Self-inflicted wounds.

This is an amazing campaign moment. Somehow, Mitt Romney found himself at a dinner of wealthy financiers with a video camera perched on a side table. The film is remarkable in the candid nature of Mitt Romney's comments. For example, he views Middle East peace as an impossible objective and he suggested that his objective would be just to "kick the can down the field and hope that ultimately, somehow, something will happen and resolve it."

But most remarkable is the utter disdain Mitt Romney's remarks show for the working poor in America. By now, many have read or heard the most widely disseminated quote, but it bears repeating here.

"There are 47% of the people who will vote for the president no matter what. All right, there are 47%  who are with him, who are dependent upon government, who believe that they are victims, who believe the government is responsible for them, who believe they are entitled to health care, to food, to housing, to you-name-it. That that's an entitlement. And the government should give it to them. And they will vote for this president no matter what... These are people who pay no income tax... my job is not to worry about those people. I'll never convince them they should take personal responsibility and care for their lives."

Romney's remarks conflate two very different data points. The first is the observation that 47% of the electorate have made up their mind to vote for Obama. Romney's figure of 47% is a bit higher than the number one can infer from the September 9th Washington Post-ABC poll. That poll suggests that 49% of Americans are leaning toward Obama, and 86% of that cohort have made up their mind. Therefore, based on that poll, 86% of 49%, or 43%, have made up their mind. 43% is a bit less than Romney's 47%, but the difference is, as they say, in the margin of error.

Second, Romney then conflates that 47% with the frequently cited figure from the Tax Policy Center that 47% of American households do not pay income taxes (the Tax Policy Center figure was actually 46%) and suggests that these are the same people.

The Tax Policy Center study that suggests that 46% of Americans do not pay federal income taxes has become the basis conservative outrage and demands for tax reform arguments for "broadening the tax base." The Tax Policy Center data, however, paints a somewhat different picture than the conclusions that have been reached in the public imagination and mirrored in Romney's remarks that somehow there is massive tax avoidance or inequity. Of the 46%, roughly half--or 23% of households--do not pay income taxes because their household income is below the minimum threshold--approximately $26,400 for a couple with two children--that would result in an income tax liability.

Based on Census data, the upper limit of the lowest quintile of household income distribution in the United States was $20,262 in 2011, so an income of $26,400 would place a family in the lower range of the second lowest quintile of family income distribution in the country. At that level, the Tax Policy Center research points out, standard deduction of $11,600 and four exemptions of $3,700 each eliminates their income tax liability. This half of the non-tax paying households, the Tax Policy Center research points out, pay no income because they do not earn enough money and would pay no taxes even if all tax expenditures were repealed.

The other half of the households that did not pay federal income tax--comprising 23% of overall household units--were recipients of tax expenditures that offset their income tax liabilities. Of that 23%, three quarters had their federal tax liabilities offset by tax credits for the elderly (44%) and tax credits for children and the working poor (30%), tax credits supported by Democrats and Republicans to ameliorate poverty in America.

Accordingly, based on the Tax Policy Center analysis, all but approximately 6% of households that pay no income taxes do so because they are working poor and elderly whose tax obligation is offset by standard deductions and targeted tax credits.

Setting aside the disdain for the poor and the elderly betrayed by Romney's remarks--and the words in the video are actually harsher in tone than the words themselves--the conflation of the 47% who support Obama and the 47% who don't pay taxes was noteworthy. Democrats have wondered for years about the share of the working poor who consistently vote Republican--and who do not pay federal income taxes for the same reason as the working poor who vote Democrat. Yet in his remarks, Romney seems to suggest that the entire 47% who do not pay federal income taxes are lost to him.

But that is not the case. Gallup weekly tracking polls suggest that lower-income Americans have favored Obama by roughly 53% to 38% over the course of the campaign. That is to say that a large measure of those who have been written off by the Republican candidate are actually supporters. After all, as the Tax Foundation points out, the deep-red southern states have the highest percentage of "non-payers." The gap Romney faces among the working poor is notably smaller than the deficit that Romney faces among younger voters (56/34) or than the deficit Obama faces among highly religious voters (36/57). 

Seeing Romney caught on camera at a fundraiser inevitably harkened back to Barack Obama's famously taped words regarding his difficulty reaching voters in economically depressed communities:

"And they fell through the Clinton Administration, and the Bush Administration, and each successive administration has said that somehow these communities are gonna regenerate and they have not. And it's not surprising then they get bitter, they cling to guns or religion or antipathy to people who aren't like them or anti-immigrant sentiment or anti-trade sentiment as a way to explain their frustration."

Obama's remarks were notable in the paternalism demonstrated before an audience of wealthy Californians, and suggesting a sociologist's distance from the plight of the embittered masses. But on a substantive level, Obama's observation mirrored the analysis underpinning the political strategy designed by Grover Norquist, which has become the foundation of the modern Republican Party that Romney hopes to lead. What Obama saw as groups clinging to guns, to religion and to different forms of xenophobia, Norquist reframed as groups whose votes would be moved by one of those single issues--pro-gun, pro-faith, anti-gay, anti-immigrant. From that insight, Norquist has built a dominant political force, and the working poor are an essential part of that coalition.

