A few different articles that caught the eye in recent days…

February 11th, 2015 at 9:14 am

–Teresa Tritch, with characteristic efficiency, nails the essentials of the building Greek/German showdown, emphasizing the critical point that this isn’t a simple story of virtuous lenders and profligate borrowers. Both sides swam in de-Nile since Greece entered the eurozone, and now that the implosion has occurred, the Greeks cannot be the only ones to shoulder the blame.

In plain terms, that means creditors must take haircuts. If there’s one thing we should have learned from this excruciating long recovery from the bubble-induced Great Recession, it’s that while creditors should of course have superior claims to equity holders, their claims are not sacred. Insolvency happens, typically as a result of the very type of denial Tritch cites, and when it does, the best way to proceed is to rip off the band-aid, charge off some of the debt, and move on.

But that hurts the politically powerful creditors/rentiers, and Tritch makes a powerful point in this regard:

…the bailout of Greece clearly was not a rescue of the country, but rather a rescue of the creditors, who could have been ruined in a default…of the hundreds of billions of euros in bailout loans supplied to Greece by the eurozone and the International Monetary Fund, only 11 percent went to finance activities of the Greek government. Sixteen percent went toward interest payments, while the rest was funneled through Greece on its way elsewhere.

That observation immediately took me back to the days of the $85 billion US gov’t bailout of AIG, of which $13 billion went right out of AIG’s back door into the coffers of…wait for it…Goldman Sachs.

–Next, there’s this fascinating “when worlds collide” piece from the WSJ the other day. I try to pay a lot of attention to both dollar policy and movements, as well as financial market reform. But I wasn’t clever enough to foresee this interaction between the two of them.

The strengthening U.S. dollar is rippling through the financial system in unexpected ways, revealing what bankers say is a hidden flaw in a Federal Reserve proposal to increase capital cushions at the nation’s largest banks.

Big U.S. banks say that, under the rule proposed in December, the recent steep rise in the dollar’s value would force some U.S. firms to hold billions of dollars more in capital than foreign competitors, including weaker European banks, because of how the Fed plans to calculate a so-called surcharge levied on the eight most systemically important U.S. banks…the high exchange rate makes their dollar-denominated assets and operations look larger relative to their European peers.

As I’ve always maintained, you can get a lot else wrong in financial oversight if you get the capital requirements right. The idea is that you want the large and interconnected financial institutions to have a large enough buffer of their own capital to be able to cover their losses without facing a situation where their assets fall below their liabilities, otherwise known as insolvency. The banks resist, because higher capital requirements mean lower leverage ratios which cuts into profits.

The Fed recently proposed an increase in capital buffers for big US banks from around 7% to north of 10% in some cases. The fast-rising dollar complicates things because regulators compare banks holdings using the same currency, and when our banks’ holdings are converted to euros, their assets appear much higher than those of their counterparts abroad, implying the need for more capital to meet the proposed buffer zone requirements.

I’d expect the finance lobby to squawk and try to play the refs as the Fed proposal is being considered. Re that little story above about AIG and GS, recall that the day before the AIG rescue, top US Treasury officials, including Sec’y Paulson, met with Goldman’s CEO. But regulators must hold firm on this. It’s one of the most critical parts of financial reform and even as the current recovery finally gains steam, we mustn’t forget the costs of what we and other nations have gone through to get here.

–Finally, I read that CAP has a new report out on how rising income inequality makes it harder to finance Social Security. I figured they’d have a graph in there that I’d been meaning to update myself showing the share of earnings above the earnings cap (read the details yourself, but the idea is that the payroll tax that funds the program is capped at around $120,000 and as inequality pushes a larger share of earnings above the cap, Soc Sec’s financing takes a hit).

And there it was, as Figure 1. Note that the share of earnings above the cap have gone from 10% to 17%. An obvious fix here would be to adjust the cap not for average earnings growth, as is now the case, but to ensure that 90% of earnings were covered (some advocate getting rid of the cap altogether, but since we usually increase the benefits to those now paying more into the system, that would mean raising Soc Sec payouts to zillionaires). According to the Social Security folks, implementing that idea–covering 90% of earnings henceforth–would close 27% of the program’s 75-year shortfall.


Source: CAP

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6 comments in reply to "A few different articles that caught the eye in recent days…"

  1. Fred Donaldson says:

    Increasing the FICA income cap will bring in much more money than the benefits will cost. From Social Security website:

    “For an individual who first becomes eligible for old-age insurance benefits or disability insurance benefits in 2015, or who dies in 2015 before becoming eligible for benefits, his/her PIA will be the sum of:
    (a) 90 percent of the first $826 of his/her average indexed monthly earnings, plus
    (b) 32 percent of his/her average indexed monthly earnings over $826 and through $4,980, plus
    (c) 15 percent of his/her average indexed monthly earnings over $4,980”

    The payments from the very wealthy will result in benefits from the higher amounts over $118,000 of 15% of the base wages, versus 40% average. Increased payments plus lower percentage payouts are a bonus to the system.

    In addition, according to the 85% rule, nearly all of this money will be subject to normal personal income tax rates. For those in the 35%+ bracket, the tax on each additional $1,000 in 15% benefits would be 35% of 15%, or about 5%, compared to bottom break point benefit of 90%.

    Including the top income folks means they will get 1/18th of the benefit of the bottom taxpayers, contributing mightily to the strength of the system, but still not making it into a “welfare” tax to benefit only one or two classes of seniors.

  2. Larry Signor says:

    Two thoughts on SS financing: 1. Why should there be a complete cap? Do we assume all income above $120,000.00 goes towards a persons retirement? Unlikely. A diminished tax above an inflation adjusted amount of earnings seems more reasonable. 2. Why are personal capital gains not subject to SS taxes at an amount proportionate to federal income tax rates on those gains?

    • Jared Bernstein says:

      Peter Orszag and Peter Diamond wrote a Soc Sec solvency plan years ago that had something like your #1 suggestion, as I vaguely recall.

  3. marc sobel says:

    I am not an economist but did you mean sacred?

    it’s that while creditors should of course have superior claims to equity holders, their claims are not scared.