Friday, August 17, 2012

David Stockman redux.

He chose him for his conservative zeal and youthful energy. His reputation as a fiscal whiz. He has intensely opposed Government intervention in the economy--whether by regulation or subsidy. He will be no mere budget trimmer, but rather a pivotal figure in the effort to restrain the Federal budget, upon which all else depends.

It was in these words that New York Times described not the political ascendency of Paul Ryan, but rather of his political doppelganger, David Stockman, thirty years ago.

David Stockman was the Paul Ryan of the Reagan era, and the similarities are uncanny. A rising conservative star whose southwestern Michigan district was just across the lake from Ryan's, David Stockman was a 34-year-old Congressman who was famous for his mastery of the arcane details of the Federal budget. When Ronald Reagan selected him to be the Director of the Office of Management and Budget, it was a pivotal appointment, as the central question facing the Reagan Revolution--from old line Republicans as well as Democrats--was whether Reagan could cut taxes, increase defense spending and balance the budget, all at once.

Stockman believed that it could be done, or as he said at the time, "The whole thing is premised on faith. On a belief in how the world works."

And the rest is history. The Reagan administration transformed Washington.

Stockman did not succeed in balancing the budget. But unlike revisionist defenders of the Reagan era, he did not blame it on the duplicity of Tip O'Neill and the Democrats, but rather on the perfidy of fellow Republicans. What was birthed in that era was--in the words of fellow Republican apostate Pete Peterson--the unholy alliance of tax cutting Republicans and big spending Republicans. Together, they untethered the Grand Old Party from its roots as the party of frugality and prudence, and embraced the singular legacy of the Reagan era--the realization that balanced budgets were no longer either a political or economic imperative.

And this perfidy lies at the core of Paul Ryan's much vaunted Roadmap for America's Future. For all the claims to being a document of budget wizardry, the Roadmap offers little policy insight beyond its fundamental, and unarguable, stipulation: We cannot continue to borrow forever. Beyond that, the Roadmap offers little more than an assertion of the author's own political imperative--in this case capping spending at 19% of GDP--and assuming that Congress in future years will agree to curb spending in excess of that cap.

I published the graph below several months ago in a post about the Obama-Boehner negotiations. The graph incidentally makes the same simple point as the Roadmap: "If Federal spending were to be capped at its pre-financial crisis average since the mid-1970s of 20.8% of GDP, five categories of spending--Social Security, Medicare, Medicaid, Defense and Net Interest--will steadily squeeze out all other areas of entitlement and discretionary spending. By 2022, Everything Else is reduced 57% from its historical average of 6.4% of GDP to 2.7% of GDP."



This is not a great insight. It is simply a product of understanding budget numbers at the most rudimentary level and having some facility with Excel. And yet this is the basic insight of Paul Ryan's plan. Ryan does not say what he proposes to cut--beyond proposed cost shifting of healthcare costs to beneficiaries--indeed he barely discusses non-entitlement, non-defense spending. Instead, he simply asserts that if there were a hard spending cap, that would force drastic--but undefined--reductions to stay within aggregate spending limits.

But to say what is squeezed out is not a question of budgetary wisdom, but pure politics. Why does Ryan's plan preserve Medicare untouched for those 55 years and older? The answer is not because they paid for it and therefore are entitled to it--because they didn't pay for it. Medicare is in large measure paid for by general tax revenues just like everything else. It is simply because they vote, and they vote with a greater sense of determination and focus than those who are 35 years old and younger.

Imagine what a roadmap might look like if those aged 18 to 35 had the political clout that their numbers might demand? One could imagine that Pell Grants would be the third rail of politics. Military action as a tool of foreign policy might be viewed with greater skepticism if political power hinged on the votes of those whose lives were to be put in harms way. And Social Security and Medicare would more likely be means tested and subject to spending limits. Perhaps if the young electorate whose wallets were to be raided to pay for it all down the road voted their self-interest with the same ferocity of older voters, we might have less willingness to borrow today to pay for a broad-based welfare state for the elderly. It is all about who shows up on election day.

