Kevin Drum

Reining in Derivatives

| Tue Apr. 20, 2010 12:20 PM EDT

Noam Scheiber brings us up to speed on the state of play of derivatives regulation in the Senate finance reform bill. Big banks, it seems, are actually feeling a little fear these days:

The reason the recent developments are so remarkable is that all reforms tend to weaken as they get closer to passage, as legislators hash out compromises with powerful interests in order to secure a deal. Bizarrely, financial reform appears to be headed in the opposite direction. When it comes to derivatives, at least, the bill Senator Chris Dodd moved through his Banking Committee in March was significantly tougher than the bill the House passed in December. Then, last week, Lincoln shocked Wall Street by producing an even tougher bill than that.

....What happened? For weeks, Wall Street had viewed the Dodd language as a placeholder while Lincoln and [Saxby] Chambliss hashed out the real details. Instead, the practical effect of the Dodd language was to create a minimum standard of toughness from which Democrats would be unwilling to retreat. As Lincoln and Chambliss bargained in March, the administration began to focus on the issue and discovered its popular resonance....By the time Lincoln finally sent the administration the contours of a possible deal with Chambliss the week of March 29th, there was no way the deal could pass muster. Several days later, Michael Barr, the assistant Treasury secretary with the derivatives portfolio, told Lincoln's staff the administration would be unable to support it because it weakened the Dodd bill.

This really does seem to be the one ray of sunshine on the regulatory front right now. I'm only lukewarm toward the rest of the Dodd bill (and its House counterpart), but the soap opera over OTC derivatives regulation really has been moving in the right direction lately. And despite the best efforts of the Chamber of Commerce to pretend that regulating derivatives will hurt ordinary businesses, nobody is buying it. Derivatives may not have been the primal cause of 2008's financial meltdown, but there's no question that (a) they helped things along and (b) the social value of complex credit derivatives is pretty close to zero. It really is just the pure shuffling around of money for the sake of generating huge fees for the five big players in the market.

That makes this a pretty easy win for Democrats if they're willing to seize it. Serious derivatives regulation is good policy since Lincoln's proposal would improve the stability of financial markets. It's good electoral politics since there's no public constituency in favor of weak regulation — especially since media coverage of derivatives has actually been fairly widespread and uniformly negative. And finally, it's good partisan politics since it exposes natural fault lines in the Republican Party. "The one tactical question Democrats do agree on," says Scheiber, "is that the GOP is ready to crumple."

Blanche Lincoln's derivatives language is actually so tough that at first I didn't take it seriously. I figured it was just for show (she's facing a primary challenge from the left and needs some anti-Wall Street cred) and would get negotiated away pretty quickly. But regardless of whether that was her intent, these things sometimes gain a momentum of their own. Right now, it looks like serious derivatives regulation might have a legitimate shot at becoming law.

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Why Are Banks Are So Rich?

| Tue Apr. 20, 2010 11:32 AM EDT

Annie Lowrey writes about the continuing spectacular profitability of Wall Street banks:

This is not quite a picture of a healthy industry. In a competitive marketplace, prices and fees at Wall Street firms should fall and margins should become thinner. 

....The profits point to a lack of competition. That is one thing the Dodd bill — via derivatives regulation — attempts to fix. Right now, Wall Street firms do not bid for big derivatives contracts — they simply quote a price and work over-the-counter. For that reason, derivatives are wildly profitable for the companies. The Dodd bill will force derivatives pricing to become public to the market, driving down margins as companies compete.

Over the past several decades, finance has gotten bigger, faster, more global, and more computerized. In other words, more commoditized. That should drive profits down. But it hasn't. James Crotty of the University of Massachussetts calls this Volcker's Paradox, "the seemingly strange coexistence of intense competition and historically high profit rates in commercial banking," because it was first pointed out by Paul Volcker back in 1997. And in a paper he wrote a couple of years ago, Crotty identified four reasons for this paradox:

  1. Rapid growth in the demand for financial products and services in the past quarter century.
  2. Rising concentration in most major financial industries that makes what Schumpeter called “corespective” competition and the exercise of market power possible (thus raising the possibility that competition is not universally as intense as Volcker assumed).
  3. Increased risk-taking among all the major financial market actors that has raised average profit rates.
  4. Rapid financial innovation in over-the-counter derivatives that allows giant banks to create and trade complex products with high profit margins.

