Content Elsewhere

I thought I'd start linking to pieces I write elsewhere. Here's a backlog of recent articles:


Reuters (with Christopher Papagianis):

The growing clout of central banks

Election has big banks in crosshairs

More to the financial crisis than just subprime


National Review's The Agenda

Dartmouth Atlas vs. Teacher Salaries

Causes of Inequality

Household Wealth Comparisons

Cut Taxes for the Long-Run Unemployed

Counterfactuals and Country Comparisons

The Premium to Top Schools

Federal Lines of Credit

The Laffer Curve

Response to Saez-Piketty on Inequality

Saez and Diamond on Taxes

Joseph Doyle on High-Cost Hospitals and Health Care Reform

Rethinking Private Equity

Labor Supply and Taxes


Stanford's Policy Review (with Christopher Papagianis)

Making the Housing Market Work Again

Individualism and the State

Robin Waterfield's Dividing the Spoils focuses on the dawning of the Hellenistic Age after the death of Alexander the Great. He observes:

One of the most striking aspects of the Hellenistic period, by comparison with what came earlier, is its focus on the human individual. Social historians agree with historians of philosophy, art, and literature that this phenomenon is characteristic of the age.

Waterfield makes the link between this growth of individualism and the parallel rise in state absolutism:

By directing citizens’ energies toward the good of the state, the system allowed poleis to flourish, but the price was a higher degree of collectivism than most of us would find acceptable today. By contrast, we consider ourselves free the more we are able to avoid or ignore the state apparatus and remain within our private lives. A citizen of a Classical Greek polis had a far more restricted sense of privacy. Almost everything he did, even fathering sons and worshipping gods, was done for the good of the state—that is, for the good of his fellow citizens.
      The Macedonian empire, however, changed the rules. Although poleis retained a great deal of their vitality, the inescapable fact was that they had become greater or lesser cogs in a larger system....

The relative disempowerment of citizens as political agents that happened as the Hellenistic empires centralized power made it possible for people to see themselves, to a greater extent, as individuals, rather than just as contributors to the greater good. Rather than acting as a liberating force, it seems that the communitarian focus of Greek poleis was actually quite corrosive to individual self-expression. One thinks of Plato's Republic for one.

Waterfield goes on to observe how Hellenistic philosophers, like the Cynics and Epicurians, focused on individual esteem, as opposed to relationship between the individual and the state. Similarly, religious mystery cults offered personal emotional salvation. Women, too, saw large gains, enjoying far greater freedoms in the Hellenistic period than before. Even slaves seemingly were more often freed in this period.

Waterfield also connects these individual-level shifts with the broader political picture, which saw a host of post-Alexander successors contesting for territorial supremacy:

In the Classical period, this individualist form of greed was invariably regarded as a particularly destructive and antisocial vice, and it was expected that the gods would punish it or that it would arouse fierce opposition from other humans. The historian Thucydides, for example, thought that Athenian overreaching was one of the main reasons that they were defeated in the Peloponnesian War. The Successors trampled on such views. For them, and for all the Hellenistic kings who came after them, greed was good. Individualism and egoism are close cousins.

This reverses most of the typical associations. One typically thinks of political enfranchisement as going together with broader self-actualization; and greed as a corruptive force. We tend think of absolutism as the greatest enemy of individual agency. Waterfield suggests that, at least in one context, those relationships don't necessarily hold.

I find this a puzzling mix of strongly pro- and anti-libertarian attitudes. One one hand, this suggests that individual attachment to the state happens to the detriment of other aspects of individual flourishing; and that social mores encouraging egoism can promote individualism. On the other hand, it suggests that removing individual participation from the workings of the state is the best way to liberate people from this greater burden of being constrained by the forces of political participation.

Schumerism

Here's a brief essay expanding on a post I made at The Agenda:


The typical discussion of the middle class begins with a tale of statistical woe. We are often told, for instance, that median household disposable income has remained virtually flat from in the last several decades. Strictly speaking, this is true. Such examples of middle class compression form the basis for narratives of how the American dream is being crushed and requires an active countervailing force to resist that pressure.