Where Norquist saw unique differences that matter, differences to which one can appeal regardless of income level, Romney seems to see only the undifferentiated poor, entitled masses yearning to be Democrats, and he has nothing but disdain for their plight. In Romney's self-proclaimed journey from moderate blue-state Republican to severe Republican, he seems to have lost sight of the rich complexity--to say nothing of the fundamental decency--of the American electorate. Where are the words to inspire faith in upward mobility that is the core of the American dream and of political leaders? As with his comments on the challenge of Middle East peace, Romney appears to have written off the problem of poverty in America.

As he has pursued a campaign strategy that lacks a positive message beyond I am not Barack Obama, one of Romney's problems is that people still do not know who he is. This leaves him vulnerable to having this video define him. But the greatest problem this video presents for Romney is not with undecided voters, but within the Republican Party itself. Romney's words of disdain for working Americans--particularly spoken with such contempt--are so at odds with the inspiring optimism that for the party faithful was the hallmark of Ronald Reagan.


That optimism and faith in the American dream--however more distant that dream may have become--has been central to the success of the Republican Party, much to the chagrin of Democrats, in garnering broad support from Americans across income groups. In casting aside 47% of the country--particularly in a room of fellow plutocrats--Romney has realized the worst fears of many in the Republican Party. Weekly Standard senior writer Stephen Hayes said it best when he suggested that if Romney really believes "those people" to be so totally irredeemable, he should not be running for president.

I'm not the other guy.

Republican pundits are beside themselves. Mitt Romney's core election strategy has been built around the observation that no incumbent since Roosevelt has been reelected when the unemployment rate is over 8%. The parallels are drawn to the Reagan-Carter campaign, and the presumption has been that if the election can be framed as a referendum on the economy--and more specifically Obama's handling of the economy--then Romney must win.

Week after week, the headlines speak to continued economic stagnation, and the news of the past week has been particularly grave. First there was the jobs report that showed continued shrinking of the labor force, as almost four times as many people stopped looking for work as found jobs. Then there was the Census Bureau report this week on income and poverty in the United States that showed growing poverty and continuing deterioration in middle class incomes. And finally, as if to put a fine point on the fact that our crisis is not abating, the Federal Reserve Bank launched a new round of quantitative easing--Fed-speak for radical measures to further reduce long-term interest rates toward zero--in the hope that lower rates will inflate stocks and other asset prices, and ultimately stimulate economic activity by boosting investor and consumer confidence.

How is it, then, Republican pundits are asking, that Mitt Romney can lose ground in his campaign bid even as the economic news gets worse. George Will voiced Republican anxieties last Sunday following the Democrat convention and the ensuing negative jobs report when he suggested that "If the Republican Party cannot win in this environment, it has to get out of politics and find another business." And in the days since Will voiced his concern, Romney has seen his the odds on his winning the White House decline from 43% to 33% on Intrade.

Part of Romney's problem may be that while there is a case to be made against Obama on the management of the economy, Romney has not made it. For example, while Romney has advocated for tax simplification, he has not explained why a flatter tax rate with fewer deductions would be more efficient and promote greater economic growth. Similarly, Romney has argued for tax cuts in lieu of government spending as a means of stimulating the economy, but has failed to explain why tax cuts in an environment of deeply depressed private sector demand would have led to a better outcome. Instead, Romney has continued to place the focus on Obama's performance, in the hope of an up or down vote on that record.

In their seminal book, This Time Is Different: Eight Centuries of Financial Folly, Harvard economists Carmen Reinhart and Ken Rogoff provide extensive data on the recovery time from financial crises with similar attributes to the 2008 collapse. They describe the patterns of events and the rationale for policy responses in detail, and their data suggests that the 2008 collapse is far from unique. Among other things their data on modern financial crises indicates that on average unemployment continues to increase for five years after the original collapse, housing values decline for six years and fall by 35.5%, that national debt nearly doubles in three years, and the restoration of employment and economic growth to pre-crisis levels takes seven to ten years.

Against that backdrop, the electorate seems to be placing the burden on Romney to articulate what his economic policies actually would be and why they would lead to a materially different outcome than the course we are now on. The Washington Post-ABC News poll released last week painted a picture of a country divided nearly 50-50 on almost every question, but one response that stood out: 63% of those polled believed that Romney has not provided enough details on policies he would pursue as President. This suggested that the strategy of simply being the anti-Obama candidate might not be not enough, people want to know what a Romney presidency would look like.

This week, barely a week after the Democrats left Charlotte, the ground under the presidential campaign shifted dramatically. As bad as the economic news was, it has been overwhelmed by the killing of American Ambassador Chris Stevens and three others in Benghazi, Libya, and the ensuing turmoil across the Muslim world as outrage over a YouTube video exploded from Tunisia to Indonesia. Ironically, there was little discussion of foreign policy in the recent political conventions, and there has been remarkably little debate--among the candidates or their surrogates--about U.S. options and policies across the extraordinary range of global issues that have made headlines just this week: U.S. relations with the evolving "democracies" in the Arab world. Our relationship with Egypt and the Muslim Brotherhood. The emerging Sunni-Shia war in Syria. The strategic interests of Russia and China in the Middle East and South Asia. Pakistan. Afghanistan. The looming disintegration of the European common currency.