While conservatives heap adulation upon the Ryan as a thinker, David Stockman is not fooled. He understands that Ryan's document demonstrates neither budgetary insight nor political courage. Writing on the op-ed page of the New York Times last week, Stockman assaulted Ryan's plan:

Thirty years of Republican apostasy--a once grand party's embrace of the welfare state, the warfare state and the Wall Street-coddling bailout state--have crippled the engines of capitalism and buried us in debt. Mr. Ryan's sonorous campaign rhetoric about shrinking Big Government and giving tax cuts to 'job creators' (read: the top 2 percent) will do nothing to reverse the nation's economic decline and arrest its fiscal collapse...

But the greater hypocrisy is his phony "plan" to solve the entitlements mess by deferring changes to social insurance by at least a decade.

A true agenda to reform the welfare state would require a sweeping, income-based eligibility test, which would reduce or eliminate social insurance benefits for millions of affluent retirees. Without it, there is no math that can avoid giant tax increases or vast new borrowing. Yet the supposedly courageous Ryan plan would not cut one dime over the next decade from the $1.3 trillion-per-year cost of Social Security and Medicare.

The sophistry of the plan rests in the simplistic assumptions it makes about the ability of Congress to designate cuts now for future years, as well as the assumption Republicans are not in fact big supporters of large swaths of the discretionary budget the Ryan presumes to simply assume that Congress will eliminate in future years. Indeed, Ryan's plan does not address how the fundamental question of how the budget would be balanced until the last few pages of his opus, this despite the presumptions that the existential threat to the nation is presumed to be the Roadmap's raison d'etre.

But that is the crux of the budgetary challenge, not a sideshow. What Ryan ultimately offers is nothing more than a repeat of the now decades-old idea of legislating hard spending caps. This is the same approach that failed with the brief experiment with the 1985 Gramm-Rudman-Hollings law. It failed in a different incarnation as Paygo rules. And it has failed again in the form of the 10-year scoring rules that are the reason the Bush tax cuts were supposed to have expired several years ago.

The problem, in its essence, is that Congress does not actually have power to impose cuts on the future, as any rule one Congress makes to control spending, the next Congress can undo. This is the essential dilemma that has underscored our budgetary politics since the political and economic imperative of balanced budgets was overturned in the wake of the Reagan revolution--only Congress can restrain itself, and if it doesn't want to, it won't.

What Stockman and Peterson understand is that for all of the hubris of conservatives in Congress, they are no different than their political brethren across the political spectrum. In fact, they have proved to be worse. They hold forth on the immorality of deficits and the path to ruin that lies ahead, but it is all just words--words that mask a deep hypocrisy and cynicism. And when David Stockman looks at the Ryan plan, and the fawning support of the conservative establishment in Washington, he cannot conceal his contempt.

It's rank demagoguery. We should call it for what it is. If these people were all put into a room on penalty of death to come up with how much they could cut, they couldn't come up with $50 billion, when the problem is $1.3 trillion. So, to stand before the public and rub raw this anti-tax sentiment, the Republican Party, as much as it pains me to say this, should be ashamed of themselves.

That about sums it up.

Monday, August 13, 2012

Born to Empire. All gone. All taken away.

In truth, it has been Albion’s summer to forget. Even as London basked in a successful Olympic Games, the City of London—their Wall Street—has suffered global attention of an altogether different sort.

Beginning in June, with the news that the British bank Barclays had agreed to pay a half-billion dollar fine for manipulating the LIBOR benchmark interest rate, the news has only gotten worse from one week to the next.

LIBOR—the London Interbank Offered Rate—actually refers to a number of interest rates along a yield curve calculated daily by the British Bankers Association (BBA). Each morning, a panel of up to 18 banks each submit interest rates at which they believe they could borrow a substantial amount of money from other banks for differing time periods—a thirty-day rate, a sixty-day rate, a one-year rate, and so forth. Much like a panel of Olympic gymnastics judges in years gone by, the BBA tosses out the highest and lowest rates, and takes an average of those in the middle that become that day’s LIBOR rates.

Barclays confessed to British bank regulators that over a period of years beginning in 2007, its traders had not submitted rates in good faith, but rather—like the East German judges of Olympics past—they had deliberately sought to skew the results, to manipulate LIBOR in directions that would benefit their trading positions. While at first it was unclear how much damage Barclays could have inflicted—after all Barclays was but one participant on the LIBOR panel—in the ensuing weeks other global bank members of the panel have come forward to admit that their traders conspired with Barclays to tilt the playing field in their favor.

