Financial Reform FAIL And A New Metric For Recessions

Simon Johnson had the same problem as I did with the President's speech on financial reform:

As a diagnosis of the problems that let us into financial crisis, it was his clearest and best effort so far. He didn’t say it was a rare accident for which no one is to blame; rather he placed the blame squarely on the structure, incentives, and actions of Wall Street.

But then he said: our regulatory reforms will fix that. This is hard to believe. And even the President seems to have his doubts, because he added a plea that – in the meantime – the financial sector should behave better [...]

Louis Brandeis, of course, would have seen things differently. The author of “Other People’s Money: And How The Bankers Use It,” was under no illusions concerning the underlying financial power structures and how they operated. He would have regarded an appeal to the better nature of bankers as somewhere between humorous and sad.

The only thing that will make a different is regulation. This is the lesson of the 1930s in the US – the regulations imposed at that time created a financial sector that did not impede growth after World War II; basic intermediation (connecting savers and borrowers) worked fine and destabilizing frenzies were avoided. During this period, the financial sector came up with venture capital, ATMs, and credit cards – arguably the three most important financial innovations of the past 100 years, and much more helpful of real innovation than anything you’ve seen since 1980.

As Johnson has repeatedly argued, we need to break up the biggest banks, end the revolving door between Wall Street and Washington and ensure that the executives taking the risks put their own fortunes at stake instead of gambling with our money. Sadly, none of these elements exist in the more modest reform proposals from the President, and even those are faltering in the face of institutional pressure.

As a result, we muddle through, resetting the clock to the pre-bailout days without having fundamentally fixed the system or prevented the possibility of a relapse. It's great that Ben Bernanke thinks the recession is over. But the 9.4 million people who have lost their jobs would disagree with him. Their personal depressions continue, and I would argue that this is a direct result of allowing the titans of Wall Street trillions in Treasury wealth while ordinary Americans suffer with a too-small stimulus and not much prospect for recovery.

Fifteen million Americans are locked in the nightmare of unemployment, nearly 10 percent of the work force. A third have been jobless for more than six months. Thirteen percent of Latinos and 15 percent of blacks are out of work. (Those are some of the official statistics. The reality is much worse.)

Consider this: Some 9.4 million new jobs would have to be created to get us back to the level of employment at the time that the recession began in December 2007. But last month, we lost 216,000 jobs. If the recession technically ends soon and we get to a point where some modest number of jobs are created — say, 100,000 or 150,000 a month — the politicians and the business commentators will celebrate like it’s New Year’s [...]

At some point the unemployment crisis in America will have to be confronted head-on. Poverty rates are increasing. Tax revenues are plunging. State and local governments are in a terrible fiscal bind. Unemployment benefits for many are running out. Families are doubling up, and the number of homeless children is rising.

It’s eerie to me how little attention this crisis is receiving. The poor seem to be completely out of the picture.

Joseph Stiglitz has a similar view in today's Guardian, arguing that the Administration through saving the financial system has perversely created banks that are not only too big to fail but too big to resolve, the way you would other entities which cannot meet their obligations. In a separate piece, he argues that the metric for evaluating recession - gross domestic product - now has almost no bearing on everyday lives, and ought to be scrapped in favor of something that truly reflects the outlook for ordinary people.

The big question concerns whether GDP provides a good measure of living standards. In many cases, GDP statistics seem to suggest that the economy is doing far better than most citizens' own perceptions. Moreover, the focus on GDP creates conflicts: political leaders are told to maximise it, but citizens also demand that attention be paid to enhancing security, reducing air, water, and noise pollution, and so forth – all of which might lower GDP growth.

The fact that GDP may be a poor measure of well-being, or even of market activity, has, of course, long been recognised. But changes in society and the economy may have heightened the problems, at the same time that advances in economics and statistical techniques may have provided opportunities to improve our metrics.

I remember Andy Stern coming up with the same idea in his book a few years ago. If we continue to use a metric based on the desires of elites, then they will please themselves with growth results even though the mass of people continue to suffer. Believe it or not, common statistics can actually change policy for the better. The problem lies in getting everybody to use it.

...Kevin Drum offers up real median income growth as a better metric. If that's the case, we've actually been in a depression for a decade.