Democrats and their allies in the media--and no small number of Republicans--jumped all over Mitt Romney for his hasty comments about events in Libya this week. It may well be that Obama's snarky comments in his convention speech about Romney's lack of experience in foreign policy got under his skin, and Romney's Libya comments may have been driven by the anti-Obama persona that he has taken on, but Romney's comments pointed to a larger issue that underscores many of the foreign policy issues noted above. The United States has spent more than a decade now with troops on the ground battling in Muslim lands, and we are now leaving. The decision by Iraq's Shia Prime Minister Nouri al-Maliki to allow Iran to use Iraqi airspace to deliver weapons to the Assad regime in Syria over our objections highlighted our waning influence in that region of the world where we have invested so much, as ancient loyalties and enmities increasingly trump the willingness of local leaders and allies to accede to our demands.

We have seen the YouTube incident before--The Satanic Verses, the Danish cartoons, and other episodes--where Western freedom to insult violates Koranic precepts. And as in those earlier cases, much of the clashes this week seemed highly orchestrated. The protests were launched on September 11th, protestors arrived with al Qaeda flags in hand, and some remembered to bring their RPGs. It is hard to imagine that a search of the 120 million videos on YouTube would not yield other comparably offensive material, but this one was chosen by someone to achieve their own political objectives. This was not a random event.

But the larger question is what one is to do about it. While John McCain made the case that the turmoil was exacerbated by our scaling down of our presence in the region, he did not go so far as to advocate for expanding our presence on the ground. It is also notable that while some Romney partisans rushed to make the case that this was one more Obama failure, Romney advisor and George W. Bush CIA chief Michael Hayden offered a more measured assessment: "I wouldn't call it a failed policy at all. We shouldn't presume that we can control events in this part of the world."

While the United States has been the apparent target of Muslim protests, these protests are as much a challenge by Salafist Islamists to the new, relatively moderate elected regimes, no doubt with al Qaeda support if not orchestration. Accordingly, the actions by those governments to quell protests and defend our embassies are as much about defending their nascent democracies as about defending us, that is to say it was not about our values, it was about their politics. And if that is the case, we should see in that turmoil a triumph of sorts, it is a sign of people owning their own future.

These protests are evidence of an instability growing out of our withdrawal from the region, but rather are an outgrowth of political change that our presence engendered. The irony of Romney's remarks is that these protests can be seen as a triumph of the Neoconservative policies in the region and the determination to topple Saddam Hussein. The goal of that policy was to create one democracy in the region, and in doing so to whet the appetite of others for similar change.

In that regard, despite Romney's urge to decry the protests as the evidence of policy failure, he should instead laud them as evidence of policy success, and recall Paul Wolfowitz comments in his 2003 interview in Vanity Fair. "There is no question that there's a lot of instability that comes with democracy and it's the nature of the beast that it's turbulent and uncertain."

The Muslim protests offered Romney a chance to claim a singular Republican triumph, but driven by his anti-Obama imperative he has lost the ability to step back and look at the larger picture. Much as Democrats would deny it, the sweep of history in the Arab world is on a positive trajectory. This week, we watched the elected Egyptian government led by the Muslim Brotherhood quell protestors at our embassy and denounce the efforts of al Qaeda and others to undermine democratic change. That is a triumph.

Perhaps if the election were a referendum on the economy, Obama would lose, perhaps not. But in focusing on the Carter-Reagan contest, Republicans strategists seem to have lost sight of the enormous impact of the Iranian hostage crisis on that election. It may be that the unemployment rate does not tell the whole story, and that Americans understand that we are in the middle of a long recovery. In the same vein, it may be that all riots in Muslim cities are not the same. Sometimes they are evidence of policy failure, and sometimes they might be indicators of change, even success.

In either event, perhaps George Will should give voters more credit, and the cause of Mitt Romney's failure to gain ground is a strategy that is built around saying as little as possible and hoping that will suffice. But as Paul Wolfowitz suggested, this is a world of turbulence and uncertainty, and it just may be that voters are interested in seeing whether a future president can manage that complexity with subtlety, and whether he has more to say than just I'm not the other guy.

Posted by David Paul on The Huffington Post

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.

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.

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.  

Before the gun sounds.

Watching the presidential contest has been like watching the beginning of an America’s Cup race. The gun does not sound for the beginning of the race until Labor Day, after the parties hold their conventions and Americans fully engage in the contest. The summer months are a time of pre-race maneuvering, as Team Obama and Team Romney are jockeying for position, seeking to define the terms of the race to come.

Despite Democrat euphoria during Republican primaries that seemed to turn back the clock on such settled matters as contraception—and pushed Obama’s reelection odds above 60% on Intrade—Mitt Romney emerged largely unscathed. This week, Real Clear Politics shows the race at 47-45, with Obama up by just 1-3 points in the critical states of Ohio, Florida, Virginia, and the new swing state, Michigan. In rough terms, Obama needs two of these states to win, Romney three, but by any measure, this is now a race.

The two sides largely view the race in the same terms. Each side has to motivate its own base, and each is fighting for the still-undecided center. And each side has chosen to make the appeal to the center largely a referendum on the Other Guy. The Republican argument is that Obama has made a hash of the economy. The Democrat counter argument is that it was hash when he got there and he is doing as much as he can with a stridently negative Republican House blocking him at every turn. The Democrat argument is that Romney is a plutocrat who cares not a whit for the large swath of the American electorate. It is the Republican counter argument that seems passive and unfocused.

