Kevin Drum

The Empire Strikes Back

| Tue Sep. 29, 2009 1:46 AM EDT

Apparently the Vatican has finally decided that the best defense is a good offense.  According to a bellicose statement issued Monday, the Catholic Church doesn't have a paedophilia problem, it has an ephebophilia problem, thankyouverymuch.  Plus this:

The statement, read out by Archbishop Silvano Tomasi, the Vatican's permanent observer to the UN, defended its record by claiming that "available research" showed that only 1.5%-5% of Catholic clergy were involved in child sex abuse.

He also quoted statistics from the Christian Scientist Monitor newspaper to show that most US churches being hit by child sex abuse allegations were Protestant and that sexual abuse within Jewish communities was common.

Only 1.5-5%!  Not bad!  And anyway, Protestants and Jews are doing it too.  So there.

Admittedly, I'm not a theological expert, but to my ears this sounds only slightly more sophisticated than something you might hear from a red-faced five-year-old.  Augustine must be spinning in his grave.

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Fixing the Ratings Agencies

| Mon Sep. 28, 2009 10:03 PM EDT

Matt Yglesias comments on the packaging of crappy loans back in the heyday of the credit bubble:

The mysterious thing isn’t that people made bad loans that they were able to package and sell off, the mysterious thing is that they found buyers for the securities.

Ultimately this looks to me to go back to the ratings agencies, an issue [Barney] Frank sort of dodged. But the ratings agencies are private for-profit companies that also enjoy a kind of government-sponsored monopoly status. In theory their behavior should be subject to market discipline, but in practice it’s not. They screwed up badly. But while lots of companies have gone bankrupt and lots of people have lost their jobs, the ratings agencies are all still in business. And no new competitors are coming to the fore and there’s no real way for anyone to break into the industry.

No question about it: over the past decade ratings agencies were, at best, negligent, and at worst, perpetrators of outright fraud.  "It could be structured by cows and we would rate it" is surely one of the all-time great quotes of the bubble era.  And the fact that agencies shared their models with issuers so they'd have an easier time tweaking their products to get high ratings is prima facie evidence of corruption.  Slapping a AAA rating on every cobbled-together junkpile that slithered its way out of a Wall Street structured finance group certainly helped fuel the fantastic expansion of risky investments that all came crashing down in 2008.

Still, I have to admit that over the past year ratings agencies have moved down my personal league table of bad actors.  If you take a look at the list of possible causes for our recent financial meltdown here, I probably would have put the ratings agencies in the top five a year ago, while today I'm not sure I'd even put them in the top ten.

Partly this is because I've become more sympathetic to fundamental macroeconomic explanations for the bubble: easy money, current account imbalances, massive abuse of leverage, and huge increases in both debt and risk that were masked by ever more baroque credit derivatives.  Partly it's because widely accepted1 risk models based on CDS spreads mostly produced the same results as the ratings agencies.  Partly it's because the negligence/fraud involved in producing high ratings was pretty clearly a two-way street: buyers and sellers of structured investments were every bit as anxious to get them as the ratings agencies were to provide them.

Beyond that, I'm also a bit flummoxed about what the answer to the ratings agency problem might be.  There's probably a reasonable regulatory solution for fraud and negligence, but there seems to be wide agreement that the real problem is incentives: since issuers are the ones paying for ratings, it's inevitable that agencies are going to lean into the wind to provide ratings the issuers like.  I've read dozens of proposals for ratings agency reform, but the only one that really gets at this fundamental conflict-of-interest problem is to simply do away with them and turn debt rating into a government function.  I'm a little skeptical of that, though, since it's not at all clear to me that a government agency could hire the kind of talent it takes to keep up with Wall Street's rocket scientists.  What's more, it's not at all clear to me that anyone — Fed regulators included — would have rated SIVs much differently during the boom years than the ratings agencies did.