To date, the list of banks who have stepped forward includes names that have become all too familiar for their participation in financial misdeeds over the course of the last half-decade: UBS, Deutsche Bank, Royal Bank of Scotland, Citigroup, JPMorgan, Credit Suisse and Bank of America. And the list goes on.

And then it got worse.

As July rolled into August, two of the most venerable British banks, Hong Kong Shanghai Bank (HSBC) and Standard Chartered, were accused by U.S. investigators and bank regulators of aiding and abetting global money laundering schemes. HSBC and Standard Chartered are particularly important institutions in British history. Each were created under charters granted by Queen Victoria, to create institutions to finance the growth and development of the Empire. HSBC was founded to fund growing British trade and investment in China, while Standard Chartered's mission focused on British colonies from East Asia to South Africa.

The first shoe to drop was HSBC, which was accused of complicity in $15 billion of money laundering and illicit transactions for Mexican drug cartels, as well as Russian and other international criminal groups. Then, before the HSBC story could fully sink in, Standard Chartered was accused by New York bank regulators of complicity in laundering a quarter of a trillion dollars of Iranian assets, and indirectly abetting terrorist activity.

For Americans, it is difficult to understand the depth of betrayal represented by the malfeasance at HSBC and Standard Chartered. America has always been suspicious of its banks, and our tradition is one of fear—if not conspiracy theories—of the power of our banks over our government, rather than the other way around.

In Britain, the anger at Barclays CEO Bob Diamond and before him Royal Bank of Scotland CEO Fred Goodwin reflected outrage at their failed stewardship of important national institution. Back here in the colonies, both the outrage and the treatment of Bank CEOs have been notably different. Regulators and the Justice Department have treated our top banks—now comprising JPMorgan, Citi, BofA, Wells Fargo, Morgan Stanley and Goldman—with kid gloves. Just this week, federal judge William Pauley grudgingly signed off on a $4.8 million fine for Morgan Stanley, for its part in an electricity price fixing scheme that cost New York consumers $300 million. Morgan Stanley earned on the deal was $21.6 million, and they admitted no wrongdoing in the plea agreement.

The Morgan Stanley settlement—representing less than 25% of their take—simply illustrated the profitability of behaving badly, and came the same week that the U.S. Justice Department decision not to prosecute Goldman Sachs for its conduct in shorting the housing market during the 2008 housing market collapse.

It should be conventional wisdom by now that regulators do not have the capacity to effectively counter the power of our dominant banks. This weeks news recalled the observation of one Wall Street trader that he and his brethren would not be deterred by fines—which are few and far between—only arrests would do the trick, as every trader’s greatest fear was that their mother would see them frog-marched off to jail on television.

In the post-2008 world, much discussion of banking in the U.S. has focused on the reintroduction of the Glass-Steagall restrictions that separated tradition commercial banking services—taking deposits and lending money—from investment banking and proprietary trading. Sandy Weill—the Godfather of the modern mega-banks who orchestrated the financial reforms that ended the Glass-Steagall restrictions—made waves in July when he recanted his views and called for the reimposition of Glass-Steagall.  Weill’s view reflects that of many on the right and the left who share the view of Paul Ryan, who stated succinctly at a town hall meeting in May, “If you’re a bank and you want to operate like some non-bank entity like a hedge fund, then don’t be a bank. Don’t let banks use their customers money to do anything other than traditional banking.” 

Writing in the New York Times, Obama Car Tsar and former Lazard Frere head Steven Rattner joined the finance industry swift reply to Weill’s treachery, arguing essentially that such banking activities should not be restricted, just regulated better, and that Glass-Steagall restrictions would put American banking out of synch with the rest of the world, where such restrictions do not exist. But in the rest of the world, international banks have traditionally been national banks, with governance and management closely aligned with national leadership.

American banking is unique, and is a reflection of the freer world of American capitalism. As the old saying goes, in Germany, what isn’t legal is illegal, while in America what isn’t illegal is legal. Glass-Steagall was important in America specifically because of the lack of essential trust and interconnection between the banks and the political sector, and the apparently reasonable concern that American banks could not be trusted as conservative stewards of public deposits.
Unlike European and Asian banks—whose roles and function in the world have traditionally been closely linked to the nations whose interest they serve—American banks are private organization that pursue their own interests and make no pretense of advancing nationalist interests—other than in acknowledging the essential role of banking to the functioning of the private economy. Accordingly, America has far more banks and resolution systems that presume that banks will fail as a matter of course. Or as Paul Ryan noted as his preamble to the comment above, “We should make sure you can’t get too big where you’re going to become too big to fail and trigger a bailout, and if you take risky behavior then you go into bankruptcy and we open up the bankruptcy laws to allow them to go into bankruptcy.”
As bad as the LIBOR scandal has been, the HSBC and Standard Chartered revelations are in their way deeper indictments of the state of international banking. HSBC and Standard Chartered are culturally rooted in the British Empire. As created by Queen Victoria, they were not simply institutions regulated by the state, but were arms of the state, chartered as essential tools of state policy.

