Baseline Scenario -- Catching Up

The Baseline Scenario
More from “The Lion”
Feed Problems?
The Financial Crisis Inquiry Commission: Ready For A Breakthrough
Bank Tax Arrives
My Last Post on Ben Bernanke
Leading Indicator of Me
The Case For A Supertax On Big Bank Bonuses
Obama and FDR
Bernanke, Manager
Money and Financial Reform
More from “The Lion”
Posted: 12 Jan 2010 07:08 AM PST
In the short days between Christmas and New Year’s, BusinessWeek published an interview with Paul Volcker conducted by Charlie Rose headlined “The Lion Lets Loose.” Rose asked him why the U.S. economy has fallen behind in some areas, such as manufacturing. Here’s the segment:
“How did that happen?““What happened is our best and brightest got attracted to Wall Street. You’ve read about those big bonuses. These are generalizations, but I do think that the pull of Wall Street on bright young people, ambitious young people, has been tremendous.”
“Will it change?““I think we’re in the process of change now. Wall Street hasn’t got quite the glamor that it had a few years ago.”
“Yes, but I hear bonuses are coming back.““Well, I hope you’ll get more competition on Wall Street and get some reforms, and profitability won’t seem quite so great. At one point, Wall Street had almost 40% of all the profits in the country. And, you know, its contribution to the welfare of the country does not approach 40%. Something’s out of line here.”
I agree with everything there, but note that Volcker says “I hope you’ll get more competition on Wall Street.” Where will that competition come from? Right now we have less competition than before the crash. Simon and I are obviously in favor of breaking up large Wall Street firms. But if policymakers are leaving that off the table, they should have another suggestion for increasing competition. This was tried with the credit rating agencies several years ago, with not very promising results, and the barriers to entry in investment banking (people, algorithms, machines, client relationships, brand, size of balance sheet) are considerable. What’s the right mechanism for encouraging the creation of newer, smaller investment banks that won’t simply be bought up by the big ones? Could you tax the big ones and use the proceeds to capitalize a new generation of competitors?
Volcker also thinks that simply paying bonuses in stock is not the answer to incentive problems. He doesn’t spell this out in great detail, but it seems the problem for him is “a lot of criteria that he’s going to manipulate to his advantage.” That is, the problem is how you calculate the bonus in the first place, because that’s where the incentives come in. I’ve already put forward my suggestion: calculate the bonuses on the basis of results over a long time period, not just one year; make it long enough, and you could even pay the bonus in cash, because the long term has already happened.
By James Kwak

Feed Problems?
Posted: 12 Jan 2010 06:05 AM PST
I’ve gotten a few messages that our feed is not working properly. And, it occurs to me that I haven’t been getting email updates for the past couple of days.
The default feed produced by WordPress (http://baselinescenario.com/feed/) is working fine, and I can read the blog fine in Google Reader. But the Feedburner version (http://feeds.feedburner.com/BaselineScenario), which generates the emails, is stuck at January 8. I’ll look into it, but if you have any diagnostic details or suggestions let me know below.
(I suspect it is related to my having changed the number of items that go into the feed from 15 to 200; I was trying to figure out a better way to convert the blog to PDF, and that was one of the steps. I reset it this morning, so that may fix it.)
Update: Forcing Feedburner to ping the default feed worked; the Feedburner feed is up to date now. I’ll watch it to see if it picks up the next post or not.
Update 2: It did. I’m guessing that email subscribers will get an email tonight. (Of course, most of you aren’t here to read this.)
By James Kwak

The Financial Crisis Inquiry Commission: Ready For A Breakthrough
Posted: 12 Jan 2010 02:34 AM PST
The Financial Crisis Inquiry Commission (FCIC) holds its first public session on Wednesday. When the FCIC was established in May, the prevailing wisdom was that the hearings and final report would be dry and rather inconclusive.
But the debate around Big Banks has started to shifted markedly, particularly in recent weeks. Anger about bonuses is increasingly expressed by the most mild-mannered policy experts. The administration itself is proposing some sort of excess profits tax on the biggest banks. And – most important – our top bankers have their tin ears prominently on display.
In the Daily Beast, I suggest exactly how the Commission can put this moment to productive use. The point is to find for rather dull and difficult technical material to become names, dates, and numbers that catch the popular imagination – and provide a genuine warning. The most obvious and reasonable way to do this is by drilling down into the details of the Wall Street compensation system, then and now - the more you dig, the more you understand why we are heading for trouble.
By Simon Johnson

