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Ohio Jumps On The Rating Agency Lawsuit Bandwagon

2009-11-20T21:32:02Z

Ohio's attorney general is suing the rating agencies in an attempt to recoup losses on its state retirement fund. The state's complaint is that the agencies' bad ratings cost it $457 million when securities it purchased lost value. This is not the first civil suit against the agencies and probably won't be the last. I noted a case back in September where a judge appeared more open-minded then usual regarding such a suit. Usually the agencies claim First Amendment protection on their ratings, claiming that they're merely opinions. Ohio alleges something beyond mere negligence, however. Yet, I'm still not convinced its particular complaint will succeed.

Here's some detail via the New York Times:

The lawsuit asserts that Moody's, Standard & Poor's and Fitch were in league with the banks and other issuers, helping to design an assortment of exotic financial instruments that led to a disastrous bubble in the housing market.

"We believe that the credit rating agencies, in exchange for fees, departed from their objective, neutral role as arbiters," the attorney general, Richard Cordray, said at a news conference. "At minimum, they were aiding and abetting misconduct by issuers."

Many people, including me, have been highly critical of the rating agencies. I've said that they should be held responsible for negligence, as I think the First Amendment claim is just silly. They provide expert opinions which are relied upon by investors. But I don't believe that their actions were generally so dastardly that their analysts deserve jail time.

In regard to Ohio's specific complaint, I don't think First Amendment protection would apply if a judge finds validity in the facts the state presents. After all, if the agencies were "in league with" banks and issuers' misconduct, then it sounds like they were accessories to defrauding investors. Free speech would have nothing to do with that, as fraud is illegal.

With that said, I find it highly unlikely that Ohio would succeed in satisfying this burden of proof. I know there are several isolated stories of rating agency analysts who weren't as prudent as they should have been or a little too cozy with bankers. But as I've said before, I don't believe that was a widespread problem. And I think proving that this was the norm at the agencies would pose an even greater challenge.

So might this complaint get past the First Amendment issue? Perhaps. Will it ultimately result in Ohio winning the case? Based on the argument presented here, I doubt it.

Fed Audit Legislation Progresses

2009-11-20T20:32:58Z

Yesterday, another interesting amendment (.pdf) to the House's financial regulation bill made it through committee. It would require an audit of the Federal Reserve. The amendment offered by Rep. Mevlin Watt (D-NC) has the spirit of a bill written up by Rep. Ron Paul (R-TX) calling for a similar end. Paul has been an outspoken critic of the Fed and offered a companion amendment (.pdf), along with Rep. Alan Grayson (D-FL), broadening the audit. It also passed. Some people are worried that the amendments could endanger the independence of the Fed. I think that's an exaggeration.

For starters, I think it's important to look at what these amendments actually say. They really just seek to provide Congress a better understanding of what's going on at the Fed. They basically give politicians the ability to determine whether the Fed is following its own policies and procedures. Essentially, Congress wants to be sure that the Fed is running a tight ship.

What they don't do is allow the auditor or members of Congress to question the Fed's monetary policy decisions. In fact they explicitly say that the auditor can't make recommendations about Fed loans or liquidity facilities. They don't even require knowing everything said by Fed officials. One section of Paul and Grayson's companion amendment reads:

Audits of the Federal Reserve Board and Federal reserve banks shall not include unreleased transcripts or minutes of meetings of the Board of Governors or of the Federal Open Market Committee.

They aren't looking to give Congress the power to micromanage the Fed. The companion amendment makes crystal clear that this legislation is not to be construed:

as interference or dictation of monetary policy to the Federal Reserve System by the Congress or the Government Accountability Office;

And as far as I can see, there really aren't any enforcement provisions. In other words, even if Congress doesn't like what it finds, I don't know that there's much it can do. Maybe it can vote to remove the Fed Chairman, but unless serious problems are found, I can't begin to imagine that happening. And remember -- it can't be due to monetary policy decisions, per Congress' own words. As a result, nothing I see in the amendments harm the Fed's independent nature.

Of course, these are only amendments to the House's version of the bill. Even though Congress' final version of financial regulation will probably look more like the House's version than the Senate's more ambitious version, any amendment could go by the wayside. So it's definitely still possible that the Senate could eliminate the audit provisions when the two versions are reconciled.