There is nothing new in attacking Mitt Romney for his years at Bain or his uncaring mien. Mike Huckabee’s famous quip that voters would ultimately disdain Romney because he “looks like the guy that fired you” has become the essence of the Obama strategy to define Romney before the fall race begins.

Making the opponent unacceptable is a time-honored strategy, and sometimes it works and sometimes it doesn’t. In 1964, Democrats succeeded in defining Barry Goldwater as unstable—if not an outright lunatic—in a campaign that culminated with the classic "Daisy" campaign ad. On the other hand, in 1980, Jimmy Carter sought to define Ronald Ronald Reagan as a dangerous alternative—in the vein of Goldwater—and led in the polls through the summer, only to see the strategy ultimately fail as Reagan was humanized through the fall, and ultimately won handily following the debates. For their part, Republicans used the strategy to great effect in 2004, when the Swift Boat attacks on John Kerry through the summer left his campaign sorely damaged once the fall campaign arrived.

The Romney campaign response to Democrat attacks seems to reflect either a lack of preparedness or a view that what happens now will not materially matter once the real race starts. It is simply inconceivable that the Romney camp did not anticipate the Bain attacks—after all, Romney has faced them before. Nor does it seem possible—despite Abby Huntsman's suggestion that Romney would resign the campaign before releasing more tax returns—that the campaign does not ultimately plan to release all of Romney’s financial information. Therefore, one has to believe that we are watching a rope-a-dope strategy of letting the summer weeks go by, content to let Team Obama punch itself out. And to date, Team Romney may be right. After all, the national numbers have remained in the range of 47-45 for some time, and the salient point of this is that as long as the President cannot sustain his numbers above 50%, the race is very much in play.

If this is the plan, the moment that seemed discordant was Romney’s demand for an apology. Apologies, and specifically demands for apologies, are just not part of the game. Or as Mitt Romney himself lecturedMike Huckabee in 2008, rule number one in politics: No whining.

Romney’s demand for an apology evinces weakness—particularly to a President who is now famously picking individuals to be targeted by cruise missiles. This is not a normal stance for a Republican facing a Democrat. But more than just violating his own political rule, by whining about attacks on Bain and outsourcing Romney is missing an opportunity to take on the central issue that has been missing from this presidential race.

Both candidates have given lip service to this race being about the middle class, yet there has been little substantive discussion of what that means. This is a real area of weakness for President Obama, whose understanding of the economy appears shallow and whose selection of advisors has been poor. On the other hand, Romney’s work at Bain should provide a window into the real forces that have affected the U.S. economy over the past thirty years. Specifically, outsourcing is a symptom, not a cause, of the problems affecting the middle class. The potential of bringing manufacturing jobs back to America is a good thing, but even that discussion has avoided the larger question of what it would take for America to regain a sustained competitive advantage in the global economy. As long as we don’t discuss our history and the causes of decline, it is difficult to make meaningful policy decisions going forward.

Richard Nixon remains a cloudy and widely reviled figure in our politics, who lived out his years in disgrace, yet his presidency marked the turning point in our modern economic history. He ended a war in Vietnam that was escalated by two Democrat presidents. And more importantly, he began the process of normalizing political relationships with our two greatest political adversaries, the Soviet Union and China. In the economic realm, he ended the Gold Standard and birthed OPEC as an economic force, both of which contributed to the emergence of the U.S. dollar as the global reserve currency.

The ensuing end of the Cold War brought hundreds of millions of workers out from behind the Iron Curtain and from formerly insular economies such as India into the world labor market. During the years of the Cold War, Democrats and Republicans alike envisioned a free trade world that would replace military hostilities and the threat of nuclear war with economic competition involving our former adversaries. And so it has.

The decline of the American middle class in the face of new, global competition should have come as a surprise to no one. Over the past three decades, nations across the world have build their own economies through labor competition tied to pegged currencies that allowed them to deliver low-cost goods to the U.S. consumer market. The fact that real incomes in the U.S. have largely been flat over the past several decades could be seen as a triumph, given the circumstances. Plunged into competition with nearly free labor, one can imagine that the devastation of our economy might have been far greater.

Unlike the President, Mitt Romney had a front seat during this era of massive economic change. He sat in corporate boardrooms where decisions were made to reduce costs or otherwise seek strategic advantage. Reducing costs and seeking competitive advantage are part and parcel of corporate strategy in competitive markets. Companies do this, or they die. And seeing such companies survive rather than die was the work that Bain Capital specialized in. If Bain Capital advised its portfolio companies to outsource manufacturing or services—and it is inconceivable that it did not—this was not out of animus to workers, but just part of the job. That is the way it is in the real world.

And the way it is in the real world is what Mitt Romney and Barack Obama should be talking about. The American worker has been lied to for decades. Election year after election year, politicians pronounce the American worker the best in the world, as if this was meaningful. Rarely does a politician speak the truth: for decades now, American workers have been thrown to the wolves, first in the interest of Cold War foreign policy, and more recently in the interests of a political and corporate elites that profit mightily from globalization.

Along with outsourcing, political contributions have become a critical tool for seeking competitive advantage. The impacts of free trade and political cronyism have been the focus of political campaigns on the right and left. Pat Robertson, Ralph Nader, Ron Paul and Dennis Kucinich each spoke to these issues, in nearly identical terms. Each have pointed out in great specificity how our economic, budgetary and military policies have undermined the middle class and served corporate interests, yet each were marginalized and ultimately ridiculed by the aligned interests of the major political parties.

