Kevin Drum - April 2010

Wall Street And Its Rents

| Wed Apr. 28, 2010 12:58 PM EDT

Matt Yglesias points me to Daniel Gross, who writes in Slate about the history of Wall Street opposition to regulation and reform:

For the past several decades, Wall Street has continually told Washington that if the Street can't do things the way it always has, and if the government changes the rules to mandate greater transparency and customer protection, that the geniuses in Lower Manhattan won't be able to make money, and it would stunt the industry. They've been wrong every time.

It's worth noting that in all of Gross's examples, the geniuses were actually right: they complained that they'd make less money, and they did. The reforms may have been good for everyone else, but they really did erode the profits of the banks that had built up their franchises around offering services under the old rules. As Gross says about their latest self-serving whining, "The opposition to moving derivative trades to a clearinghouse isn't about protecting customers. It's about protecting the entrenched positions and profits of large banks."

That's all perfectly understandable, of course. The real puzzlement is why customers haven't ganged up to complain about this more. Or, for that matter, aggressive small banks that think they could break into the derivatives market if it were more transparent. It's pretty obvious why big banks don't want to give up the massive profits of the OTC derivatives trade, but a little less clear why their opposition is so muted.

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Rushing Through Reform

| Wed Apr. 28, 2010 12:34 PM EDT

Right now, credit derivatives are the personal fiefdom of five big banks. Blanche Lincoln wants to make those five banks spin off their derivatives operations, but the Fed's technical staff is opposed:

Fed staff members wrote that the provision, advanced by Senate Democrats, "would impair financial stability and strong prudential regulation of derivatives; would have serious consequences for the competitiveness of U.S. financial institutions; and would be highly disruptive and costly, both for banks and their customers."

Democrats rejected the Fed's push and decided to include the controversial provision, originally drafted by Senate Agriculture Committee Chairman Blanche Lincoln (D., Ark.). It would force any financial company that has insured deposits or can borrow from the central bank to spin off its derivatives operations. Ms. Lincoln has said this would protect taxpayers from having to offer public support for speculative trading operations. The Agriculture Committee passed the derivatives bill last week.

I'm not altogether sure where I stand on this. But I will make one comment: Republicans have a habit of complaining that Democrats are "rushing" their legislative agenda, and most of the time the charge is simply ludicrous. Whether it's heathcare or climate change or financial reform, they're usually talking about things that have been publicly discussed for years and actively part of the legislative process for many months at a minimum. It's a useful rhetorical tool for gullible reporters, but nothing more.

But in this case, there's something to it. Lincoln's proposal, as near as I can tell, came out of nowhere a couple of weeks ago. There's a general argument in its favor — namely that it would push risky derivatives away from federally insured banks and reduce the size of those banks at the same time — but not much in the way of serious discussion of the upsides and downsides. That hasn't changed much in the past couple of weeks, either. I've seen virtually no detailed discussion of what this proposal would entail.

I'm sympathetic to the idea on the simplistic grounds that it would (a) reduce the size and profitability of big banks, and (b) probably reduce the size of the derivatives market. I also find the Fed staff's arguments weak. It's the kind of boilerplate that we're fed about practically every proposal to rein in the financial sector. Still, it's hard to believe that we should enact a measure this sweeping with virtually no time for serious discussion. This one really needs a little more time for consideration.

Petitions and Politics

| Wed Apr. 28, 2010 11:49 AM EDT

Stephanie Mencimer writes today about a Supreme Court case challenging the right of Washington state to release the names of people who signed a petition to overturn its domestic partnership law:

The lawyer leading the attack on these states' disclosure laws is James Bopp, a leader of the Christian Right with an uncanny ability to spot weaknesses in campaign finance statutes and obliterate them via the First Amendment....And while his clients in these cases are usually religious or conservative groups, the biggest beneficiary of these efforts has been, almost exclusively, corporate America.

....Bopp has already succeeded in keeping the Ref. 71 names under wraps for a year, winning an injunction from a federal district court in Washington. The 9th Circuit Court of Appeals reversed that decision, but then the Supreme Court reinstated the injunction and agreed to hear the case. The high court's interest in Reed should trouble anyone unhappy about the court's overreach in Citizens United. If the court finds that petition-signers deserve anonymity, it's not much of a stretch for it to decide that campaign donors should also be shielded, lest they get nasty emails about their political views.

I'm a little nervous about this. Obviously Bopp and his cause don't evoke much sympathy from us liberals, but I'm not sure that I'm not on his side here. To me, signing an initiative petition seems more similar to voting than it does to giving money to a candidate. It's one thing to take the risk of making your political views public if you take the active step of contributing to a candidate or a cause, but it strikes as quite another thing to take that risk for the very routine step of signing an initiative petition. It's simply not clear to me what the public good is in allowing this.

