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“Middle-Class Economics”

Fri, 02/27/2015 - 09:46

By James Kwak

Supposedly President Obama is making “middle-class economics” one of the key themes of his final two years in office. I don’t really know what this is supposed to mean in a country where people making ten times the median household income call themselves “middle class” and there are tens of millions of people in poverty.

For starters, I think it’s important to understand the distribution of wealth in the country as it stands today. That’s the theme of a story I wrote on Medium earlier this week, “The Magnitude of Inequality,” which uses charts and pictures to try to convey just how unequal a society we live in.

Yesterday I published another story on Medium about one of Obama’s “middle-class economics” proposals: the forthcoming Department of Labor rule that will try to protect people’s retirement savings from financial advisers’ conflicts of interest. It’s a complicated topic to understand, and the administration proposal will undoubtedly help—but not very much, given the scope of the retirement security problem.

What Is Citigroup Hiding From Its Shareholders Now?

Wed, 02/11/2015 - 10:53

By Simon Johnson

In the early and mid-2000s, Citigroup had compensation practices that can fairly be described as a disaster for shareholders (and for the broader economy). Top executives, such as then-CEO Chuck Prince, received big bonuses and generous stock options. Lower level managers and traders were paid along similar lines. These incentives encouraged Citi employees to take risks and boost profits. Unfortunately for shareholders, the profits proved largely illusory – when the dangers around housing and derivatives materialized fully, the consequences almost destroyed the firm.

The market value of Citigroup’s stock dropped from $277 billion in late 2006 to under $6 billion in early 2009. The shareholders could easily have been wiped out – they were saved from oblivion by a generous series of bailouts provided by the federal government (see Figure 7 in the final report of the Congressional Oversight Panel; direct TARP assistance was $50 billion but “total federal exposure” was close to $500 billion). In the next credit cycle, the experience for Citi shareholders could be even worse. So it is entirely reasonable for shareholders to look carefully at, among other things, the details of how executives and other key employees are paid – and to understand the current incentives for taking and managing risk.

But Citigroup is resisting efforts to disclose fully the structure of relevant compensation contracts. What is Citigroup hiding now?

The specific issue is a request by Richard Trumka, president of the AFL-CIO, for Citigroup to disclose precisely how employee compensation is affected when a person takes a government position. (See David Dayen’s article in the New Republic for more detail and context, including requests for similar information from other large banks. I use Mr. Dayen’s very helpful links to documents below.)

As Mr. Trumka puts it, “Like many institutional shareholders, the AFL-CIO supports the use of compensation plans that align the interests of senior executives with the long-term interests of the company. We oppose compensation plans that provide windfalls for executives that are unrelated to their performance.”

Citigroup’s compensation arrangements remained troubled long past the financial crisis. In 2011 shareholders rejected Citigroup’s executive compensation plan, in part because of concerns about the incentives for then-CEO Vikram Pandit. (Mr. Pandit was subsequently eased out of Citigroup, on generous terms relative to the value he provided to shareholders.)

The current board of directors has stated repeatedly that the problems with these policies are now fixed, precisely because executive compensation is now related to performance – including what happens after decisions are taken (see, for example, the company’s 2014 proxy statement).

But Mr. Trumka is flagging a major issue – and one the board does not want shareholders to review or apparently even understand in detail. When an executive or other manager leaves Citigroup to join the government, what exactly happens to their deferred compensation? What is the precise wording in their contracts and how much money is involved?

Goldman Sachs offers a lump-sum payment to employees who leave to join the government (see section 9 in this filing.) The logic here is that a government official should avoid any appearance of a potential conflict of interest; see Mr. Antonio Weiss’s ethics statement to Treasury in November.

Such an arrangement obviously raises an important issue for shareholders. If deferred compensation is supposed to encourage more careful risk-taking, then acceleration of vesting and immediate payments will tend to do the opposite.

Citigroup argues that its arrangements are different – and that vesting will continue on the original schedule. It’s hard to see how this can be a credible commitment. If a Citi executive becomes, for example, Treasury Secretary or US Trade Representative or First Deputy Managing Director of the IMF (all positions occupied by Citi alums), how can such a person continue to gain in significant material fashion from Citigroup’s performance? Anyone with broad responsibility for economic policy and financial sector oversight should not be in a position to gain or lose large amounts of money from the performance of a single financial firm (let alone one of the world’s biggest banks, with interests spread around the globe.)

Presumably the board of directors can – and would – make an exception for anyone joining the government at a sufficiently senior level. Some statement of policy along these lines would presumably provide helpful guidance to shareholders, who are entitled to agree or disagree with the details.

In any case, Mr. Trumka is only requesting more disclosure of Citigroup’s precise arrangements. And, not satisfied with the lack of response from Citigroup, the AFL-CIO is now asking that shareholders be allowed to vote on making these details known, as part of the process surrounding the 2015 annual meeting of stockholders. The proposed motion reads,

“RESOLVED: Shareholders of Citigroup (the “company”) request that the Board of Directors prepare a report to shareholders regarding the vesting of equity-based awards for senior executives due to a voluntary resignation to enter government service (a “Government Service Golden Parachute”). The report shall identify the names of all Company senior executives who are eligible to receive a Government Service Golden Parachute, and the estimated dollar value amount of each senior executive’s Government Service Golden Parachute.”

“For purposes of this resolution, “equity-based awards” include stock options, restricted stock and other stock awards granted under an equity Incentive plan. “Government service” includes employment with any U.S. federal, state or local government, any supranational or international organization, any self-regulatory organization, or any agency or instrumentality of any such government or organization, or any electoral campaign for public office.”

Citigroup has asked the Securities and Exchange Commission for permission to exclude this proposal from its proxy statement, i.e., for permission not to put the issue before shareholders.  (See Mr. Dayen’s article for more details.)

What exactly is Citigroup hiding this time?

Tax Breaks (for the Rich) Are Forever

Thu, 01/29/2015 - 22:13

By James Kwak

This week I returned to one of my favorite topics: raising taxes, particularly on the rich. First I wrote an article for Medium about the single most obvious change that should be made to the tax code: eliminating the step-up in basis at death for capital gains taxes. If you’re not sure what step-up in basis means, or why it’s a ridiculous idea, you should read the article.