An End To Tax Havens

I guess the President met with Joe Stiglitz and Paul Krugman last week. Ultimately, these one-off meetings mean little in the context of the larger discussion inside the White House, which appears dominated by the axis of Summers and Geithner. But notably, the President came out the very next week with a plan to put a halt to offshore tax havens.

President Obama will present a set of proposals on Monday aimed at changing international tax policy, calling for the elimination of benefits for companies and wealthy individuals that harbor their cash in offshore accounts.

The president and Treasury Secretary Timothy F. Geithner will announce their plans during a late-morning appearance at the White House. The proposed overhaul in the tax code, which will be fully unveiled in the administration’s budget later this week, could help raise $210 billion in revenues over the next 10 years.

One of the key proposed changes would restrict companies from deferring the payment of taxes on profits earned overseas. Administration officials said the plan also would keep firms from taking deductions against their taxes by inflating the amount of foreign taxes they paid.

Mr. Obama raised the idea frequently during his presidential campaign. In a speech to Congress in February, as he outlined his priorities for the year, he pledged to make the tax code more equitable by “finally ending the tax breaks for corporations that ship our jobs overseas.”

We have heard the "end tax breaks for companies that ship jobs overseas" line since the Kerry campaign. But what we're really talking about here goes back even further than that. The Obama campaign wants companies to pay their taxes under the law. That's pretty much it. As quoted in the press release put out by the Administration, corporations have a 2.3% effective tax rate on their foreign earnings. That's absurd and wrong. The use of tax havens in the Cayman Islands and elsewhere suck wealth out of the country and give corporate interests a free ride to use the commons at virtually no cost. The tax breaks for shipping jobs overseas is only a part of this plan. Here's President Obama with more.

The way we make our businesses competitive is not to reward American companies operating overseas with a roughly 2 percent tax rate on foreign profits; a rate that costs -- that costs taxpayers tens of billions of dollars a year. The way to make American businesses competitive is not to let some citizens and businesses dodge their responsibilities while ordinary Americans pick up the slack [...]

For years, we've talked about ending tax breaks for companies that ship jobs overseas and giving tax breaks to companies that create jobs here in America. That's what our budget will finally do. We will stop letting American companies that create jobs overseas take deductions on their expenses when they do not pay any American taxes on their profits. And we will use the savings to give tax cuts to companies that are investing in research and development here at home so that we can jump start job creation, foster innovation, and enhance America's competitiveness.

For years, we've talked about shutting down overseas tax havens that let companies set up operations to avoid paying taxes in America. That's what our budget will finally do. On the campaign, I used to talk about the outrage of a building in the Cayman Islands that had over 12,000 business -- businesses claim this building as their headquarters. And I've said before, either this is the largest building in the world or the largest tax scam in the world.

And I think the American people know which it is. It's the kind of tax scam that we need to end. That's why we are closing one of our biggest tax loopholes. It's a loophole that lets subsidiaries of some of our largest companies tell the IRS that they're paying taxes abroad, tell foreign governments that they're paying taxes elsewhere -- and avoid paying taxes anywhere. And closing this single loophole will save taxpayers tens of billions of dollars -- money that can be spent on reinvesting in America -- and it will restore fairness to our tax code by helping ensure that all our citizens and all our companies are paying what they should.

We're talking about what amounts to an illegal fraud of the public commons, to the tune of at least $21 billion dollars annually. Corporations have grown accustomed to it and see it as their birthright. Their sycophants in the media try to turn history on its head and claim that the founding principle of what it means to be an American is to cheat on taxes.

SCARBOROUGH: They tell me though it's all legal - ALL LEGAL.

BURNETT: Of course it is.

SCARBOROUGH: There's a big difference between tax avoidance and being an all out tax cheat.

BURNETT: That's right. Isn't it your obligation in this country - there is a tax code for a reason, to take advantage of every bit of it you can and pay as little as you can.

I'd be fine with lowering the corporate tax rate if I thought corporations actually paid it. But they don't. They "avoid" (not cheat! Don't you dare say cheat!) them and increase the burden on working people. And it's time this stopped. Obviously, the corporate interests who want to maintain the status quo will fight like hell to stop this. Here's Robert Gibbs at his presser today;

Q Okay. And on the announcement he made today about international tax policy, several big corporations are lined up against it, the deferral provision -- Pfizer, Oracle, Microsoft and trade associations like the Chamber of Commerce, Business Roundtable. And I'm just wondering how you think you're going to overcome that opposition and if you think this faces a big fight in Congress.

