political appointees understood what was expected of them and did not interfere.
I don’t raise this point to cast aspersions, but to inspire thought as to how Republicans can deliver better results next time. Republicans talk budgetary policy (that’s why Paul Ryan has become a heart-throb of the party). They need to think about economic policy. The measure of success is not shrinking the deficit – that’s just a means to an end – but raising incomes. We need an open discussion about why our policies failed to deliver that result in the 2000s as a preliminary to doing better after 2012 or 2016.
Which is roughly a paraphrase of the president's critique yesterday. I suspect the answer is pretty bleak: conservatism as it has evolved since the 1980s has no fundamental solution to how to raise the incomes of the lower middle class in a global economy where Chinese and Indians can do what any American can for a fraction of the cost. If that's true for high-tech, how much truer for other sectors? Education is key, and is one of Obama's least-appreciated emphases. In other words, the free lunch is over. America's unique advantages and blessings during the Cold War have been removed. Protectionism won't help. And even higher levels of education won't make much difference. At some point, as David Brooks shrewdly notes today, the culture will have to adjust away from the pursuit of wealth to the pursuit of happiness within far more constrained horizons.
What I fear and see is the right's inability or refusal to face this or to innovate genuinely new policies to address these questions (Manzi is an exception who proves the rule). And in its place, they will offer a cultural politics of reaction at home and war abroad. They will intensify the red-blue divide, and blame the "elites" for everything, and turn Islam into the modern equivalent of Communism (unwittingly helping the enemy), and take the world to the brink of chaos. That's what I fear in my bleaker moments. Because it works for a while. And it will make millions for those who want to use America's decline rather than reverse it, and will distract the heart by deadening the mind. And I see no one with the gravitas or decency or responsibility in the GOP to be an Eisenhower.
That's why Obama still matters. It's why, in my view, he matters more than ever.

The State of the Republicans and the Right

Sully is back from his vacation with a blistering commentary on the state of the Right as they approach an election they may win.
The other brutal truth is that the opposition has nothing substantive to offer to remedy this. If all they've got is keeping the Bush tax cuts for those earning over $250,000 a year, they really have got nothing. What they do have is cultural symbolism and the exhausted right-left tropes that were trotted out at the mercifully vacuous parade of God and Country on the Mall with Beck and Palin. (A cynical atheist's parody of such vacuousness can be read here.) Maybe in power, by some miracle, the Tea Party Republicans will actually propose the long-term massive cuts in entitlements they claim to believe in. But I don't believe it for a second. I don't believe they are in any way serious about spending restraint and are only serious about their bewilderment at the real America where racial, religious and cultural diversity is a fact, where illegal immigration has been plummeting, where gay marriage is winning, where legal abortion will never go away, and where the new empire the last administration embarked upon has bankrupted us for a generation at least.

And this, in the end, must be what our politics is about: substantive policy responses to profound crises inherited from the past. Obama's call for transportation infrastructure investment is one tiny but real response and no panacea but it's paid for and it's something. His persistent attempt to get a real two-state solution in Israel-Palestine is unlikely to succeed given the forces arrayed against it in Washington and Tehran but it is necessary if we are to win this long war against Jihadism. His endurance in Afghanistan is, in my view, a tragic mistake, but anyone who claims that withdrawal would not have appalling moral consequences and great strategic risks is lying to you. His diplomatic and economic isolation of Iran's coup regime may also fail to prevent the Revolutionary Guards getting a nuclear capacity, but the alternative - a military strike - would initiate a new round of global religious warfare of terrifying gravity, where the Islamists would have the moral high-ground of being attacked first. His success in bringing a modicum of healthcare security to the working poor is also a work in progress but again, the practical alternative on the table is ... what exactly?
In the end, these difficult practical decisions will count because they have to count. And Obama's persistent refusal to take the red-blue bait still pushed by Fox News like a cheap bump of ideological meth is to his credit. It is emphatically not about his failure to "take them on". He is taking them on - but on his terms, not theirs'. Take it away, Mr president:
When it comes to just about everything we’ve done to strengthen our middle class, to rebuild our economy, almost every Republican in Congress says no.  Even on things we usually agree on, they say no. If I said the sky was blue, they say no. If I said fish live in the sea, they’d say no. They just think it’s better to score political points before an election than to solve problems.  So they said no to help for small businesses, even when the small businesses said we desperately need this.  This used to be their key constituency, they said.  They said no.  No to middle-class tax cuts.  They say they’re for tax cuts; I say, okay, let’s give tax cuts to the middle class.  No. No to clean energy jobs. No to making college more affordable.  No to reforming Wall Street.  They’re saying right now, no to cutting more taxes for small business owners and helping them get financing. 
You know, I heard -- somebody out here was yelling “Yes we can.” Remember that was our slogan?  Their slogan is “No we can’t.”