Then today I wrote an article for the Atlantic about why (a) killing 529 plans was a great idea in President Obama’s latest tax proposals and (b) why 529 plans are impossible to kill. Here’s the crux of the matter:

“If you’re poor, a 529 plan gives you nothing, since you don’t pay income taxes; the American Opportunity Tax Credit gives you $4,000 ($5,000 under Obama’s proposal) because you can take $1,000 of the credit per year even if you pay no taxes. If you’re in the ‘middle class’ (making at least $74,900 and able to save $3,000 per year per child), a 529 plan gives you $5,800; the AOTC gives you $10,000 ($12,500 under Obama’s proposal). If you’re in the upper class, a 529 plan gives you $26,300; the AOTC gives you nothing. Do I even need to write the rest of this article?”

My editor took out that last sentence, but I liked it so much I’m putting it back here. (Those number are based on some basic scenarios I described in the article.)

Every politician likes to say that he is in favor of simplifying the tax code, eliminating tax breaks for people who don’t need them, and helping the middle class. Only it just isn’t true.

Nominate A Qualified Undersecretary Of Domestic Finance Now

Sun, 01/25/2015 - 15:36

By Simon Johnson

The Obama administration urgently needs to nominate a qualified individual as Undersecretary for Domestic Finance at the Treasury Department. The Dodd-Frank financial reforms are under sustained and determined attack, and the lack of a confirmed Undersecretary is making it significantly harder for Treasury to effectively defend this important legislation. Failing to fill this Undersecretary position would constitute a serious mistake that jeopardizes a signature achievement of this presidency.

In the continuing absence of an Undersecretary for Domestic Finance, the administration has recently displayed an inconsistent – or perhaps even incoherent – policy stance on financial sector issues. On the one hand, in mid-December, the White House agreed to rollback a significant part of Dodd-Frank – the so-called “swaps push-out,” which was shamefully attached at the behest of Citigroup to a must-pass government spending bill. The White House put up little resistance to this tactic and, at the critical moment, lobbied House Democrats to support the repeal of Section 716.

Also in December, the White House pushed hard for the confirmation of a Wall Street executive, Antonio Weiss, as Undersecretary for Domestic Finance. (In mid-January, in the face of continuing legitimate questions about his qualifications, Mr. Weiss withdrew himself from consideration. He has become a Counselor to the Treasury Secretary, but this in no way addresses the need for a well-qualified Undersecretary and the equally pressing need for a consistent administration policy.)

On the other hand, the President has recently issued veto threats to protect financial reform. His first threats were made during the opening two weeks of the new Congress as House Republicans pushed bills to de-regulate Wall Street and rollback financial reform. And, in his State of the Union address last Tuesday night, President Obama threatened to veto any legislative “unraveling” of “the new rules on Wall Street”.  In addition, the administration is also proposing a new targeted tax on the liabilities of large banks, motivated by the – well-founded – concern that these banks receive dangerous implicit subsidies from taxpayers.  And on January 9, 2015, Treasury Secretary Jack Lew published an article in the Washington Post strongly defending financial reform.

What exactly is the Obama administration’s policy on the financial sector in general and on sticking up for the president’s reform legacy, the Dodd-Frank Act, in particular?  Are top officials willing to sell this potential legacy in pieces, as part of deals with Republicans to get spending bills?  Or, as is the case with the Affordable Care Act, will the administration refuse to repeal any part of Dodd-Frank – so if the Republicans want to undo any part, they will need to seek enough votes to override any veto?

These questions will be asked repeatedly in the months ahead, including with regard to the Volcker Rule (which limits proprietary trading by big banks) and the orderly resolution authority (Title II of Dodd-Frank, which provides for a government-run bankruptcy process, again for big banks). The Consumer Financial Protection Bureau (CFPB) will also likely come under intense pressure. The big bank lobby is pressing hard on all these dimensions and more – supported, naturally, by large campaign contributions.

The House Republicans show every sign of doing what they can to help Citigroup, JP Morgan Chase, and others remove all effective restrictions on megabanks’ ability to take on large amounts of risk.  The big banks want to return to the days of executives getting the upside when things go well and the taxpayer left holding the bag whenever disaster strikes.

The Treasury Department urgently needs to focus intellectual and administrative attention on the substance of defending Dodd-Frank, including shoring up support with Democrats, resisting the political onslaught led by House Republicans, and reaching out to senators of both parties who are willing to help. A key piece of becoming properly organized – intellectually and in terms of liaison with Congress – involves appointing a credible, qualified Undersecretary for Domestic Finance who hits the ground running and really knows what he or she is talking about.

Mr. Weiss’s failed nomination obviously generated a great deal of controversy. And there appear to be hurt and angry feelings among some officials who were in the Weiss corner. But the Undersecretary position is too important – and the financial reform stakes are far too high – for this appointment to be held up by any kind of emotional debris.

There are only three Under Secretaries at the Treasury Department , with responsibilities for: International Affairs; Terrorism and Financial Intelligence; and (all of) Domestic Finance. Leaving Domestic Finance vacant for the remaining two years of this administration would be akin to political malpractice.

Various excuses are being offered for not filling the position of Undersecretary. Some well-placed people say, “if not Weiss, then no one”. Others are more explicit that they think leaving the position vacant will teach a supposed lesson to those – across the political spectrum – who questioned Mr. Weiss’s credentials. And it has even been claimed that no one will want the job after observing the experience of Mr. Weiss.

All of these arguments are, frankly, absurd.

This is a large and well-educated country, with a vast pool of talent – including highly qualified people who would be honored to help defend Dodd-Frank. As for the process, the Weiss nomination failed for reasons that should not impact any candidate with more plausible credentials.

Mr. Weiss’s principal problem was simple: he was not qualified for the job. Contrary to some of the spin from the pro-Weiss camp, this was in no way about having worked on Wall Street. There are plenty of talented people who have worked on Wall Street and who have a proven track record of using that experience to defend financial reform. Two prominent examples spring to mind: Gary Gensler, previously with Goldman Sachs and most recently the pro-reform head of the Commodity Futures Trading Commission; and Sheila Bair, a former New York Stock Exchange executive who was a bastion of pro-reform views while chair of the Federal Deposit Insurance Corporation, 2006-2011. (Full disclosure: I am a member of the independent and non-partisan Systemic Risk Council founded and chaired by Ms. Bair.)

