Recycling an oldie/goodie: You wanna whack this and future recoveries? Get rid of Dodd-Frank

June 8th, 2017 at 3:22 pm

Sorry to recycle, but with the Comey hearings sucking up all the air, folks may have missed that today the House today passed that fahrblunget bit of chazari known as the Choice Act, which largely repeals Dodd-Frank financial reform (it requires D votes in the Senate, so a much heavier lift over there, thankfully). Back in February, I wrote this defense of “finreg” (for WaPo) and while I insert a few updates [in brackets], I think I was as right then as now on this.

[From Feb 2, 2017]

There are two important pieces of economic news out this morning, and while it might not seem so, they’re intimately connected.

First, we got another in a stream of solid reports on the U.S. job market. Payrolls were up 227,000, and while the jobless rate ticked up to 4.8 percent, that was for a good reason: more people entering the labor market. Hourly pay is up 2.5 percent over the past year, ahead of inflation, meaning real paychecks have more buying power. There’s still some slack in the job market — too many underemployed folks, for example (part-timers who want to work full-time) — but if we stick on this path, we’ll squeeze out the remaining slack within the year or so.

[Of course, since last Feb, unemployment has fallen further, to 4.3 percent, though hourly pay is still growing at around 2.5% and inflation has picked up (that’s overall inflation, due to higher gas prices; core inflation has decelerated!]

That’s the good news.

The bad news is that the Trump administration is threatening to blow up the job market recovery by rolling back financial market oversight. It’s repeal-without-replace all over again, invoking the feared economic shampoo cycle: bubble, bust, repeat.

If you think I’m being alarmist, let me explain. The economic recovery of the 2000s was unquestionably ended by the bursting of the housing bubble, which in turn was inflated by underpriced risk. Financial “innovations,” often poorly understood by even those selling them (you saw “The Big Short,” right?), securitization (bundling loans into opaque packages), and sloppy underwriting of mortgage loans led to a housing boom that fed on itself. Brokers explained to home buyers that their obviously unsustainable loans would be absolutely fine, as long as home prices kept defying gravity.

But gravity has a way of reasserting itself, which is exactly what it did, and, as I explained above, eight years into this expansion, we’re still not fully recovered.

The thing is, while this round of the shampoo cycle was uniquely damaging, it was anything but unique (ergo, the “cycle”). We saw a mini-version of the same dynamics in the bubble that ended the previous expansion. Economic historians have unearthed countless such examples, and the economist Hy Minsky documented the process. The bust and the losses it generates realign the price of risk with reality. But as the recovery proceeds, the memory of the bust fades and lenders begin to “get their risk on,” often through clever new instruments, and not just exotic loans, but derivatives that take out bets on how those loans will perform.

As the cycle proceeds, the onset of econo-amnesia is sharply goosed by the fact that everybody’s making stupid money (i.e., everybody in the top few percent). Even the “risk-assessors” are in on the deal, as loan quality analysis is beset with grade inflation.

Then it ends, and guess who gets screwed? Yes, there are big financial losses, but in a scheme that would make Bernie Madoff blush, the banks that inflated the bubble point out that because they’re now sitting on bundles of nonperforming loans, we either bail them out or the ensuing credit freeze blocks the recovery.

As a member of the Obama administration when Dodd-Frank was devised and passed, I assure you that the legislation was motivated by our desire to break this cycle. I’m not claiming it’s perfect by a long shot. It’s super complicated, but then again, so are these markets. And we left a lot of the regulatory details to be completed post-legislation, which meant we allowed the deep-pocketed bank lobbyists to get into the fray, and that never ends well.

But somewhat to my surprise, many aspects of the law are working. As Dennis Kelleher, president of Better Marketstold me before the election:

“Financial regulation is much better today than it has been in decades. However, there is still a long way to go before the unique risks from this handful of very dangerous too-big-to-fail firms are either eliminated or reduced to the lowest levels possible. No question a number of key Dodd-Frank provisions are working, but many still have to be finalized, implemented and, importantly, enforced. It is a comprehensive, integrated law and it all must be enacted to effectively rein in Wall Street’s riskiest activities.”