Today, the plight of the middle class is debated in terms of inequality. Yet this debate has focused on who pays how much in taxes—epitomized by the Occupy movement “single, clear demand” for a Robin Hood tax—which again is a symptom of the problem, not the cause, rather than on global labor and currency markets.

Mitt Romney maintains that his campaign is about the plight of the middle class, yet so far, he has had little to say beyond the normal prattle about knowing how to create jobs. He has failed to show how his inside experience in the corporate world combined with his experience as a governor of an industrial state give him a unique insights into the nature of global economic competition, and the ability to craft solutions that might aid the plight of working Americans. There is a case to be made for changes that would be directly enhance our competitive advantage as a nation—such as ending pegged currency relationships, building low cost energy as a national competitive advantage, addressing structural deficits—but Romney has not made that case. 

This is the response that Romney has failed to make as the onslaught continues from the Obama campaign. No apology will be forthcoming, and none should be. Bain did—during Romney’s tenure or otherwise—what Bain was supposed to do, what the rules of the competitive marketplace dictates that companies must do. If there is an apology to be made, it should be from Romney for his failure to make good on the central argument of his campaign: that he understands how the economy works, and can translate that knowledge in to a positive vision for renewal of the American economy.

For the next six weeks, the respective presidential campaigns will seek to define the terms of the race to come. The Obama campaign is an open book. As the incumbent, he has no choice but to run on his record. Its challenge will be to motivate its base to replicate the turnout it achieved four years ago—knowing that the moment of inspiration is past—keep the focus on Romney's character and Republican recalcitrance, and convince independent voters that the President remains their best option.

The Romney campaign is far more opaque, as even its summer strategy seems to lack focus. Unlike the President, the Romney campaign has all of the tools in place to assure a motivated base, from John Roberts’ treachery, to the stewing resentments around contraception funding, to the ultimate motivation: the thought of four more years of Barack Obama occupying the Oval Office. Ironically—given Romney's bona fides as a moderate, blue state governor—Romney’s challenge will be the independent vote. That vote disdains the passions of the Republican base and is looking for more than a negative motivation. Perhaps the Romney campaign summer strategy is playing rope-a-dope, dumbing down expectations before a campaign of shock and awe to win the center. Endorse Simpson-Bowles, break up the banks and tackle campaign finance excesses.

Or perhaps what we see is what we get, and Mitt Romney doesn’t really have anything to say. Or as one Massachusetts pol commented to me a while back, "you'll see, there really is no there there."

Unrighteous mammon.

As I write this, Bruno Iksil is still riding the Bongo Board. We have all done it, at least those of us of a certain age. We got up on the Bongo Board and we thought we could stay up forever.

One can only imagine the endorphins pumping across the world’s trading desks. The king of the hill, JPMorgan, has seen its killer trade—reputed to entail multiple hundreds of billions of credit default swap notional amount—go the wrong way, and now they need to reverse out of their position before the stink gets worse. The loss of two billion dollars announced a week ago grew by a billion in a week, and clearly the fire sale is not over.

Faced with a public relations fiasco, Jamie Dimon let his long-time, trusted lieutenant, Ina Drew, take the fall. Meanwhile, Iksil—the trader that amassed the positions that have been a topic online since early April—cannot be let go because he is the one that understands the billions and billions of complex derivative contracts that now need to be unwound. It must be quite a spectacle on derivatives trading desks around the world. It is get-back time, and in that world no one takes any prisoners.

As the hedge funds continue to circle in the water, feeding off of JPMorgan's exposed balance sheet, Dimon’s friends on Capitol Hill have been quick to come to his defense. House Financial Services Committee Chairman Spencer Bachus (R-Alabama) was quick to minimize the importance of one loss, whatever its size, while across the aisle President Obama lauded Dimon's bona fides and JPMorgan as “one of the best-managed banks there is.”

Politicians jumping to Jamie Dimon’s defense are missing the point. This is not about a single trade or one loss. Iksil, whose nicknames “Voldemort” and the “White Whale” (think Ahab’s nemesis, not a fat Frenchman) should give a hint as to his industry reputation, and now that the hedge funds have tasted blood JP cannot get out until the counterparties are good and ready. That the loss is still growing simply means that they are not ready to let go.

But if JP’s counterparties have Bruno by the balls, so too does Dimon have a firm grip on the nation’s political leadership. Last week on Meet the Press, Jamie Dimon described himself as still a Democrat, but just barely. Once a prominent Obama supporter, Dimon is one of many across the finance community who feel that they have been unfairly tarred for cratering the global economy.

To put a finer point on it, despite the media feeding frenzy surrounding Voldemort’s personal Black Swan event (Nicholas Taleeb’s now-famous phrase for things that can’t go wrong, until they do) comments from our nation's capitol remain measured, almost fawning. Democrats and Republicans have fallen over each other to praise Dimon as America’s Greatest Risk Manager notwithstanding JPMorgan's contretemps. Dimon's reputation grew out of the ease with which JPMorgan navigated the financial crisis, though some have suggested that Dimon's predecessor as CEO, Bill Harrison, deserves a fair share of the credit. Harrison, apparently, minimized the bank's exposure to exotic mortgage derivatives and handed Dimon a pretty clean balance sheet when Dimon arrived on the scene as CEO in 2006.