Mr. Weiss did not have the relevant general domain expertise and also lacked a sufficiently convincing grasp of the economic and political details surrounding financial regulation.

The search now should be quite straightforward. Find someone with relevant experience and a good track record – including statements and actions that are on the public record and that demonstrate willingness to challenge the megabanks’ worldview. To make things smoother, this person should not be carrying the kind of extraneous baggage that weighed down Mr. Weiss – such as work on “tax inversions”, or a huge exit payment from a major financial firm, or anything along these lines.

The ideal candidate should be someone with a public and private sector track record along the lines of Gary Gensler or Sheila Bair (both of whom would be great to have fill positions at the very top of this or any future administration). Depth of expertise and experience in dealing with the public policy dimensions of issues such as banks, derivative markets, and asset management will be critical.  Ideally, the nominee would bring people (and Senators across party lines) together – although presumably no one can command unanimous support.

There are some very good people at the Treasury Department, but they need stronger engagement with Capitol Hill.  The Department must put its best team on the field to resist the myriad lobby-driven efforts that are headed our way.

Nominating a credible Undersecretary for Domestic Finance quickly is an essential step towards helping the Treasury Department most effectively serve the American people – and towards preventing the collapse of financial reform.

Shareholders, Managers, and Capitalism

Wed, 01/21/2015 - 11:06

By James Kwak

This morning I posted an article over at Medium about the question—raised again by Goldman analysts earlier this month—of whether JPMorgan should be broken up. The answer is obviously yes. The interesting thing is that this is not a socialist-vs.-capitalist, academic-vs.-manager, regulator-vs.-businessman sort of argument. It’s a shareholder-vs.-manager issue, and the shareholders are wondering why Jamie Dimon insists on defending an empire that is best known for crime and ineptitude.

Earlier this month I wrote another Medium article about whether or not directors have a so-called fiduciary duty to maximize profits. The answer is no. They can do pretty much whatever they want, as long as they have enough sense to come up with some sort of plausible justification for whatever else it is that they want to do. Whether that’s a good thing or a bad thing is a closer question, and it depends on whether you view directors as protectors of great institutions against rapacious fund managers, or whether you see them as cronies who are too willing to cater to their golf-club buddies in the executive suites.

Vote in the Democratic Shadow Primary Now: Support Elizabeth Warren

Wed, 01/14/2015 - 20:48

By Simon Johnson

The shadow primary for the Democratic Party is in full swing. What will be the ideas, themes, and messages that win support in 2016 – and will they carry the day in the presidential election?

You can vote now at the Big Ideas project on almost every viable proposal from the progressive wing of the Democratic Party. Expressions of interest will feed into conversations on Capitol Hill and with presidential candidates. Nearly 1 million votes have already been cast.

Voting ends Friday at noon. Currently, in the section on the Economy & Jobs, the proposal to restore Glass-Steagall is in third place; breaking up Citigroup is close behind. (Vote now for these or for your own priorities.)

I suggested Break Up Citigroup, but it is based directly on Elizabeth Warren’s December 12, 2014, speech on the Senate floor. (The Restore Glass-Steagall idea was proposed by Byron Dorgan, former Democratic Senator from North Dakota; Senator Warren has also proposed bipartisan legislation along these lines.)

Senator Warren made another powerful speech last week laying out what has gone wrong in America – and what can be done better in the future. She covers a lot of ground and lays out a compelling statement of the issues, including how to raise incomes for most Americans.

But everyone has to start somewhere, and this is where she begins,

We know that democracy doesn’t work when congressmen and regulators bow down to Wall Street’s political power – and that means it’s time to break up the Wall Street banks and remind politicians that they don’t work for the big banks, they work for US!”

You could start by reading Senator Warren’s recent speech and, if you agree with what she says, vote for her Big Ideas.

The Republican Strategy To Repeal Dodd-Frank

Wed, 01/07/2015 - 18:44

By Simon Johnson

On January 7, 2015, Day 2 of the new Congress, the House Republicans put their cards on the table with regard to the 2010 Dodd-Frank financial reforms. The Republicans will chip away along all possible dimensions, using a combination of legislation and pressure on regulators – with the ultimate goal of relaxing the restrictions that have been placed on the activities of very large banks (such as Citigroup and JP Morgan Chase).

The initial target is the Volcker Rule, which limits the ability of megabanks to place very large proprietary bets – and their ability to incur massive losses, with big negative consequences for the rest of us. But we should expect the House Republican strategy to be applied more broadly, including all kinds of measures that will reduce capital requirements (i.e., make it easier for the largest banks to fund themselves with relatively more debt and less equity, taking more risk while remaining Too Big To Fail and thus benefiting from larger implicit government subsidies.)

The repeal of Dodd-Frank will not come in one fell swoop. Rather House Republicans are moving in several stages to reduce the scope of the Volcker Rule and to gut its effectiveness.

The first step in this direction came on Wednesday, with a bill brought to the floor of the House supposedly to “make technical corrections” to Dodd-Frank. This legislation was not considered in the House Financial Services Committee, and was rushed to the House floor without allowing the usual debate or potential for amendments (formally, there was a “suspension” of House rules).

Buried in this legislation is Title VIII, which will extend the deadline for one important aspect of Volcker Rule compliance to 2019. (The specific topic is by when big banks should divest themselves of some Collateralized Loan Obligations, CLOs – on how these investments function as internal hedge funds at the largest three banks, see this primer from Better Markets, a pro-reform group.)

Some very large banks and House Republicans previously asked to extend this deadline for CLO compliance through 2017, and a full extension was actually granted by the Federal Reserve in 2014. (Specifically, in April 2014 the Fed extended the divestment deadline for CLOs to 2017and then, in December 2014, extended the divestment for all covered funds under the Volcker Rule until 2017.)

Now that Citigroup, JP Morgan Chase and Wells Fargo already have the extension through 2017, they immediately ask for… an extension through 2019.

The strategy here is clear: delay for as long as possible. Perhaps the regulators will cave in, again, under pressure. Perhaps the White House will agree to another rollback of Dodd-Frank, for example attached to a spending bill – which is what happened in December 2014. (Remember that government spending is only authorized until September 2015, so there will be plenty of opportunities).

And perhaps, after November 2016, a Republican president will work with a Republican Congress to eliminate all parts of Dodd-Frank that crimp the style of very large leveraged financial firms.

