Kevin Drum

Quote of the Day: Gordon Brown

Always turn off your mike before venting to your aides.

| Wed Apr. 28, 2010 12:04 PM 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.

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Endgame in Greece

Greece is screwed, and the rest of us might be too.

| Wed Apr. 28, 2010 11:28 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?

Steven Teles argues that the best place for consumer protection is inside the Federal Reserver.

| Tue Apr. 27, 2010 11:32 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.

Chart of the Day: The Public Mood

Are people starting to get a little more optimistic?

| Tue Apr. 27, 2010 5:02 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

Goldman Sachs may not have broken the law, but that doesn't make what they did right.

| Tue Apr. 27, 2010 3:22 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

Larry Lessig says she's more progressive than we think.

| Tue Apr. 27, 2010 1:38 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.

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Apple vs. Gawker

Sometimes even stopped clocks are right.

| Tue Apr. 27, 2010 1:00 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.

Hating on Ratings

Fixing the ratings mess is a mess all its own.

| Tue Apr. 27, 2010 12:15 PM EDT

One of the big villains in the housing bubble was the ratings agencies. Providing ratings for complex securities is lucrative business, and in order to get it the agencies implicitly — or sometime explicitly — colluded with issuers to provide higher ratings for their securities than they deserved. The conflict of interest is obvious: having the issuer of a security pay for its rating is like having a student pay his professor for a grade. Dean Baker explains what to do:

The obvious way to fix the conflict is to take away the hiring decision from the issuer. The issuer would still pay the rating agency but a neutral party — the SEC, the stock exchange on which the company is listed, the local baseball team — would make the decision as to which agency gets hired.

I guess this is my question: if you do this, the ratings agencies no longer have any incentives to do much of anything. There are three of them, and presumably each one would get a third of the business at a price set by the SEC. So their incentive would be to hire the cheapest possible analysts and cut costs to the bone. The result would be ratings agencies even less able to cope with complex modern securities than the current ones.

This is what stonkers me about the ratings dilemma: there just doesn't seem to be any good answer. Turning the ratings agencies into regulated utilities might be better than the current situation, but not by much. And if you're going to do that, why bother with ratings agencies at all? Why not just have the SEC provide ratings?

I've read other proposed solutions too. Open up the business to more firms, for example, or pay the agencies based on the accuracy of their ratings. But the first doesn't really get at the conflict of interest, and the second is difficult because it often takes years before you know if a rating is accurate.

I remember once someone telling me that after every financial crisis ever, the ratings agencies are always rolled out as sacrificial lambs. They had always been too optimistic, or too stupid, or too corrupt, or something. And then there'd be a hue and cry about "fixing" them, even though the real problem was that every single person on Wall Street, buyers and sellers alike, had wanted them to do exactly what they did: help inflate a bubble that made everyone truckloads of money. The hue and cry, he suggested, was more a way of deflecting blame from the real villains than it was a serious attempt to address an underlying problem.

I don't remember who told me that, and I don't even know for sure if it's true. It's stuck with me, though. I'm just not sure what the answer is here.

Turning Off the Texting

A middle school experiments with real life.

| Tue Apr. 27, 2010 11:17 AM EDT

K C Cohen, a counselor at Riverdale Country School in New York, recently asked students to participate in an experiment: spend two days without texting. The results:

This text-free Sunday, the Riverdale students said, was unusually relaxing. They were shocked at how quickly they finished their homework, undistracted by an always-open video chat, or checking in on Facebook or responding to the hundred messages they typically get in a day. Kayla and her mother went for a stroll in SoHo, a rare outing, with them both off the computer.

I think we can count this as a data point against the idea that multitasking is a productivity boon. Kids today might multitask more than earlier generations, but that doesn't mean they're getting more done. Probably a good deal less, in fact. But this, I thought, was even more interesting:

The experiment left Kayla Waterman, a 12-year-old sixth grader, with a new appreciation for the convenience of texting over calling. On Monday morning, instead of texting, she called her mom to let her know there were “a gazillion fire trucks at school.” Then she called right back: false alarm — fire drill. “I could tell she was getting annoyed because I kept calling,” Kayla said. How many times during the school day does she usually text her mom? About 10, Kayla said; a friend nodded in agreement.

Boundaries between work and home have long since fallen, so maybe it should not be surprising that the same is true for school and home. But what middle school student 20 years ago would have voluntarily reached out to her mother 10 times between 9 a.m. and 3 p.m.? If school had any universally agreed upon upside, it was that it gave a 12-year-old some much-needed space to revel in independence or struggle with rejection — space in which, presumably, that 12-year-old could start to figure out who she was, or how he wanted to navigate the world.

I don't really have anything profound to say about this. But it does strike me that, in general, teenagers these days frequently have closer relationships with their parents than they did in the past. Obviously that has a good side as well as a bad one. They're more comfortable around adults at an earlier age, for example. But I wonder what the downside is?

Groupthink and the Markets

Market failure is an example of groupthink too. Maybe the biggest example of all.

| Tue Apr. 27, 2010 1:46 AM EDT

David Brooks suggests that since the establishment herd mostly missed the housing bubble, financial reform ought to take power away from the establishment:

One might have thought that one of the lessons of this episode was that establishments are prone to groupthink, and that it would be smart to decentralize authority in order to head off future bubbles.

Both N. Gregory Mankiw of Harvard and Sebastian Mallaby of the Council on Foreign Relations have been promoting a way to do this: Force the big financial institutions to issue bonds that would be converted into equity when a regulator deems them to have insufficient capital. Thousands of traders would buy and sell these bonds as a way to measure and reinforce the stability of the firms.

....The premise of the current financial regulatory reform is that the establishment missed the last bubble and, therefore, more power should be vested in the establishment to foresee and prevent the next one....But the bill doesn’t solve the basic epistemic problem, which is that members of the establishment herd are always the last to know when something unexpected happens.

I don't have a firm opinion on the Mankiw/Mallaby idea. But I will say this: it wasn't just the "establishment" that missed the housing bubble. It was also the market, represented by those thousands of traders who buy and sell bonds. In fact, pretty much by definition, the market always misses bubbles.

Brooks has the causation backward here, I think. The establishment didn't miss the housing bubble because of generic groupthink. It missed the housing bubble because of a specific case of groupthink: the nearly unanimous belief that markets can't be wrong. Thus, if the market price of housing is going up, it had to be the case that housing prices should be going up. All that was left was to invent reasons to explain skyrocketing property prices, and the establishment did that in spades. But it was market delusion that drove establishment delusion, not the other way around.

Brooks is right that the market and the regulatory establishment and the political establishment all colluded to allow the bubble to get out of control. Merely giving regulators more authority probably isn't enough by itself to prevent a repeat. But relying on the market isn't either. That was the ur-delusion that brought the global banking system to its knees in the first place.