Author: Megan McArdle

A day after the Obama administration proposed its new set of financial rules, reality is setting in.  I’m not seeing anyone who thinks it’s particularly dangerous to split off prop trading from client service, or to impose limits on total bank liabilities.  But there’s a lot of skepticism that anything like this can pass.  Folks like Chris Dodd and Chuck Schumer will have a lot to say about this, and they aren’t interested in making life difficult for their constituents in the financial services industry–especially not Dodd, who’s going to need his friends after he retires.

Economics of Contempt thinks it’s a political stunt that is going to quietly die in committee.  Felix Salmon points out that the devil is in the details on the prop trading ban:

This is a good idea, but cutting back on prop trading, in particular, is going to be hard. Goldman Sachs has told me repeatedly that they don’t have prop trading: everything they do is ultimately for the benefit of their clients. Absent a corner of the trading floor with a big flashing “prop desk” sign above it, in practice it’s very hard to draw the line between the kind of daily trading that any broker dealer has to do, on the one hand, and proprietary trading for a bank’s own account, on the other. Both of them involve the bank taking risk and making money, after all.

Felix later adds that if this gets regulators up in the face of the prop trading desk, it’s a good thing.  But I’m with Economics of Contempt:  our regulators are overburdened as it is.  If we want them to get up in the face of the prop trading desk, we should be tripling the budgets of the regulatory agencies, and taking them off government scale so we can pay them something kind of vaguely competitive with what Wall Street pays.  It doesn’t do any good to give them more power if we don’t give them a lot more capacity to wield it.

For some reason, however, people freak out when you say that the SEC employees should get paid hundreds of thousands of dollars a year.  I’ve been told more times than I can count that we don’t want people who are just in it for the money.  But try to look at it the other way.  For someone who really understands securities regulation to go to the SEC–or stay there–they have to give up hundreds of thousands of dollars, not to mention a workplace where they get treated nicely.  If they have to live in New York, as many of them do, that’s a huge sacrifice.  You’re talking about the ability to put your children in good schools, or have a commute no longer than an hour.  It’s not reasonable to demand that from people, and even if it were, you wouldn’t get it.

We clearly need some new financial regulations.  But let’s start with some new regulators.  That shouldn’t be hard for anyone to agree on.

Even if I weren’t a pretty hard core absolutist about the first amendment, I don’t think I’d be particularly worried about yesterday’s Citizens United ruling.  They’re already doing a lot of this stuff anyway, just funnelling it through various front groups, and as far as I’m concerned, I’d rather have it done directly than through increasingly arcane loopholes. And anyway, I’m unconvinced that political advertising has this enormous power to broadcast secret mind-control rays into our homes.

Besides all that, there’s a fairly hard limit on how much political advertising corporations can do.  There’s only so much space on the airwaves.  And frankly, I just can’t bring myself to worry that now corporations will be able to send us more junk mail we won’t read. 

What I think is interesting is that in the days before elections, corporations may effectively be competing with themselves.  Do they want to spend more money advocating deregulation, or do they want to spend more money advertising their new brand of fabric-softening salad dressing?  Good for media companies.  But bad for the rest of us?  Fewer and fewer people watch commercials.  And I can’t say that I believe that either ads for policy positions, or ads for salad dressing/floor wax, are so mind-shatteringly effective that I’m much worried which kind we get.

James Fallows is not happy about the difference between John Roberts’s testimony in his confirmation hearing, in which he said we should be deferential to precedent, and his questioning during oral argument of Citizens United:

And even if Kagan were wrong — and, she is right — is it not breathtaking for one appointed Justice, on his own, to decide that he does not like the balance that elected legislators decided on many decades ago, and that many waves of his judicial predecessors have declined to tamper with?

On the merits, Roberts’ approach is like the idiot-savant faith in flawless markets that we all recall from Introductory Ec class. The cliched joke about this outlook concerns the economist’s refusal to pick up a $20 bill sitting on the sidewalk: After all, if really were a $20 bill, someone would already have picked it up. But the merits of his argument aren’t the point. It’s the disjuncture between the person who presented himself with “humility” at the confirmation hearings and the man happy to legislate from the bench.

The head of the nation’s judicial branch was purposefully deceptive during his “umpire” testimony. Or he had no idea what his words meant. Or he has had a complete change of philosophy and temperament while in his mid-50s. Those are the logical possibilities. None of them is too encouraging about the basic soundness of our governing institutions.

I find this reaction a little odd.  First of all, at least as I’ve always understood it, during oral argument the judges often ask extreme questions, because they’re probing for weaknesses in the case.  That doesn’t mean they’re endorsing the extreme, any more than employing the infamous trolley problem to explore our intuitions about making tradeoffs that cost human lives, means I think we should stop runaway street cars by throwing people in front of them.

Second of all, surely no one could have expected that John Roberts was going to endorse every single precedent ever decided by the Supreme Court.  In fact, questions about “deference to precedent” are, again at least as I understand it, code for “are you going to overturn Roe v. Wade”, not a request for an actual pledge to endorse any and all things the Supreme Court has ever said in its history.  

The description in the first paragraph could just as easily describe sodomy law before Lawrence v. Texas, civil rights law pre-Brown, or indeed, the state of abortion law pre-Roe.  Had Roberts voted for the majority in one of these cases, would we be hearing the same anguish about his lack of deference to precedent?

And respectfully, one does not need to be an idiot savant from Introductory Ec class to think that “Congress shall make no law . . . abridging the freedom of speech” means that, well, Congress shouldn’t make any law abridging the freedom of speech, even if that speech is done by corporations.  Nor is it crazy to think that as long as people have the right of exit, their decision not to exit legitimates the ability of organizations to speak for them.

