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Where's the regulatory middle ground?

Economist Mark Thoma of the University of Oregon is no fan of Republicans, so he's probably not a go-to source for suggestions on how they should conduct themselves in Congress. But he raised an interesting point in a blog post Saturday that questioned the rationale of the GOP's "Nobama" approach in response to the most obvious market failures of our generation:

There's an inconsistency between free market ideology and the need for reform in areas like health care and financial services. One of the first steps in reforming the system is to acknowledge that the market won't take care of the problems itself. Once that is acknowledged, i.e. that regulation is needed to fix these market failures, the only question is whether that regulation will be of the "market-based" variety or by edict (e.g. this is the difference between system of tradable carbon permits that allow least cost carbon reduction strategies to emerge and a government set emission limit for each industry which generally does not achieve carbon reductions at least cost).

With Democrats mostly opposed to old fashioned edict style regulation -- with their willingness to embrace market-based solutions to regulatory issues --  and with Republicans unwilling to embrace anything that Democrats propose, there is little ground left for those Republicans who are willing to admit that markets sometimes fail to stand upon. Democrats have taken the middle ground -- market based regulation -- from Republicans. This leaves Republicans with a choice of going along and compromising (and thereby embracing proposals they have made in the past, e.g. the health care bill looks an awful lot like the health care program [then-Gov. Mitt] Romney put in place in Massachusetts), or standing in opposition simply because it is a Democratic proposal. The choice they've made, standing in opposition to everything, is a losing strategy that allows policy to be shaped entirely be the other side. It will be interesting to see if a fissure develops within the Republican Party over this.

Will Republicans be able to share the market-based regulatory ground Democrats have taken away? There are already signs that Republicans will work with Democrats on financial reform, but there were early signs of a bi-partisan effort on health care as well, so we'll see how this plays out. I think people are fed up with banks and want something to be done, and Republican attempts to block legislation won't play well with the public at all. So I expect the coalition of no to be broken -- some legislators will see that they cannot continue just saying no and expect public support -- but not without big fights within the Republican Party between the extremists and the centrists. If Republicans do move in this direction, and it's more likely they'll do so on financial reform than on climate change legislation, you'll see an attempt to reclaim these policies as Republican (here's a great example: Health Care Reform--A Republican Idea?). And given the administration's centrist tendencies, in many cases they'll have a pretty good argument.

For those who might want to argue that the debacle triggered by the subprime collapse wasn't a market failure, please revisit then-Treasury Secretary Henry M. Paulson's comments to the Times' editorial board in December 2007. That's in the halcyon days prior to the failure and/or bailout of Bear Stearns, Lehman Bros., AIG, Fannie Mae, Freddie Mac and others, when "market failure" seemed more like a treatable illness than a pandemic.

-- Jon Healey

 

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andrew nelson

There's an inconsistency between what the corporate giant, Tribune Company, owner of the LA Times describes as free market ideology and the need for reform in areas like health care and financial services. One of the first steps in reforming the system is to acknowledge that (1) there is no free market, and (2) that the economy of the United States has been 'cornered', that the media industry, energy industry, the financial industry, and the health care industry, all have effectively captured our government—a state of affairs that more typically describes emerging markets, and is at the center of many emerging-market crises.

Once that is acknowledged, i.e. that regulation is needed to fix these market failures, to create true free markets, the only question is whether that regulation will be of the "market-based" variety or by edict (e.g. this is the difference between system of tradable carbon permits that allow least cost carbon reduction strategies to emerge and a government set emission limit for each industry which generally does not achieve carbon reductions at least cost). Or whether health care can be made affordable to all by eliminating the monopolies in states, or by edict, (i.e. that government MANDATES that individual citizens purchase from monopolies, despite price fixing, despite no market force mechanisms that control cost.)

If the International Monetary Fund's (IMF’s) staff could speak freely about the U.S., it would tell us what it tells all countries in this situation: recovery will fail unless we break the financial, health, and energy oligarchy that is blocking essential reform. And if we are to prevent a true depression, we’re running out of time.

