Economics, Financial Services, Pethokoukis

Wall Street should stop complaining about new bank capital rules

Image Credit:

Image Credit:

Wall Street is kvetching up a storm over modest toughening of megabank capital requirements by federal regulators. ”This rule puts American financial institutions at a clear disadvantage against overseas competitors,” Tim Pawlenty, chief executive of The Financial Services Roundtable and former GOP presidential candidate, told Reuters.

The new rule increases the required leverage ratio – the amount of equity capital a bank holds as a share of assets — to 5% versus the 3% ratio in the international Basel III agreement. Under the new rule, megabanks could borrow only 95% of money they lend versus 97% under Basel. By 2018, they would have to rely more on selling stock or retained earnings.

If other nations want riskier big banks, that’s the business of their taxpayers who’ll be on the hook for future bailouts. A tougher leverage ratio and bigger safety cushion make the US financial system somewhat safer, but not as safe as it could and should be. The US has suffered 14 major banking crises over the past two centuries, as documented by Charles Calomiris and Stephen Haber in their new book, “Fragile by Design: The Political Origins of Banking Crises and Scarce Credit.” (None in Canada, by the way.) One could reasonably assume US economic growth would have been a least a smidge better without all those other crises.

In a recent Wall Street Journal op-ed, Calomiris and coauthor Allan Meltzer note that at the start of the Great Depression, the big New York City banks ”all maintained more than 15% of their assets in equity” and none went bust. Likewise, “losses suffered by major banks in the recent crisis would not have wiped out their equity if it had been equal to 15% of their assets.”

Wouldn’t a 15% leverage ratio hurt bank lending and economic growth? Consider: First you have to calculate whether it would hurt economic growth more than a continuation of America’s serial financial crises. Second, it’s a pernicious myth that debt is somehow “more expensive” than equity capital. The more stock a bank issues, the less risky the bank becomes, and the lower the return shareholders demand.

Don’t banks know this? Look, banks are responding to incentives. Bank debt operates on unequal footing thanks to Washington’s “too big to fail” backstop. University of Chicago economist John Cochrane explains that without government guarantees, “a bank with 3% capital would have to offer very high interest rates—rates that would make equity look cheap.” Like researchers Anat Admati and Martin Hellwig in their book “The Bankers’ New Clothes,” Cochrane endorses dramatically higher capital levels. So should policymakers if they want to avoid another century of financial shocks.

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.


Obamacare is, apparently, declining to implode

Jim Capretta and Ramesh Ponnuru, in separate pieces, offer some gentle truth telling about Obamacare. It’s not going to implode of its own inherent economic faults anytime soon. Ponnuru: “The law will continue to be implemented, with the administration making whatever revisions it thinks necessary.”

And even if Republicans gain control of the White House and Congress, there are limitations to what a GOP president would do. For instance, maybe President Rand Paul would decide to disallow the federal health exchange from paying premium credits to 10 million Americans. As Capretta puts it, “A reversal of this kind would be politically tumultuous, to put it mildly.” Adds Ponnuru: “It seems unlikely that Congress would pass legislation to strip coverage from millions of people.”

And that’s probably even with a reasonable replacement plan all lined up. Just a few years after one massive, convulsive change, Republican are going to offer another massive, convulsive change? What’s more, while center-right policymakers are cooking up various reform plans, one ingredient needs to be in all of them: universal coverage as an explicit policy goal. As Avik Roy wrote earlier this year:

No conservative politicians oppose universal public education; instead, we champion reforms that improve the quality of public education that poor Americans receive. Ensuring that every American has access to quality health coverage is a legitimate goal of public policy, and it can be done in a way that expands freedom and reduces the burden on American taxpayers.

There is no “repeal” in the Roy plan. Broadly he would (a) deregulate the exchanges, (b) gradually raise the Medicare age, effectively funneling more people into the exchanges, and (c) put acute-care Medicaid patients into the exchanges, “while returning its long-term care and disabled populations fully back to the states, free of federal interference.” Whatever the flaws in the Roy plan, it has a big advantage in that it works off the status quo, rather than attempting to scrap the status quo. (See: path dependence.)

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.