In fact, I think speech through associations is a lot more complicated than I think this post captures.  Many of the organizations we like making political speech don’t get any more  supervision from the majority of their members than publicly held corporations do.  I mean, quick, name the charities you were supporting during the last United Way drive!  Pick three of the groups you gave to directly last year, and tell me what issues their lobbyists are working on right now! (Yes, I virtually guarantee that if they’re a large state or national group, they have at least one “our man in the capitol”.)  Maybe you know the answers to those questions, because you’re the sort of motivated and very well informed person who, well, reads my blog.  But the majority of people don’t know.  They give to causes because they want to be associated with the vague sentiment.

It’s not crazy to think that if you own a company, even through a mutual fund, you want that company to make money.  The corporation spending money to that end is presumed to be advancing those goals.  That it may contradict with other speech you want made is not, itself, proof that it shouldn’t be allowed.  Many, many people give to groups that may sometimes be at cross purposes with each other–indeed, if you support a politician, and some group like the Sierra Club, this is virtually certain.  

We don’t presume that the Sierra Club gets speech because it flawlessly reflects the views of its members.  I canvassed for environmental groups, and trust me, most of the membership have no idea what the hell these groups do with their money.  Frankly, they have no idea what the hell these groups should do with their money; their own ideas are usually vague, and frequently self-contradictory.   Their donation to the Sierra Club is less an endorsement of its platform than a way to say, “I care (a little) about the environment!”  

But the Sierra Club translates this very loose endorsement into very specific political speech advocating things that many of its members would hate if any of it actually got enacted.  We presume that the Sierra Club’s political speech is nonetheless a legitimate use of the organization’s money, because if the members hated it enough, they’d take their money elsewhere.  This is the standard you have to apply in nation full of enthusiastic and trusting givers who mostly aren’t particularly engaged in the policy process.

The financial Twitterverse has been abuzz this morning with speculation as to what the administration was going to propose?  Yes, yes . . . they’re going to sweat down Too Big to Fail banks.  But how?  Some commentators thought the gist would be HULK SMASH BANKS!!!  Others predicted it would be a minor tweak on the measures already proposed.

Now we know.  The administration’s new proposal has two core pieces, both of which are at least somewhat novel.  First, banks that have access to the discount window will not be able to trade for their own account.  That means no prop trading desk.  No owning hedge funds or private equity funds.  No investments of any kind to make profits for your shareholders.  Financial institutions can make profits by servicing clients, or they can make profits by investing for their own book.  But they can’t do both.

Senior administration officials I spoke to made it clear that this would not include market making activity, which the administration views as something you do for your clients.  But while that may partially reassure banks, that seems to mean that market makers–i.e. Goldman Sachs–are very definitely included.  That impression was reinforced by the way  Indeed, if they pass this thing, they should probably call it the Hey Goldman Sachs! You’re Not Going to Be So Profitable Any More Act of 2010.

The second proposal is to extend something like the caps that already prohibit banks from holding more than 10% of federally insured deposits, to other kinds of liabilities.  I asked, but got no clarity, on what exactly this means.  Are regulators going to swoop in whenever a diversified financial institution has too big a share of the total liabilities in all US debt markets?  Or are they going to intervene when a bank becomes dangerous to one particular debt market, the way Lehman turned out to be in commercial paper?

One thing is clear, though:  the banks screwed up.  As I’ve been saying for months now, it was a simply gigantic mistake to seek huge profits and big bonus pools. Yes, I know that they were competing for talent with foreign banks.  Well, they kept the talent, and now it looks like they may well lose the profitable lines of business that they needed the talent for.  Last time I looked, Goldman’s proprietary investments made up something like 90% of its profits.  Do they give up their profits, or their implied government guarantee?  Either move is going to hurt, which is why, despite reporting record profits today, Goldman’s stock is down 4% at this writing.

Now, as to the merits of the policy:  is it a good idea?  On first pass, I’m going to say tenatively yes.  The government is recognizing that banks “paying back” the funds they were given is essentially meaningless, because they’ve still got a very, very valuable implied government guarantee.  One could argue that they’ve had it since 1991 when the Federal Reserve got the power to loan money to investment banks in extremis.  But since last fall, it’s the next best thing to explicit.  That means the government needs to take steps to mitigate its own risk.

The way you do that is to decouple the key operation the government insures–the funneling of credit from those with money to those who want to borrow it–from making bets on market outcomes that can go badly wrong.  And to ensure that no institution has enough liabilities to take down the system if it fails.

That said, I’m not necessarily confident that this is going to work.  I’m not even sure that I understand how it will work at this point. I have only a hazy understanding of how the liability limits will be enforced, and after talking to administration officials, I’m not sure that they really know either; they seem to be waiting to see what the legislators and regulators say.  And while splitting off proprietary investment seems like it might mitigate systemic risk, it may be very hard to enforce.  Would “eating your own toxic waste” be prop trading, or client service, for example?  It’s possible that this thing will end up with loopholes you could drive a truck through, and if so, it will probably be worse than nothing.

Too, I haven’t talked to any prop traders or investment banking executives this morning.  They might be able to offer a convincing reason we shouldn’t do this.

But even if it’s not the best idea in the world, there are definitely many worse rules that we could think up.  And after a stunning defeat on health care, the administration needs to score big points against the bankers quickly.  If “Don’t just stand there, do something!” is the order of the day, there are clearly worse somethings we can do.