So: rising demand, reduced competition, higher leverage, and the growth of opaque OTC derivatives that are easy to overprice because they're one-off products that can't be easily compared to each other. As Lowrey says, the Dodd bill might address reason #4 if it ends up truly forcing most derivatives to be exchange traded, but it doesn't do much about the other three. Most likely, then, financial sector profitability is going to stay high even after financial reform has been passed, and that means the power of bankers over Congress is going to stay high too.

UPDATE: I've been trying to remember all day where I first saw this paper. Answer: over at Mike Konczal's place. He links to it here, along with lots of other interesting commentary about bank profitability.

Factlet of the Day

| Mon Apr. 19, 2010 10:38 PM EDT

From the Washington Post:

Pepsico has developed a new shape for sodium chloride crystals that the company hopes will allow it to reduce salt by 25 percent in its Lay's Classic potato chips.

A new shape for salt? How about that. I suppose the crystals somehow have more surface area or something like that. More importantly, though, this comes from an article describing a new FDA initiative to reduce the amount of salt in food:

The government intends to work with the food industry and health experts to reduce sodium gradually over a period of years to adjust the American palate to a less salty diet, according to FDA sources, who spoke on the condition of anonymity because the initiative has not been formally announced.

...."This is a 10-year program," said one source. "This is not rolling off a log. We're talking about a comprehensive phase down of a widely used ingredient. We're talking about embedded tastes in a whole generation of people."

I am so in favor of this. It's sort of like the Do Not Call list: I don't really care about ideology here, and I don't really care if this is nanny statism or government overreach or anything else. I'm just totally in favor. And you know what? By the time this is done, my guess is that nobody will even remember a difference. They'll just be eating healthier food that tastes better and doesn't cause as many strokes or heart attacks. Three cheers for the FDA.

Defending Goldman Sachs

| Mon Apr. 19, 2010 10:18 PM EDT

According to the Wall Street Journal, the recent SEC vote to sue Goldman Sachs broke down along partisan lines:

The Securities and Exchange Commission decided to sue Goldman Sachs Group Inc. over the objections of two Republican commissioners, suggesting an unusual split at the agency that could politicize one of its most prominent cases in years....People familiar with the vote said [Mary] Schapiro — a registered independent — joined two Democrats on the commission, Elisse Walter and Luis Aguilar, in supporting the fraud case against Goldman. The two Republican commissioners, Kathleen Casey and Troy Paredes, were opposed, they said. 

....In a letter to be sent Tuesday to the SEC, Rep. Darrell Issa (R., Calif.) plans to ask the agency why the Goldman case was brought as the financial-regulation bill was pending, according to Mr. Issa's spokesman. "Democrats are desperate to cast Wall Street as the villain so they won't be held accountable for the country's economic condition," Mr. Issa said. "It must be nice for the Democrats that the SEC's filing against Goldman Sachs so conveniently fits into their political agenda."

Hmmm. Darrell Issa seems to think that describing Democrats as the party that wants to "cast Wall Street as the villain" will somehow be bad for Democratic fortunes. And that defending Goldman Sachs will be good for the Republican Party.

I suppose anything is possible. But I'm willing to take my chances on casting Wall Street as a villain — and the only sure way to find out who's right is to run a test. So with that in mind, I encourage the rest of the GOP caucus to join Issa's crusade to defend Goldman Sachs against the depredations of Democratic SEC commissioners. In a few months we'll see how that plays out for them.

Everybody Hates Washington

| Mon Apr. 19, 2010 8:50 PM EDT

A new Pew poll is out, and it can be summarized pretty easily: everybody hates Washington DC. "By almost every conceivable measure," says Pew, "Americans are less positive and more critical of government these days."

No surprise there. The good news comes in two places. First, if you take a look at this chart, you'll see that trust in government rebounded strongly during the Clinton administation and then sank like a stone during the Bush administration. So it's far from impossible for Obama to turn things around once the economy starts to pick up. Second, in addition to hating the government, people also hate banks and large corporations these days. This suggests a pretty obvious way for Congress and the president to get back on the public's good side, no?
 

So that's the poll. And now to random kvetching. I went ahead and took their "How satisfied are you with government?" quiz, and it turned out that I was surprisingly satisfied. More on that later. For now, though, I just want to highlight question #6 as a sign of how impoverished our discourse has become. When Pew asked about your preferred size of government, the answers ranged from "way smaller" to "the same as now." Apparently the folks who designed the poll were literally unable to believe that any significant number of people might want government services expanded. This is despite the fact that their own surveys have shown that about 40% of Americans would prefer a bigger government that offered more services. We liberals still have some work to do.