Pethokoukis, Economics, U.S. Economy

Is the temp economy permanent?

Image Credit: shutterstock

Image Credit: shutterstock

If the US job market were undergoing some sort of major, long-lasting transformation, how would we know? Well, the data might start looking kind of weird. Maybe the labor force participation would collapse, or wages would stagnate, or job creation would shrivel. Or we might see something like a big rise in temporary workers. Indeed, Wall Street Journal reporter Damian Paletta points out, “More than 2.8 million workers were categorized as having temp jobs in March—about 2.5% of the workforce—up from 1.7 million in August 2009.” Of course a rise in short-term jobs is typical after a downturn, and a big increase often comes right before an upturn in permanent hiring. But maybe not this time. Paletta:

The boost is fueled by companies that reduced hiring amid the recession and learned they can save money in wages and benefits, as well as increase their flexibility, by using fewer permanent workers—even as the economy grows. Technology advances, particularly in manufacturing, have led companies to rethink how many permanent workers they need at a time when temp jobs have become increasingly long term.

So are we are headed to where Japan already is? A third of its workers are temps who are paid less, receive fewer benefits, and have less job security. Not surprisingly, all this takes a toll on family formation, the last thing a nation with a shrinking population needs. If this trend is longer-term, it argues for better education and training so workers can do the high-value things machines can’t. Government should also be careful of polices that raise hiring costs like mandating benefits or wage floors. In fact,  policymakers should take a deep look at wage subsidies for lower-skilled workers. Above all, lawmakers at all levels need to take seriously the impact of technology on labor markets. From The Economist:

Nick Bloom, an economics professor at Stanford, has seen a big change of heart about such technological unemployment in his discipline recently. The received wisdom used to be that although new technologies put some workers out of jobs, the extra wealth they generated increased consumption and thus created jobs elsewhere. Now many economists are taking the short- to medium-term risk to jobs far more seriously, and some think the potential scaleof change may be huge.

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.


More signs the US labor market is hardly back to full health


There are ways to gauge the job market besides the unemployment rate or labor force participation. One way is to look at total job opening and total job separations, from the Labor Department’s Job Openings and Labor Turnover Survey. If you add total job openings to total job separations, you get a sense of job churn. Deutsche Bank:

Generally speaking, higher job churn corresponds to a healthier and more dynamic labor market. At present, gross job churn is only around 8.4 million per month, which is where the series was in July 2008. From 2003 to 2007, when the unemployment rate averaged just 5.2%, gross monthly job flow averaged slightly more than 10 million workers per month from 2003 to 2007.

Also both the hiring rate and quit rate remain low:

…  the hiring rate was only 3.3% in January, which is 70 basis points (bps) below its 2005 peak, and 50 bps below the 3.8% average that prevailed from 2003 to 2007. The hiring rate is closely correlated with the change in nonfarm payrolls, so if the pace of the latter accelerates, then the hiring rate should rise significantly.

The pattern on the quit rate is similar to that of the hiring rate.  The quit rate is currently 1.7%, which is up 40 bps from its record low of 1.3% set during 2009 and 2010.  However, the quit rate averaged 2.0% from 2003 to 2007, so it still has to edge a bit higher to get back to “normal”.

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.

Economics, Pethokoukis

If the West has never had so much economic freedom, why do our economies stink?

"Economic liberty in the long run: Evidence from OECD countries" by Leandro Prados de la Escosura,

"Economic liberty in the long run: Evidence from OECD countries" by Leandro Prados de la Escosura,

In “Economic liberty in the long run: Evidence from OECD countries” economist Leandro Prados de la Escosura takes the long view of economic freedom — as measured by trade, property rights, monetary policy, and regulation — and arrives at the following conclusion:

Economic liberty is higher nowadays in the OECD than at any time over the last one and a half centuries and, probably, in history.

Let’s assume that’s true regarding advanced economies. (Weird that the level of marginal tax rates isn’t in the mix.) De la Escosura highlights this quandry: “If economic freedom is usually associated with economic growth, how can we reconcile good economic performance in the OECD during the 1960s and early 1970s with stagnant and relatively low levels of economic freedom?”