If we do choose this “something”, Americans should probably be clear that this is going to deal a major setback to New York as a world financial capital.  Many of the rules that were undone in the last two decades were got rid of because they were making it too hard for American banks to cope with foreign competition.  If we do this, America’s financial sector will shrink, and our banks will lose a lot of business to foreign firms.  That means, among other things, that we are going to lose big chunks of tax revenue, because bankers are very disproportionate contributors to federal coffers.  It also means that New York’s renaissance will probably slack off–and the people who complain about the bankers will discover how many city services those banker salaries paid for.

That doesn’t mean we shouldn’t do it.  I think finance has taken on an outsized role in our country, and as we’ve seen over the past year and a half, that hasn’t been a healthy state of affairs.  But this means a substantial change to the American financial system, and as with all change, we won’t like every single thing that follows.

Join the conversation about this story »

See Also:

• Quote Of The Day: "Obama Is Taking This Massachusetts Vote As An Excuse To Attack US Industry"
• Let Me Tell You How I’m Going To Stick It To Wall Street
• Obama Earthquake Rocks Wall Street

The financial Twitterverse has been abuzz this morning with speculation as to what the administration was going to propose?  Yes, yes . . . they’re going to sweat down Too Big to Fail banks.  But how?  Some commentators thought the gist would be HULK SMASH BANKS!!!  Others predicted it would be a minor tweak on the measures already proposed.

Now we know.  The administration’s new proposal has two core pieces, both of which are at least somewhat novel.  First, banks that have access to the discount window will not be able to trade for their own account.  That means no prop trading desk.  No owning hedge funds or private equity funds.  No investments of any kind to make profits for your shareholders.  Financial institutions can make profits by servicing clients, or they can make profits by investing for their own book.  But they can’t do both.

Senior administration officials I spoke to made it clear that this would not include market making activity, which the administration views as something you do for your clients.  But while that may partially reassure banks, that seems to mean that market makers–i.e. Goldman Sachs–are very definitely included.  That impression was reinforced by the way they spoke about the problem–emphasizing that this is aimed at disasters like Bear and Lehman.  If they pass this thing, they should probably call it the Hey Goldman Sachs! You’re Not Going to Be So Profitable Any More Act of 2010.

The second proposal is to extend something like the caps that already prohibit banks from holding more than 10% of federally insured deposits, to other kinds of liabilities.  I asked, but got no clarity, on what exactly this means.  Are regulators going to swoop in whenever a diversified financial institution has too big a share of the total liabilities in all US debt markets?  Or are they going to intervene when a bank becomes dangerous to one particular debt market, the way Lehman turned out to be in commercial paper?

One thing is clear, though:  the banks screwed up.  As I’ve been saying for months now, it was a simply gigantic mistake to seek huge profits and big bonus pools. Yes, I know that they were competing for talent with foreign banks.  Well, they kept the talent, and now it looks like they may well lose the profitable lines of business that they needed the talent for.  Last time I looked, Goldman’s proprietary investments made up something like 90% of its profits.  Do they give up their profits, or their implied government guarantee?  Either move is going to hurt, which is why, despite reporting record profits today, Goldman’s stock is down 4% at this writing.

Now, as to the merits of the policy:  is it a good idea?  On first pass, I’m going to say tenatively yes.  The government is recognizing that banks “paying back” the funds they were given is essentially meaningless, because they’ve still got a very, very valuable implied government guarantee.  One could argue that they’ve had it since 1991 when the Federal Reserve got the power to loan money to investment banks in extremis.  But since last fall, it’s the next best thing to explicit.  That means the government needs to take steps to mitigate its own risk.

The way you do that is to decouple the key operation the government insures–the funneling of credit from those with money to those who want to borrow it–from making bets on market outcomes that can go badly wrong.  And to ensure that no institution has enough liabilities to take down the system if it fails.

That said, I’m not necessarily confident that this is going to work.  I’m not even sure that I understand how it will work at this point. I have only a hazy understanding of how the liability limits will be enforced, and after talking to administration officials, I’m not sure that they really know either; they seem to be waiting to see what the legislators and regulators say.  And while splitting off proprietary investment seems like it might mitigate systemic risk, it may be very hard to enforce.  Would “eating your own toxic waste” be prop trading, or client service, for example?  It’s possible that this thing will end up with loopholes you could drive a truck through, and if so, it will probably be worse than nothing.

Too, I haven’t talked to any prop traders or investment banking executives this morning.  They might be able to offer a convincing reason we shouldn’t do this.

But even if it’s not the best idea in the world, there are definitely many worse rules that we could think up.  And after a stunning defeat on health care, the administration needs to score big points against the bankers quickly.  If “Don’t just stand there, do something!” is the order of the day, there are clearly worse somethings we can do.

If we do choose this “something”, Americans should probably be clear that this is going to deal a major setback to New York as a world financial capital.  Many of the rules that were undone in the last two decades were got rid of because they were making it too hard for American banks to cope with foreign competition.  If we do this, America’s financial sector will shrink, and our banks will lose a lot of business to foreign firms.  That means, among other things, that we are going to lose big chunks of tax revenue, because bankers are very disproportionate contributors to federal coffers.  It also means that New York’s renaissance will probably slack off–and the people who complain about the bankers will discover how many city services those banker salaries paid for.

That doesn’t mean we shouldn’t do it.  I think finance has taken on an outsized role in our country, and as we’ve seen over the past year and a half, that hasn’t been a healthy state of affairs.  But this means a substantial change to the American financial system, and as with all change, we won’t like every single thing that follows.

So if the Democratic plans are dead, what’s left?  What’s the Republican plan?

I think those of us who opposed the Democratic bill should have one.  And I happen (ahem) to have a modest little plan right here . . .