MR. GIBBS: Well, I don't think change is ever easy and I think whenever you're taking on some bigger interest that mountain gets a little bit steeper.

But the President strongly believes that the policy that he outlined, the steps that we have to take to close tax loopholes and ensure some fairness in this process is the right policy for America and the right policy for American business. By closing these loopholes and replacing these tax advantages with fairness, using a portion of the money that's recouped to make or to fund research and development and experimentation tax credit for the next 10 years is an important investment for American business.

Since 1981 the R&D tax credit has expired on 13 separate occasions. So providing business with some certainty for research and development we think is important. And as the President said throughout the campaign, we have -- our tax code has an incentive that provides -- an incentive that rewards companies that are investing overseas at the expense of investing here in America. We know we're going to take on some tough interests in that, but the President believes this is a fight we should have and one that we can win.

As you can see, corporations would get a permanent R&D tax credit out of this, which would save them billions in the exchange, in effect a bribe that must be offered in exchange for getting them to actually pay their taxes.

I'm glad Obama's making this fight, and when you combine it with his comments on the shrinking of the financial sector, maybe we can say that the Krugman/Stiglitz meeting did the trick.

Not Just Geithner, They're All In Bed Together

There have been two very informative and revealing articles on Treasury Secretary Tim Geithner recently: this one from Gary Weiss in Portfolio (which is apparently going out of business), which is a sot profile, and this much harder-edged piece in the New York Times, suggesting that Geithner is part and parcel of the old-boys club on Wall Street.

Even as banks complain that the government has attached too many intrusive strings to its financial assistance, a range of critics — lawmakers, economists and even former Federal Reserve colleagues — say that the bailout Mr. Geithner has played such a central role in fashioning is overly generous to the financial industry at taxpayer expense.

An examination of Mr. Geithner’s five years as president of the New York Fed, an era of unbridled and ultimately disastrous risk-taking by the financial industry, shows that he forged unusually close relationships with executives of Wall Street’s giant financial institutions.

His actions, as a regulator and later a bailout king, often aligned with the industry’s interests and desires, according to interviews with financiers, regulators and analysts and a review of Federal Reserve records.

Wow. That's a bit of a bombshell. And it's backed up with a fair bit of knowable facts. You can draw conclusions from who Geithner met with and where he ate dinner, but you can draw far more lasting conclusions from the fact that stress tests appeared to look tougher on regional banks than the large Wall Street players. You can build a narrative out of friends and associates, or you can just take a look at the hundreds of billions flowing to the biggest banks, while consumer lending programs fail utterly to deliver for regular people. While the banks whine about the constraints put on them by the government and feel reluctant to participate in government programs designed to boost the economy, I think you can make a compelling case that the banks have been coddled while the people continue to struggle.

I agree with Joseph Stiglitz here:

To Joseph E. Stiglitz, a Nobel-winning economist at Columbia and a critic of the bailout, Mr. Geithner’s actions suggest that he came to share Wall Street’s regulatory philosophy and world view.

“I don’t think that Tim Geithner was motivated by anything other than concern to get the financial system working again,” Mr. Stiglitz said. “But I think that mindsets can be shaped by people you associate with, and you come to think that what’s good for Wall Street is good for America.”

In this case, he added, that “led to a bailout that was designed to try to get a lot of money to Wall Street, to share the largesse with other market participants, but that had deeply obvious flaws in that it put at risk the American taxpayer unnecessarily.”

And the facts in the marketplace reflect that instance of snap-psychology. However, I would add that Geithner is one person. In fact, the revolving door between Washington and Wall Street is much bigger than the Treasury Secretary. The argument that the oligarchs have essentially taken control of government does not depend on him. So I wouldn't make so much of this. I would say that the coziness between these two seats of power represents a real threat to getting us out of this economic crisis.

The Vicious Cycle

If the no drama team is scared, then I'm scared.

