Kevin Drum

The Nuclear Summit

Knee-jerk partisanship and loose nukes.

| Wed Apr. 14, 2010 2:19 PM EDT

Via Spencer Ackerman, here is Sen. Jon Kyl (R–Ariz.) kvetching about the recently completed Nuclear Security Summit:

“The summit’s purported accomplishment is a nonbinding communique that largely restates current policy and makes no meaningful progress in dealing with nuclear terrorism threats or the ticking clock represented by Iran’s nuclear weapons program,” said Sen. Jon Kyl (R-Ariz.), a prominent critic of Obama’s nuclear policies.

Well now. China agreed to sanctions on Iran. Ukraine agreed to give up their HEU. Russia agreed to close down its last plutonium plant. And the entire conference agreed to focus far more attention on keeping fissile material out of the hands of terrorists.

But, yeah, it didn't solve every world problem instantly in its first meeting. By that yardstick the whole thing was a failure.

And that sound you just heard? It was Kyl's knee jerking so hard he gave himself a concussion. Crikey.

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The Muzzles

How's free speech doing these days?

| Wed Apr. 14, 2010 1:50 PM EDT

Via Jon Fasman, here are this year's Muzzles, given each year by the Thomas Jefferson Center for the Protection of Free Expression. I suppose this won't be a widespread opinion, but I'd say they go to show that the First Amendment is doing pretty well these days. Some of the items are infuriating (Texas basing tax breaks on whether you say nice things about Texas, Southwestern College banning peaceful protests practically everywhere on campus), but really, if the ten things on this list are the worst offenses of the entire year then free speech is in pretty good shape. I was expecting a lot worse.

Five Fights to Watch

How do we fix the ratings agency problem?

| Wed Apr. 14, 2010 12:25 PM EDT

Andy Kroll has a good piece up about "Five Fights to Watch" in the upcoming battle over financial regulatory reform. The whole thing is worth reading, but it's #2 that I have the hardest time figuring out how to fix:

2) The Ratings Agencies' Conflict of Interest Problem
The toxic mortgage bonds and other products that helped demolish the economy were stamped with blue-chip ratings from the big three ratings agencies — Moody’s, Standard and Poor’s, and Fitch. Why did they affix their seal of approval to junk investments? The answer is complex, but largely centers on the fundamental conflict of interest with the rating agencies: they get paid by the same firms that are seeking ratings for their products. This arrangement allowed banks to shop around for the highest score regardless of whether the product deserved it or not.

It’s not clear whether the Senate bill will fix this problem. Senate banking committee chair Chris Dodd (D-Conn.) has proposed creating a new watchdog within the Securities and Exchange Commission to keep an eye on the agencies. The bill would also give investors the right to sue them for “a knowing or reckless failure” to thoroughly investigate a product before issuing a rating. But will that SEC watchdog address the conflict of interest in how rating agencies get paid? Will it revisit the pseudo-governmental role played by the Big Three agencies, whom the SEC has used as official arbiters of safety in the markets? These questions, raised by academics, experts, journalists, and others, have yet to be fully addressed by the Senate.

This is a head scratcher. Ratings agencies made a ton of money out of the housing bubble. Basically, banks came to them with a swelling array of rocket-science securities and paid them to provide a rating. Because these structured securities were complex, the fees for figuring out the rating were high, and it turned into a lucrative source of business.

The conflict of interest is obvious: banks wanted high ratings and the agencies wanted lots of deal flow. That meant they were motivated to push the envelope in order to insure a steady stream of business. After all, if you get a little too picky about things, clients will just head across the street to see if a different agency might treat them a little better.

So the problem is pretty clear. But what's the solution? Ideally, someone else should pay the ratings agencies. But there's no one to do that, so that's out. Regulation might work, but then again, it might not. Complex securities really are complex, and figuring out the right model to apply is genuinely difficult. What's more, the guys structuring the deals are a lot smarter than the working stiffs at the agencies. It's really not a fair fight. Another idea is to open up the industry to more competition, but I've never really understood how that would improve things. The basic conflict of interest is still there no matter how many federally approved ratings agencies there are.