Raise the Medicare tax by half a percentage point, and eliminate the tax-deductibiity of health insurance benefits for people making more than $150K a year in household income, $100K for singles.  Then make the federal government the insurer of last resort.  Any medical expenses more than 15% or 20% of household income, get picked up by Uncle Sam.

Yes, people don’t like taxes.  But it’s a pretty small tax.  The benefit exclusion gets the camel’s nose under the tent for ending the employer-health insurance relationship, but it’s targeted at groups that a) aren’t particularly sympathetic and b) can afford it.  And it answers the central fear people have, which is that they’ll end up sick and bankrupt.  20% of your income is a lot.  But it’s a manageable amount, especially if, as I suspect, many more people choose to self-insure for the first 15%, and take the differences as wages.

It doesn’t answer every single thing we could possibly want–David Cutler argues that compliance with treatment regimes is already so low that we don’t want to erect any cost barriers.  But it’s progressive, solves the biggest part of the problem, and it still leaves the market for most health care services intact.

In fact, I think it will be a more powerful impetus for cost control than any excise tax or IMAC could have been, because consumers will be making the decisions by themselves, not sullenly fighting an insurer, employer, or government bureaucrat.  It doesn’t exert cost pressures on end of life care, which will certainly blow the caps–but I found it pretty implausible that we were ever going to find the political will to cut off marginal treatments to the sickest and most vulnerable.  And in other areas, it could make a big difference.

Meanwhile, whatever awesome plans Democrats had to control costs in Medicare and Medicaid, they should implement and show us all how well they work.

That’s my suggestion.  I’m sure you can pick holes in it, and it might be pretty ugly by the time the lobbyists got through with it.  On the other hand, it just might work.

Join the conversation about this story »

See Also:

• Privately, Democrats Know Healthcare Reform Is Toast
• More Than Healthcare Or The Recession, Obama’s Presidency Will Be Defined By Haiti
• We’re Gonna Pass Healthcare No Matter What

So if the Democratic plans are dead, what’s left?  What’s the Republican plan?

I think those of us who opposed the Democratic bill should have one.  And I happen (ahem) to have a modest little plan right here . . .

Raise the Medicare tax by half a percentage point, and eliminate the tax-deductibiity of health insurance benefits for people making more than $150K a year in household income, $100K for singles.  Then make the federal government the insurer of last resort.  Any medical expenses more than 15% or 20% of household income, get picked up by Uncle Sam.

Yes, people don’t like taxes.  But it’s a pretty small tax.  The benefit exclusion gets the camel’s nose under the tent for ending the employer-health insurance relationship, but it’s targeted at groups that a) aren’t particularly sympathetic and b) can afford it.  And it answers the central fear people have, which is that they’ll end up sick and bankrupt.  20% of your income is a lot.  But it’s a manageable amount, especially if, as I suspect, many more people choose to self-insure for the first 15%, and take the differences as wages.

It doesn’t answer every single thing we could possibly want–David Cutler argues that compliance with treatment regimes is already so low that we don’t want to erect any cost barriers.  But it’s progressive, solves the biggest part of the problem, and it still leaves the market for most health care services intact.

In fact, I think it will be a more powerful impetus for cost control than any excise tax or IMAC could have been, because consumers will be making the decisions by themselves, not sullenly fighting an insurer, employer, or government bureaucrat.  It doesn’t exert cost pressures on end of life care, which will certainly blow the caps–but I found it pretty implausible that we were ever going to find the political will to cut off marginal treatments to the sickest and most vulnerable.  And in other areas, it could make a big difference.

Meanwhile, whatever awesome plans Democrats had to control costs in Medicare and Medicaid, they should implement and show us all how well they work.

That’s my suggestion.  I’m sure you can pick holes in it, and it might be pretty ugly by the time the lobbyists got through with it.  On the other hand, it just might work.

None of the journalists who opposed health care reform quite want to say it’s dead–at least, not any of the ones I’ve talked to.  On the one hand, Democrats are in full panic mode, and they no longer have a filibuster-proof majority.  On the other hand, Democrats have already pushed this far, far past where any of us thought they would be willing to take it.  Yesterday’s results show what we all knew:  ramming through an unpopular health care bill on a party-line vote is very politically costly.  But until last night, the entire caucus somehow seemed to have convinced themselves otherwise.  So who wants to say they keep going with their current message to voters . . . which is to say, “Lalalalalalala I have my fingers in my ears!  I can’t hear you!”

But still, I can’t see any path to passage at this point.  The centrists began bolting so quickly that it’s pretty clear they weren’t gladly risking their careers for an unpopular bill they deeply wanted to pass–they were voting for it under heavy pressure from the leadership.  Now that the leadership is itself threatened, they can’t keep the caucus in line.

Let’s look at the three possible paths to a bill:

Rush through a compromise before Brown is seated  Not going to
happen.  Brown’s margin is too big to delay certification longer than
15 days, which means there is probably not enough time to get a full
compromise scored by the CBO and then jump all the procedural hurdles. 
Even if there were,Lieberman, Bayh and Webb have already signalled
pretty strongly that they will not vote on anything until Brown has
been seated; I can only assume that Nelson, Lincoln and Landrieu are
even more reluctant.

Have the House pass the Senate bill unchanged 
Er . . . maybe, but I don’t see how.  Pelosi has already lost one of
her votes, Robert Wexler, who quit to become president of a DC think
tank.  It looks like at least Bart Stupak, and possibly more members of
the pro-life caucus, will refuse to vote for it.  And Louisiana
Republican Joseph Cao has already said he won’t vote for it again.