The big concern, of course, is that "it's not much of a stretch" to decide that campaign contributions should be kept private too. But I don't see that. Substantively, there's a huge difference: knowing where money is coming from is fundamental to even the most limited kind of campaign finance regulation. If you strike that down, you've essentially wiped out the power of Congress in this area almost entirely. Conversely, keeping the names on initiative petitions private has virtually no knock-on effects at all.

Practically, I'm not sure I see the slippery slope either. If a majority of the Supreme Court decides that campaign contributions can be kept private, then that's how they'll rule. I don't think they need to sidle up to it slowly by ruling on initiative petitions first.

But I guess here's my challenge, and it's an honest one: can anyone explain to me the social good that comes from making names on initiative petitions public? On the downside, it will make people less likely to sign petitions,1 and it also opens them up to potential harrassment from opponents and employers2 — not to mention fundraising pitches from fellow travelers. On the upside — what? I can't think of any argument that wouldn't also apply to exposing my votes to public scrutiny. But school me in comments if you think I'm missing something.

1Which, admittedly, some might see as an upside. But that's just snark, not a serious public policy argument.

2I'm thinking here of, say, a secretary in a Mormon church who signs a petition in favor of gay marriage and finds his name on the internet a couple of months later. How long would it be before someone in the church office figured out an excuse to fire him?

Quote of the Day: Gordon Brown

| Wed Apr. 28, 2010 11:04 AM EDT

From British prime minister Gordon Brown, forgetting to turn off his mike after chatting with constituent Gillian Duffy:

She was just a sort of bigoted woman. She said she used be Labour. I mean it's just ridiculous.

Poor Gordon. I mean, at some point you almost have to feel sorry for a guy so badly suited to politics. Nick Clegg must practically be cackling. You can watch the whole debacle on the right. The insults come at around the 4:30 mark.

Endgame in Greece

| Wed Apr. 28, 2010 10:28 AM EDT

As I've mentioned several times before, I think that Greece is screwed. And if I think Greece is screwed, you can only imagine what Nouriel Roubini thinks. But now you don't have to imagine, because he was on a panel discussion about Greece yesterday and Felix Salmon was there to take notes:

Greece, which is already seeing riots at any hint of fiscal austerity, just isn’t the kind of nation which is likely to decide that five years of wage cuts in a painful and deflationary recession is a price worth paying to stay current on the national debt.

....Nouriel, of course, takes that kind of thinking to its logical conclusion, and kicked off the panel by announcing that it was just in time: “in a few days,” he said, “there might not be a eurozone for us to discuss.” There’s no way that Greece can implement the 10% spending cut it needs to do in order to stop its debt spiralling out of control at current interest rates — and even if it did, the economic effects would be disastrous.

....Of course, this being Nouriel, it goes downhill from there: if Greece is worse than Argentina, he says, then Spain is worse than Greece. Its housing bubble and bust has left the banking sector much weaker than Greece’s; its unemployment situation, especially with the under-30 crowd, is much worse than Greece’s; and the cost of any Spain bailout would be so much more enormous than the cost of a Greek bailout as to be almost unthinkable....There’s no good news here. The least bad course of action for Greece, in Nouriel’s eyes, is some kind of coercive yet orderly debt restructuring, which keeps the face value of the debt unchanged but which reduces coupons and pushes out maturities. And an exit from the euro.

One of the key takeaways from Reinhart and Rogoff's This Time is Different is that, historically, countries aren't forced into default, they choose to default. That is, they decide that the austerity measures it would take to pay down their debt simply aren't politically feasible, so they make the decision to default rather than pay off their loans. That's pretty much where Greece is.

That's bad enough on its own, but because Greece is stuck in the eurozone and can't devalue its currency or inflate away its debt, it's even worse for them. It's hard to see any non-disastrous ending for this. Financial markets may be hugely profitable right now, but they're still skittish as hell and completely unwilling to accept significant risk. So even if the IMF and the EU end up rescuing Greece, I'm not sure that will save them for even a few months, let alone a few years. And once the contagion spreads to Portugal and Spain, as it's almost certain to, what then? As Roubini says, it might effectively mean the end of the eurozone.

Or maybe not. I suppose that muddling through sometimes works better than anyone believes it will. But I wouldn't bet on it this time, and more to the point, neither will the world's financial markets. In fact, they're already betting against it pretty heavily, and they're only going to amp up the pressure as time goes by. The best case now is probably an immediate default followed by a bank rescue, and then a prayer that no other country needs the same treatment. Beyond that, it's anyone's guess. Pretty soon, we're likely to find out if some systemically important bank is overexposed to Greek debt, or to the euro, or to some derivative thereof. Buckle up.