Friday, September 3, 2010

Lehman Revisited

In response to former Lehman Bros. CEO Dick Fuld's claim that the Fed chose to let Lehman fail in 2008, Barry Ritholtz reviews once again what actually happened and why.
1. Under-capitalized, over-leveraged: Lehman Brothers was the biggest bankruptcy in US history. To avoid that fate, LEH needed to be sufficiently capitalized, and use only moderate leverage (LEH embraced 40 to 1 leverage). Rather than have a sufficient capital base, the bank chose instead to chase profits: A greater capital cushion meant less underwriting activity, smaller gains, greater risk. The downside of having a de minimus capital structure is when bad investments are made, there is no room for error.

2. Bad Modeling Assumptions: LEH made numerous false assumptions in their econometric models: a) Residential RE never goes down; b) The derivatives market is always liquid, with ready buyers available; c). We can always borrow short and lend long with no liquidity concerns;  There was substantial evidence and warnings that ALL of these assumptions were false, but they were ignored by management as a risk to profits.

3. Excess RE Exposure: Lehman was the biggest securitizer of mortgages on Wall Street. They underwrote more mortgages than any other bank on Wall Street. By 2004, LEH was originating $40B per year in mortgages to feed their own CDO machine (which as Roger Lowenstein has pointed out, was more lucrative than the stock and bond business).

4. Reliance on Ratings: Lehman’s entire business model was predicated on the ratings of Moody’s and S&P being reliable. However, LEHMAN was one of the prime purveyors of credit rating payola — they were paying the NRSROs a fee to slap a Triple AAA rating on junk paper. If they did not know the credit ratings were utterly worthless, they sure should have.

5. CDO Ownership: Lehman kept the senior-most layers of CDOs they created for themselves, but bought credit default swaps on them “for safety.” Consider that they were not confident enough of the models which forecast the solvency of those tranches, yet they used the same models to determine AIG was a credit worthy counter party to insure them.
That’s why LEH collapsed, and it was apparent (at least to us) back in June 2008 they were in trouble.  Why did the Fed not save them? There were several reasons:

1. One off: The Bear Stearns bailout was supposed to be a “one of a kind,” not the start of a series of rescues. The Fed hoped to hold the line at only one such taxpayer backed rescue. The fear was if they did a 2nd, they could not say no to the rest of the Street. Lehman was in effect the Fed’s Maginot Line (it also was out flanked and rendered strategically useless).

2. Fed Overreach:  Bernanke was widely criticized for the Bear rescue as a huge overstep of authority. Even former Fed Chair Paul Volcker overcame the inherent reluctance of formerFOMC chairs to to criticize sitting Fed heads to express his concern about the over reach and power grab.

3. No to Private Rescue: Dick Fuld turned down a private rescue just months earlier. Warren Buffett offered Fuld billions, plus the equivalent of the Berkshire Hathaway Good corporate Housekeeping seal of approval. FULD TURNED BUFFET DOWN. How could the Fed, in good conscience, bail out a firm that refused to accept a Buffett rescue? Indeed, his terms for LEH were far more generous than what BRK ultimately offered Goldman Sachs and GE.

4. Insolvent: Lehman books are why a loan never happened. LEH was essentially insolvent, with liabilities that vastly outweighed what few assets there were. This insufficiency is why a loan was simply not possible — it was  considered a guaranteed loss.

5. Moral Hazard: How much of a clusterfuck must any financial firm be before a rescue is deemed an outrageous moral hazard? For the 3rd and 4th reasons above, Lehman was believed to be “Beyond rescuing.” And it was due to the specific choices Lehman’s management made.