That
means that Pelosi has to find more votes.  It was widely believed that
she had some in reserve, who she allowed to vote no last time.  But if
they were allowed to vote no, that means that they needed to vote no. 
It’s hard to see many people becoming willing to switch now.  Democrats
have been pushing the line that “you’re already pregnant”–having voted
for the thing once, the damage is done.  But for these representatives,
that’s not true–and the safest place to be seen right now is probably
bucking their party. 

Even progressive Anthony Weiner was on television last night, saying this means they need to slow down.

Pass it through budget reconciliation 
At this point, the most likely–but not likely.  The math in the Senate
gets better–but if they lose just three more people, they can’t even
do reconciliation.  And I don’t see that the math in the House
improves, especially since so many vote-buying elements have to be
stripped out in order to get the parliamentarian to approve it.

All
in all, I think it’s dead.  I think we’ll get a Medicare expansion
later in Obama’s term.  But I’ve been back and forth on this so many
times, that I don’t know how confident I am in my prediction.

I
do have one pretty powerful indicator, though.  The “anti” journalists
are quoting represenatives saying no and running numbers.  The
progressive journalists are floating theories of how it could happen,
and lambasting their side for being panicky, spineless wimps.

A reader emails to ask me what lessons one of my favorite books, William Easterly’s The Elusive Quest for Growth, might offer for Haiti.  Since Easterly is often seen as a critic of lavish aid, I think my answer might surprise you:  we should give Haiti a bunch of money and other help.

Easterly makes a convincing case that aid doesn’t improve the level of economic growth, or pull nations out of poverty.  But aid can alleviate human misery, and that’s what Haiti has a lot of right now.  Haiti may not be any richer when we pull out.  But it will have fewer dead people, fewer children missing parents, or parents missing limbs.  It will not have descended as far into the brutal chaos of starvation and desperate thirst–a chaos which can irreparably rend the social fabric.

The important thing, I think, is that we start with our exit strategy in mind.  It needn’t be a rapid exit–maybe we plan to be out in ten years.  But we should be focused on the beginning at building institutions that can survive our withdrawal, which means giving Haitians as much power as possible even when it slows us down.  We may not be able to leave Haiti richer than it was when we went in, or any more likely to grow.  But we can probably avoid leaving it worse than we found it.

Cadbury has been holding out against a proposed Kraft merger, flirting with suitors like Hershey, or saying demurely that they had no plans to pair up with any one, thank you very much.  But it looks like, in the end, they’ll be marrying for money.  Cadbury’s CEO is recommending that shareholders take the 850 pence ($13.89) per share offered by the giant food conglomerate.  Insiders had hoped to find some other way, but ultimately, without another bidder, Cadbury’s lackluster performance made it unlikely that shareholders would go along.  The CEO has been under intense pressure from institutional investors who wanted cash in hand, not the promise that really, someday Cadbury was going to get it together.  Since ultimately, they’re his bosses, this was probably inevitable in the absence of a better bid from another firm.

Republicans want Brown seated ASAP, if he wins.  Democrats, naturally, would like to stretch out the process as long as reasonably possible.  I think that if Scott Brown wins tomorrow, we’ll be hearing a lot of back and forth on these precedents.  My summary: the folks in power tend to do whatever they want.  Which is usually okay, because it just doesn’t matter that much.

I don’t know which narrative will catch on.  But I’m not sure that’s the most important factor.  Whether or not it’s fair for Democrats to stall Brown’s swearing-in, can they actually do it?  Or rather, can they actually do it, and then pass a massively unpopular health care bill on a straight party-line vote?  Even if only a small minority think of this as illegitimate procedural shenanigans, that’s going to further tarnish the chances of a party that’s already under fire for cutting too many DC insider deals.

That’s not to say that Democrats won’t do it, of course.  The Democratic determination to commit electoral suicide over this issue has been impressively firm over months of negotiations; there’s no particular reason they should stop now.

Either way, though, we can look forward to at least several weeks of Bush v. Gore style continuous arguments over previously unimportant procedural points.  I suppose it’s a nice break from the death panels and the accusations of mass murder.

So the polls have Martha Coakley in free-fall, and even Nate Silver, who’s been pretty pessismistic on Brown, says the FiveThirtyEight forecasting model puts Brown at a 3:1 chance of winning.  Intrade also has her at 25 cents on the dollar.

I confess, I can’t quite believe it.  It’s Massachusetts.  Teddy Kennedy’s seat.  And special elections are notoriously difficult to poll–many of the results rely on educated guesses about the makeup of the electorate tomorrow.  I’m very tempted to take a flyer on Ms. Coakley’s chances, at 3:1.

And even if I thought those numbers were about right, it might make
sense as a way to hedge my net psychic wealth.  If Scott Brown wins,
I’m happy–and if Martha Coakley wins, at least I get $50 or so to
drown my sorrows.

I’m a great believer in hedging emotional
risks.  Betting against an outcome you really want is an excellent way
to manage downside disappointment.  But in the case of the whole future
of our nation’s health care policy, I can’t quite bring myself to do
it.  Some risks are better off unhedged.

There’s a fair amount of debate in the liberal blogosphere about what to do if Republican Scott Brown wins the Massachusetts special election on Tuesday.  It looks like there are essentially two options that get health care passed:  pass the Senate bill, or pass something else really, really quickly.

I don’t think number two is going to work.  They have about ten days
between election and certification.  There’s been talk of delaying
either the certification or the seating, but while this is possible, I
don’t think the Democrats dare do this (nor do I know that they want to
commit a fairly outrageous breach of the electoral process).  Moreover,
it may be moot:  apparently, the Senate precedent is that Kirk loses his ability to vote the day of the special election. 