This seems not so hard. The 1960s and 1970s saw Europe complete its postwar catchup. Also, one might expect mature economies to grow a bit more slowly. And maybe the “neoliberal” revolution that brought this flowering of freedom had a big flaw that de la Escosura is missing. Ashwin Parameswaran:

The neo-liberal era is often seen as the era of deregulation and market supremacy. But as many commentators have noticed, ”deregulation typically means reregulation under new rules that favor business interests.” As William Davies notes, “the guiding assumption of neoliberalism is not that markets work perfectly, but that private actors make better decisions than public ones”.

And this is exactly what happened. Public sector employees were moved onto incentive-based contracts that relied on their “greed” and the invisible hand to elicit better outcomes. Public services were increasingly outsourced to private contractors who were theoretically incentivised to keep costs down and improve service delivery. Nationalised industries like telecom were replaced with heavily licensed private oligopolies

The neo-liberal era saw a rise in incentive-based contracts across the private and public sector but without the invisible foot of the threat of failure. The predictable result was not only a stagnant economy but an increase in rent extraction as private actors gamed the positive incentives on offer.

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.


Is deflation, not inflation, the bigger threat to the US economy?


Maybe so, says AEI’s John Makin in a must-read, must-share analysis. The report provides a needed counter to the ongoing inflation obsession on the right, including theories that the government is altering price data. One part of this argument that really jumped at me is how deflation might play into weak ongoing US business investment. Makin:

A rising real interest rate discourages investment, and weaker investment results in slower growth, which in turn reinforces the tendency for deflation to accelerate. In fact, many commentators have been surprised by the weakness of US investment spending during this weak recovery. Few have observed that falling inflation and the threat of deflation that boosts the real costs of borrowing may be to blame. Beyond pushing up the real cost of borrowing, actual deflation reduces the attractiveness of investments since the goods produced with the investment may be saleable only at a lower price, thereby reducing the return on any investment.

Expectations matter. And imagine how expectations would change if the Fed, say, committed to a 5% NGDP target.

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.


Is more infrastructure spending really the way to end America’s ‘secular stagnation’?

Image Credit: shutterstock

Image Credit: shutterstock

No wonder President Obama wanted Larry Summers to head the Federal Reserve. Judging by a spate of op-eds, the former Obama economic adviser would’ve continually hectored Congress for more fiscal action. That syncs with his old boss’s preference. Both fellows even agree on a favored form: increased government infrastructure spending. But it’s a simplistic answer to a complicated problem.

In a Financial Times commentary today, Summers claims the case for more public investment is “overwhelming” and would “reduce burdens on future generations, not just by spurring growth but also by expanding the economy’s capacity and reducing deferred maintenance obligations.”

Recall that Summers worries America is facing a chronic demand shortfall. It’s the key element of his “secular stagnation” thesis. So he’s probably talking about a long-term, deficit-financed program, not merely timely, targeted, and temporary stimulus. The win-win here, from Summers’s perspective, is that more infrastructure spending would boost demand and also increase potential GDP.

One problem with the Summers Solution is that more government spending on infrastructure is not the only or even the best way to fix our roads, bridges, runways, rail, water pipes, and grid. For instance: selling some roads and airports to the private sector would, argues Brookings scholar Clifford Winston, raise revenue for government and get more bang for the buck. Private operators would (a) minimize construction costs, (b) respond better to user needs, (c) and innovate such as through congestion pricing.

Second, Summers is unnecessarily pessimistic about boosting demand through monetary policy, especially given its recent successful record in offsetting US fiscal austerity. Targeting total spending in the economy, or nominal GDP, would be an improvement on current Fed strategy. Perhaps Summers is so negative because such an approach might mean accepting higher inflation for a bit — a tough public stance for person who might believe a future Fed post isn’t yet out of the question.

Third, secular stagnation thesis was born in the 1930s and hinged on a forecast of slowing population and innovation. And Summers is worried about both, in addition to income inequality. So it’s strange he doesn’t talk more about boosting labor force participation and productivity, both of which are being hampered by government policy.