Chuck Schumer has done more than virtually any politician in voicing that narrative. Yet his success comes in equal measure from voicing tales of doom, as well as cannily recognizing the ways in which middle America has changed in order to offer up government solutions to satisfy people's new needs. To the extent that we confront a larger government, it is because Americans have increasingly bought an ideology — “Schumerism” — that sells government spending as the solution to the problems of an increasingly affluent middle class.

This rising wealth stems from the continuous productivity advances of the last several decades, which have yielded enormous improvements in the typical American quality of life. One telling statistic comes from the CBO, which estimates that a typical family of four received in 2010 an overall pre-tax compensation of $94,900. In some sense, the vast majority of Americans are millionaires — not of course in terms of their immediate access to assets, but rather in the raw earnings potential a typical family can expect over a lifetime. This reflects a degree of prosperity unimaginable in 1958, when John Kenneth Galbraith already considered the pattern of private wealth to constitute unbelievable affluence. Families with two-earners or more education than average can expect to earn even more.

Thus, in comparisons with generations past, Americans find themselves with a lower need for government than ever before. If the goal is simply to ensure a basic absolute level of income, the insurance and welfare aspects of government are less necessary than they ever have been.

That simple economic logic has had drastic implications for both political parties. Democrats in particular have been forced to adapt to new economic realities. Their core constituencies have simply evaporated as the working class has graduating in income; College education has increasingly become the norm; and union membership has plummeted. If the voting patterns based on education and income had remained fixed from, say, the 1970s -- Democrats would simply be politically annihilated. In order to remain electorally viable, Democrats have been forced to appeal to the demands of an increasingly wealthy and educated public.

This appeal has rested on a potent and incisive understanding of the demands of wealthier households. As an Atlantic profile of Chuck Schumer explained:

 “A lot of times, what Democrats say are the struggles of the middle class are not really the struggles of the middle class,” says Jim Kessler, a longtime Schumer adviser and a vice president of Third Way, a centrist Washington think tank. “They’re the struggles of people who are actually poor. So when people in the middle class hear you talking about these things and calling them middle-class problems, they actually think you’re talking about someone else’s problems.” 

For Chuck Schumer and other politicians from both parties, this represents potential crisis as well as an opportunity. Conceivably, the rising affluence of the middle class could result in a lower dependence in government. But if politicians could target the new demands of increasingly wealthy households, government could expand to fit new niches. The result has been a government increasingly tasked with handling the pressures of new middle class life.

A full reckoning of these programs begins with the tax code and the various deductions that enable off-balance sheet subsidies to favored consumption categories. The Treasury estimates that all income tax expenditures will reach $1.2 trillion in fiscal year 2011. The largest of these categories include the exclusion for employer-sponsored health insurance and the mortgage interest deduction - both of which subsidize middle class consumption of healthcare and housing.

The universal nature of Medicare and Social Security constitute the two other pillars of government spending. Regardless of the essential merits of these programs, their universal status guarantees millions in subsidies to Americans capable of financing their own retirement and future health expenses.

In the pivotal areas of government focus — housing, healthcare, and education — the genius of Schumerism lies in government's ability to sell itself as a solution to problems created by its other various branches. For instance, as the Economist Ed Glaeser has emphasized, high housing costs faced by residents of the coasts areas owe in large part to onerous restrictions on construction and rent control. Yet instead of supporting free market attempts to cut down on such regulation, such housing policies generate additional pressure to regulate housing prices or generate additional housing finance to make home purchases more affordable.

The same is true in education. Education costs have spiraled in part due to increasing demands for educational amenities. For instance, the student-teacher ratio has plummeted from 22.3 to 15.6 in the last forty years, while educational facilities are better than ever. The stranglehold that public provision and unions place on the structure of K-12 education has ensured steady inflation in education costs. Yet politicians have successfully sold parents on the idea that the real problems with education lie in insufficient funding for their local schools -- to be financed through additional rounds of government funding.

In healthcare, the imposition of government mandated fee-for-service has been directly responsible for spiraling growth in this sector. Amy Finklestein, an Economist at MIT, for instance has roughly estimated that roughly half of the increase in real per capita health spending from 1950 to 1990 may be accounted for by the spread of insurance - in particular government mandated insurance. Medicare has enshrined a low-deductible fee-for-service model that is popular with voters, but has proven destructive to pocketbooks. The healthcare deduction provides additional incentives for labor compensation to be drawn in the form of health insurance.