The lawsuit idea is an interesting one, though. Ratings agencies are immune from suits right now because years ago the courts bought their argument that ratings are just opinions and therefore protected by the First Amendment. You know, just like George Will and Paul Krugman are protected for their opinions. That sounds silly, but hey — the law is an ass. But even if that gets changed, "knowing or reckless failure" is a pretty high standard and it's not clear to me that it would really provide much of a brake on reckless behavior. Maybe worth a try, though.

Luckily, I don't think ratings agencies were really at the core of the financial meltdown. They helped things along for sure, but other stuff was a lot more fundamental. It would still be nice to come up with some kind of compelling fix for the conflict of interest at the heart of the ratings business, though. I'm just not sure what it is.

Talk to Chuck

It's long past time to end the outrageous carried interest rule.

| Wed Apr. 14, 2010 11:35 AM EDT

When I wrote my piece on financial regulation a few months ago ("Capital City," January), my intent was to illustrate the power of the finance lobby by providing examples of laws so egregiously favorable to the industry that even the fabled man on the street would instantly be outraged by them. Debit card fees was one example. The Commodity Futures Modernization Act was another. The SEC's ruling that investment banks could increase their leverage in 2004 was yet another.

But my favorite has always been the carried interest rule:

Wall Street bankers may seem like a pretty well-off bunch, but when they decide that a million dollars doesn't go as far as it used to, they leave and start up a hedge fund. Hedge fund managers typically get paid 2 percent of the value of the assets under their control plus 20 percent of the investment profits, and for a successful manager this can add up to tens or even hundreds of millions of dollars a year. Aside from market reversals, the only real threat to their riches is the IRS.

Their defense against the taxman is something called the carried interest rule, and it's elegant in both its simplicity and its shamelessness: It simply declares their compensation to be capital gains, not ordinary income. That means it gets taxed at 15 percent instead of 35 percent.

At first, it's hard to figure out how they get away with this. After all, capital gains are the profit you make on money of your own that you invest. But hedge fund managers invest other people's money and get paid a piece of the action. By any customary definition, this is ordinary income, the same as a sports agent taking his 10 percent or a CEO whose bonus depends on performance.

But enough money can buy you a defense of the indefensible.

The rest of this riff was mainly an attack on Sen. Chuck Schumer (D–NY), who, whatever his other fine qualities, was a defender of the indefensible when he blocked action on the carried interest rule three years ago. Now it's back in the news again, and there's at least one Republican who's practically daring Democrats to take action:

Senate Finance ranking member Chuck Grassley said he didn’t think Democrats would let things get that far. “The House first voted to change the taxation of carried interest almost two-and-a-half years ago, and has passed legislation three times,” Grassley said. “Senate Democrats must have concerns, since the Senate hasn’t adopted the change in that timeframe. So the policy appears to be controversial with Senate Democrats.”

Grassley is, to put this delicately, not exactly the most calm and composed member of the world's greatest deliberative body. But a dare is a dare, and if Grassley is willing to vote with Dems to end the insanity of the carried interest rule and start taxing billionaires at at least the same rate as bus drivers — well, who are we to turn him down? Among big ticket tax items, this is probably the most outrageous example of coddling the rich currently on the books, and if we can't change it now, with the public practically in a mood to lynch Wall Street bankers, when can we change it? So why not give Chuck Schumer a call and politely suggest that it's time to do something about this? He's at 202-224-6542.

Quote of the Day: Close to Zero

Being trigger happy really doesn't go well with being president.

| Tue Apr. 13, 2010 5:27 PM EDT

It's Jonah Goldberg day! Here he is again, writing about Obama and nuclear weapons:

Even if we had no missile treaties of any kind, the likelihood that he would ever use nukes remains close to zero. I think pretty much everyone around the world knows that about him.

Jesus. I sure hope that the likelihood of Obama ever using is nukes is "close to zero." Not exactly zero, mind you, because you never know. But close? Oh yeah. I wonder what likelihood Jonah would prefer?

Wait, $45 To Stow Your Carry-on?!