Bank Tax Arrives
Posted: 11 Jan 2010 04:55 PM PST
The Obama administration tipped its hand today – they are planning a new tax of some form on the banking sector. But the details are deliberately left vague – perhaps “not completely decided” would be a better description.
The NYT’s Room for Debate is running some reactions and suggestions. The administration is finally getting a small part of its act together – unfortunately too late to make a difference for the current round of bonuses.
We know there is a G20 process underway looking at ways to measure “excess bank profits” and, with American leadership, this could lead towards a more reasonable tax system for finance. In the meantime, my point is that taxing bonuses – under today’s circumstances – is not as bad as many people argue, particularly as it lets you target the biggest banks.
By Simon Johnson

My Last Post on Ben Bernanke
Posted: 11 Jan 2010 12:39 PM PST
His confirmation, that is. I summarized most of my position in Foreign Policy, which asked me to lay out the anti-confirmation argument. My reasons overlap with Simon’s but are not identical–I think Simon worries about cheap money and asset bubbles more than I do. I was originally not particularly motivated by the anti-Bernanke campaign, because I didn’t think Obama would appoint anyone better, but as Russ pointed out, whether Bernanke should be confirmed and what the alternative is are two separate questions.
Whom would I pick? I certainly don’t know the candidates well enough to make a good choice. But the first thing I would say is that the Federal Reserve chair does not need to be Superman. The Federal Reserve Board of Governors is a board, and while the chair is important, he or she should really be the first among equals. You want someone who will push the Board in a certain direction, but the chair can draw on the experience and skills of the other board members and the staff, who are technically very competent. The idea that the chair must be Superman seems to be a product of the Greenspan era, and we project it back onto Volcker because of his success in fighting inflation in the early 1980s. And it’s a bad idea, just like searching for a savior CEO. In this context, I think it’s limiting to insist that the nominee have experience on the board, or have government experience, or be a prominent academic, or anything in particular.
For a rough parallel, think of John Roberts. When he joined the Supreme Court, he was by definition the least experienced of the bunch–yet President Bush made him chief justice, and no one objected that he was not competent enough for the job (the objections were over his anticipated policies). In short, the nominee must have intellectual heft and people skills, but otherwise President Obama should feel free to pick someone on the basis of his policies. It’s no accident that Ronald Reagan picked an ardent free marketer back in 1987.
My other observation is that the bench on the progressive side is pretty thin, because there has been a de facto consensus around central banking in the past two decades. That is, everyone seems to think that inflation is more important than full employment, and most people at the Fed have shared the pro-innovation/anti-regulation stance of Greenspan and Bernanke, and hence the emphasis on monetary policy as opposed to regulation. (I’m not an experienced Fed watcher, so I’m sure I’m overlooking someone in those generalizations.) But if Obama wanted a progressive choice (which he doesn’t, but just as a hypothetical), there doesn’t seem to be an obvious one.
But anyway, after all that lead-up, what about Paul Krugman? I think he’s said he doesn’t want the job (or was it Treasury Secretary that he didn’t want?), but I’m sure Obama is a hard person to say no to. Or Brad DeLong? He’s clearly smart and knowledgeable, and I like what he says about inflation and deficits. Whether either of them has the people skills to be chair of the Fed I have no idea. But I don’t think we should be confining ourselves to previous board members, especially since this is a fruitless intellectual exercise, because Bernanke will be confirmed sooner or later.
By James Kwak