It's quite unsettling to talk to members of Barack Obama's transition teams these days, especially those who are helping with the economics portfolio. Without going into details, the sense I get from them is that they are very worried that the economy will get a lot worse before it gets better. Not just worse... a lot worse. As in -- double digit unemployment without the wiggle factors. Huge declines in aggregate demand. Significant, persistent deficits. That's one reason why the Obama administration seems to be open to listening to every economist with an idea and is stocking the staff with the leading lights of the field. In one sense, the general level of concern among Obama advisers and transition staffers is reassuring; they get the magnitude of the problems, and they're not going to assume that, just because the bottom has never dropped out before -- certainly not in the lifetimes of most people doing policy these days, the bottom will never drop out.

Ambinder winds this around to the worry that an unstable nation, like Pakistan, will suffer a total economic collapse and the US won't have the wherewithal to bail them out. But I see a bigger problem - that the worldwide slowdown and drop in demand crashes China's stratospheric growth, which has been an engine for the global economy for the last decade.

BEIJING — Chinese exports registered their largest drop in nearly a decade last month, suggesting that the global recession could be far worse than many economists had previously predicted.

According to statistics released by the Chinese government Wednesday, exports fell 2.2 percent from November 2007 to November 2008 — the largest year-over-year monthly decline since April 1999.

Even at a time of increasingly dour economic news, the Chinese trade numbers stunned many economists. They struck an ominous note for China, where labor unrest has increased markedly as the economy has slowed in the last month.

Many analysts had anticipated that the monthly trade figures would show China's export machine slowing along with the global economy, but few had expected it to slip into reverse. In October, exports surged 19.2 percent year-over-year.

"We were expecting a slowdown, but the magnitude is a bit shocking," said Wang Tao, an analyst at UBS Securities.

China makes stuff that American consumers buy. When American demand drops, China has a lot of surplus labor. And their factories close. Really terrible situation.

We're also seeing extremely stable entities like the NFL and National Public Radio cut jobs and close down parts of their business (the Arena League? Gone).

In these troubled times, it's important to hold people responsible, so that as we drag ourselves out of this ditch, we never put ourselves in the same situation again. Joseph Stiglitz, who isn't on Obama's economic team right now for reasons that are inscrutable, makes the argument in this month's Vanity Fair that the problem was explicitly ideological.

There will come a moment when the most urgent threats posed by the credit crisis have eased and the larger task before us will be to chart a direction for the economic steps ahead. This will be a dangerous moment. Behind the debates over future policy is a debate over history—a debate over the causes of our current situation. The battle for the past will determine the battle for the present. So it’s crucial to get the history straight [...]

Greenspan played a double role. The Fed controls the money spigot, and in the early years of this decade, he turned it on full force. But the Fed is also a regulator. If you appoint an anti-regulator as your enforcer, you know what kind of enforcement you’ll get. A flood of liquidity combined with the failed levees of regulation proved disastrous.

Greenspan presided over not one but two financial bubbles. After the high-tech bubble popped, in 2000–2001, he helped inflate the housing bubble. The first responsibility of a central bank should be to maintain the stability of the financial system. If banks lend on the basis of artificially high asset prices, the result can be a meltdown—as we are seeing now, and as Greenspan should have known.

What we ought to see here is the death of both neoliberalism and free market fundamentalism - the ideas that risk can always be managed, that asset bubbles are good when they're running so they should be encouraged, that investment banks should be unregulated and free to make big bets with other people's money, that credit rating agencies owned by the banks would be independent enough to make judgments on those banks, that tax cuts are an economic panacea, all of it. Stiglitz' final paragraph should be seared into our brains.

The truth is most of the individual mistakes boil down to just one: a belief that markets are self-adjusting and that the role of government should be minimal. Looking back at that belief during hearings this fall on Capitol Hill, Alan Greenspan said out loud, “I have found a flaw.” Congressman Henry Waxman pushed him, responding, “In other words, you found that your view of the world, your ideology, was not right; it was not working.” “Absolutely, precisely,” Greenspan said. The embrace by America—and much of the rest of the world—of this flawed economic philosophy made it inevitable that we would eventually arrive at the place we are today.

What has me worried is that this failure of ideology will result in a very long and deep economic collapse, out of which there isn't much hope for a few years, and that Obama, not his predecessors, will be tarred with the responsibility for the problem because he could not work the country out of it, and in opposition we get the exact same failed solutions (really, Mike Pence is calling for things like a balanced budget amendment), and an American public starving for relief will buy what Republicans are selling again. That's the vicious cycle we have to avoid, and so drastic steps must be taken without worrying about the short-term political consequences.