How Inaccurate GDP Figures Can Lead to Inflation

2009-11-20T20:19:00Z

There is a lot of concern about how the Federal Reserve plans to reign in the deluge of money it's dumped on the economy to stimulate lending and spending. When will the Fed sell the securities it took off the banks' balance sheets? When will it raise interest rates to stave off serious inflation? These are crucial questions, and as the Economist's Buttonwood blog explains, it's incredibly hard to know when to start tinkering with monetary policy because the information we get about the economy's health -- quarterly GDP estimates -- can be wrong. Sometimes, it can be very wrong:

Tim Bond of Barclays Capital has looked back through the American data since the mid-1960s. he points out that the difference between GDP as first reported (and therefore known to policymakers) and GDP (as subsequently revised) was around 1.4%. That is greater than the average level of the estimated output gap over this period.

As an example, policymakers thought that American GDP dipped 7.7% in the 1974-1975 recession; in retrospect, the decline was only 2.5%. No surprise then that the Fed eased monetary policy by too much and the result was high inflation.

Bond's conclusion is that, given the shock they have suffered, policymakers may end up overestimating the output gap, keeping policy too loose for too long, and tipping us more towards inflation than deflation.

Update: Ezra Klein writes:

At some point, however, the Fed going to need to raise rates. It's going to need to decide when reflation has given way to inflation. And that's what the argument over inflation is actually about. Not whether we're there now, but whether we can trust the Fed to know when we've gotten there, or whether it's going to be listening to the wrong people along the way.

Yup. I'm with Ezra on joblessness being a graver concern than inflation right now. But the interesting thing about Bond's finding, if it's accurate, is that it doesn't matter who you're listening to if the data is wrong. And our best data about output can be misleading, or even wrong.

Oprah Winfrey Ending the Most Successful Television Show Ever

2009-11-20T19:13:10Z

Oprah Winfrey has announced that she is ending her show after its 25th season. You can see why she's doing it: one of the wealthiest people in America, with $2.6 billion to her name, Ms. Winfrey hardly needs to keep showing up for a job that must be getting a little repetitive by now. Moreover, she still has a massive media empire with properties like O Magazine to keep the money rolling in. And with the termination of her show, she'll be launching her very own cable network, OWN.Of course, it remains to be seen whether her empire will remain intact after she leaves broadcast television. For all the complaints about the declining viewership of the Big Four, they have many times the audience of the Discovery Channel, which is helping Ms. Winfrey launch her new property. Memories are short in the media business. Will women continue to buy her magazine if they aren't spending their weekday afternoons watching her show?

AppleCare: No Smokers Need Apply

2009-11-20T18:52:23Z

Allegedly, Apple is declining to repair Macs owned by smokers on the ground that secondhand smoke is dangerous. This a gross misunderstanding of the science--theoretically, tobacco tar could be hazardous if applied to your skin, but you'd have to really slather it on, leave it there for an extended period, and reapply fairly frequently. But it also seems like a gross misunderstanding of who makes up their customer base on the East Coast.

State Unemployment Changes Mixed In October

2009-11-20T18:00:47Z

Today, the Department of Labor Statistics released its state-by-state unemployment statistics for October. The national unemployment rate increased significantly in October, rising from 9.8% to 10.2%. But only 30 states (including DC) saw an increase in thier unemployment rates, while 13 saw a decline. The other eight states' rates were unchanged. Some states' results are surprising, but others are more predictable.

First, there's good news for a few of the usual suspects. Ailing Michigan and Nevada were actually in the top five for the highest declines in unemployed, with 7,000 and 6,100 fewer jobless, respectively. That decreased Michigan's unemployment percentage by 0.2% from 15.3% to 15.1% -- still the highest in the U.S. Similarly, Nevada's rate decreased by 0.3% to 13%, and also continues to rank second highest. Massachusetts, West Virginia and New Hampshire were the biggest winners by percentage, seeing their unemployment rates decline by 0.4%.