The reason, of course, is that the IMF specializes in telling its clients what they don’t want to hear.

Every crisis is different, of course. Ukraine faced hyperinflation in 1994; Russia desperately needed help when its short-term-debt rollover scheme exploded in the summer of 1998; the Indonesian rupiah plunged in 1997, nearly leveling the corporate economy; that same year, South Korea’s 30-year economic miracle ground to a halt when foreign banks suddenly refused to extend new credit.

To IMF officials, all of these crises looked depressingly similar. Each country, of course, needed a loan, but more than that, each needed to make big changes so that the loan could really work. Almost always, countries in crisis need to learn to live within their means after a period of excess—exports must be increased, and imports cut—and the goal is to do this without the most horrible of recessions. Naturally, the fund’s economists spend time figuring out the policies—budget, money supply, and the like—that make sense in this context. Yet the economic solution is seldom very hard to work out.

No, the real concern of the fund’s senior staff, and the biggest obstacle to recovery, is almost invariably the politics of countries in crisis.

Typically, these countries are in a desperate economic situation for one simple reason—the powerful elites within them overreached in good times and took too many risks. Emerging-market governments and their private-sector allies commonly form a tight-knit—and, most of the time, genteel—oligarchy, running the country rather like a profit-seeking company in which they are the controlling shareholders. When a country like Indonesia or South Korea or Russia grows, so do the ambitions of its captains of industry. As masters of their mini-universe, these people make some investments that clearly benefit the broader economy, but they also start making bigger and riskier bets. They reckon—correctly, in most cases—that their political connections will allow them to push onto the government any substantial problems that arise.

But inevitably, emerging-market oligarchs get carried away; they waste money and build massive business empires on a mountain of debt. Local banks, sometimes pressured by the government, become too willing to extend credit to the elite and to those who depend on them. Overborrowing always ends badly, whether for an individual, a company, or a country. Sooner or later, credit conditions become tighter and no one will lend you money on anything close to affordable terms.

The downward spiral that follows is remarkably steep. Enormous companies teeter on the brink of default, and the local banks that have lent to them collapse. Yesterday’s “public-private partnerships” are relabeled “crony capitalism.” With credit unavailable, economic paralysis ensues, and conditions just get worse and worse. The government is forced to draw down its foreign-currency reserves to pay for imports, service debt, and cover private losses. But these reserves will eventually run out. If the country cannot right itself before that happens, it will default on its sovereign debt and become an economic pariah. The government, in its race to stop the bleeding, will typically need to wipe out some of the national champions—now hemorrhaging cash—and usually restructure a banking system that’s gone badly out of balance. It will, in other words, need to squeeze at least some of its oligarchs.

Squeezing the oligarchs, though, is seldom the strategy of choice among emerging-market governments. Quite the contrary: at the outset of the crisis, the oligarchs are usually among the first to get extra help from the government, such as preferential access to foreign currency, or maybe a nice tax break, or—here’s a classic Kremlin bailout technique—the assumption of private debt obligations by the government. Under duress, generosity toward old friends takes many innovative forms. Meanwhile, needing to squeeze someone, most emerging-market governments look first to ordinary working folk—at least until the riots grow too large.

Eventually, as the oligarchs in Putin’s Russia now realize, some within the elite have to lose out before recovery can begin. It’s a game of musical chairs: there just aren’t enough currency reserves to take care of everyone, and the government cannot afford to take over private-sector debt completely.

Jon, you didn't even frame the debate honestly. Or maybe you just don't realize it. But that's because you, and your oligarchy in the mainstream media are part of the problem.

This is a fight between Big Government, and Big Industry Oligarchies. If congress would regulate interstate commerce, like they were supposed to, we wouldn't be in this mess.

andrew nelson

In regard to your comments on finanical meltdown:

In its depth and suddenness, the U.S. economic and financial crisis is shockingly like what we have recently seen in emerging markets (and only in emerging markets): South Korea (1997), Malaysia (1998), Russia and Argentina (time and again).