Yet the resulting high costs of healthcare become arguments for why additional subsidies and regulations are required. The latest iteration of this vicious cycle is PPACA -- another system of subsidized insurance coverage (again, for increasingly wealthy Americans) who cannot afford insurance in government-fixed markets.

The final mechanism of creeping demands for government support comes through taxes. It is true that taxes, as a share of GDP, have remained relatively constant; and that marginal tax rates are relatively low by historical standards. But if the tax burden has remained constant in the face of rising GDP -- that implies a government growing at the rate of income. Even as we have become richer and better capable of weathering the storms of economic insecurity, the government has steadily found new programs to satisfy new demands created by more income.

The cost of these programs has taken a heavy toll on the middle class's balance sheets. In The Two Income Trap, Elizabeth Warren and Amelia Tyagi painted a dire picture of middle class evolution by presenting the balance sheet of one family in the 1970s and another in the 2000s. The two families, the authors argue, end up with a similar discretionary income - a sign of the middle class’s stagnation. Yet as Todd Zywicki has pointed out, a key factor behind this seeming stagnation is the fact that a typical family in this situation can expect to see their tax liability grow by 140%.

The result has been a middle class pressure cooker. If families don’t feel as rich as the $94,000 they receive in compensation, it’s because households have felt their post-tax compensation suffer due to a variety of cost pressures — coming either directly from the government (in the form of higher taxes) or indirectly in the form of greater regulations and higher costs in fields like housing and healthcare. Yet rather then offering fundamental reforms to alleviate those cost pressures, politicians like Chuck Schumer have instead offered individualized government programs as the solution. The benefits of those programs are clear and immediate to struggling households; the long-run costs are less visible but serve to escalate the long-run cost pressures and create demand for future entitlement and public spending.

Another form of relief has come from extending lines of credit. Wall Street and big government have common interests in many fields, a relationship personified by Chuck Schumer’s excellent finance contacts. Wall Street is happy to purchase government debt and extend credit to consumers. As Raghuram Rajan argued in Fault Lines, increases in credit serve as another palliative to the fundamental stresses in the middle class balance sheet — stresses induced in no small part by the government. Fannie and Freddie, too, drastically expanded their operations starting in the late 90s. Today, the federal government backs over 58% of the mortgage market, including virtually all new mortgage originations. This flow of credit enables the sort of housing consumption that the new middle class demands, but cannot afford due to cost pressures elsewhere.

Collectively, in essence, we have decided to delegate the task of household consumption. Instead of purchasing goods ourselves, we have the government spend and regulate consumption for us. Such a decision might have made some sense if the government were an effective arbiter of spending. Unfortunately, it is not -- too many government programs are badly functional and breed the very cost pressures that they were designed to counter.

It is easy to see how the broad coverage of such government entitlement and spending programs might generate instant political appeal. But the demands to ensure universal access to such programs have another source -- the belief among many liberals that programs meant for the poor will be poorly funded. The argument goes that even if universal access and broad spending may benefit individuals who strictly speaking could afford services on their own; such buy-in is essential to ensure the continued stream of services to the truly needy. The richer, in this reading, cannot truly empathize with the poor unless they receive the same services -- so it's essential to ensure that the rich continue to consume Medicare and send their children to public schools.

The logic behind this sentiment is questionable. Medicaid, for instance, has seen steady rises in public funding over the decades, even if recessions leave state governments temporarily stressed and reluctant to expand that program. It's not at all clear that buy-in from relatively prosperous sections of society is necessary to ensure the continued success of public programs. Many European countries for instance combine greater spending on the poor in relative terms with more expansive spending in general — while America directs a greater proportion of government spending to the rich.

But more fundamentally, ongoing fiscal challenges will heighten the challenge of large-scale spending on both the middle class as well as the poor. Rather than serving as the guarantee that the poor will receive sufficient spending of their own, middle class entitlement programs increasingly compete with those programs for funding. And the political life that they have taken on ensures continual sources of funding, while programs for the poor are increasingly on the cutting block.