Then, there were the losers. Unfortunately, Florida and California are still seeing their unemployment numbers increase. Those states were in the top six highest increases in unemployed, with 8,700 and 36,000 more jobless, respectively. Luckily, given the sizes of those states, that did not affect their unemployment percentages too drastically, raising the rate in California by 0.2% to 12.5% and in Florida by 0.1% to 11.2%. In terms of percentage, the worst hit states in October were Wyoming, Alaska and Illinois who all saw their rates jump by 0.6%. Arkansas, Mississippi and the District of Columbia also had a bad month, with their rates rising by 0.5%.

Incredibly, North Dakota's unemployment rate is still a just 4.2%, the best in the nation. Nebraska and South Dakota aren't much worse at 4.9% and 5% respectively.

Here's the whole picture, from BLS:

As you can see, from an employment perspective it remains pretty good to live in the center of the map.

Are Fat People Good for America?

2009-11-20T17:59:06Z

So there's this Wall Street Journal column about how we should be nicer to obese people because Winston Churchill was pretty fat, and he did a good job during World War II, and where would we be without Alexandre Dumas' chubby little fingers and Catherine the Great's heft, and so on. It took me a while to see that the piece was written by Joe Queenan, a satirist, and was not meant (I think?) to be a terribly weighty contribution to the obesity-in-America discussion. But I think it inadvertently raises an important point. Those historical fatties were mostly really rich.

From an historical perspective obesity is a privilege of the rich. Throughout much of history food costs ate (as it were) much deeper into disposable incomes. But food companies have made remarkable strides in the last century mass-producing food that is both very cheap and very fatty. From an economic perspective, cheap food is a good thing. From a health perspective, cheap, fatty food is dangerous since our evolutionary instinct to maximize caloric intake has married our economic instinct to buy cheap. Today our obesity epidemic is especially acute in poor communities. And there's a simple explanation. Take a look at this graph of how butter and soda prices have fallen in the last three decades...

...and this graph of national obesity graphed against time spent eating.

See the six countries with the highest % of population with BMI>30? Four of those countries -- the US, New Zealand, Australia and Canada -- happen to be the four countries with the most McDonald's per capita in the world (the UK is number 9). What does this weight do to our health care system? It's difficult to know for sure, but one study estimates that obesity will cost the US $344 billion in health costs by 2018. Take that number with a grain of salt (and only a small grain of salt, America!) but the bottom line is pretty clear to me. There are negative externalities to our ability to produce cheap, fast, fat food. They are very costly. And we should think seriously about ways to price those negative externalities. So yes, the history books are heavy with portly heroes. And nope, I don't think that's an argument for doing nothing.

The Media is Wrong about Goldman Sachs, AIG

2009-11-20T17:34:52Z

This week brings us a joint effort from the New York Times and Reuters, reminding us all that Goldman Sachs is the devil incarnate and without the generous AIG bailout, they'd be just as hosed as their more earthly competitors:

Goldman Sachs Group Inc could have suffered dramatic losses if the federal government had not intervened to prop up American International Group Inc , according to a government report.
It was revealed in March that Goldman received $12.9 billion in payments and collateral from AIG. (emphasis mine)

Well, nothing to really hammer home your agenda like rank speculation and utterly horrific summation. The TARP report (or SIGTARP) is 32 pages long, and traces the AIG bailout/credit default swap settlement from start to finish. The NYT article, at 350 words, focuses on a very small, cherry-picked section of the report's contents, and it ignores what I believe is the far more important point: Government (Treasury, Fed) officials failed to embrace their duty to the American people with hasty, and not particularly well-thought-out decision-making. That's right folks, I am defending not just Goldman, but the other banks that were paid "effectively par" (which is the report's language) on their credit default swaps with AIG as well.

From where do I draw this conclusion? From the actual report, which I read, carefully, in its entirety. Now, let me be clear: I fully understand the fear and uncertainty that motivated regulators to act quickly last autumn. But as the adage goes, "haste makes waste," and unfortunately that's exactly what happened with AIG. The following are pulled directly from the report filed by the Special Inspector General for the Troubled Asset Relief Program, issued yesterday, with page numbers for each quote, lest anyone doubt my integrity.