To Fed Or Not To Fed?

| Tue Apr. 27, 2010 10:32 PM EDT

Should the proposed Consumer Finance Protection Agency be part of the Fed? Or should it be a standalone agency? The general lefty view is that a standalone agency would be more powerful and more independent, and conservatives seem to agree. That's why liberals mostly like the idea of a standalone CFPA and conservatives don't.

But is this true? After reviewing Reputation and Power, a monumental history of the FDA, Steven Teles says the conventional wisdom just might be wrong:

The Fed is taken seriously by the financial industry itself, and because of its reputation and more attractive salary schedule it is substantially more able to attract talent than other federal regulatory agencies. If placed inside the Fed, the CFPA would be able to build a strong, clear organizational image (especially if it were given the insulation from the rest of the Fed that Senator Dodd’s bill would provide, including near-complete control over its own budget). This would help foster the political will to grant the agency the autonomy it needs to effectively regulate the financial industry.

....Second, in building an agency with the kind of power that the FDA had at its height, personnel matters. An agency with the ability to control, at least to some degree, its political destiny and strike fear into the hearts of those it regulates requires not only high-quality people, but also people possessed of a particular regulatory spirit. The FDA encouraged the development of the nascent field of clinical pharmacology and then recruited adherents to the agency. This gave the FDA a built-in coherence, and thus the ability to develop a strong organizational culture. The CFPA would need to do the same thing, perhaps by hiring the best behavioral economists from academia to lead the agency, and sponsoring research by those on the outside. This, again, might be easier to do from within the Fed, with its preexisting reputation and more generous salaries, than it would be in a brand-new agency.

Hmmm. Clearly the Fed has lots of expertise in the financial markets, and in theory that could help a newly formed CFPA to hit the ground running. On the other hand, the Fed is, pretty clearly, already a victim of regulatory capture. What's more, its expertise and respect is almost entirely in the area of macroeconomic management, not regulation. A CFPA inside the Fed would never be more than a redheaded stepchild to the big wheels setting monetary policy.

Still, I notice that the first of Teles's reasons for endorsing the Fed approach includes the fact that it would allow the CFPA to inherit its "more attractive salary schedule." And the second of his reasons includes the fact that a Fed agency could offer "more generous salaries." These are magic words, and I gather from this that salary schedules at the Fed are higher than standard federal GS schedules. I didn't know that. Everything else aside, that might be reason enough to prefer a Fed-based CFPA.

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Chart of the Day: The Public Mood

| Tue Apr. 27, 2010 4:02 PM EDT

Here's the headline summary of the latest Democracy Corps poll:

Health care’s passage did not produce even a point rise in the president’s approval rating or affection for the Democratic Congress. Virtually every key tracking measure in April’s poll has remained unchanged, including the Democrats’ continued weakness on handling of the economy.

Sounds grim. So I was surprised to see that the poll actually contains some modestly good news for Democrats: a substantial drop in the number of people who think the country is on the "wrong track" and a small rise in the number who have warm feelings toward congressional Dems. This improvement is due almost entirely to changes among self-identified Democrats, which can be spun two ways. The positive way: the base is getting more excited! The negative way: But no one else is!

Anyway, the chart is below. The complete report is here.

Goldman's Time Bombs

| Tue Apr. 27, 2010 2:22 PM EDT

Matt Steinglass warns those of us defending Goldman Sachs' overall desire to short the housing market in 2006 not to get sidetracked. Hedging as a general strategy is fine. But deliberately constructing specific securities that you believe will implode, and then selling them to your clients as great investments is not so fine. According to the Senate subcommittee investigating Goldman, that's what they did on five different CDOs they issued in 2006 and 2007. Here's their description of one of them:

Goldman executives told the Subcommittee that the company was trying to remove BBB assets from the company books during this period of time. Goldman Sachs was the sole short investor in this proprietary deal, buying protection on all $2 billion in referenced assets and essentially placing a bet that the assets would lose value.

Matt comments:

Throughout 2007, the subcommittee says, while Goldman Sachs was putting together subprime mortgage-based CDOs, it had a strong net short position on subprime mortgage-based securities. And, the subcommittee says, this wasn't a matter of one hand not knowing what the other was doing. The effort to package and sell the CDOs was part of a deliberate effort to get subprime mortgage-based securities off the company books, because the bank believed they were going to collapse. In essence, the subcommittee is saying, Goldman Sachs was ripping off both its customers, and the people who sold it CDS protection.