In an age of austerity, we can no longer afford an expansive welfare state — at least without corresponding increases in taxation that even Democrats have been reluctant to endorse. Yet the pressures of an aging population and rising healthcare costs will result in enduring budgetary costs. The only solution is to trash Schumerism, and accept that increasingly affluent Americans must pay their own way.

War for US Capital Markets

I have an op-ed with Chris Papagianis at Forbes I've been meaning to link to for a bit. Here's a sample:

The private sector is fighting the government for control of capital markets, and the government is winning. The most recent data from the Federal Flow of Funds reveal that Uncle Sam stands behind over 58% of the mortgage market – a hike of 13 percentage points since 2006. 

But it has now been three years since the fall of Lehman Brothers, and the grip of government-backed finance is still tightening as opposed to letting up.  On October 20, 2008, the Washington Post ran the headline “Is Capitalism Dead?” This question and the short-lived philosophical debate has now faded, yet a fair reading of capital market data today indicates that the two sides are still battling. 

We are now at a point where it is almost impossible to imagine a functioning capital market without an oversize role for government. The longer the government maintains a dominate role, the more the private sector’s capacity to fill in or take control atrophies. This dynamic needs to shift back in the direction of the private sector. In many ways, the most important battle the U.S. faces over the next few years is wrestling back control of its own capital markets.

Labor Supply and Taxes

I have a post at The Agenda on the impact of taxes on labor supply:

While many recent discussions of tax policy are motivated by using taxation for the purposes of economic stimulus or for addressing income inequality, the really important long-term impacts of taxation center on labor supply. Higher taxes induce people to cut back on hours worked (what economists refer to as the intensive margin), as well as to drop out of the workforce entirely (the extensive margin). Figuring out how much taxes induce household labor behavior along these dimensions has been a major area of economic research, and the implications for government policy are sizable... 

Broadly, macroeconomists like Ed Prescott, studying the behavior of economies in the aggregate, tend to prefer large labor supply estimates; while microeconomists like Saez and Diamond, studying groups of individuals, tend to support smaller estimates. This empirical dispute has fairly far-reaching consequences on the structure of government policy. If Diamond and Saez are right, then even large hikes in taxation, though they may affect after-tax income, will not impact labor supply or GDP. If Prescott are company are right, then hikes to marginal tax rates will hit labor supply, and through that GDP, and so damage a key source of competitive advantage for the US economy... 

In the midst of continuing economic woes, there is little appetite to raise taxes on anything but a tiny fraction of Americans. Yet, eventually, politicians will face difficult fiscal choices. Raising taxes may avoid difficult cuts to social spending programs; yet there is a sizable body of research that suggests higher taxes may have long-run consequences on the long-run success of the economy — which will in turn make it more difficult to balance Debt/GDP. This may still be a choice worth making. Yet it is important to keep in mind the tradeoffs that higher taxes imply. At the very least, it’s a reason to pursue tax reform that lowered marginal tax rates by broadening the tax base, which would improve economic efficiency with few economic costs.

More on Repos

After my last post on this, I went to look up some more facts on the repo market. This issue concerns not only the importance of "safe assets," but also the role of the repo market failure in precipitating further financial market instability. I ran into a paper by Krishnamurthy, Nagel, and Orlov that provides new data and presents a revisionist take on the role of repo in the shadow banking system. Here are some principal quotes:

The table also details the amount of these securities financed by repo. Total repo of non-Agency MBS/ABS is $171bn. Even if we include the repo extended against corporate bonds, the repo total is only $386bn. This is a small fraction of the out- standing assets of shadow banks. This observation underscores a principal finding of this study: repo was of far less importance in funding the shadow-banking sector than is commonly assumed.
If repo was not the principal source of funding, what was? The table details the direct holdings of these securities by MMFs and security lenders. The direct holdings are substantial, totaling $745bn. It is likely that such holdings are high grade and short maturity tranches of securitization deals...

First, while in their data average haircuts are frequently zero in 2007 for corporate debt and securitized products, the repos undertaken by MMF in our data always have average haircuts of at least 2%, even for Treasuries and Agency debt. Second, although our value-weighted averages (which is the most relevant measure of aggregate funding conditions) are difficult to compare with the equal-weighted averages in finer categories reported in Gorton and Metrick (2011b), an informal comparison suggests that haircuts in tri-party repos of MMF increased much less than the haircuts in their bilateral repo data (Gorton and Metrick report average haircuts in excess of 50% for several categories of corporate debt and securitized products).