On September 15th, 2008, AIG's long-term credit rating was downgrades, and, without some kind of assistance, the company faced bankruptcy. FRBNY [Federal Reserve Bank of New York] believed that a consortium of private banks would be able to offer assistance to AIG. The consortium, however, believed AIG's liquidity needs exceeded the value of the company's assets, and the private sector solution failed in the wake of the bankruptcy of Lehman Brothers (pp. 6)

The next day, scared to the gills of having another Lehman (my thoughts on the handling of that case notwithstanding), the Powers That Be decided to extend an $85 billion revolving credit facility to AIG. That's all well and good - we were all afraid of collapse then - but in their haste, said Powers failed to analyze the terms attached to the facility, a decision which would come back to haunt them only a short time later.

In a rush to take action quickly, FRBNY did not craft its own terms and instead simply adopted in substantial part the economic terms of a draft term sheet under consideration by a consortium of private banks, which included a very high interest rate. The terms of this agreement, including the substantial increase in the amount of AIG debt and the substantial interest rate, would later put AIG's credit rating in jeopardy once again, requiring additional Government action. (ibid)

So the consortium, which actually put some (although its not clear how much) time/effort into analyzing an emergency credit facility for AIG came back with a firm "No way, Jose," but the Fed gave it the green light, anyway. Huh.

The group (consortium) developed a loan term sheet, but an analysis of AIG's financial condition revealed that liquidity needs exceeded the valuation of the company's assets, thus making the private participants unwilling to fund the transaction. FRBNY officials told SIGTARP that, in their view, the private participants declined to provide funding not because AIG's assets were insufficient to meet its needs, but because AIG's liquidity needs quickly mounted in the wake of the Lehman bankruptcy and the other major banks decided they needed to conserve capital to deal with adverse market conditions. (pp. 8)

Terrified of repeating history, the feds went too far in the opposite direction. Immediately realizing their mistake in letting Lehman fail, the Fed decided the best course of action was to do the complete opposite with AIG and hastily throw money at the problem.

In the final analysis, the Federal Reserve and Treasury believed that the risks of not rescuing AIG outweighed the risks associated with rescuing the troubled insurance company, and on September 16th, 2008, the Federal Reserve Board authorized an $85 billion credit facility for AIG. (pp. 11)

And so it went, which was all well and good, except, as previously mentioned (again, emphasis mine):

FRBNY did not develop a contingency plan in the event that the private financing did not go through and did not conduct an independent analysis regarding the appropriate terms for Government assistance to AIG; instead it used in substantial part the economic terms of the private sector deal, albeit for $85 billion instead of the $75 billion prepared by JPMorgan Chase for the unsuccessful private sector solution. (pp. 11)

So the NY Fed floated a loan to a company spiraling into the abyss that pushed them even further into it. Brilliant. This was supposed to be emergency rescue financing, not LBO debt on a junk-rated company! Did anyone at the Fed bother to actually read the term sheet before they gave it their John Hancock?

An FRBNY official told SIGTARP that, by September 17, 2008 - the day after FRBNY provided initial assistance to AIG and two days after AIG's Ratings downgrades - it was clear that the rating agencies were planning another downgrade of AIG because of the deteriorating financial condition of the company and the impact of the $85 billion FRBNY loan could have on AIG's capital structure, including the high interest rate payments AIG would have to make to FRBNY. (ibid)

Well, if there's a silver lining at least they realized their mistakes almost immediately! Wait. It took them almost two months to do something about it? Well, at least they used that time to roll up their sleeves and use their negotiating leverage to pressure counterparties into cooperating, right? Wait again. After retaining Blackrock to advise on possible solutions, the Fed chose not to apply pressure to AIG's counterparties, but actually did the opposite, selecting the option lease likely to require negotiation, and most likely, in their eyes, of being accepted ASAP.