Leading Indicator of Me
Posted: 11 Jan 2010 09:20 AM PST
If I ever go to another school, you should run away from it as fast as you can. That is the practical implication of Felix Salmon’s post a few days ago rounding up arguments for why you should not get a Ph.D. in the humanities or go to law school.
Thomas Benton’s article, “Graduate School in the Humanities: Just Don’t Go,” nails the basic reasons why I went to UC Berkeley nineteen years ago: excitement in the subject, a history of high grades, the comforting structure of academia, romanticization of university life, and no practical application of academic skills. (See the six bullets halfway down the article.) When I left Berkeley in 1997, I could not get an academic job that I wanted … and the rest is history, I guess. If you do get a Ph.D. in the humanities these days, the numbers are even more heavily against you than they were then. First, American universities as a whole are shifting from tenure-track jobs to untenured adjunct positions; second, within universities, the jobs are shifting from the humanities into vocational fields like accounting and nursing. The ongoing bloodbath in state finances is only making things worse, since most of the good universities in the country are public.
Law school (where I am now) is probably a better bet, but it could be getting worse. This is the money chart, from the National Association of Legal Professionals (commentary by Bill Henderson here; on the reasons for that distribution, see Henderson here):

(Those are starting salaries after graduation, not current salaries.) There are some caveats here. 9.6% of the people in that distribution are judicial clerks, which means they will probably be leaving those jobs in one-two years, and many of them will move from the left-hand mode to the right-hand mode (which, these days, is around $170,000). 5.4% of them are public interest lawyers, which means they may have been planning to have a modest income all along–but that doesn’t change the fact that they have a modest income and, most likely, a lot of debt. (Some might be independently wealthy, but this post indicates that the proportion of public interest lawyers is actually higher among people with high debt loads than among people with no debt. Which also implies, indirectly, that the people who have money most want to make more of it.)
In other words, law school is no guarantee that you’ll make enough money to pay off $45,000 of tuition per year. And the trends, though weaker than for the humanities, are probably negative. That right-hand mode is based on the ability of top-tier, big-city law firms to bill out associates at outrageous rates. The trend is for big corporations to refuse to pay those rates for people right of law school, which is putting pressure on the system as a whole. (I don’t think this trend has a ton of momentum behind it yet, though, so it may fizzle out.)
Of course, no individual’s prospects are perfectly represented by the aggregate distribution. If you can get into a top school, your chances are better. When I went to Berkeley, the history department was essentially tied for the top position in the country, and I couldn’t get a good job; however, one of my closest friends in graduate school got tenure early at Harvard and another friend recently won a MacArthur “genius” grant. But nothing is guaranteed. At the very top law schools, if you want to be in that right-hand mode, you will probably get there. But you may not stay there for long enough to pay off your debts. At one school, although about 70 percent of grads go to law firms (most of the rest to public interest or government work), by five years after graduation slightly less than half are still at those firms. Job satisfaction is higher among the people not at law firms, not surprisingly.
Personally, I think law school is great: the classes are moderately interesting, the people are great, it’s super-non-competitive (at least at Yale), you can do whatever you want, … So I wouldn’t necessarily counsel people not to do it. But prospective students should know what the numbers are, they should be aware of how much debt they’re taking on, and they should know what type of lifestyle it takes to make the whole thing pay off financially. And, as always, they should watch out for optimism bias. It’s easier to say that you will be the person working late nights through your late twenties and early thirties than to actually do it.
B y James Kwak