Taken together with our findings of the relatively small amounts of MMF repos against private-label MBS and ABS collateral, these observations suggest that the “run on repo” may have had a more modest effect on aggregate funding conditions for the shadow banking system than what one may guess from the enormous increase in haircuts for securitized products in the bilateral repo market as reported by Gorton and Metrick (2011b)...

 This finding does not support the emphasis that Gorton and Metrick (2010, 2011b, 2011a) and Adrian and Shin (2010) have placed on the repo market in explaining the collapse of the shadow banking system. Instead, the short-term funding of securitized assets through ABCP and direct investments by money market investors are an order of magnitude larger then repo funding, and the contraction in ABCP is an order of magnitude larger than the run on repo. Troubles in funding securitized assets with repo may have been a major factor in the problems of some dealer banks that were most heavily exposed to these assets, but for the shadow banking system as a whole, the role of the repo market appears small.

These results are in strong contrast to Gary Gorton's work, which has focused on the bilateral repo market. His research suggested that the financial crisis could be understood as a bank run similar to past financial crises, as in the 1930s. However, in this case, the bank run simply came instead to the shadow banking system in the form of the repo market closing up. The implication is that much of the fallout in the last several years can be understood using the same framework for why maturity mismatch induces normal banks to face runs.

The results from Krishnamurthy and company are in some tension with this interpretation. Repo by itself seems to have constituted a small share of financing in the shadow banking system. Correspondingly, the "run" on repo had little impact on aggregate bank financing systems (though painful for certain individual banks). The run was concentrated on repos collateralized by private label AAA securities, not on repos in general. Even risky banks were able to obtain repo financing by collateralizing with different securities.

Meanwhile, repo haircuts for some assets mirror their levels during the crisis. This seems inconsistent with the idea that the crisis involved some extraordinary and temporary run, as opposed to a general shift in the attitude towards the risk of certain assets.

To be sure, the results are specific to repo supplied by dealers and money-market-mutual funds. It seems likely that their financing supply remained more inelastic throughout the crisis compared to financing between banks, which decreased dramatically in response to a credit crunch environment.

It's interesting to compare this narrative with Ivashina and Scharfstein, who argue that new bank lending had begun to decline in 2007Q3, well before the turmoil in repo/shadow banks became more pronounced. A GNI approach to the economy shows stagnation in this period as well, while mortgage defaults were starting to kick in.

One story consistent with all of this would emphasize the role of deteriorating productivity and credit conditions throughout the crisis, combined with a shadow-bank driven monetary crunch in 2008. Stagnating income for a substantial period of time induced higher levels of household borrowing; defaults on which triggered bank retrenching. In turn, this induced short-term financing effects that were important, but largely limited to inter-bank financing. The bank repo effect, however, comes with a money multiplier that continued to further amplify the crisis.

Safe Assets, MBS, and Sovereign Debt

David Beckworth kindly links to my last post on safe assets:

Gupta also makes some other points, but this is his main one.  His point sounds reasonable, but I wonder how important this effect is explaining the overall trend.  As I mentioned in my previous post, this shortage of safe assets can arguably be traced all the way back to the bursting of Japan's asset bubble.  It is also influenced by the gap between the rapid economic growth in the emerging world and their own inability to produce safe assets.  And then there is the demographic challenge: all the baby boomers in the rich world are shifting out of riskier assets into safer ones as they retire.  Is Basel really more important than all these other factors? 

This is a fair point. It’s tough to figure out how important Basel regulations might be relative to all of the various other factors driving the use of AAA-rated securities. 