Over the past decades, the dominance of the U.S. Federal Reserve Bank—combined with the failures of the European Union to develop effective, unified bank regulation—have led to a creeping Americanization of global finance. International banks, like Barclays, have found themselves run by American or American-trained chief executives, and their cultures have migrated toward the those of their large American counterparts, where trading and investment banking—and the higher compensation that those activities can generate—have undermined the traditional banking values focused on credit and long-term relationships.

Internal emails at Standard Chartered published in the New York Times, provide a hint at the awareness of bank managers of their own activities and the reputational risks that they were taking. According to one email, the Standard Chartered chief executive for American activities warned London that the Iranian activities had “the potential to cause very serious or even catastrophic reputational damage to the group.” The response was telling, “Who are you to tell us, the rest of the world, that we’re not going to deal with Iranians.”

Back in the day, such a response might well have reflected directives from Whitehall that Britain was supportive of Iranian relations, and Standard Chartered need not curtail its activities in deference to the political priorities of their American cousins. But those days are long past. Like Barclays and the list of other LIBOR manipulators, Standard Chartered had no such defense. In today’s world, each bank is acting only on their own account, with traders focused on their own bonuses, and with little regard for the impact of their activities on the world around them. 

The devolution of the venerable Victorian banks from instruments of the British state to instruments of individual self-interest is unfortunate, if not tragic. Those banks have lost their mission, their purpose and the tether to the national government that they were created to serve. Queen Victoria would not be pleased

But the problems are not Britain’s alone. It appears that we may be migrating toward the worst of both worlds. Even as global banks are loosening their traditional ties to their political masters, and migrating into trading activities delinked from their traditional banking focus in pursuit of greater compensation, our banks are increasingly tied to the political system. But here, it is not the political system that guides the banks toward areas of strategic national interest, but rather the other way around.  Through our open system of political funding, political influence increasingly appears to flow from the banks to the politicians, and from there up the latter of the political and regulatory apparatus.

Saturday, August 11, 2012

Bold move.


Four months ago, a colleague high up in the Romney camp suggested in a conversation that Mitt Romney would run on a bold economic agenda to “inspire the middle to vote their disappointment.” “2010,” he noted, “was an anger-fueled wave turnout election. Unlikely that [this fall] R's will be as angry or D's as dispirited. The center is the way to win but he has to occupy that center with a bold agenda—a Bowles/Simpson level of boldness.”

Through the summer, no such boldness was apparent, and it has been unclear what kind of campaign Romney would actually run. Even as the Obama campaign launched a blitz of negative ads in swing states, the Romney campaign remained relatively quiet, clinging to benign themes, along with their own stable of negative ads. Now, as the conventions approach and the real start looms, Romney has finally shown his cards.

With the selection of Paul Ryan, Mitt Romney has made a definitive statement. Gone are the accusations that Romney would be afraid of a bold choice, afraid of being over-shadowed. Gone as well are the suggestions that his would be a tactical choice, driven by a narrow objective of winning 50%-plus-one electoral votes. Paul Ryan is a political star in his own right, and has proven his willingness to take on the toughest issues. By picking him, Romney is suggesting that the fall campaign will go beyond negative attacks and focus on real and substantive choices.

The instant response to the pick from the Democrat side has been to attack Ryan’s Medicare plan. That plan essentially proposes to keep the existing system intact for those over 55 and then migrate to a private insurance/voucher plan, ultimately ending Medicare as we know it. Opposition to that plan, interestingly, has focused on the costs that would be absorbed by future retirees under the voucher plan, rather than on the inequity of a plan that places no burden on current recipients and older workers in its effort to control the share of overall healthcare costs funded by government revenues.