In each of those cases, global investors, afraid that the country or its financial sector wouldn’t be able to pay off mountainous debt, suddenly stopped lending. And in each case, that fear became self-fulfilling, as banks that couldn’t roll over their debt did, in fact, become unable to pay.

This is precisely what drove Lehman Brothers into bankruptcy on September 15, causing all sources of funding to the U.S. financial sector to dry up overnight. Just as in emerging-market crises, the weakness in the banking system has quickly rippled out into the rest of the economy, causing a severe economic contraction and hardship for millions of people.

But there’s a deeper and more disturbing similarity: elite business interests—financiers, in the case of the U.S.—played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of the government, until the inevitable collapse. More alarming, they are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive. The government seems helpless, or unwilling, to act against them.

Top investment bankers and government officials like to lay the blame for the current crisis on the lowering of U.S. interest rates after the dotcom bust or, even better—in a “buck stops somewhere else” sort of way—on the flow of savings out of China. Some on the right like to complain about Fannie Mae or Freddie Mac, or even about longer-standing efforts to promote broader homeownership. And, of course, it is axiomatic to everyone that the regulators responsible for “safety and soundness” were fast asleep at the wheel.

But these various policies—lightweight regulation, cheap money, the unwritten Chinese-American economic alliance, the promotion of homeownership—had something in common. Even though some are traditionally associated with Democrats and some with Republicans, they all benefited the financial sector. Policy changes that might have forestalled the crisis but would have limited the financial sector’s profits—such as Brooksley Born’s now-famous attempts to regulate credit-default swaps at the Commodity Futures Trading Commission, in 1998—were ignored or swept aside.

The financial industry has not always enjoyed such favored treatment. But for the past 25 years or so, finance has boomed, becoming ever more powerful. The boom began with the Reagan years, and it only gained strength with the deregulatory policies of the Clinton and George W. Bush administrations.
Several other factors helped fuel the financial industry’s ascent. Paul Volcker’s monetary policy in the 1980s, and the increased volatility in interest rates that accompanied it, made bond trading much more lucrative.

The invention of securitization, interest-rate swaps, and credit-default swaps greatly increased the volume of transactions that bankers could make money on. And an aging and increasingly wealthy population invested more and more money in securities, helped by the invention of the IRA and the 401(k) plan. Together, these developments vastly increased the profit opportunities in financial services.

Not surprisingly, Wall Street ran with these opportunities. From 1973 to 1985, the financial sector never earned more than 16 percent of domestic corporate profits. In 1986, that figure reached 19 percent. In the 1990s, it oscillated between 21 percent and 30 percent, higher than it had ever been in the postwar period. This decade, it reached 41 percent. Pay rose just as dramatically. From 1948 to 1982, average compensation in the financial sector ranged between 99 percent and 108 percent of the average for all domestic private industries. From 1983, it shot upward, reaching 181 percent in 2007.

The great wealth that the financial sector created and concentrated gave bankers enormous political weight—a weight not seen in the U.S. since the era of J.P. Morgan (the man). In that period, the banking panic of 1907 could be stopped only by coordination among private-sector bankers: no government entity was able to offer an effective response. But that first age of banking oligarchs came to an end with the passage of significant banking regulation in response to the Great Depression; the reemergence of an American financial oligarchy is quite recent.

Of course, the U.S. is unique. And just as we have the world’s most advanced economy, military, and technology, we also have its most advanced oligarchy.

In a primitive political system, power is transmitted through violence, or the threat of violence: military coups, private militias, and so on. In a less primitive system more typical of emerging markets, power is transmitted via money: bribes, kickbacks, and offshore bank accounts. Although lobbying and campaign contributions certainly play major roles in the American political system, old-fashioned corruption—envelopes stuffed with $100 bills—is probably a sideshow today, Jack Abramoff notwithstanding.