Diane Wood's Record

| Mon Apr. 19, 2010 2:28 PM EDT

Based on what I've read and heard, my favorite among the shortlist candidates to replace John Paul Stevens on the Supreme Court has been Diane Wood of the 7th Circuit Court. But I'm not a lawyer and my knowledge of her actual jurisprudence is necessarily limited.

Glenn Greenwald, however, is a lawyer, and he's spent the past week reviewing her record and talking to Wood's former clerks to get a better sense of where she stands. His conclusion: she's not a truly left wing candidate (none of those are even on the shortlist), but she does have a "long, clear, inspiring record" on issues of both civil liberties and economics. Glenn goes into some detail about her defense of the rule of law shortly after 9/11 — which you should read — but the thing about Wood that has most impressed me is that she's not just someone with a solid progressive view of the law, but someone with the intellectual heft to make a difference on the court. Here's Glenn:

Her expertise in anti-trust law and economics is (a) especially relevant now given the cases likely to come before the Court in the wake of the financial crisis and (b) rare for a federal judge on the liberal/Democratic side.

....What makes Wood so unique is that she combines her principled convictions with an extraordinary ability to secure the support of other judges for her opinions. Her creative and flexible intellect enables her simultaneously to stay within the confines of the law while finding the most equitable outcomes that attract a broad range of support. The 7th Circuit is one of the most conservative circuits in the country, yet Wood's influence on that court and her ability to induce right-wing judges to support her rulings is remarkable, an attribute particularly important for replacing Justice Stevens.

....Vince Buccola, who clerked last year for the right-wing Judge Easterbrook, described to me the close professional and personal relationship Wood has developed with the court's conservatives. "She’s lightning quick, amazingly well-prepared, very smart and also very knowledgeable about law," he said....Margo Pave, another former clerk and now a partner in a D.C. law firm, added: "Throughout her entire time on the bench, she has had that ability to convince her conservative colleagues, as well as her moderate and liberal colleagues, to adopt her view of an issue. She does this by figuring not only what is the right interpretation of the law, but an approach to it and argument for it that even convinces the Judge Posner and Easterbrooks of the world." For that reason, Pave — who, like most people I spoke with, described Judge Wood as "brilliant" — said she'd make a "phenomenal addition to the Court, particularly for the seat being vacated by Justice Stevens, who has also excelled at forging consensus with Court conservatives."

I think this is quite likely the most important trait in a Supreme Court choice right now. Not only does Wood have basically sound views, but she has a track record of using those views to actually make a difference. She speaks her mind and doesn't back down from a fight, but she also knows how to win fights. That's something we need right now. Glenn's entire piece is worth a read.

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Capitalism and Climate Change

| Mon Apr. 19, 2010 12:58 PM EDT

Over at the Climate Desk, Clive Thompson writes that although politicians can posture and bleat about climate change denialism without fear of paying a price, the business community doesn't have the same luxury:

This makes capitalism a curiously bracing mechanism for cutting through ideological haze and manufactured doubt. Politicians or pundits can distort or cherry-pick climate science any way they want to try and gain temporary influence with the public. But any serious industrialist who's facing "climate exposure" — as it's now called by money managers — cannot afford to engage in that sort of self-delusion.... Consider, as one colorful example, the skiing industry. Beginning 10 years ago, the Aspen Skiing Company began noticing that European ski lodges were being slowly destroyed by warmer weather. Europe's ski resorts tend to be located on lower mountains — about 6,000-8,000 feet high, compared to American peaks up around 11,000 feet — so they're vulnerable to even extremely tiny increases in global temperature. The 2 percent temperature rise in the 20th century was enough "to put a lot of them out of business," says Auden Schendler, executive director of sustainability for Aspen Skiing, which operates two resorts spread across four mountains.

But now Aspen's own season is getting shorter: "More balmy Novembers, more rainy Marches," Schendler says. "That's what we're seeing, and that's what the science suggests would happen. If you graph frost-free days, there are more and more in the last 30 years." Climate-change models also predict warmer nights. Aspen Skiing has noticed that happening too, and the problem here is that nighttime is when ski lodges use their water-spraying technology to make snow — "and if you make it when it's warmer it's exponentially more expensive." The increasing volatility of weather overall — another prediction of climate change — poses a particular danger for ski resorts, because they operate in the red most of the year, making up their deficit during the busy spring break in March. So if the weather is terrific for the entire winter but suddenly balmy during March break, that can ruin the whole fiscal year.