On Wednesday, the Republican bill that would have weakened the Volcker Rule actually failed – under the suspension of the rules, it needed two-thirds of all members present in order to pass, and the vote was 276 in favor and 146 against. When enough Democrats hold together, they can make a difference.

But all of this is just a warm-up. In coming months we should expect: the largest few banks (always masquerading as representing the social interest) will pressure for a change in technical definitions, e.g., what kind of hedge fund they are allowed to own and what it means to “own” something. They will ask for more delays and “clarifications”. And they will argue that lending to some category of firms (“job creators”) should be exempt from any kind of restriction.

Section 716, which would have forced big banks to keep their derivatives business somewhat separated from their insured deposits, was repealed in December 2014. This measure primarily benefited Citigroup and JP Morgan Chase. At the time, some Democrats – including people close to the White House – said, not to worry, “we’ll always have the Volcker Rule.”

In fact, the signal from the repeal of Section 716 is that the store is open. The White House had previously said “no” to any proposed repeal of Dodd-Frank, including when attached to a spending bill. This moratorium has clearly been lifted, and the lobbyists are hard at work.

The House Republican rhetoric will be “technical fixes” and “job creation”. But the reality is that they are determined to strip away all meaningful restrictions imposed on Citigroup, JP Morgan Chase, and other megabanks – and to roll-back Dodd-Frank as far as possible, until it becomes meaningless or they are finally able to repeal it completely.

Insider Trading and the Art Bubble

Tue, 12/23/2014 - 10:05

By James Kwak

I recently wrote two more articles for the Bull Market collection at Medium. The first was my explanation of the Second Circuit’s decision in United States v. Newman and Chiasson, which said that insider trading is only a crime if the original tipper gained a personal benefit from leaking confidential information, and if the eventual trader knew of that personal benefit. If you don’t like this outcome, the original problem is a poorly written Supreme Court opinion (isn’t that redundant?) from the 1980s, Dirks v. SEC.

The second article was a response to a column by James Stewart and a post by Felix Salmon about soaring prices in the art market—which, almost by definition, constitute a bubble.

Elizabeth Warren And The Independent Community Bankers of America Are Right: Antonio Weiss Should Not Become Undersecretary for Domestic Finance

Wed, 12/17/2014 - 14:22

By Simon Johnson

Antonio Weiss has been nominated to become Undersecretary for Domestic Finance at the Treasury Department. A growing number of people and organizations have expressed reservations about this potential appointment, which requires Senate confirmation – including Senator Dick Durbin (D., IL), Senator Jeanne Shaheen (D.,NH), Senator Joe Manchin (D., WV), the American Federation of Teachers (in a press release on December 17th), and other groups. And, from another part of the political spectrum, the Independent Community Bankers of America has also come out strongly against Mr. Weiss.

In a speech last week, Senator Elizabeth Warren detailed her concerns about Mr. Weiss’s background:

“He [Mr. Weiss] has focused on international corporate mergers and companies buying and selling each other. It may be interesting, challenging work, but it does not sufficiently qualify him to oversee consumer protection and domestic regulatory functions at the Treasury that are a critical part of the job.”

And Senator Warren made it clear that the Weiss nomination needs to be seen in this broader context:

“Time after time in government, the Wall Street view prevails, and time after time, conflicting views are crowded out.”

A line must be drawn and, as Senator Warren said on Friday evening, with regard to the Wall Street view that what is good for executives at big banks is good for the country,

“Enough is enough.”

The latest round of pushback from Weiss supporters against Senator Warren makes three points. First, this administration is not captured by the Wall Street view. Second, Mr. Weiss is not captured by the Wall Street view. And, third, that Mr. Weiss is so perfectly qualified for the job that all these broader issues are irrelevant or even illegitimate. None of these points has a substantive basis or can withstand scrutiny. The ICBA, AFT, and Senators Durbin, Machin, Shaheen, and Warren are right to continue opposing Mr. Weiss’s appointment.

On the extent of capture of this administration by the Wall Street view, the facts are straightforward. The Obama administration has continually refused to put forward any potential nominee for a senior position who has shown serious backbone with regard to financial reform. There appears to be a litmus test. If you want to be tough on reform – in the sense of confronting Too Big To Fail head-on or even just reducing the reckless risks that big banks take with derivatives – you cannot have a senior administration job.

A few reformers have, of course, managed to get through. Gary Gensler took financial reform seriously and implemented the Dodd-Frank law as chair at the Commodity Futures Trading Commission. The administration seems to have been surprised by how tough he was – and they did not reappoint him. Janet Yellen became chair of the Federal Reserve Board, but only because the White House could not get sufficient support for Larry Summers. And Tom Hoenig and Jeremiah Norton are strong voices for sensible policy at the Federal Deposit Insurance Corporation – but they were both put in office by the Republicans.

There is no balance of views at the top of the US Treasury. The Wall Street view – what’s good for the people who run big banks is good for the country – is fully in control. The most recent demonstration of this point came just last week, when House Republicans proposed to repeal Section 716 of Dodd-Frank – a direct attempt to help Citigroup and other megabanks by allowing them to run more dangerous derivatives out of their insured banks (and therefore create more downside risks for taxpayers and the broader economy). Treasury and the administration not only did not oppose this measure – they actively undermined House Democrats and Senator Warren in their attempts to stick up for Section 716. There is no backbone on financial reform at Treasury.

Regarding Mr. Weiss himself, the reasonable question is: to what extent does he believe in any version of the Wall Street view?