While some of the adulation garnered by Dimon may well be warranted, it is likely that most of the politicians uttering the hosannas have no idea what risk management is. It may be that what we are actually watching is a not very subtle food fight between our two political parties for campaign cash. Simply stated, this is not about Dimon's management skills, rather it is about his wallet.


Over the past two decades, the financial services sector has been the most generous source of political money, and that money has been up for grabs. For decades, the Republican Party was the party of Wall Street. That singular identity ended during the Clinton administration, which was determined to lure Wall Street's lucre across the aisle. While Clinton and the Democrats grabbed the golden ring, the price for the nation was steep: the Financial Services Modernization Act of 1999 and the ensuing Commodity Futures Modernization Act of 2000 that together laid the groundwork for the financial services world as we know it, and as the world came to experience it in the global financial meltdown of 2008. During the last presidential cycle, according to OpenSecrets.org, the financial sector remained far and away the largest source of political contributions, with 54% going to Democrats, while this time around—in the wake of industry anger over Dodd-Frank reforms—the tide has turned and 77% of that money is gracing Republican coffers.

Could it be that Chairman Bachus was quick to rise to the defense of JPMorgan because that bank has been the leading source of contributions to his campaigns over the course of his career? Could it be that President Obama is treading lightly on the issue because to date he appears to have lost his edge with two of his largest financial supporters from 2008—Goldman Sachs and JPMorgan—who according to OpenSecrets.org are the two largest sources of contributions to the Romney campaign?

It is getting boring reading about how the events of the past week—to say nothing of the past decade—suggest why our banks should be smaller or risk trading functions separated from traditional commercial banking. Democrats that continue to believe that we can regulate our way out of this either don’t want to give up their share of the money or simply lack imagination. Banks should be smaller so they can fail with the regularity with which small banks do fail. JP’s oft-repeated argument that their nearly one hundred trillion dollars derivatives book is book-matched and therefore does not constitute a systemic risk to the financial system is disingenuous at best and simply dishonest at worst. 

Lost in the endless—and endlessly self-serving—arguments is the fact that commercial banking is essential to the economy—and thus is supported by numerous institutions including the FDIC and the Fed—and that the integration of investment banking and commercial banking—a brainchild of Dimon’s mentor Sandy Weill—has brought little to no demonstrable value to commercial banking’s core societal function, while bringing much to the investment banking world—massive bonuses, a bottomless supply of free capital and the socialization of trading risk.

Both Jamie Dimon and our nation’s political leaders face the same fundamental problem: as risky as the status quo might be, no one can afford to give it up. For Jamie Dimon, derivatives trading is a gravy train that has underpinned JPMorgan's profitability, regardless of the larger threat it may entail, while for our political leaders major contributors are an irreplaceable constituency always for sale to the highest bidder. 

But don’t worry about Bruno Iksil. Whether Jamie Dimon finds he has to let him go, or figures out a way to keep him, he will be fine. There will always be a market for a proven derivatives trader, particularly one with the moniker of the true master of the universe. He will not be tainted by this trade, no matter what the final damage turns out to be, or at least not for long. After all, take a look at his new boss who took over from Ina Drew. He was formerly a trader at Long-term Capital Management.

Same story, just a few crises ago.

Not the way it was supposed to be.

Last month, the Territory of the Northern Mariana Islands became the first U.S. public pension fund to declare bankruptcy. Like many public pension plans across the country, the financial condition of the Northern Mariana's pension fund deteriorated significantly over the past five years. With $256 million of pension fund assets available to fund $1 billion of pension fund liabilities—a "funded ratio" of just 25%—the trustees of the Northern Mariana's pension fund have suggested that they may be able to pay out just 50% of the retirement benefits promised to public employees under the defined benefit pension plan.

There may be those who hope that because this tiny U.S. territory is way, way offshore—situated as it is somewhere between Japan and Papua New Guinea—events there cannot be a harbinger of things to come here on the mainland. But just two weeks later, much closer to home, Mayor Angel Taveras of Providence, Rhode Island, approved a plan to sharply curtail pension benefits to current workers and retirees in an effort to keep that city out of bankruptcy. Faced with a pension fund that is 32% funded, Taveras' pension reforms ended cost of living increases for retiree benefits until the City pension system’s funded ratio increases to 70% and capped the annual pension payable to any one individual at 150% of the median state household income.

Problems with public employee pension plans have been brewing for some time. These plans promise retirees a “defined benefit” that is generally calculated as a percentage of an employee’s average compensation over the last few years on the job. The cost of the future benefits are supposed to be budgeted and funded each year by a combination of employer and employee contributions in an amount calculated by the system actuary to be sufficient to fund—together with projected earnings rate on those contributions—the future benefits earned in that year. That way, as long as these “normal costs” are budgeted and paid over to the pension trust fund each year, and the assumed earnings rate on the pension fund deposits are achieved, the pension system will be fully funded and future taxpayers will not be required to fund benefits earned by employees in prior years.

As recently as a decade ago, in the wake of the stock market boom of the late 1980s and 1990s, municipal pension plans were in good shape, with many boasting funded ratios in excess of 100%. But over the past decade, equity markets have not fared well and pension fund investment returns have fallen short of actuarial targets, averaging less than 6.00% over the course of the decade and 1.00% over the last year.