People have been confusing this issue by pointing out that there's nothing wrong with shorting housing, or that there's nothing wrong with hedging your investments. And that's true. What's wrong is shorting a mortgage-backed security and then telling your clients, to whom you have a fiduciary duty, that they should buy that mortgage-backed security. Or insuring yourself against the failure of a CDO, while arranging to have all your worst mortgage-backed securities, which you expect to go bust, stuffed into that CDO, so that it's sure to fail. Did Goldman Sachs really do this? We don't know yet. But these are the accusations.

Legally, I don't know what Goldman's fiduciary responsibility was to its customers. So I'll leave that aside. But from a non-Wall Street rube's point of view, here's what's always struck me as the best evidence that Goldman knew just how mendaciously they were acting: they didn't have to construct complex new securities in order to hedge their own subprime holdings. They could have simply sold them instead. Or tried to, anyway. But of course, that would have given the game away: if Goldman had tried to sell off a whole bunch of the subprime ABS on its books, the whole world would have immediately wondered what Goldman knew that they didn't. The housing bubble would have popped and the market would have declined 12-18 months before it did.

Of course, most people in that position wouldn't have had any other choice. They would have sold their holdings and taken their lumps. But because Goldman was a major player in credit derivatives, they did have another choice. Instead of selling their ABS holdings, they constructed complex synthetic securities that allowed them to keep this stuff on their books but profit from its decline. This had the unfortunate side effect of inflating an already destructive housing bubble even beyond the ability of mortgage brokers to do it with dodgy loans, but Goldman didn't much care about that. They just wanted to invent some clever way to quietly unwind their bad bets, and if that created billions of dollars of new bad bets out of whole cloth, well, that was just the world's tough luck.

It probably wasn't illegal. But it sure piled damage on top of damage. Keeping it from happening again would be a boon.

The Case For Elena Kagan

| Tue Apr. 27, 2010 12:38 PM EDT

Larry Lessig, a good friend of possible Supreme Court nominee Elena Kagan, makes the case today that liberals shouldn't be afraid of her:

Some have suggested we can know Kagan from the policy advice she offered President Clinton. That inference is a mistake....Likewise, some have wondered about Kagan's progressive credentials because as Dean of the Harvard Law School, she didn't take a lead in criticizing the policies of the Bush Administration. Here again, the inference is flawed....Finally, some have worried that Kagan has not pushed strongly enough to the progressive side as Solicitor General. But once again, the inference from her job to her views is unfair.

....In all of these cases, my point is not that Kagan's work shows she is the progressive I know her to be. My point is different: That inferences from these cases that might conflict with a view of her as a modern progressive are invalid. They are not evidence of her views, they are evidence of how she did her job. And while they may not strengthen your confidence about her position as a modern progressive, neither should they weaken it.

....In drawing an inference about who someone is, you can't confuse what they say when they're free to speak with what they say when they work for someone else. Dissembling and pandering is a sin no doubt. But excessive personalization is a kind of self-importance that none should reward.

Fair enough, as far as it goes. Still, if Kagan's career has been marked mostly by positions in which she felt unable to publicly construct a track record of how she views the law, where does that leave the rest of us? Lessig himself may be convinced that Kagan has a sound judicial philosophy, but those of us who don't know her personally can be excused for wanting a little more.

It's also worth mentioning, however, that the first half of Lessig's essay is devoted to Kagan's ability to shift a court majority in a more progressive direction. This is the aspect of Diane Wood's character that many people (including me) find especially attractive, so it's worth reading just for that.

Apple vs. Gawker

| Tue Apr. 27, 2010 12:00 PM EDT

Let me just say at the outset that I don't like Apple Computer. Not the products, the company. Basically, I think they're dicks. Now, it's their company, they run it well, they make lots of money for their shareholders, and they don't break any laws. So if they want to act like dicks, they have every right. But I don't have to like it. And I especially don't like it when they try to position themselves as hip individualists while running their corporation with about the same subtlety that J. Edgar Hoover ran the FBI.1

End of rant. That said, I'm a little unsure that Apple is really doing anything all that wrong by going after Gawker in the case of the missing iPhone. They are, it's true, being dicks. Still, paying some guy $5,000 for an iPhone prototype that was "found on a barstool"? Seriously? Gawker just accepted that story and forked over the cash? I mean, this is pretty much the same story a guy told me once who offered me a Blu-Ray player out of the backseat of his car for twenty bucks. Perhaps a little skepticism is legitimately in order here?2

1Just to give equal time, as a longtime PC user I also hate Microsoft, Symantec, and Adobe. In fact, I sometimes wonder just which one I hate the most. So really, I guess I'm just a hater.

2Note that this is in no way meant as a comment on the legal aspects of the case. I believe Gawker is unquestionably a media outlet protected by California's shield law. Exactly how that law applies in this case, however, I really don't know.