Of
course, the Senate could violate its own precedent.  But you can be
damn sure the Republicans would turn it into a circus akin to Bush v.
Gore, and the political cost would be appalling; I’m not sure it’s too
much to say that any Blue Dog who voted for such a procedural shift
would probably lose their seat come fall.  I’m sure it’s a price that
Pelosi is willing to pay–but I’m not sure the Blue Dogs are.

So
it comes down to the Senate bill.  Is Stupak serious about holding out,
or was he only playing super-hardball?  If he and his little band of
merry pro-lifers are serious, the bill dies; I don’t think that Pelosi
can make up their votes, especially when you consider that the
popularity of this thing has dropped even further since they took
them.  They might pass the Senate bill and promise to amend it
immediately, but that’s pretty dicey, especially since Scott Brown is
pro-choice. 

If he’s just being a tough negotiator, maybe it
passes–but I’m betting that even if Stupak caves, there will be a lot
of other Blue Dogs with insurmountable objections to the bill.  The
problem with Brown’s election is not just that it would the Democrats
of a seat in the Senate.  It’s that it would send a chill down the
spine of every Democrat who is not sitting in an ultra-safe,
ultra-liberal seat.

Oddly, Felix Salmon and I find ourselves on different sides of a debate over credit card rates–and he is taking the side of the banks.  Felix is worried about an impending rule against putting “floors” on credit card interest rates:

Sounds great, right? Surely if there’s no minimum interest rate, that’s got to be good for consumers? Actually, no: there’s a problem here, due to the fact that interest rates are very low right now.

Let’s say that I’m a customer-owned credit union, and I want to issue my customers a card carrying a low interest rate of 9.9%. I also want to protect myself in case rates rise a lot, so I put in language saying that the interest rate always has to be at least 3.9 percentage points over the Prime rate. Prime is currently just 3.25%, but if Ben Bernanke were to raise the Fed funds rate past 3%, then the rate on the credit card would begin to rise.

As of February 22, that kind of product will be illegal. The variable-interest bit (Prime + 3.9%) is fine. But if you have a variable-interest credit card, you can’t set a floor any more. Which means that since Prime is just 3.25% right now, the interest rate today would be set at an uneconomical 7.15%.

As a result, if I want to charge a 9.9% interest rate today, I need to peg the card’s interest rate at Prime + 6.65%, and the rate on the card will start rising as soon as Bernanke raises rates by so much as a quarter-point.

Clearly a Prime + 3.9% card with a floor of 9.9% is a better deal for consumers than a Prime + 6.65% card. But the Fed is banning the former product, and forcing issuers into the latter.

The point here is that banks need to charge at least 10% or so on their credit cards, no matter how low prevailing rates are, just because of charge-offs and expenses. That doesn’t mean they always need to charge at least 10 percentage points more than the Fed funds rate, however.

If you’re worried that consumers can’t find their way through a maze of complicated products, then there’s a limit to how many features they can have, even if those features make consumers better off.  A LIBOR+3.5% card with a 10% floor is a hard product to explain in a simple rate sheet, and arguably harder for consumers to follow.

I actually don’t find the prospect of the floors all that worrying, from a consumer point of view.  Experts tell me the evidence shows that most consumers who carry balances are surprisingly savvy about their interest rates (financial writers tend to assume they don’t, because if you don’t carry a balance, you pay no attention to the rate.  I have four credit cards, and no idea what my interest rate is on any of them, because I never even use them except for business expenses.)  They also shop pretty aggressively with balance transfers and other techniques for managing their balances.

When rates go up, people with high rates will look around for better deals; in bad times, banks will cut back on the credit lines for low-rate cards, and issue higher rate ones.  It’s a little more ponderous.  On the other hand, everyone will understand the terms up front.  It’s annoying, and probably has some frictional downsides, but I doubt it means much in the end.

I’m still not convinced that the chances of Scott Brown beating Martha Coakley in the Massachusetts special election are as high as 50%.  I would like this to be true, but the universe is not here to please me–though Martha Coakley’s nearly unprecedented gift for putting her foot in her mouth certainly seems to be.

Nonetheless, I think it’s worth speculating, as my colleague Derek Thompson already has:  what if?  What happens to health care? 

The
progressive pundits seem to be pretty united in their belief that this
is no big deal, nothing to see here, move along–either they’ll rush
through a compromise, or the House will pass the Senate bill
unchanged.  The libertarians I know, on the other hand, are equally
convinced that this means the death of the bill.  At this point, there
are clearly a fair number of Democrats who would really rather not pass
this, but are afraid to defy their party.  If all they have to do is
stall long enough to let Brown take his seat, well, that’s not hard to
do, especially since Stupak seems so far pretty adamant about accepting
the Senate compromise.

Moreover, Brown’s election probably makes
a bunch of Blue Dogs even more nervous than they already are–when
they’re already about as nervous as a long-tailed cat in a room full of
rocking chairs.  How much discipline can the leadership exert on those
quailing members, given how shaky many of their campaigns are looking?  If Scott Brown can get elected in Massachusetts
with a pretty clear mandate to kill the health care bill–even in an
off-year special election . . . well, how frightened are you really
that Harry Reid’s going to be around next year to take his vengeance?

The
leadership could try to stall Brown’s certification.  But I have no
evidence that they are any less appalled by the idea than I am–and
even if they were, I’m pretty sure they’ve already realized that it
would be political suicide.  There is simply a limit to how brazenly
legislators can flout the will of the folks who elect them. 