Summers is worried America will become stagnant Japan. So why, then, follow Japan’s example of relying on infrastructure to boost demand? If we need better roads and airports, let’s bring in the private sector to repair and run them. Let the Fed handle NGDP. And have Congress start cleansing the tax and regulatory code of cronyist subsidies that help incumbents over startups. Maybe that’s how you end secular stagnation.

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.


Here is exactly how you would get rid of the corporate income tax


A great, pro-growth idea, but no one said it would be a walk in the garden. From “Major Surgery Needed: A Call for Structural Reform of the U.S. Corporate Income Tax” by Eric Toder of the Urban‐Brookings Tax Policy Center and AEI’s own Alan D. Viard:

The second option, which could be adopted unilaterally by the United States, would replace the corporate income tax with increased taxation of shareholders. American shareholders of publicly traded companies would be taxed on both dividends and capital gains at ordinary income tax rates and capital gains would be taxed upon accrual.

The option would ensure that American shareholders in both U.S. and foreign‐based multinational corporations pay tax on their worldwide income, while improving incentives for both domestic and foreign corporations to invest in the United States and increasing the competitiveness of U.S.‐resident MNCs.

It would also curtail a host of closed‐economy distortions, including the current system’s biases against corporate equity‐financed investment, dividend payments, the sale of appreciated assets, and specific industries and types of capital.

But it would face a number of design challenges and would reduce federal revenue. It would also confront severe political obstacles because it would be perceived as a giveaway to corporations, it would tax accrued gains that many shareholders do not consider to be income, and it would require other tax increases or spending cuts.

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.


It looks like the weather, not Obamacare, was responsible for shortening the average workweek


Is Obamacare causing a decline in the length of the average workweek? That has been given as one possible explanation for the drop in average hours from 34.5 in September to 34.2 in February. The March jobs report, however, points to the weather as a more likely culprit. Scott Sumner: “Now it looks like the harsh winter did explain the drop in hours—the March numbers bounced back to 34.5, essentially where they have been since 2006, except for a brief dip in 2008-09.”

Here is how the BLS put it:

The average workweek for all employees on private nonfarm payrolls increased by 0.2 hour in March to 34.5 hours, offsetting a net decline over the prior 3 months. The manufacturing workweek rose by 0.3 hour in March to 41.1 hours, and factory overtime rose by 0.1 hour to 3.5 hours. The average workweek for production and nonsupervisory employees on private nonfarm payrolls increased by 0.3 hour to 33.7 hours.

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.

Economics, Pethokoukis, U.S. Economy

The March Jobs Report: Is the Great Recession finally over?


Is the US job market back, finally? One interesting data point in the March employment report: the US economy added 192,000 private-sector jobs last month, pushing private payrolls to 116.09 million. That level surpasses the former high of 115.98 million reached in January 2008.

Hardly an insignificant milestone, and one that shows how far the labor market recovery has come. Although the American economy has been growing since summer 2009, a return to prerecession private-job totals is also an important marker. Perhaps, one could say, we’ve even returned to normal.

If so, it’s a dreary new normal. Consider this: private-sector jobs typically grow by about 3% a year during strong recoveries and expansions, such as the ones in the 1980s and the 1990s. From 2010 through 2013, however, they grew only by 2.1% a year. If the current recovery and expansion had been as robust as the ones during the Reagan and Clinton years, we would have around 121 million private-sector jobs right now. So we’re still a good five million private-sector jobs short of where we might be — a pretty significant “jobs gap” — by that rough calculation.

What’s more, we are nearly four million full-time jobs — both public and private — short of prerecession levels, not even assuming a stronger recovery. Just 81% active US workers have a full-time job versus 83% in November 2007. And, don’t forget, another 4 million Americans are long-term unemployed.

Another way to look at it: monthly payroll growth has averaged 178,000 this year vs. 185,000 in the 2011-2103 period. At that pace, it would take nearly six years to return to prerecession employment levels, according to the Hamilton Project’s jobs gap calculator. (See below.) Overall, then, few signs of economic acceleration, though plenty of Wall Street economists think both GDP and jobs growth will pick up in coming months. We can only hope. But for now there is no reason for Washington policymakers to consider America’s economic emergency anywhere near over, even if the Great Recession technically is.

Hamilton Project

Hamilton Project