The Case For A Supertax On Big Bank Bonuses
Posted: 11 Jan 2010 05:00 AM PST
The big banks are pre-testing their main messages for bonus season, which starts in earnest next week. Their payouts relative to profits will be “record lows”, their people won’t make as much as in 2007 (except for Goldman), and they will pay a higher proportion of the bonus in stock than usual. Behind the scenes, leading executives are still arguing out the details of the optics.
As they justify their pay packages, the bankers open up a broader relevant question: How much bonus do they deserve in this situation? After all, bonus time is when you decide who made what kind of relative contribution to your bottom line – and you are able to recognize unusually strong achievement.
Seen in these terms, the answer is easy: people working at our largest banks – say over $100 bn in total assets – should get zero bonus for 2009.
The big bank executives make three points in favor of paying bonuses for 2009.
If the bonuses are not paid, people will leave our major banks. It’s unlikely that many good people will leave, but if they do move to smaller institutions that are not Too Big To Fail, that’s good for the rest of us.
Big banks made these profits fair-and-square, so the bonuses belong to the workforce. This is wrong at two levels (a) the profits in 2009 (and 2008) were solely the result of massive government intervention, designed at saving and recapitalizing big banks, and (b) the recapitalization part of that strategy only works if the profits generated are retained - not if they are paid out.
You cannot now tax the bonuses for 2009 without violating all the norms of reasonable taxation – i.e., that it not be retroactive, not be confiscatory, and not mess seriously with incentives. Ordinarily, these are good arguments. But today’s circumstances are so egregious that we need to take highly unusual steps. The banks and their key employees are so far from understanding what they did wrong, they don’t even have a framework within which they can understand what they need to do right going forward. This industry needs a wake-up call.
The administration should immediately propose and the Congress must at once take up legislation to tax the individuals who receive bonuses from banks that were in the Too Big To Fail category – using receipt of the first round of TARP funds would be one fair criterion, but we could widen this to participation in the stress tests of 2009.
The supertax structure being implemented in the UK is definitely not the right model – these “taxes on bonuses” are being paid by the banks (i.e., their shareholders – meaning you, again) and not by the people receiving the bonuses.
Essentially, we need a steeply progressive windfall income tax – tied to the receipt of a particular form of income. This is tricky to design right – but a lot of good lawyers can get cranking.
And we should be honest about the distortionary effect that even proposing such legislation will have on incentives. It will send a signal that income generated by working at big banks is less secure – all employees of these banks should be looking over their shoulders; sooner or later, the Internal Revenue Service is coming. This is particularly relevant for 2010, which looks set to be another bumper year for the financial sector.
At this stage, tilting the playing field towards smaller participants in financial markets is not a bug, it’s a desperately needed feature.
By Simon Johnson

Obama and FDR
Posted: 10 Jan 2010 04:17 PM PST
Kevin Drum found a great quotation from FDR and what he thought of bankers, monopolists, and speculators. It’s so good he deserves to have you go there and read it.
Drum’s point is that while health care may have required conciliation and moderation, “When it comes to financial regulatory reform, Obama needs to let us know whose side he’s on.” So far Obama has played the peacemaker, the reasonable man in the middle, the man who bridges divides. “My administration is the only thing between you and the pitchforks,” he said last March; note that he brought up the pitchforks, but positioned himself as the center, holding back the crazies.
With financial regulation, there is no powerful force in Washington pushing for major change; Obama’s own Treasury Department is pushing for moderation. The closest thing the common man has to an advocate in Washington is Elizabeth Warren, and her job is chair of the TARP Congressional Oversight Panel. So financial regulation has become a negotiation between the centrists at Treasury and the banking lobby, which is an unlikely recipe for change. I’m no Axelrod, but it seems to me that taking a stand would be good politically, too; with unemployment likely going to be high in November, taking the side of the man in the street against the man in the glass tower couldn’t hurt.
There’s another contrast to draw with FDR. This is what Arthur Schlesinger had to say about the FDR administration in 1933 in The Coming of the New Deal (p. 444):
“No business group was more proud and powerful than the bankers; none was more persuaded of its own rectitude; none more accustomed to respectful consultation by government officials. To be attacked as antisocial was bewildering; to be excluded from the formation of public policy was beyond endurance. When one remembered both the premium bankers put on inside information and the chumminess they had enjoyed with past Presidents and Secretaries of the Treasury, the new chill in Washington was the cruelest of punishments.”
Obama came into office hoping to pick up the mantle of FDR. It’s not too late.
By James Kwak