So
I guess I’m in the camp that thinks a Scott Brown victory means that
the health care bill goes down.  On the other hand, given the
near-perfect correlation of one’s opinion on the matter with one’s
opinion on the health care bill, I think it’s pretty clear that we’re
all seeing what we want to see.

I am against levying a special tax on banks in order to recoup losses on TARP and AIG.  On the other hand, I am in favor of levying a special tax on TBTF banks in order to recoup the costs to the government of the now-implicit guarantee.  Unlike commentators such as Nicole Gelinas, I am unconvinced that there was a significant moral hazard component to the housing bubble; as Lehman shows, there was no guarantee that the banks would not be allowed to fail.  However, unlike commentators like James Surowiecki, I am pretty convinced that there is now substantial moral hazard in the financing of the larger banks–though remembering that bank creditors are usually made whole, I’m not sure it’s all that much larger than the moral hazard surrounding ordinary banks.

Still, the fact is, creditors are expecting us to bail them out.  Which means lenders are more likely to help them get into trouble, from which they will need to be bailed out.  And the fact is, the lenders are right.  In that moment of crisis, it will be too dangerous to crush the market’s implicit assumptions, for fear of spawning further chaos. 

That implicit guarantee is very valuable, and the taxpayer should get something in return.  But more important is making sure that the federal government is prepared for the possibility that we may have to make good on those guarantees.  If we’re going to levy a special tax on TBTF banks, let it be a stiff one, and let it fund a really sizeable insurance pool that can be tapped in emergencies.  Like the FDIC, the existance of such a pool would make runs less likely in the shadow banking system, but it would also protect taxpayers.  Otherwise, with our mounting entitlement liabilities, we run the risk of offering guarantees we can’t really make good on.

When Paul Krugman said “Europe’s economic success should be obvious even without statistics. For those Americans who have visited Paris: did it look poor and backward? What about Frankfurt or London? You should always bear in mind that when the question is which to believe — official economic statistics or your own lying eyes — the eyes have it.” I had roughly the same reaction that Matt Welch did:  having lived in London for intermittent (short) periods, I found it noticeably poorer than the United States.

It is not noticeable to tourists, mind you.  London, like any
European city that wasn’t actually flattened in the war, is rich in
architectural assets that make it feel very posh–low rise buildings
older than thirty or forty years are a luxury in most American cities. 
Walking around a European city, the diversity and beauty of the
architecture is dazzling.

But the standard of living in any
given profession is much lower.  Preserving London’s dazzling antique
architecture has meant that most of the people I knew had much longer
and more expensive commutes than their American counterparts would. 
They lived in smaller quarters that were hotter in summer and colder in
winter.  At any given professional level, you found British people
doing things that only much poorer Americans would do, like bringing
lunch, hanging their clothes to dry, or going without cable (though the
Americans I knew said the cable wasn’t worth it anyway).  People in
Britain are not poor.  But they have a noticeably lower standard of
living than Americans do.  If they were doing it in 1960’s vintage
apartment buildings and tract homes, it would be quite obvious.  When I
lived there, I literally could not afford to eat meat regularly or take
the tube to work, and as a consequence wore holes in my shoes.  (In
fairness, I was being paid in dollars and the exchange rate was
awful–but I wasn’t the only one walking to save money.)

I
don’t want to sound as if I’m saying Britain’s a terrible place–it’s
lovely, and I miss it.  But the amount that people are able to consume
is much less than the amount Americans are able to consume, and many of
the things they forego make real difference in things like personal
comfort.  (Based on my admittedly limited sample of British mattresses,
they must be unimaginably hardy sleepers).  Consumption isn’t
everything.  But it is something, and that is what’s being captured in
the GDP differences.

The labor unions have been fighting the Senate health care bill for some time now–specifically, the provision that levies high taxes on “Cadillac” plans that exceed certain maximums.  That was expected to be a sticking point in the negotiations between the Senate and the House, but as Samuel Johnson once said, “the prospect of being hanged focuses the mind wonderfully.”  With the potential loss of their 60 vote majority lurking ahead, they can’t dawdle on the details; it’s time to haul in their lente and festina like hell.

And so it looks like they may have reached a deal sooner than otherwise expected: unions get a special two-year exclusion from the tax.

Presumably, the unions plan to go back and get their exclusion extended every few years.  Otherwise, the deal doesn’t make much sense.  The ostensible reason for the respite is to allow them to renegotiate new collective bargaining agreements, but in these inflationary times, how many collective bargaining agreements last longer than three years?  I could be wrong about that, but unless I am, 2013 is plenty far enough away for most of the unions in question to negotiate better contracts.  

Giving them an extra two years seems like acknowledging that they can’t negotiate better contracts, a situation that won’t really change very much after the recession is over for many of the unions in question.  Moreover, trading wage gains for less generous health benefits arguably gets very complicated for unions with multi-employer plans.  Not least because the workers will not be feuding with insurance plans over claim denial, but with the unions themselves.

The next question is: where do they make up the lost money?  There are three obvious places left: use some part of the “millionaire’s tax” that the House bill imposed; beef up the scope of the “automatic” cost cuts; or slash provider reimbursements even further.  The former is problematic because it hits New York and California’s powerful delegations the hardest.  And as far as I can tell the trend has been towards weakening, rather than strengthening, the automatic cost cutting authority.  So I expect there will be some enhancement to the “productivity indexing” for provider payments, and/or a new special tax on one or more classes of provider.

Of course, they could just eat the concession; they have wiggle room in the CBO estimates.  But I doubt they will.  For one thing, they will probably have to make other concessions that eat up the wiggle room.  For another, they like making each bill more deficit-busting than the last; I fully expect whatever monstrosity emerges from this quasi-conference will have a CBO score even better than the final Senate bill.  So they’ll probably be looking to make up the money somewhere.
 