So what is this "Climate Desk" thing, anyway? It's a new collaboration between the Atlantic, the Center for Investigative Reporting, Grist, Mother Jones, Slate, Wired, and the new PBS current affairs show "Need to Know." And it's dedicated to reporting on climate change. But you probably already figured out that part. It's kicking off with a two-week series of pieces about how businesses are adapting to climate change that includes both Thompson's article and a piece by Felix Salmon explaining why business adaptation isn't even more widespread.

The main site is here. The RSS feed is here.  Or you can follow us on Twitter at theclimatedesk.

Have the Tea Parties Peaked?

| Mon Apr. 19, 2010 12:30 PM EDT

I mentioned this via email to a friend yesterday, but let me toss it out in public for comments too. Here's the question: how long will the tea party movement last?

My take on the tea partiers is that they're basically a 21st century version of the Birchers of the 60s. Except that where the Birchers had to rely on mimeograph machines to get out their message, the tea partiers have Fox News and the internet. At first glance, this is nothing but bad news: the Birchers were bad enough as it was, so just think what kind of damage they could have done with modern communications technology.

But maybe not! Being limited to flyers and PTA meetings might have slowed the rise of the Birchers, but it also made them a fairly long-lived movement. The tea parties, conversely, skyrocketed to fame in just a few months. And we all know what happens to novelty acts that skyrocket to fame: most of them plummet back to earth within a year or two. We just get bored too quickly these days, and the media moves on to new things. So it's possible that the tea parties peaked too fast and don't have much longer to live. In fact, my sense is that the media is starting to get bored with them already.

They'll certainly last through the November election, but I wonder if they'll be able to keep up a head of steam much after that? My tentative guess is that they won't, especially if Democrats start fighting back and manage to keep control of Congress. Comments are open if you disagree.

The Cocoon

| Mon Apr. 19, 2010 11:58 AM EDT

Back in the mists of time, conservatives used to mount an argument about liberal groupthink that went something like this: liberals, they said, are in a cocoon because they never really have to face conservative arguments. They go to college and they're surrounded by liberal students and liberal professors. They turn on the TV and they get Murphy Brown or Friends. When they want the news, they bask in the warm liberal glow of the New York Times or Dan Rather.

Conservatives don't have this luxury. In college they have to fight for their beliefs and that teaches them about how liberals think. They might read National Review for their politics, but they don't have much choice except to read the New York Times too if they want to know what's going on. Liberals can ignore conservative culture if they want to — and mostly they do want to — but conservatives can't do the same. They're exposed constantly to the liberal worldview.

That was the argument, anyway. Like most arguments of this kind, there was maybe a grain of truth in it if nothing more. But if Bruce Bartlett can be believed, even that grain is pretty much gone these days. Here he is explaining what happened a few years ago after the New York Times magazine published a big article that quoted him extensively criticizing the Bush administration:

A few days after the article appeared I was at some big conservative event in Washington. I assumed that my conservative friends would give me a lot of crap for what I said. But in fact no one said anything to me — and not in that embarrassed/averting-one's-eyes sort of way. They appeared to know nothing about it.

After about half an hour I decided to start asking people what they thought of the article. Every single one gave me the same identical answer: I don't read the New York Times. Moreover, the answers were all delivered in a tone that suggested I was either stupid for asking or that I thought they were stupid for thinking they read the Times.

I suppose this shouldn't have surprised me, but it did. After all, the people I was questioning weren't activists from the heartland, but people who worked on Capitol Hill, at federal agencies, in think tanks and so on. They represented the intelligentsia of the conservative movement. Even if they felt they had no need for the information content of the nation's best newspaper, one would have thought they would at least need to know what their enemies were thinking.

For at least a part of the conservative movement, the Times is apparently no longer a news source. It's just a prop in the culture wars. For these people, news comes solely from overtly friendly sources like Fox and talk radio and the Washington Times. These are Sarah Palin's people, and they live in a parallel universe.

Quote of the Day: Subprime Lending

| Mon Apr. 19, 2010 12:10 AM EDT

From 13 Bankers, by Simon Johnson and James Kwak:

Before the market for private mortgage-backed securities took off in the 1990s, subprime lending was constrained by the fact that subprime lenders wanted to be paid back.

Indeed. There is something remarkable about living in a world in which this sentence can not only be written, but actually makes sense.