So....I'm not sure what the answer is.  Tighter regulation would obviously be welcome, but how do we get rid of the underlying conflict-of-interest problem?  How do we align agency incentives in favor of long-term accuracy?  How do we encourage real competition between the agencies, rather than a race to the bottom?  None of the regulatory reforms I've seen really get at this in a fundamental way.  Does that mean that a government takeover is the only real answer?  Or does it mean that there is no real answer and we've collectively decided to shrug our shoulders and allow this to happen all over again in a few years?  Somebody should ask Barney Frank.

1Whether they should have been widely accepted is a different question.  But they were.

800 Years of Financial Folly

| Mon Sep. 28, 2009 7:00 PM EDT

Carmen Reinhart and Kenneth Rogoff have done something that, apparently, no one has done before: rigorously collect data on debt and risk management (or lack thereof) over the past 800 years, rather than only since 1980.  Their conclusion: excessive debt accumulation is always and everywhere a very, very bad thing.

Also: credit booms and busts happen over and over throughout history, with only the details changing; public sector debt crises are common and devastating; banking crises hit every country, rich and poor alike; and when credit bubble pop, everything pops along with it.  And finally, a fifth lesson, as summarized by Martin Wolf:

The final lesson is that financial liberalisation and financial crises go together like a horse and carriage. It is no surprise, therefore, that the last 30 years have seen waves of financial crises, of which the latest one is merely the biggest. The current crisis is the worst since the Great Depression. Yet, argue the authors, no one should have been surprised by this outcome. The US showed all the classic symptoms of a country heading for crisis: a huge current account deficit; soaring house prices; headlong credit growth; and, let us not forget, excessively complacent regulators.

It always comes back to debt and leverage, doesn't it?  There are lots of other things to watch out for too, but the bottom line is that if you keep leverage at reasonable levels, your financial crises are likely to be manageable.  If not, not.  Tim Geithner, please take note.

Assignment Desk Watch

| Mon Sep. 28, 2009 2:07 PM EDT

If the New York Times is serious about its shiny new plan to cover the conservative noise machine more thoroughly, they better jump on this one right away.  By tomorrow it will probably be gone, yet another important story missed by the mainstream media.  Get cracking, guys.

The Case of the Missing Documents

| Mon Sep. 28, 2009 1:44 PM EDT

Two years ago the ACLU filed a request for records about torture and detainee abuse.  Part of what they got was a list of 181 documents the government considered exempt from release.  But when the feds took another look this year, they couldn't find ten of the documents on the original list.  What happened?  Nick Baumann speculates:

"It was impossible to ascertain whether the discrepancy was the result of an error by the prior administration when it created the original...index or whether the prior administration misplaced the documents in question," Tracy Schmaler, a Justice Department spokeswoman, told Mother Jones. In other words, CIA and Justice Department lawyers might have mistakenly listed documents that never existed in the first place.

But is it plausible that the inconsistency could be merely a clerical error? After the Bush administration created the index, a CIA official swore under oath that she had reviewed the documents on the original list. And one of the disputed documents was listed on the original index as a 46-page memo "providing legal advice," classified as top secret and dated 25 July 2002. Schmaler says the Obama administration's search never found a document matching that description. Could the CIA and Justice Department lawyers who composed the original list have mistakenly included a non-existent memo — complete with a date and precise page count?

Well, maybe there were two 46-page memos written on 25 Jul 2002.  Or, um, maybe it was actually a memo about restraining booze, not detainee abuse.  Or something.  I'm sure it will all be cleared up soon.  Move along folks.  Nothing to see here.

The Third Rail

| Mon Sep. 28, 2009 1:04 PM EDT

Conor Friedersdorf comments on Glenn Beck's recent heresy that a McCain presidency might have been even worse than an Obama presidency:

It is therefore no surprise that Comrade Beck is now being turned on by Comrade Limbaugh and Comrade Levin (the one among the trio who actually believes most of what he says)....

Well, Levin might believe most of what he says, but I was at Blockbuster the other day and found myself thumbing through a copy of his recent bestseller, Liberty and Tyranny(Why does Blockbuster now sell books?  That's a question for another time.)  To my surprise, it turns out that for all his bombast, Levin is a wimp.