We know many things about Mr. Weiss but we don’t know everything. Therefore any reasonable observer faces a signal extraction problem – there is plenty of noise and distraction, but what are his real views? Here is what we have to work with:

  • Weiss has no known competence on anything to do with financial regulation. There is no track record.
  • Weiss has never communicated, in public or private, on financial reform issues with anyone who has worked hard against the Wall Street view over the past six years (or ever).
  • Weiss’s employment has involved advising on international mergers and acquisitions for 20 years. Lazard, his firm, does deals involving big banks – and it hires plenty of people who previously worked at global megabanks such as Citigroup.
  • Many people who live and work in this kind of milieu share some version of the Wall Street view. For example, some of the most vociferous defenders of Citigroup are people in smaller financial firms and in law firms (and in think tanks) who make their living from the Citi ecosystem (and the implicit government subsidies that keep this bizarre and dangerous structure going).
  • Not everyone who has worked in finance believes in the Wall Street view (e.g., Gary Gensler). But at this point – six years after the crisis – most of the serious skeptics regarding the supposed advantages of megabanks have made their voices heard, at least in private.
  • Weiss is associated with Robert Rubin, for example through a paper (on fiscal issues) they both signed that was produced by the Center for American Progress. Mr. Rubin has, while in office during the 1990s, while at Citigroup during the 2000s, and still today, consistently exhibited a strong version of the Wall Street view.
  • Rubin has exerted great apparent influence on this administration, including by directly or indirectly encouraging the White House to hire people with minimal public track records on financial reform – who then prove to be profoundly disappointing by siding repeatedly with the big Wall Street players.
  • More broadly, the attitude of the Obama administration on financial reform has been profoundly disappointing – including, now, not even going to bat for their own legislation.
  • Everyone on the Board of Governors of the Federal Reserve System has at this point been appointed or re-appointed by the Obama administration. The only person on that Board who definitely does not share the Wall Street view is Janet Yellen.
  • The administration has steadfastly refused to take seriously any potential appointees to the Fed Board of Governors who would be tough on the Wall Street view. There have long been two vacancies on the Board – and the administration will not advance a single person who worries about the profound risks created by big banks or any kind of proven willingness to implement the Dodd-Frank reforms.

In recent days, Mr. Weiss’s supporters have sought to rally support through two outside letters that stress Mr. Weiss’s supposed qualifications for the job. But both these letters further weaken the case for Mr. Weiss – seen in terms of the signal extraction problem, these interventions strengthen the likelihood that Mr. Weiss shares a disturbing version of the Wall Street view.

One letter, dated December 11, is from four former Undersecretaries for Domestic Finance. The authors concede that Mr. Weiss has no experience in managing the national debt so, by their own definition, the issue is whether Mr. Weiss is suited to a key position relative to financial regulation. Their argument comes down to this:

“Mr. Weiss has spent a quarter century operating in financial markets, including more than 20 years at Lazard, the last five of which as Global Head of Investment Banking. He has specific expertise advising companies how to grow, and how to finance that growth. Lazard is not a money center or lending bank and does not engage in sales and trading. Mr. Weiss has been deeply involved on behalf of large and small client companies in negotiating every type of financing, from debt and equity through more complex structures.”

All this says is: he worked on Wall Street, knows about corporate finance, and did not directly get bailed out in 2008-09. But there is no definite or specific information here that helps us understand or verify whether Mr. Weiss at all shares, or even deeply believes in, the Wall Street view – an important part of which now is “bailouts are fine” and “the government made money”; completely ignoring the costs of the financial crisis to the broader economy and to ordinary Americans.

The fact that Mr. Weiss’s strong supporters would send a letter devoid of relevant information on this point should itself be interpreted as a signal. If Mr. Weiss were at all skeptical of megabanks, now would be a good time to communicate that point – and we see nothing of the kind.

The second letter, dated December 12, is from the Partnership for New York City, which is an organization comprised primarily of leading New York-based companies – naturally heavily weighted towards finance. The membership of the Partnership includes all the Too Big To Fail banks, although most of them chose not to sign this letter (with the exception of Morgan Stanley).

Instead, the prominent names among those signing include top Wall Street lawyers, people at financial firms that do a lot of business with TBTF banks as partners or counterparties, and former executives from the largest global megabanks (including the former chairman of Citigroup). Many of these individuals have no material interest in seeing an end to the distortive government subsidies associated with any financial firm perceived as being Too Big To Fail. Indeed, the net worth, status, and professional opportunities for many on the Partnership’s letter are presumably closely tied to the fortunes of TBTF banks. These are smart, rational people with a good grip on how the world works – it does not seem unreasonable to think many of them wish to continue receiving, indirectly, the benefits of implicit taxpayer support provided to the likes of Citigroup.

Similar views to those of high-profile individuals in the Partnership for New York are not underrepresented in this administration and in this Treasury Department. Many of these people have access also to the very top of the White House.

And, as matter of routine, an influential subset of this group also appoints, oversees, and can actually remove from office one of our most important financial regulators, the president of the Federal Reserve Bank of New York. A major part of our modern difficulties can be traced back to the fact that the New York Fed has become completely captured by the Wall Street view. (Senator Jack Reed has a legislative proposal that would help deal with this problem by reducing the powers of the Board of the New York Fed, where the banking sector still holds the reins.)

It is hard to see the letter from the Partnership for New York as anything other than confirmation of the points made by opponents of Mr. Weiss. Camden R. Fine, president of the ICBA, put it this way:

“While Mr. Weiss has impressive credentials as a top Wall Street executive specializing in international mergers and acquisitions, Wall Street is already well represented at Treasury, and the narrow focus of Mr. Weiss’s professional experience is a serious concern for ICBA and community banks nationwide.”

Senator Warren agrees completely, with slightly different wording:

“It’s all about the revolving door – that well-oiled mechanism that sends Wall Street executives to make policies in the government and that sends government policymakers straight to Wall Street. Weiss defenders are all in, loudly defending the revolving door and telling America how lucky we are that Wall Street is willing to run the economy and the government.”

As argued by his opponents and as confirmed by the public statements of his strongest supporters, Antonio Weiss does not have the right background, qualifications, or – as far as anyone can reasonably determine – views to become Undersecretary for Domestic Finance.

Citigroup Will Be Broken Up

Fri, 12/12/2014 - 22:24

By Simon Johnson

Citigroup is a very large bank that has amassed a huge amount of political power. Its current and former executives consistently push laws and regulations in the direction of allowing Citi and other megabanks to take on more risk, particularly in the form of complex highly leveraged bets. Taking these risks allows the executives and traders to get a lot of upside compensation in the form of bonuses when things go well – while the downside losses, when they materialize, become the taxpayer’s problem.

Citigroup is also, collectively, stupid on a grand scale. The supposedly smart people at the helm of Citi in the mid-2000s ran them hard around – and to the edge of bankruptcy. A series of unprecedented massive government bailouts was required in 2000-09 – and still the collateral damage to the economy has proved enormous. Give enough clever people the wrong incentives and they will destroy anything.