This may backfire.  If you think that the Nebraska deal was unpopular, just wait until the administration announces higher taxes on everyone but its friends in the labor movement.  We may see if the popularity of the health care bill still has room to fall.

Kevin Drum is shocked to find Jamie Dimon admitting that they weren’t modeling a total collapse in house prices. I’m shocked to find that Kevin is shocked. That’s pretty much the standard explanation–at least, a partial one–for why lenders became willing to take on so much risk. Massive house price depreciation had pretty much dropped out of their models, which mostly focused on prepayment risk.

This is not quite as crazy as it sounds. For one thing, Kevin has truncated the quote a little bit; the version I read
has Dimon saying “We didn’t stress test housing prices going down by
40%.” America had not had a sustained national decline in residential
housing prices since the Great Depression.  So while local banksmight
need to model the risk of substantial price depreciation, banks
glomming together national pools of mortgages figured this wasn’t such
a big problem–as long as you didn’t think we were going to have
another Great Depression.  And most regulators, commentators,
economists, bankers, and ordinary folks thought we weren’t going to
have another Great Depression.

Indeed, we didn’t.  It turned out to be a sufficient, but not necessary condition for a collapse in housing prices.

Even
if they had put housing price implosion in their models, where would
they have gotten the data to fine-tune their models?  It’s not enough
to say, “We should model a broad national decline in house prices”; you
need some values for how many people will default when house prices
fall.  The last time we had such a national collapse, mortgages were
relatively short term debt instruments that didn’t self-amortize. 
We’ve had local bubbles since in places like New York and California. 
But New York is definitely a bad model–it’s a city mostly of renters
in which co-ops frequently demand downpayments of 25-50%, or even all
cash.  California might have been better, but unlike a lot of places,
it’s a non-recourse state.  And so on. How well could Dimon have hoped
to build a nationwide model off of a few local jurisdictions?

That’s
not to excuse the bankers for not trying; some allowance for the risk
of a broad price decline would have been better than none.  But I’m not
sure that it would have done much to alter their lending habits.  Going
on historical data, the risk of a huge price drop within the average
lifetime of a mortgage (which is less than ten years), would normally
have been very small, and would have shown up in any
probability-weighted model as a fairly trivial adjustment compared to
the large risk that the mortgages in the pool would be refinanced. By
the time it was obvious that the risk of a broadly falling market was
very great, the bubble was about to pop of its own accord.  Indeed,
even without such a model, Dimon pulled out of subprime, because he
didn’t need a spreadsheet to tell him that it was going to turn into a
disaster.

Tyler Cowen suggests that Haiti, as a nation, may have just effectively ceased to exist.  Haiti, as a people, is still there.  But the institutions that made up the Haitian nation state, and its economy, have literally been flattened.  Aid agencies usually work through local governments, which already have distribution systems for hospitals and so forth.  But the local government in this case does not really seem to exist at the moment; it has been hollowed out by deaths.  The main port seems to have suffered heavy damage, and while flights are making it to the airport, there’s no one there to unload. 

This has made it attractive for some of Cowen’s commenters to argue that we should basically take the army in there and run the place:  make it Iraq II, without the resistance.  But the reason that Iraq failed is not primarily that Al Qaeda wanted to run the place (they failed too).  The reason it failed is that it’s really hard to impose good institutions on someone else’s country, not to mention paternalistic.  Why are we supposed to be able to do better this time?  Because they practice voodoo instead of Islam?  There will be plenty of local power-brokers who will be happy to resist any top-down imposition of an outside institutional structure.  I probably would too.

On the other hand,  in the short term, the initial reports make it seem like we’re going to have to impose some sort of order just to distribute aid.  At this point, we can assume that people are already dying from lack of medical care, clean water, and relief supplies, and the losses will mount geometrically as days pass.  But there is no one to tell anyone what to do, and no way to tell them, as all communications seem to be knocked out.  Until they’re restored, Haiti is effectively in the eighteenth century.

But in the longer run, what do you do for a country that already had one of the worst-functioning governments in the world?  Half the budget was provided by foreign aid before the earthquake.  For the next few years, we will effectively hold government power there, whether we want to or not, because we’ll probably essentially be providing all of its funding, and can threaten to turn the taps off unless things go as we demand.

This has made it attractive for some of Cowen’s commenters to argue that we should basically take the army in there and run the place:  make it Iraq II, without the resistance.  But the reason that Iraq failed is not primarily that Al Qaeda wanted to run the place (they failed, too.)  The reason it failed is that it’s really hard to impose good institutions on someone else’s country, not to mention paternalistic.  Why are we supposed to be able to do better this time?  Because they practice voodoo instead of Islam?  There will be plenty of local power-brokers who will be happy to resist any top-down imposition of an outside institutional structure.  I probably would too.

On the other hand,  in the short term, the initial reports make it seem like we’re going to have to impose some sort of order just to distribute aid.  At this point, we can assume that people are already dying from lack of medical care, clean water, and relief supplies, and the losses will mount geometrically as days pass.  But there is no one to tell anyone what to do, and no way to tell them, as all communications seem to be knocked out.  Until they’re restored, Haiti is effectively in the eighteenth century.

But in the longer run, what do you do for a country that already had one of the worst-functioning governments in the world?  Half the budget was provided by foreign aid before the earthquake.  For the next few years, we will effectively hold government power there, whether we want to or not, because we’ll probably essentially be providing all of its funding, and can threaten to turn the taps off unless things go as we demand.