The end of his book is taken up by a "conservative manifesto," and it's chock full of fire-breathing stuff.  Eliminate the income tax, eliminate corporate taxes, put a hard cap on the size of the federal government, eliminate tax-exempt status for all environmental groups, rein in judicial review, insist on originalism as the only proper way to interpret the constitution, make governments pay property owners for all zoning changes that affect them, wipe out all teachers unions, no national healthcare, crank up military spending, put God back in government, etc. etc.  I'm paraphrasing a bit, but you get the idea.  It's hardcore right-wingerism.

Obviously, then, a guy like this wants to do away with Social Security and Medicare, right?  Well, hold on there, pardner.  Let's not go off half-cocked.  Sure, they're "poisonous snake oil," but all Levin can bring himself to suggest is that young people be educated about the intergenerational "trap" of entitlements so that they can be "contained, limited, and reformed."  Educated!  Limited and reformed!  That's it.

Pretty weak tea for a firebreather.  Even among the wingers, it turns out, Social Security is a third rail.  After all, I guess Levin wants old people to buy his book too.

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Who Benefits From Medicare Advantage?

| Mon Sep. 28, 2009 11:44 AM EDT

When Congress passed the Medicare prescription drug plan in 2003, it provided two ways for seniors to get access to pharmaceuticals: they could enroll directly in a prescription drug plan or, via Medicare Advantage, they could enroll in an HMO that offered drug coverage.  Medicare Advantage, of course, has long been controversial because the government provides subsidies to HMOs to participate, which means that it's more expensive to taxpayers than standard Medicare.

Still, Medicare Advantage enrollees enjoy extra benefits.  The program also provides incentives for HMOs to enter new areas and compete with each other.  So it's not as if the subsidies are being completely wasted.

But it does turn that they're being mostly wasted.  Austin Frakt, a health economist at Boston University, provides the dismal numbers:

My work (with Steve Pizer and Roger Feldman) shows that for each additional dollar spent by the federal government (taxpayers) on the program since 2003, just $0.14 of it can be attributed to additional value (consumer surplus) to beneficiaries....

What do we make of the other $0.86? That goes to the insurance companies but doesn’t come out “the other end” in the form of value to beneficiaries. In part it pays for the additional benefits themselves and in part it is captured as additional insurer profit.

Conversely, standard prescription drug plans provide more than a dollar of benefit for each dollar spent.  Roughly speaking, these plans cost taxpayers about 75 cents for each dollar of value they provide.

Bottom line: if healthcare reform cuts back on Medicare Advantage, the effect on retirees would be tiny.  Putting even half of the cuts back into standard prescription drug plans would almost certainly make everyone better off except for insurance companies.  The full paper is here.

Quote of the Day

| Sun Sep. 27, 2009 12:52 PM EDT

This is from Binyamin Appelbaum's front-page story in today's Washington Post about the Fed's unwillingness to regulate subprime lending by affiliates of commercial banks:

"There was a long period when things were going very well and regulation was viewed as something that got in the way," said Alice Rivlin, the Fed's vice chairman from 1996 to 1999 and now a fellow at the Brookings Institution.

The Fed also minimized repeated warnings about mortgage lending abuses in part because it was an institution dominated by big-picture economists focused on the health of the broader economy rather than the problems faced by individual borrowers.

[Former Fed chairman Alan] Greenspan said in an interview that he did not think the Fed was suited to policing lending abuses because of its focus on broader issues, but he added, "I'm not sure anyone could have done it better." He said the administration's plan to create a consumer protection agency was "probably the right decision."

Greenspan is exactly right.  This is more than just the usual issue of regulatory capture (though it's that too).  The Fed is a bad choice to regulate this stuff because their first priority is always going to be macroeconomic stability.  That's exactly as it should be, but it means that regulating consumer products will simply never be anything more than an afterthought for them.

The same is true for virtually every other existing regulator too: they already have settled missions and settled cultures that value specific tasks.  Consumer lending regulation isn't one of them, so it will never be able to compete effectively for attention.  The only place it has a chance of succeeding is at a new agency in which everyone from top to bottom considers it their primary mission in life.  That's what a strong CFPA brings to the table.