Now the supposedly brilliant people who run Citigroup have, in the space of a single working week, made a series of serious political blunders with long-lasting implications. Their greed has manifestly proved Elizabeth Warren exactly right about the excessive clout of Wall Street, their arrogance has greatly strengthened a growing left-center-right coalition concerned about the power of the megabanks, and their public exercise of raw power has helped this coalition understand what it needs focus on doing – break up Citigroup.

In a blistering speech on Tuesday, December 9th, Senator Warren emphasized how much power large Wall Street banks have in Washington. The pushback from those banks’ supporters was, not surprisingly, to deny any special rights and privileges.

On Wednesday, a provision — drafted by Citigroup — to repeal part of the Dodd-Frank financial reforms (Section 716) was added by House Republicans to their spending bill. On Thursday, Citigroup led the charge to persuade enough Democrats to vote for that bill. The repeal of Section 716 stayed in the spending bill only because Wall Street brought so much pressure and influence to bear.

Everything that transpired on Wednesday and Thursday exactly fit the pattern that Senator Warren had described on Tuesday.

Those seeking to disparage Senate Warren now attempt to paint her as some sort of extremist – the tea party of the left. But such a description is completely at odds with the reality of this week.

In arguing against the repeal of Section 716, Senator Warren was supporting arguments put forward by Thomas Hoenig (a Republican appointee at the Federal Deposit Insurance Corporation), Sheila Bair (Republican and former chair of the FDIC), and Senator David Vitter (R., Louisiana). On Friday, the Systemic Risk Council – chaired by Sheila Bair – put out a statement against the repeal of Section 716. (I am a member of the SRC; the council includes people from the left, center, and right of the political spectrum.)

These are not left vs. right issues. And the key divide is certainly not the liberal left against anyone else. This is a broad coalition of people who care about financial stability — and who are fighting against a mighty lobby.

Speaking on the floor of the Senate on Friday evening, Senator Warren articulated the core of the problem and what needs to be done. (All the quotes that follow are from the text circulated by her press office.)

“Mr. President, in recent years, many Wall Street institutions have exerted extraordinary influence in Washington’s corridors of power, but Citigroup has risen above the others.  Its grip over economic policymaking in the executive branch is unprecedented.  Consider a few examples:

Three of the last four Treasury Secretaries under Democratic presidents have had close Citigroup ties. The fourth was offered the CEO position at Citigroup, but turned it down.

The Vice Chair of the Federal Reserve system is a Citigroup alum.

The Undersecretary for International Affairs at Treasury is a Citigroup alum.

The U.S. Trade Representative and the person nominated to be his deputy – who is currently an assistant secretary at Treasury – are Citigroup alums.

A recent chairman of the National Economic Council at the White House was a Citigroup alum.

Another recent Chairman of the Office of Management and Budget went to Citigroup immediately after leaving the White House.

Another recent Chairman of the Office of Management of Budget and Management is also a Citi alum — but I’m double counting here because now he’s the Secretary of the Treasury.

That’s a lot of powerful people, all from one bank. But they aren’t Citigroup’s only source of power.  Over the years, the company has spent millions of dollars on lobbying Congress and funding the political campaigns of its friends in the House and the Senate.”

And on the big banks’ complaints about Dodd-Frank, she said this,

“There’s a lot of talk lately about how the Dodd-Frank Act isn’t perfect.  There’s a lot of talk coming from Citigroup about how the Dodd-Frank Act isn’t perfect.

So let me say this to anyone who is listening at Citi:  I agree with you.  Dodd-Frank isn’t perfect.

It should have broken you into pieces.” (Emphasis in the original)

We are going back to the original Republican principles and courage at work the last time this country took on – and won against – concentrated corporate power.

“A century ago, Teddy Roosevelt was America’s trustbuster.  He went after the giant trusts and monopolies in this country, and a lot of people talk about how those trusts deserved to be broken up because they had too much economic power.  But Teddy Roosevelt said we should break them up because they had too much political power.  Teddy Roosevelt said break them up because all that concentrated power threatened the very foundations of our democratic system.”

“And now we’re watching as Congress passes yet another provision that was written by lobbyists for the biggest recipient of bailout money in the history of the country.   And it’s attached to a bill that needs to pass or else the entire federal government will grind to a halt.”

“Think about this kind of power.  A financial institution has become so big and so powerful that it can hold the entire country hostage.  That alone is a reason enough for us break them up.  Enough is enough.”

Don’t Repeal Swaps Push-Out Requirements (Section 716 of Dodd-Frank)

Wed, 12/10/2014 - 22:52

By Simon Johnson

Section 716 of the Dodd-Frank financial reform act requires that some derivative transactions be “pushed-out” from those part of banks that have deposit insurance (run by the Federal Deposit Insurance Corporation) and other forms of backstop (provided by the Federal Reserve). This is a sensible provision that, if properly implemented, would help keep our financial system safer, protect taxpayers and reduce the likely need for bailouts.

Now, at the behest of the biggest Too Big To Fail banks and as part of the House’s spending bill (to be voted on tomorrow or in coming days), this “push out” requirement is on the verge of being repealed. Democrats and Republicans should refuse to vote for the spending bill as long as it contains this requirement.

This is not a left vs. right issue. It is a fundamental systemic risk issue, on which people across the political spectrum who want to lower those risks can agree – Section 716 should not be repealed. In fact, some of the sharpest voices on this issue come from the right.

In a statement on Tuesday, Thomas Hoenig, appointed by the Republicans to be Vice Chair of the FDIC, said:

“In 2008 we learned the economic consequences of conducting derivatives trading in taxpayer-insured banks. Section 716 of Dodd-Frank is an important step in pushing the trading activity out to where it should be conducted: in the open market, outside of taxpayer-backed commercial banks. It is illogical to repeal the 716 push out requirement.”

And on Tuesday evening, Senator David Vitter (R., Louisiana) put the issue in its proper broader context,

“Ending too big to fail is far from over. Before Congress starts handing out Christmas presents to the megabanks and Wall Street – we need to be smart about this. Removing these risky derivatives that aren’t even necessary for normal banking purposes is important, and Members of Congress need to rethink repealing this critical provision.”

The effort to repeal Section 716 comes primarily from the largest banks (and some say from Citigroup), who claim that these restrictions are somehow onerous or unreasonable. These arguments have no merit.