Bernanke, Manager
Posted: 10 Jan 2010 12:48 PM PST
There’s a platitude repeated by most CEOs that their main job is not anything so mundane as making decisions, but “mentoring and supporting people” or something like that. Most of the CEOs who repeat this are mediocre at best at mentoring or supporting people, since the key people for any CEO are not the people who work for him or her, but the members of the board of directors. But the truism that is still true is that when you are head of a large organization, you can’t do everything yourself, and your real impact is made through the people you hire, promote, and don’t fire.
In October, Ben Bernanke named Patrick Parkinson director of the Division of Bank Supervision and Regulation. Who is Patrick Parkinson?
EB at Zero Hedge has the history in ten years of extended quotations. Here’s one example from 2005:
“[Transactions between institutions and other eligible counterparties in over-the-counter financial derivatives and foreign currency] are not readily susceptible to manipulation and eligible counterparties can and should be expected to protect themselves against fraud and counterparty credit losses.”
Here’s another from July:
“One of the main reasons the credit derivatives market and other OTC markets have grown so rapidly is that market participants have seen substantial benefit to customizing contract terms to meet their individual risk-management needs. They must continue to be allowed to bilaterally negotiate customized contracts where they see benefits to doing so.”
Now, it’s plausible that the benefits to parties of certain types of transactions may outweigh the costs of those transactions to society at large. But to say that parties must be allowed to negotiate customized contrasts simply because they want to is frivolous. (Insert analogy to illegal drug sales here.)
So Parkinson was another mini-Greenspan–what’s wrong with that? Nothing, really–except that Bernanke promoted him, now when we need someone new to take bank supervision seriously.
Where’s the change?
By James Kwak

Money and Financial Reform
Posted: 09 Jan 2010 04:00 AM PST
Last week, Ryan Grim and Arthur Delaney wrote a story for the Huffington Post about the difficulty of getting substantive reform through the House Financial Services Committee. They focus on two main things. First, because a seat on the committee is valuable for fund-raising purposes, the Democratic House leadership seems to have stacked it with vulnerable freshman and sophomore representatives from Republican-leaning districts, meaning there are a lot of Democrats who are either personally inclined to vote with the financial services industry or feel a lot of political pressure to do so. Second, a lot of committee staffers end up switching sides to work as banking industry lobbyists, and some of them then come back to be committee staffers, raising the usual questions about the revolving door. Barney Frank comes off as something of a hero; the idea is that Frank and his senior staffers are so smart and skilled that they can get effective legislation through despite the cards being stacked against them.
There are just a couple of things I wanted to point out.
“[Former committee lawyer Howard] Menell and others claim that nobody used to bat an eye when staffers went to K Street and back. It was all part of the pro-Wall Street consensus that developed during the boom years. By contrast, the new climate is creating tensions on the committee. When the financial system collapsed last fall, the bipartisan consensus on Wall Street came down with it.”
Today, we’re seeing a partisan battle over financial regulation, especially the CFPA: progressive Democrats are for, every single Republican is against, and the battle is over the “moderate” Democrats. In a sense, this is a good thing. Because for most of the past two decades, instead we had a bipartisan consensus that what was good for Wall Street was good for America, which made it completely unremarkable that legislation was being written by people close to the industry. Remember, the landmark bills that people point to–Riegle-Neal, Gramm-Leach-Bliley, the CFMA–were products of Clinton administration and of a Republican Congress with usually smaller minorities than the Democrats have now.
“Frank laments staff compensation: ‘We underpay public officials. Particularly the staff. [Lawmakers] get a certain degree of non-monetary compensation — psychic. You know, I get mentioned on “Gossip Girl.”‘
“Staffers get a good look at how the other half lives; they rub elbows with lobbyists both at work (in meetings or even on extravagant field trips) and off the clock, during ritualistic happy hours. Those who attend know the unspoken rule: don’t talk too much shop but bring plenty of business cards. The friendly social scene helps explain why there’s not much condemnation from staffers for colleagues who leave for higher pay.
“”Everyone comes here to stand up for something they believe in, and at some point they go downtown to make money, and at some point someone they worked for draws them back [to the Hill],’ said a former staffer who works as a lobbyist. ‘It’s the running joke: a staffer gets married, you better go downtown! Spots open and one of the committee staffers has a kid. They’ll be moving downtown. Money is number one.’”
Individually, you can’t blame them. Private schools in DC cost around $25,000 per year. A lot of these people graduated from law school with $90,000 in debt (that’s around the average these days). But the fact remains that it’s a terrible system for the country. The money is in lobbying, and the environment erodes the qualms that people might have about it going in.
And it’s getting worse. In the 1960s, banking and law paid roughly like being a professor starting out; now they pay about 3-4 times as much, and the pay goes up much faster, too. This inequality problem we have is helping to erode our political system, among other things. Frank is right; we need to pay staffers more. I don’t see any way around it (except paying bankers, lawyers, and lobbyists less, and that’s not under public control).
By James Kwak