Why new bag fees might not be so bad.

| Tue Apr. 13, 2010 4:59 PM EDT

Matt Yglesias tries to convince me that charging $45 to stow a carry-on bag on my next flight isn't such a bad thing:

Everyone outraged by Spirit Airlines’ decision to start trying to charge an extra fee for people who want to use the overhead bins — including Chuck Schumer who seems to be aiming for a quasi-regulatory solution or else a way to get on camera — should consider Paul Krugman’s argument that price-discrimination in monopolist-dominated markets is socially optimal.

Technically, I don't really disagree. Ever since deregulation, airlines have been the poster children for rampant price discrimination. Everybody says they hate it, but the fact that airlines have practically been driven out of business by their inability to make money suggests that consumers have done pretty well by it. What's more, Spirit's bag fee has all sorts of excellent arguments in its favor. It gives you an incentive to pack light. It gives you an incentive not to slow everyone down loading and unloading the overhead bins. It lets people fly extra cheap if they're willing to fly with no baggage — as my grandmother used to do. (Don't ask.)

And yet....there's a social aspect to this that gnaws at me a little bit. A while back there was a minor blog thread that made the rounds over the issue of free bread at restaurants. Economically, this is inefficient. People eat more bread than they really want because it's "free." People who don't want bread subsidize everyone else. Etc.

All true. But one of the primary causes of personal stress is decisionmaking, and modern life jacks that up every time we're forced to make yet another goddam decision. Do we really want to have to decide if we want the bread or do we just want to enjoy dinner? Do we want a dozen different options on our flight, or would we rather just buy a ticket that includes all the usual stuff? Should credit card apps have 30 pages of legalese attached to them or would a few simple rules about interest rates and annual fees be enough?

Choice is good. Most of the time we want it, and economically it's often beneficial. But it can also hide things and make prices hard to compare.  Is the Spirit flight really cheaper? Better do a close comparison! Is dinner at Joe's the same price as dinner at Mary's? If Joe charges for bread, maybe not. And that cheap credit card might not be as cheap as you think if your rate suddenly gets jacked up because you paid your water bill late and didn't realize that made a difference. Not having to worry about that stuff might be worth a few dollars.

Anyway, just a thought. Cheap flights are good, but sometimes there's such a thing as a market that's too efficient. We might all find ourselves a little bit happier and a little bit less frazzled if prices were a few dollars higher and, in return, there were a few less decisions forced on us every day.

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The Investment Drought

Housing becomes a bubble only when there's nothing better to invest in.

| Tue Apr. 13, 2010 2:58 PM EDT

Via Tyler Cowen, a guy who goes by the handle "Phone Booth" offers this take on the global savings glut and the great financial meltdown:

It wasn't that the world was saving too much relative to the past and the uncertainties of the present. Instead, low long-term interest rates were caused by the lack of demand for savings. This lack of demand for capital is, of course explained by the lack of investment opportunities.

....The whole crisis makes perfect sense if you start with lack of high [return on equity] investment opportunities in the world as a whole, with local markets struggling to incorporate this information appropriately. To institutional investors, ranging from pension funds to insurance companies, fixed income investments appear disproportionately attractive in this environment, driving long-term interest rates low. Consequently, mortgage rates drop, making equity investment in housing attractive for homeowners....This temporarily cushions the blow to the economy of not having high ROE investment opportunities, by becoming the high ROE investment opportunity itself.

....[But these] investment opportunities turn out to have been illusory and cause significant losses for whoever in the supply chain is stuck with the excess inventory. The growth in supply of housing uncovers the illusion and the resulting price volatility causes a credit crisis and a severe economic downturn, as the economy faces both the temporary shock of price volatility and the long term shock of lack of high ROE investment opportunities.

And what explains the lack of high ROE investment opportunities in the first place? There are many places to look, but the biggest is the supply bottleneck in energy. While the growth in information technology has been impressive, as is the consequent potential for increase in productivity, none of this can increase return on capital against the backdrop of energy supply bottleneck. 

Years and years ago, this was the very first thing that got me worried about the U.S. economy. I hadn't even heard of the infamous savings glut at the time (it was before Ben Bernanke invented the idea, I think) but the flip side of a savings glut is an investment drought and that sure seemed to increasingly describe an ongoing phenomenon. Corporations were hoarding cash and buying back stock instead of making investments in the real world, and that was pretty worrisome. Sure, we were just coming off the dotcom boom and everyone was a little nervous, but during an economic expansion there ought to be plenty of good opportunities to expand business and attract new customers. So why weren't companies more bullish?