Under Section 716, interest rate swaps, foreign exchange derivatives, and cleared credit derivatives can remain on the balance sheet of the insured bank. This is almost all derivatives. And hedging of risks by banks using derivatives is most definitely allowed.

The push out applies most notably to uncleared credit default swaps (CDS), equity derivatives, and commodity derivatives. (See Tom Hoenig’s statement for a succinct and precise statement of the issues.)

The point of the push out is to get these potentially high risk swaps away from the insured part of the bank – and away from the explicit backstop provided by deposit insurance (and ultimately by the taxpayer).

The big banks (such as JP Morgan Chase and Citi) are actually a complex collection of separate companies – only one of which is typically an insured bank. That insured bank is regarded as a better credit (i.e., lower risk) by people in the market precisely because of the federal government-run deposit insurance. Like all better credits, those banks get to borrow at lower costs.

If these swaps are pushed out from the insured part of the bank, these speculative derivative positions will be priced by the market based on their actual risk – not mispriced due to the backing of taxpayers. Thus the derivative activities of these four banks, conducted by their uninsured subsidiaries, will become more expensive to fund.

Really this is just taking the state out of subsidizing some of these particularly high risk derivatives. That would be no more than reintroducing the market and market pricing of credit risk.

The four largest banks (according to the Office of the Comptroller of the Currency, OCC) conduct more than 93% of all derivatives activities in the US. (That is using “total banking industry notional amounts”; if you prefer net current credit exposure, NCCE, the same banks are 82% of the industry.) The repeal of section 716 is for them.

Remember when JP Morgan Chase lost more than $7 billion in its so-called “London Whale” trade? That was a high risk, highly leveraged proprietary bet involving complex Credit Default Swap indices. And JP Morgan Chase’s bet, which reportedly had a notional value of more than $1 trillion, was funded in part with insured deposits. (Publicly available information indicates that JP Morgan Chase – just like Citigroup – has the vast majority of its derivatives activities run out of the insured bank.)

So the vote this week is simple. Democrats and Republicans should vote to, at least partially, bring back the market forces – by rejecting the repeal of Section 716.  End state subsidies for these megabanks’ derivatives activities.

This is not what Citigroup, JP Morgan, Bank of America, or Goldman Sachs wants, of course. They want government insurance and their derivatives dealing to be subsidized by taxpayers, on the most favorable terms possible: it lowers their costs and increases their profits. As a result, Too Big To Fail banks’ executives and traders get the upside when things go well; and when things go badly, the downside is someone else’s problem.

Or, as Dennis Kelleher of Better Markets puts it,

“If Wall Street gets the upside in big bonuses from its high-risk derivatives deals, then it should also have to pay the downside for any losses.”

Remember that Citi’s lobbyists and their colleagues worked long and hard during the 1990s to relax all meaningful limits on their ability to take big risks. And the firm subsequently hired top Clinton-era officials to guide their economic and political strategy in the 2000s. This ended very badly – with the near-failure of Citigroup, multiple taxpayer bailouts, and a deep recession from which, six years later, we have not yet fully emerged. Citigroup was at the epicenter of what went wrong on Wall Street in 2007-08 and received more bailouts than any other single institution, almost $500 billion.

In the 1990s there was a Citigroup-inspired consensus in favor of deregulation. That legislative push proved to be a mistake, but at least it was done in the open. Now similar forms of deregulation – encouraging excessive risk-taking – are being pursued through back-room deals, with no hearings, and no debate.

To start again down the same path – and at the instigation of the same set of banks – is pure folly.

And to do it through this underhand process shows you that the big banks have no intellectual arguments left on their side. All they have to offer now is the prospect of large campaign contributions.

Antonio Weiss Is Not Qualified To Be Under Secretary For Domestic Finance

Sat, 12/06/2014 - 19:46

By Simon Johnson

Antonio Weiss has been nominated by President Obama to become the next Under Secretary for Domestic Finance at the U.S. Department of the Treasury. Mr. Weiss’s supporters argue that he is highly qualified for this senior fiscal policy job. They are wrong. Mr. Weiss has no known relevant qualification or experience for this position.

In the organizational structure of the Treasury Department, the Under Secretary for Domestic Finance is “primarily responsible for policy formulation and overall management” at the Office of Domestic Finance – a very important role. This Office is central to our debt management policies, but the Under Secretary also guides the administration’s fiscal policies much more broadly,

“Domestic Finance advises and assists in areas of domestic finance, banking, and other related economic matters. It develops policies and guidance for Treasury Department activities in the areas of financial institutions, federal debt finance, financial regulation, and capital markets.”

Here is the detailed org chart of Domestic Finance. On paper, this Under Secretary is the third most senior official in the executive branch with regard to fiscal decision-making. Given the way the Treasury Department works, along with the position of the United States in the world economy, on a day-to-day basis, this person is effectively the number two on many budget- and debt-related issues.

There is no disagreement on what Mr. Weiss has been doing for the past 20 years. Writing recently in the New York Times, Andrew Ross Sorkin said, Antonio Weiss is “a longtime adviser on mergers at the investment bank” [Lazard]. And “He has spent his career whispering strategic advice in the ears of corporate leaders.” (More detail on his career advising corporations is in the New York Times news coverage.)

Bloomberg reports his title as global head of investment banking at Lazard. For more details of the firm’s activities and clients see this Lazard page on their “M&A and Strategic Advisory” and their most recent results. You can also search the Lazard website for mentions of Antonio Weiss. Or look at Mr. Weiss’s job description, from Lazard’s press release on his March 2009 promotion to his current position. Without question, Mr. Weiss is experienced in advising companies how to buy other companies, particularly across international borders.

Mr. Sorkin thinks Mr. Weiss is the right pick because, “the job requires deep experience in the capital markets and global relationships.”

But Mr. Weiss’s “high profile M&A activities” are completely unrelated to the central task of this position: running responsible federal government finances. The Under Secretary for Domestic Finance does not typically buy and sell companies – or engage in any activities remotely related to advising companies on acquisitions. The treasury job requires knowledge of sovereign credit, experience with the practicalities of public debt sustainability, and an understanding of the intricacies of our national budget. From the public record and otherwise available information, Mr. Weiss has no substantial knowledge or expertise on any of these issues.