By 2010, according to a study by Barclays, state pension funds on average were just over 60% funded, and underperformance relative to actuarial earnings targets has led to new "unfunded actuarial pension liabilities" that are now the responsibility of the sponsoring governments in the same manner as a communities general obligation bonds. The Barclay's study began by noting that the unfunded pension liabilities of the states are estimated to be as much as $3 trillion, or six times the amount of bonds outstanding. The impact of pension problems at the local level has been dramatic, as pension system actuaries have required significant, long-term increases in pension contributions to fund theses new, unfunded pension liabilities.

For example, based on data from the California State Controller, in my city of Berkeley, the employer contribution rate for police—the largest area of municipal spending—has grown from 3.6% of salaries ten years ago to 40.4%, usurping much needed funds from other purposes to meet these new pension costs. The same issue is affecting funding for government services across the County, according to data from the Stanford Institute for Economic Policy Research.  The following graphic illustrates dramatic impact of the growing cost of these new pension liabilities, which will soon consume 10% of the entire County operating budget. This translates into a diversion of approximately $200 million that would otherwise be available for spending on public safety, public assistance, healthcare and other critical public programs.

This is not the way it was meant to be. Beginning around the 1840s—in the wake of defaults by a number of states in the nascent United States—new state constitutions were established across the country that placed severe restrictions on the ability of states to take on debts or other liabilities that would place a burden on subsequent generations. For example, the California constitution that provides that "The Legislature shall not, in any manner create any debt or debts, liability or liabilities" without a two-thirds vote of the legislature and subsequent approval by popular referendum. However, at the same time, that constitution and the federal constitution prohibit the impairment of contracts, which has been presumed to protect public employee pensions.

The moral dilemma presented by the pension issue is embodied in the apparent conflict between two first principles of governance: Limitations on the creation of debt and the sanctity of contracts. On the one hand, the constitutional framework established in the 1840s placed severe hurdles on the ability of elected officials of one generation to place burdens on future generations. On the other hand, sanctity of contract provisions of both state and federal constitutions provides both the moral and legal basis for non-impairment of vested pension rights.

As defined benefit pension plans have evolved—by taking on greater investment risk as they increased benefit payouts—the effect has been to shift 100% of that investment risk to the taxpayers. When pension fund investment returns fell short of the actuarial earnings target, new liabilities were created. Essentially, the labor agreements that embodied the pension commitments became a source of new public liabilities, bypassing what in many states are long-standing rules constraining the creation of new liabilities.

Moral indignation lies at the heart of the pension crisis. For their part, workers have for decades paid into their pension plans based upon contractual commitments. Pensioners reasonably believe that they are entitled to what the rules say they are entitled to, that they obtained their benefits openly and legally and properly, and that the benefits are owed to them as a matter of rights.

On the other side are communities that are being forced to cut essential services as the cost of unfunded pension liabilities—liabilities that appeared as out of thin air—grab an increasing share of current budgets. Public support for public pensions has been further eroded by stories about abuses of pension rules—pension "spiking" schemes and double dipping—that game the system to increase individual payouts.

Although early on the pension crisis seemed destined to play out as a one more Democrat vs. Republican spat, it has migrated beyond party boundaries. It was a Democrat mayor in Providence that approved new, draconian pension reforms, and a Democrat Governor in California that is proposing pension reforms that so far have only received Republican endorsement. And last year, San Francisco's elected Public Defender Jeff Adachi—an unabashed progressive—ran for mayor specifically to confront the pension question and the huge diversion of funds from core social services that is undermining that city's social service infrastructure. 

The pension issue is not going to go away. The financial impacts of pension deficits are going to be felt at the state and local level for years, and will continue to influence the political landscape as politicians are forced to confront that which is manifestly broken. And lying in the background will be the experience of the Northern Mariana Islands, a harbinger of things to come if communities and public workers fail to confront, and ultimately fix, the problem.

Published on The Huffington Post on May 24, 2012.

Aung San Suu Kyi and the prospects for a new grand bargain.

The election of Aung San Suu Kyi is a useful reminder that change and progress is possible even in the most apparently sclerotic societies. Whatever the combination of external pressure and internal dynamics, the notion that there is a parliament in the country formerly known as Burma, that there are elections that matter, and that long-time pro-democracy dissident Aung San Suu Kyi won a seat, is a reminder to a casual observer that the status quo can evolve. Perhaps if change is possible in Myanmar, it is possible here as well.

After a week of watching the partisan hostilities surrounding the Supreme Court’s oral arguments on Obamacare, Matt Bai’s article in the New York Times revisiting the failed “grand bargain” that might have ameliorated our continuing budget crisis suggests both how close the sides came to a viable agreement. Notwithstanding lingering questions about whether the President Obama changed the terms of the deal at the last moment and whether Speaker John Boehner could have delivered the votes of his restive caucus, it seems clear that Obama and Boehner fundamentally understand the urgency of addressing our long-term budget challenges before market forces make such a resolution far more difficult.

The intractability of our budget problems are illustrated in this dynamic graphic that illustrates the changes over time in the population distribution by age of the United States from 1950 to 2050. As shown here in the snapshots of the beginning and end of that century long period, the age distribution by 2050 has a far greater share of the population in the post-65 retirement years, compared to the beginning of the century when the population distribution reflected a larger working age population supporting their retired parents and grandparents.