First, I would point to role of various policies in driving the growth of repo to begin with. Martin Oehmke has two recent papers that touch on this issue. The first, with Patrick Bolton, argues that the super-seniority given to derivatives like repo under the bankruptcy law results in a socially inefficiently large repo market. The argument is that granting derivatives higher status in bankruptcy (done in the 2005 bankruptcy reform) induces firms to invest far more in derivatives. The issue is that expanding derivative contracts is equivalent to creating high-seniority collateralized debt; and in the event of default, derivative counterparties can seize that collateral even as other creditors are subject to an automatic stay. As a result, firms want to take advantage of the repo market as an additional form of risky investment. The authors argue: 

Our model thus predicts that under the status quo equilibrium derivative markets will be inefficiently large: the positions taken in derivatives, swaps and repo markets will be larger than is socially efficient. This incentive to speculate disappears if the special treatment for derivatives in bankruptcy were removed. These results are consistent with the view that the special treatment of derivatives in bankruptcy may be one of the driving forces behind the tremendous growth of derivatives, swaps and repo markets in recent years. In particular, it may explain the increase in the size of derivatives markets since the 2005 bankruptcy reform, which widened the set of derivatives and types of collateral assets to which the special bankruptcy treatment applies.

Another paper by Oehmke and Markus Brunnermeier expands on the short-term basis of financing contracts. Starting with the standard Diamond-Dybvig model, the trend has been to see maturity-mismatch in bank financing as in some sense inherent to the act of banking. Others, such as Diamond and Rajan, have articulated other motives for having banks lend for long-term loans while financing themselves through short-term debt. 

Oehmke and Brunnermeier instead develop a model in which banks come to rely on an inefficiently large amount of short-term financing. The issue here is similar as with repos: short-term debt contracts induce externalities on the other creditors to a bank. Shortening one form of financing allows that creditor to update their contracting terms more frequently in response to fast-changing information, as happens for instance during a period of financial crisis. As a result, there is a maturity “rat-race” in which pressure from creditors results in a level of short-term financing that needlessly encourages bank runs and financial crises. 

The reason this matters is that the role of safe assets in Beckworth/Gorton’s model comes in exactly as collateral to fuel repos. To the extent that repos themselves are risky and socially wasteful, a lack of assets to fuel there growth may not be very troubling.

Then there’s the issue of how important Basel ratings were in determining the choice of assets, as opposed to various other factors. As I referenced earlier, Jeffrey Friedman and Vladimir Klaus make the argument extensively in Engineering a Financial Crisis that the advent of Basel-II and the Recourse Rule was associated with a dramatic level of bank interest in AAA-rated securities. The present the following graph, which shows the regulatory nature of capital adequacy regulations:

That is, Basel-II (and its US counterpart in the Recourse Rule) dramatically reduced the amount of regulatory capital needed as a hedge against high-rated assets. As Friedman and Klaus discuss, this had an enormous impact on the incentive for banks. While unsecured lending or traditional mortgage lending carried large capital buffer requirements, holding AAA-rated debt carried very little capital requirements, leaving open bank capital for other purposes. Friedman and Klaus argue that this rule change was behind the enormous surge in interest in AAA-rated mortgage securities. They document how the growth in private-label mortgage securities took off in 2002, just as the regulations came into effect, and how banks came to hold hundreds of billions in AAA-rated securities on their books. Hyung Shin, too, has described how European financial institutions came to hold large amounts of AAA-rated securities on their books. This pattern doesn’t explain the repo/safe asset explanation. Nor do typical explanations for the credit boom suggest why capital was directed towards mortgages specifically.

All of that applies to mortgage debt; but a similar story can be made for sovereign debt. As with high-rated mortgage securities, regulators ensured that holdings of all European sovereign debt needed to carry no additional capital buffer. This decision dramatically lowered the yields on European bonds, and falsely declared an actually risky asset (sovereign debt) to be risk-free. European banks, in particular, came to hold enormous quantities of risky European sovereign debt on their books — again, not for the purposes of conducting repo, but as part of their traditional lending portfolio. The whole problem with the European debt crisis recently has revolved around the fact that this debt was not, in fact, risk-free. Ratings downgrades have now left European banks scrambling to raise new capital, while the threat of actual sovereign default threatens to make insolvent major financial institutions and their counterparties. 

None of this is conclusive, and records of actual holdings of actual assets by particular banks is hard to come by. Still, I believe it adds up to at a plausible case for why rather than thinking there is a genuine shortage of safe assets, instead regulatory changes have unnecessarily encouraged short-term financing and ratings-driven investment.