Will it eventually be captured by the industry it's supposed to regulate?  Sure.  And then we'll have to try to fix things again.  But no solution is eternal, so that's hardly a good reason not to act.  We should set up a CFPA that's as strong as we can make it; that has its incentives aligned as precisely as we can align them; and that has an institutional base of power that allows it to actually get things done.  It won't be perfect, but it will be a lot better than anything we have now.

The Meltdown List

| Sat Sep. 26, 2009 8:01 PM EDT

Off the top of my head, here's a list of the various things people have blamed for last year's economic meltdown:

1. Housing bubble
2. Mortgage securitization mania
3. Massive growth of complex credit derivatives
4. Mortgage fraud, growth of NINJA/liar/HELOC/option ARM/etc.
5. Asian savings glut
6. Long-term current account imbalances
7. Ratings agency flimflam
8. 2007-08 oil shock
9. Overuse of leverage on Wall Street
10. Easy money policy from Fed
11. Reliance on bad risk models (VaR, CAPM, etc.) that led to consistent undervaluation of risk
12. Too much debt (both household and financial sector)
13. Government efforts to increase homeownership
14. Repeal of Glass-Steagall

I don't have any particular agenda here.  I'm just collecting reasons, and obviously there's quite a bit of overlap on this list already.  But I'm still looking for more!  If I'm missing anything that a significant number of people think had a significant effect, please leave it in comments.

UPDATE: Added from comments:

15. Pay practices that provided incentives for risky behavior
16. Greenspan/Bernanke put (i.e., the widespread belief that the Fed would bail out any big bank that failed)
17. Inadequate regulation of shadow banking sector
18. Poor bank capitalization regulations that allowed too much off-balance-sheet risk

Adapting to Climate Change

| Sat Sep. 26, 2009 5:39 PM EDT

Are conservatives stuck over climate change because they're devoted to free market principles and there just aren't any free market solutions to reducing CO2Matt Yglesias thinks this is too kind an interpretation:

How about reductions in subsidies for fossil fuel production and consumption? The free market credentials seem impeccable. Or how about a “green tax shift” in which carbon is taxed or carbon emission permits are auctioned and the revenue is used to finance deficit-neutral reductions in other taxes?

....But that’s not what we have. Not because market-oriented approaches are inadequate to the challenge but because too many of the key institutions that espouse market-oriented approaches are run by people who are too corrupt, incompetent, immoral, stupid, or cowardly to get their side to take the problem seriously.

Generally speaking, I agree.  There are a few conservatives out there who have argued in favor of free-marketish solutions like Pigouvian taxes and the like, but they're pretty thin on the ground.  The vast bulk of the conservative movement has simply decided to declare climate change a hoax and refuse to even consider doing anything about it.

Still, there really is a philosophical problem here too.  Eliminating subsidies for fossil fuels is a good idea, but it's also a drop in the bucket.  (And Democrats tend to be pretty big offenders on the subsidy front too.)  Revenue-neutral taxes could go a lot further, but they're not enough either.  Conservatives know that if they actually fess up to the full scope of the global warming problem, they're eventually going to have to accept some pretty serious government intervention to halt it.  Things like fuel economy standards, green research and development programs, moratoriums on coal-fired plants, tax incentives for conservation, new building efficiency standards, and much, much more.  There's nothing wrong with any of this stuff, but there's no question that it's a considerable amount of interference in the market.

Still, conservatives could adapt if they were smart.  After all modern conservatives have never really been very dedicated to free markets.  They're dedicated instead to being business friendly, which is quite a different thing.  And while not every business sector can benefit from new climate change regulations1, an awful lot of them can2.  So why not accept the science of climate change and then simply press for the most business friendly solutions possible?  It would mean rewarding a different set of business partners than they're used to, but so what?  Might as well start currying favor (and campaign contributions) from the businesses of the future instead of the businesses of the past.  Right?

1Coal-fired electricity, beef production, and SUVs, for example.  Those are almost certainly losers no matter what approach you take to limiting climate change.

2Nuclear/wind/solar electricity, biofuel production, weatherproofing, electric cars, etc. etc.