[See also this short post I put up this AM on ways in which DF is making markets safer/less bubbly.]

One thing we recognized back when crafting Dodd-Frank (with heavy prompting from now-Sen. Elizabeth Warren) was that, given the evolution of the shampoo cycle and the complexity of modern credit markets, financial reform needed to set up a Consumer Financial Protection Bureau. Here’s what Kelleher said about this:

“The CFPB had to be started from scratch just five years ago but has already made consumer protection a priority in our financial markets, as proved by an impressive record of returning more than $10 billion to 27 million ripped off American consumers. One of the key accelerants of the 2008 crash was widespread predatory, illegal and, too often, criminal conduct where consumers were routinely ripped off and fraud was a frequently a business model. That was due to very little consumer protection pre-crash, which was also highly fragmented and mostly ineffective. The CFPB was a solution to that gaping regulatory hole and it is proving itself to be an invaluable protector of financial consumers across the country.”

[The Choice Act cuts CFPB off at the knees.]

Today I read that team Trump is going after Dodd-Frank, the CFPB, and another, similarly oriented Obama-era initiative, the “fiduciary rule” designed to diminish conflicts of interest between financial advisers and people saving for retirement by requiring such advisers to adopt a standard to act in their clients’ best interests, not their own.


Now, check out this poll result from a recent survey of Trump voters by the respected pollster Morning Consult. Strikingly, 65 percent say that Obama-era regulations “requir[ing] financial advisors to put their clients’ interests ahead of their own when providing retirement and investment advice” should be kept in place, while only 17 percent support repeal.

Dismantling consumer protections, restoring conflicts of interest and cranking up the economic shampoo cycle are all absolutely fantastic ways to kill the expansion, end the job and wage gains finally starting to reach low- and moderate-income households, exacerbate the income and wealth inequality still very much embedded in our economy, and stick it to some of the very people that helped elect this administration.

Or, as team Trump calls it, the end of week two.

[Updated: end of day 139…]

This word “deregulation.” I don’t think it does what you think it does.

June 8th, 2017 at 8:43 am

A quick note on “deregulation,” which is the other half of the mantra, i.e., the phony growth recipe–“tax cuts and deregulation”–you hear endlessly repeated in uninformed DC conversations.

I’ve been in these conversations for decades and I have no idea what these people are talking about and neither do they. What, specifically, do they want to “deregulate?” What evidence do they have that to do so would be pro-growth? Obviously, they’re just hand waving.

To take a timely example, the House is about to vote on the “Choice Act” today, designed to repeal most of the regs in Dodd-Frank. The bill will likely clear the House but needs D votes in the Senate where, hopefully, it is likely to come up short.

Now, consider this, from yesterday’s WSJ, touting favorable conditions in financial and credit markets:

The banking system is more resilient because of the regulations since 2008, as firms shifted away from short-term borrowings without collateral…Instead, banks are issuing longer-term debt in the low-yield environment as a way to reduce rollover risk, the risk from having to replace maturing debt.

 “The risk is that funding would run away for the banks in time of market stress,’’ said Steve Kang, interest rate strategist at Citigroup who specializes in money markets. ”Less reliance on short-term funding means more stable funding for banks and there is still lots of liquidity in the system.”

It’s one example of a regulation having its intended impact–I was there at the creation of Dodd-Frank, and I assure you, this was one of its targets–one that in this case, is boosting market stability and pushing back of the Minsky’esque risk underpricing that regularly occurs around this time in the cycle.

One could surely find counterexamples, and believe me, I’m sure there is brush to be cleared in our regulatory system. I’ll even go so far as to admit that Trump has a point re how long it takes to get infrastructure builds underway.

But sweeping allegations are meaningless. You’ve got to get down to cases, and when you do, you will find that many regulations are there for a good reason and they’re working as intended.

KS legislature for the win!

June 8th, 2017 at 8:09 am

Really happy to see the Kansas legislature reject the predictably failed supply-side tax cut “experiment” that’s been whacking the state’s coffers since 2012. Over at WaPo but one extra note here.