Medicare is the fundamental challenge facing the U.S. budget, as it has steadily increased as a share of GDP. As federal income tax receipts declined in the wake of the 2008 fiscal collapse, healthcare costs increased dramatically as a share of the taxes individuals pay, growing from just over one-third of federal personal income tax payments before 2008 to well over one-half in recent years.

One might not like Ryan's solutions, but he has been willing to grapple with issues and offer detailed proposals where others have no not. His proposals have winners and losers, as any solution will. His Medicare plan shifts costs onto future beneficiaries, while effectively holding current retirees and older workers harmless, as it places the burden of paying for both current retirees and future retirees on those Americans now under 55.

Making younger workers pay a heavy price to support the retirement years of boomers has become a public policy theme of late. Across the country, state and local governments are reforming their pension plans in ways that reflect the Ryan formula. Retirees pay little or nothing, older workers pay some, but the real bailout comes from new employees. These solutions do little to tackle current costs, but instead promise changes down the road. They tend to alienate elderly voters less, while younger voters seem not to be paying attention. In a country where voter turnout is roughly correlated with age, this is a formula that combines fiscal and political viability.

The data on Medicare costs and benefits reinforces the fact that the problem is not simply one of overall cost. Research published by Eugene Steuerle and Stephanie Rennane of the Urban Institute suggests that while Social Security has been the more frequent target of reform efforts, that system is relatively sound. Most cohorts of households Steuerle and Rennane studied pay into the system as much or more than they ultimately receive in benefits. In contrast, Medicare taxes across all income groups pay only a fraction of the benefits people receive. The rest falls on the working population who essentially support retiree health costs, reinforcing generational inequity as costs rise.

The broader problem that America faces is a cultural problem. Cornell professor Suzanne Mettler has published useful data on this issue in her work on what she refers to as the “Submerged State.” Her data, presented here, suggests that a large number of Americans who benefit from public programs deny that they are indeed recipients of governmental largess. For example, 40% of Medicare recipients state that they have not used a government program, only slightly less than 44% for social security recipients who actually pay much of their own costs.

Mettler’s data suggests that the deep distrust of government that has long been a hallmark of the American psyche now rests at the center of our political and budget debates. It offers insight into how a man at a Sarah Palin rally in 2008 famously cried out “Don’t let the government get its hands on my Medicare.” Apparently Americans are able to reconcile their dislike or distrust of government by convincing themselves that those programs from which they themselves benefit are “not government.” Based on Mettler's data, it is apparent that the disconnect between what we receive and what we are willing to pay for runs deep.

And this is deep-seated problem. In the era of the Tea Party, the question of what government people want to have and what they are willing to pay for is a central one. Last year, the $1.4 trillion cost of Medicare, Social Security and defense expenditures alone—those that would appear to be sacred even to Tea Party acolytes—exceeded federal personal income tax payments by over $300 billion. This suggests that even if all other areas of government—the entire discretionary budget as well as Medicaid and other entitlements—were cut, the taxes we pay as individuals would not support those three areas of expenditure.

In coming months Paul Ryan will be decried for his Medicare plan and the burdens it will place on future retirees. Yet his plan is not alone in the intergenerational inequity on which it is constructed. None of the tax or budget proposals embraced by the Obama administration bridge the gap between what people appear to want and what they are willing to pay for either. The conventional wisdom remains that people will support tax increases on the other guy. But taxing the other guy—even all those rich people whose effective tax rates are far below those of middleclass workers—would not be sufficient to bridge the difference between what we appear to want, and what we appear to be willing to pay.

At some point, we will have to come to grips with the imbalance between what we appear to want and what we appear to be willing to pay. The interesting question now that Romney has selected Paul Ryan as his running mate is whether Romney is really proposing to engage in that debate, or whether the selection is merely a political calculus. Paul Ryan's entire political brand is premised on being the person who is prepared to engage those issues. Yet, there is no evidence to date that Ryan's Tea Party supporters have seriously considered what his proposed changes would mean for “their Medicare.” 

Mitt Romney and his campaign believe that the pivotal voters in the independent center—who have not yet made up their minds—will reward him for his choice of Ryan as his running mate, and the signal it sends that Romney is prepared to make hard choices to address the nation's economic and fiscal challenges. What remains to be seen is whether voters will recoil once they understand the details of Ryan's plan, or whether they are prepared to support candidates that offer solutions to problems that the electorate claims to want to see solved, however painful those solutions might be.