These demographic trends tell much of our budget story. The steady aging of the population and the declining share of the population that are in their economically active years demands that difficult choices be confronted. With an aging population and with increasing longevity, and a declining share of the population in their economically productive years, the costs per retiree are growing steadily and demanding a steadily increasing share of national resources.

When the Social Security system was created in the 1930s, average longevity was less than the retirement age of 65. That is to say that the average American at the time died before they were eligible to receive benefits. In 1950, there were sixteen workers paying into the system—which remains in large measure a pay-as-you-go system where current payroll taxes pay for current retiree benefits—compared to 2.8 workers by 2010. Today, with longevity approaching 80s and the retirement age still at 65 for most Americans, simply to cap retiree and health spending at a constant percentage of GDP would require some combination of extending the age of eligibility, means testing and/or changes to the benefits formula.

The graph below illustrates the pattern of federal spending over the past several decades, and projected for the next decade by the Congressional Budget Office. As illustrated here, over the past decades, the cost of core entitlements has grown steadily to usurp a growing share of federal spending. As this graph suggests, 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.

The Obama-Boehner negotiations illustrate the challenge to the two political parties—and particularly to the ability of the party leadership to bring along their rank and file—in navigating their way to a long-term budget solution. The urgency of controlling our destiny sooner rather than later is illustrated in the growing Net Interest share of the federal budget over the coming decade. The growth in Net Interest shown here reflects optimistic assumptions by the Congressional Budget Office of only gradual increases in federal borrowing costs, with the 10-year treasury barely reaching 5% over the coming decade.

It is notable that Net Interest, currently 1.5% of our national GDP, peaked in 1991 at 3.3% of GDP in 1991 in the wake of Reagan-era deficit. However, our public debt currently stands at four times the amount in 1991, while current net interest costs reflect today's absurdly low interest rates that are around one-fourth of what they were back then. We do not have to face a Greece-like scenario threatening loss of market access, skyrocketing interest rates and default for our failure to control our financial destiny to wreck havoc on our national budget and politics. All it would take is for economic activity to rebound and investors regain comfort with global debt and equity markets, and we can reasonably expect to face a scenario with substantially higher federal borrowing costs. For example, should interest rates return to 1991 levels, the interest costs of our current level of public debt would rise from the current 1.5% to closer to 7% of GDP, well more than the share of national income consumed today by Medicare, Social Security or defense.

The problem, of course, is that everyone in Washington wants to solve the nation's fiscal imbalances by placing the burden on the back of someone else’s constituency. Democrats, as New York Mayor Michael Bloomberg pointed out in an op-ed this week, are living an illusion in their suggestion that tax hikes on the rich alone can do anything meaningful to solve our fiscal problems. For their part, Republicans have demonstrated no appetite for compromise on budget solutions. W. counsel John Yoo argued in an op-ed this week that regardless of the outcome of this week's Supreme Court arguments, salvation can only come through complete dominance of both branches of Congress as well as the executive branch.

House Budget Committee Chairman Paul Ryan is one of few in Washington who has proven himself willing to grapple with the entitlement nettle, however vague his budget proposals might be. Democrats only undermine their own credibility as they attack Ryan's budget proposals with accusations that Republicans are throwing the elderly under the bus. The fact is that one way or the other, the future will be different from the past, the question is when our political leaders will face up to the challenges. And the longer they wait, the more painful the required changes will be.

Congressman Ryan, like President Obama, rejected the Simpson-Bowles Commission recommendations. The failure of the President to provide leadership on the issue was particularly puzzling as the Commission report came in the wake of the off-year 2010 elections in which Democrats—and the President in particular—were soundly rebuked. One does not need the benefit of hindsight to wonder how the President’s political advisors at the time could have believed that he could negotiate a better deal with Republicans than what the Simpson-Bowles Commission put on the table.

Looking back, one has to imagine that either the President underestimated the severity of the budget challenge or overestimated his ability to persuade his Republican opposites. Neither conclusion is comforting. However, the portrait painted by Matt Bai in the President's negotiation with the Speaker suggest the latter, that the President is prone to overestimate his negotiating ability, as Bai's account suggests that the President had a deal within reach, but changed the terms at the last minute.

For his part, Paul Ryan’s rejection of the Simpson-Bowles Commission recommendations as a member of the Commission led directly to the Commission’s failure. Had Ryan supported that balanced plan, he likely would have brought with him the two more votes necessary to force an up-or-down vote in Congress, and the entire history of the fiscal debate and the debt ceiling travesty might well have been different.

For Tea Party fellow travelers—who in Matt Bai's account were an unmovable obstacle to a budget deal even as the President won the acquiescence of Congressional Democrats—the budget question is fairly straightforward: What is the greater evil, debt or taxes? Both parties would prefer to imagine a world where they dictate the outcome and do not have to compromise on their principles. But we don't have a parliamentary system; the two sides ultimately have no choice but to work together and no one is going to get the outcome that they prefer.

Aung San Suu Kyi’s victory should give us hope that if change can happen in Myanmar, we should set aside our cynicism and insist that the dysfunction and gridlock in our nation's capital not allow our country to risk meandering further down the tracks toward a fiscal and—societal—train wreck. President Obama and Speaker Boehner understood the parameters of a solution—as did the Simpson-Bowles Commission—and came remarkably close to a deal. The solutions are not difficult to imagine, just the willingness of our leaders to embrace them, and their followers to follow.