I’ve heard some supporters of the cuts–and there are surprisingly few, which I consider another gain for humanity–argue: “But KS is adding jobs; GDP is up; just give it a chance!”

This is absolute gibberish. It is a completely meaningless defense. We are in year eight of an economic recovery. Job growth is up most everywhere, in places that have raised their taxes and lowered them. In fact, if you want to get technical, economic indicator in KS look like nothing special compared to the nation.

The only thing you can be sure of re tax cuts is the first order effect: revenue losses. Beyond that, linkages between tax changes and growth are 98.8% phony rhetoric, 1.2% ambiguous economics. The KS legislature learned that the hard way, but at least they learned it.

Reax to NYT oped

June 5th, 2017 at 10:16 am

I’ve got an oped in this AM’s NYT on four big ideas that I see Democrats, and not just traditional progressives, but also centrists, converging around.

–a universal child allowance;

–a $15 minimum wage;

–a large expansion of the EITC;

–direct job creation.

Here are some responses and pushbacks. Much of what folks raised are policy ideas omitted from the piece, which is partly a function of space. For reasons I can’t explain, the NYT insists that other opeds have to be on the page today too:

That’s too redistributive an agenda!: This one doesn’t bother me. Read Dean Baker’s “Rigged,” which documents the extent of upward redistribution embedded in today’s operative policy agenda, and add on top of that the Ryan/Trump fiscal/tax agenda.

What about payfors?!: Yep–didn’t have space to get into that, but the minimum wage increase has virtually no budgetary cost. The direct jobs program is hard to score. It’s very sensitive to scaling and economic conditions. An employer subsidy program can be in single digit billions (as was the TANF EF e.g. I cite in the oped) while a direct job guarantee can be a lot more expensive. I’ll have more to say about this in forthcoming posts.

The big, ongoing costs are the child allowance (CA) and the EITC. I would fold the current Child Tax Credit into the CA, which would net ~$60bn/yr. For the rest, here’s where I’d start.

Advocates of the CA argue that we should tax back that part of it that goes to wealthy households, or, less preferable in their view, have it phase out at high levels–“less preferable” because they correctly point out that raising kids is expensive for everyone. I’m congenitally against complicated policies, of which give-it-to-them-then-tax-it-back fits the bill. But the CA advocates believe its universality is a great selling point, even with the tax-back. This needs more thought, but the main thing is to get the discussion going.

BTW, there was a link in an earlier draft to this pro-CA work by libertarian policy wonk, Sam Hammond, which I found to be a smart, thoughtful take on the issue, though I certainly wouldn’t rob from Peter’s SNAP budget to pay for Paul’s CA.

What about single payer health care?! I would like to have added something about this idea but didn’t have the space. Ben S and I tout it here, ftr.

But to make this list, the policy must not only be progressive; it must be something a majority of Congressional Democrats are warming to (the child allowance may sound like a bit of a reach by that metric, but in fact, many D’s, I believe, support a Child Tax Credit that starts at zero and doesn’t necessary depend on earnings; which amounts to the same thing).

I don’t know if D’s are coalescing around single-payer, though I’ve seen some evidence to that end. I do think there’s some very positive energy around the idea of Medicare for All, or if not “All,” then a slow reducing of the eligibility age. Re payfors, this would have to be matched with higher taxes, though that would be a cost-shift from private premiums.

Other stuff I left out!: More bargaining power, stuff to boost entrepreneurialism, anti-monopoly. All good ideas, and the latter two might meet my criterion above re D coalescing. But re bargaining power, anyone who knows even a fraction of my work knows that’s at the heart of my model of how the world and markets work. I wish I could say this met my political criterion, and no question, many D’s get this point. They understand the importance of unions, for example, and recognize the deep, structural costs of their diminished strength.

But my experience when I worked in government was that R’s hated unions more than D’s loved them, and therein lies the problem. Not sure if that has changed much, though I certainly hope so. Had the union movement remained strong, we might well not be in the mess we’re in today.

I’m still not sure what to do to boost entrepreneurs and tend to the think this is more organic and wave-like than policy oriented. However, it’s connected to pushing back on monopolistic competition, which everyone, left and right, should be for.