Mr. Weiss was one of 12 people who signed a paper on fiscal issues published by the Center for American Progress in 2012 (co-authored with Robert Rubin, among others). However, Mr. Weiss’s role in formulating ideas or writing that paper remains unclear. This is the only paper Mr. Weiss has written with CAP or, as far as can be determined, elsewhere on this topic (or on anything else to do with economics or public finance.) There are also no other publicly available speeches, op eds, or other writing by him on issues that might touch on the substantive duties of the Under Secretary position.

Mr. Sorkin suggests that failing to immediately confirm Mr. Weiss could have serious negative implications for our national cash flow.   Citing Ben White of Politico (who got this from an anonymous “Wall Street exec”), Mr. Sorkin says,

“if the interest on the securities the Treasury sells was just 20 basis points higher for a year because of uncertainty or mismanagement, it would cost taxpayers $32 billion — more than it would cost to fund the Consumer Financial Protection Bureau for 50 years.”

To suggest that the interest rate paid by the U.S. Treasury would in the short term increase due to any part of the nomination process for this specific candidate is absurd. Mr. Sorkin fails to provide any evidence or logic to support his assertion that Mr. Weiss’s confirmation (or not) would affect the full faith and credit of the U.S. government – and how that is perceived by the market.

The Washington Post editorial page then weighed in last week along the same lines as Mr. Sorkin:

“The 48-year-old Mr. Weiss would bring much in the way of relevant experience to the job, having graduated from Harvard Business School and gone on to a successful career in finance, most recently as head of investment banking for the venerable Lazard firm.”

Again, Mr. Weiss simply has no relevant experience. Working in corporate M&A is profoundly different from managing public (government) finance.

Bill Cohan, who used to work at Lazard, adds further detail in another New York Times column that is strongly supportive of Mr. Weiss, “In addition to being a much-respected global M.&A. adviser, he [Antonio Weiss] has supervised bankers who worked for Detroit pensioners, the National Association of Letter Carriers and the American Airlines pilots.” Important work, no doubt, but again not something that could fairly be regarded as qualifying someone to become Under Secretary for Domestic Finance.

And, importantly, the New York Times felt the need to add a significant correction at the foot of Mr. Cohan’s column:

“An earlier version of this column described imprecisely part of the work history of Antonio Weiss, based on a document prepared by the Treasury Department. While he supervised bankers who advised Detroit pensioners, the National Association of Letter Carriers and the American Airlines pilots, he did not advise them directly himself.”

This suggests that the Treasury Department has been stretching its facts regarding Mr. Weiss’s experience in an inappropriate manner – to make him look more qualified for the job than he really is. (My understanding is that the work in question was actually done by Ron Bloom.)

Announcements about further scrutiny or appropriate pushback regarding the qualifications of Mr. Weiss have not and will not move the market for U.S. Treasury debt.

Interest rates are influenced by many factors including – in the first instance these days – by Federal Reserve policies, but also by the balance of global savings and investment, as well as inflation expectations and views on how quickly the US economy (and, to some extent, the global economy) will make a full recovery. Threats of a government shutdown or a confrontation over the debt ceiling might also play a role – at least, that has been the experience in recent years.

In coming years, the overall stance of US fiscal policy will matter a great deal for long-term interest rates, with one key issue being whether domestic and international investors remain convinced that our debt-GDP ratio is on a sustainable path. (James Kwak and I wrote a book on this topic.)

Based on the record, there is no indication that Mr. Weiss has the skills likely to help put us on such a path (yes, fiscal policy is determined by Congress as much as by any administration – but the Under Secretary is an important part of the decision-making mix).

And there is a legitimate concern about Mr. Weiss’s qualifications which, ironically and perhaps inadvertently, was raised by Mr. Sorkin himself, when he conceded, “that Mr. Weiss doesn’t have a lot of experience in the regulatory arena, and at least part of the role he is nominated for involves carrying out the remaining parts of the Dodd-Frank overhaul law.”

The negative fiscal implications in that statement are potentially first-order. Ineffective financial regulation increases the probability of a serious crisis. And such crises have major negative effects on the public balance sheet – the near-collapse of the financial system in 2007-08 caused a recession that will end up increasing our debt-to-GDP ratio by about 50 percentage points (this is based on the Congressional Budget Office’s analysis.)

Having the experience, commitment, and world view necessary to ensure this never happens again should be essential background for whoever might become the next Under Secretary. Regrettably, this critical responsibility is too often an afterthought – when it should be a priority. Given the cost of the crash and the lasting economic wreckage of the Great Recession, this is indefensible.

It’s hard to think of any senior fiscal official from a serious country with qualifications as weak as those of Mr. Weiss.

Mr. Weiss might be qualified for other positions, for example in the Commerce Department. Based on the available facts, he is simply not qualified for the post of Under Secretary for Domestic Finance in the Treasury Department.

Law School and Radio

Fri, 12/05/2014 - 11:46

By James Kwak

This week I posted two things on Medium. The first was a commentary on changes in the markets for law students and lawyers. In short, if you are thinking of going to law school, the case is significantly stronger than it was four years ago. Whether it’s strong enough to pull the trigger depends on too many factors for me to say anything about your particular situation.

The second was about Serial, the new podcast from the This American Life people. Longtime blog readers know that I love love love TAL. I was really looking forward to Serial, and it had its moments. But I finally gave up on it when it framed one too many unreliable recollections with pregnant pauses and ominous music. I just don’t think there’s enough there there, at least not for me.

Obamacare, Taxes, United Airlines, and My Tea Infuser

Mon, 11/17/2014 - 17:02

By James Kwak

Over at Medium, I just posted a new article about the Jonathan Gruber-Obamacare “scandal.” Republicans are highlighting Gruber’s remarks as proof that the individual mandate really is a tax, and that the administration hid that fact in order to put one over on the public. But this whole argument flows from a faulty premise: that whether something is a tax or not is a question that has a knowable answer.

Last week I wrote a post complaining about my dismal experiences on United Airlines, which I chalk up to two things. The first is miserable computer systems. (It’s remarkable when you can see a computer system failing, and you know exactly what’s going wrong.) The second is the oligopolistic/near-monopolistic structure of the industry, especially when combined with a do-nothing Antitrust Division over at DOJ. It’s not just me: Tim Wu thinks so, too.

Finally, before that I wrote a post about Amazon’s extraordinary dominance in online retailing of physical goods. Who cares if no one will buy your phone when people are happy using other people’s phones to buy toilet paper and diapers from you?