Instead, the American financial industry gained political power by amassing a kind of cultural capital—a belief system. Once, perhaps, what was good for General Motors was good for the country. Over the past decade, the attitude took hold that what was good for Wall Street was good for the country. The banking-and-securities industry has become one of the top contributors to political campaigns, but at the peak of its influence, it did not have to buy favors the way, for example, the tobacco companies or military contractors might have to. Instead, it benefited from the fact that Washington insiders already believed that large financial institutions and free-flowing capital markets were crucial to America’s position in the world.

One channel of influence was, of course, the flow of individuals between Wall Street and Washington. Robert Rubin, once the co-chairman of Goldman Sachs, served in Washington as Treasury secretary under Clinton, and later became chairman of Citigroup’s executive committee. Henry Paulson, CEO of Goldman Sachs during the long boom, became Treasury secretary under George W.Bush. John Snow, Paulson’s predecessor, left to become chairman of Cerberus Capital Management, a large private-equity firm that also counts Dan Quayle among its executives. Alan Greenspan, after leaving the Federal Reserve, became a consultant to Pimco, perhaps the biggest player in international bond markets.

These personal connections were multiplied many times over at the lower levels of the past three presidential administrations, strengthening the ties between Washington and Wall Street. It has become something of a tradition for Goldman Sachs employees to go into public service after they leave the firm. The flow of Goldman alumni—including Jon Corzine, now the governor of New Jersey, along with Rubin and Paulson—not only placed people with Wall Street’s worldview in the halls of power; it also helped create an image of Goldman (inside the Beltway, at least) as an institution that was itself almost a form of public service.

andrew nelson

Bottom Line Up Front:

Of course, the U.S. is unique. And just as we have the world’s most advanced economy, military, and technology, we also have its most advanced oligarchy.

In a primitive political system, power is transmitted through violence, or the threat of violence: military coups, private militias, and so on. In a less primitive system more typical of emerging markets, power is transmitted via money: bribes, kickbacks, and offshore bank accounts. Although lobbying and campaign contributions certainly play major roles in the American political system, old-fashioned corruption—envelopes stuffed with $100 bills—is probably a sideshow today, Jack Abramoff notwithstanding.

What we are witnessing now, is the musical chairs of the dancing oligarchs. Someone has to lose.

Jon Healey

@Andy -- When we media oligarchs lift extensive passages from someone else's work without attribution, it's called "plagiarism." So what would you call what you did to Simon Johnson, whose piece from the Atlantic last year (http://www.theatlantic.com/magazine/archive/2009/05/the-quiet-coup/7364/) you recycled at great length in your comments here?

I mean, you took so much of his piece in your first comment, I took it down just to be fair to the Atlantic and its copyrights. But then you did it again in your second comment, and your third is little more than a paraphrase. So I'm leaving them up so that I can point to them the next time you suggest that *I'm* not being honest, as you did here. You can (and obviously do) disagree with me, but at least let people know whose words you're recycling. I also urge you to treat assertions of fact the same way. Link to the source, let people know where your numbers are coming from. It makes for a better debate.

andrew nelson

But in regard to health care, your dichotomy is false, and the choices are false:

This is not free market ideology, nor is this a choice between the free market and the need for reform in areas like health care and financial services.

One of the first steps in reforming the system is to acknowledge that the U.S. is a 'captured' market, and not a free market.

That the fight is between Big Government, and Oligopolies. Once that is acknowledged, i.e. that regulation is needed to fix these market failures, the only question is whether that regulation will be of the "market-based" variety or by edict (i.e. breaking down state imposed barriers to insurance OR MANDATING that individual citizens buy insurance from a monopoly, with no control over the price of that insurance, or no free market mechanism to contain the costs)

Your 'choice' s are bleak for us. Big Government or Oligopoly.

If congress would regulate interstate commerce the way it was supposed to, we would not be in this mess.

Tom Davis

The financial system collapsed because of one thing and one thing only: The repeal of the Glass Steagall Act in 1999. Without that, the finanncial disaster of the last decade would not have been possible. On November 12, 1999, in a bi-partisan act of insanity, Democrats and Republicans together destroyed the wall that insulated our financial system for over 60 years. The first thing our congress should do is reinstate Glass-Steagall.


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