Like Tyler, I'm not sure that energy is the answer here, but then again, it's not a bad guess either. The steady rise in oil prices during the aughts, followed by the spike in 2007-08, probably deserves more blame for the financial crisis than it usually gets. But whatever the reason, certainly one of the reasons for the housing bubble was the simple fact that real-world investment opportunites in goods and service just didn't look very attractive. Figuring out why really ought to get more study than it has.

Chart of the Day: Bankers Back in the Saddle

Bankers back to doing what they do best: makeing money for themselves.

| Tue Apr. 13, 2010 1:57 PM EDT

This Bloomberg chart on financial industry profits prompts Paul Kedrosky to snark that it just goes to show that "even the worst bankers struggle to find ways to lose money when short rates are zero, the yield curve is steep, and credit is tight."

But I think that's mistaken. Wall Street is only full of bad bankers if you think the role of bankers is to provide efficient financial services to the rest of the economy. If you adopt the more correct attitude that the role of bankers is to make lots of money for bankers, then America has the best bankers in the world. And they're proving it yet again.

The $16 Billion Dots

Does password masking really cost Americans $16 billion a year?

| Tue Apr. 13, 2010 1:41 PM EDT

Felix Salmon picks up today on the computer security paper by Cormac Herley of Microsoft that I wrote about a few weeks ago, and after quoting Herley's estimate that one wasted minute per day among online users comes to $16 billion per year, says:

I think it's reasonable to assume that the idiotic practice of masking passwords by turning them into dots takes up a good minute of people's time each day, and saves much less than $16 billion a year if it saves anything at all.

That took me aback. I'd never even considered the thought that password masking might be a bad idea. Felix links to an Alertbox column by Jakob Nielsen which suggests that (a) password masking causes more errors and prompts users to choose simple passwords and (b) usually no one is looking over your shoulder anyway so it doesn't do any good. Maybe for banking sites it's OK, but we should skip it everywhere else.

I guess I'm not sure about this. The great divide in computing these days isn't between PC and Mac users (spare me, please), it's between the deskbound and the mobile. The problem is that password masking cuts both ways. I'm deskbound myself, which means that it really is true that no one is ever looking over my shoulder. On the other hand, it also largely means that password masking doesn't cause me any problems.1 Conversely, if I were mobile I might make more mistakes typing in my passwords, but then again, there's also a greater chance that someone really might be looking over my shoulder.

I guess my feeling is that password masking probably doesn't provide a ton of protection, but then again, I don't really believe it costs $16 billion a year either. Trying to do cost accounting on tiny snippets of personal time is a mug's game, and kind of a dumb one even if I've been known to do it myself from time to time.

But I dunno. Maybe password masking causes more problems than I think. What says the hive mind?

1Though in an office, even the deskbound ought to be careful. Coworkers are probably more likely to try and steal a password than some random guy in a bus station.

Subway Bombers vs. Airplane Bombers

| Tue Apr. 13, 2010 12:59 PM EDT

Ever since he pled guilty to terrorism charges a few weeks ago, would-be subway bomber Najibullah Zazi has been cooperating with authorities. The New York Daily News brings us up to speed:

Chilling new details about the foiled Al Qaeda plot to blow up the city's busiest subways have emerged as a fourth suspect was quietly arrested in Pakistan, the Daily News has learned.

The unidentified man, who helped plan the plot, is expected to be extradited to the U.S. to be tried in Brooklyn Federal Court with Adis Medunjanin and Zarein Ahmedzay of Flushing, Queens, sources said.

Am I missing something here? Because I don't remember Fox News putting Zazi on a 24/7 loop and insisting that trial in a civilian court was basically a surrender to al-Qaeda. The right wing world doesn't seem to be objecting to this latest development, either. Why? Is blowing up an airplane somehow different from blowing up a subway? Are civilian courts and Miranda rights OK if the terrorist plot is broken up before it can be carried out, but not after? Or what? I'm a little confused about the conservative position on this stuff. Help me out.