The third option, which FRBNY eventually selected, was to create a SPV to purchase the underlying CDOs from AIGFP's counterparties, in connection with a termination of the related CDS. Within this option, BRS noted that counterparties could receive effectively par value or FRBNY could seek a reduction in the amount that counterparties would receive - otherwise know as concessions or a "haircut" - for the total of the CDOs and related swaps held by each of AIGFP's counterparties. FRBNY's AIG monitoring team explained that this structure had the benefit of minimizing valuation disputes with counterparties, because combining the payment by Maiden Lane III for the CDO's and the offset of collateral for the tear-up of the CDS contracts eliminated the need to agree with counterparties separately on the market price of the CDOs and the value of the CDS contracts. Blackrock assessed this option as having a "high certainty of execution" and the "simplest structure." FRBNY officials told SIGTARP that this structure was also attractive because it fit within the legal authorities of the Federal Reserve to lend against collateral. (pp.14)

So, despite having what most sane, reasonable people would consider significant negotiating leverage with AIG's counterparties (given the various Fed programs keeping banks afloat), the brain trust at the Fed decided to go with "simple" and "easy." In fairness to the staff at the Fed, they did actually "try" to negotiate haircuts on the CDS, but to no avail. Maybe their lack of success had something to do with the fact that from the get-go, they called AIG's eight largest counterparties - SocGen, Goldman, Merrill, Deutsch Bank, UBS, Caylon, Barclays, and BofA - on the phone (strike one), and stressed that any concessions were voluntary (strikes two and three, in my book). Seven of eight refused any concessions, and the only bank to budge, UBS, conceded to only a 2% haircut if and only if all the other banks agreed to the same.

By this time, Fed officials were worried about further ratings downgrades if they could get the counterparties to agree to reductions in payments. Interestingly, it doesn't appear anyone from the Fed actually spoke to any of the ratings agencies to let them know what was going on.

So, why, exactly, did AIG's counterparties think they could stand tall against the Fed, given their seemingly inferior negotiating position?

· They had collateral already posted by AIG to protect against the risk of AIG default. That, plus the fair market value of the underlying CDOs equaled par value of the CDS. Thus, from the counterparties perspective, offering a concession would mean giving away value and voluntarily taking a loss, in contravention of their fiduciary duty to their shareholders.

· In addition to the collateral, they had a reasonable expectation that AIG would not default on any further obligations under the CDS because the U.S. Government had already demonstrated that it would not allow AIG to go bankrupt.

· They had already incurred costs to mitigate the risk of an AIG default on its obligations that would be exacerbated if they were paid less than par value.

· They were contractually entitled to the par value of the CDS (pp. 16)

As I've written previously and above, the counterparties presented a pretty strong case as to why they were entitled to par on their CDS contracts. Also, the above bullet points - notably the first two - show, the Fed was severely outmatched at the negotiation table. It seems each time they showed up to the table they were fantastically unprepared for what they encountered, suggesting that they should have consulted, or heeded the advice of professionals more experienced with such negotiations.

Many observers (like derivatives expert Janet Tavakoli) have pointed an irate finger specifically at Goldman Sachs, as if

1. They were the only bank that was paid at effectively par,

and

2. They were lying about the extent, magnitude, and degree of their exposure to AIG on the CDS.

Again, as I've said in the past, the only way for her - or anyone else for that matter - to make such a ridiculous statement would be if they'd seen Goldman's trading book when this all went down, which, as far as I know, no one outside Goldman has.

Until now. SIGTARP actually went to the source and asked Goldman to defend themselves against such criticisms. To summarize the Masters of the Universe from 85 Broad:

· Goldman did NOT own the underlying CDOs; on the contrary, they'd sold equivalent protection on CDOs owned by its clients, and hedged its exposure by buying protection from AIG. If Goldman conceded to the Fed's request for a haircut, they would have taken a loss on their obligations to their clients.

· The Maiden Lane III settlement with Goldman covered $13.9 billion of swaps, however on that portfolio, Goldman already had $8.4 billion of collateral from AIG to cover a drop in value of the underlying to that point based upon AIG's calculations. However, Goldman calculated the loss was actually $9.6 billion, and had purchased additional protection to cover the difference. Thus, the $8.4 billion in collateral, the $1.2 billion in additional protection, and their calculated FMV of the underlying at that point of $4.3 billion meant Goldman would have been made-whole (received par) if AIG defaulted.

· Goldman had collected collateral on other hedges, and they claim that even if AIG had defaulted (gone bankrupt), they would have been "ok." (pps. 16-17)

I find it relatively unlikely we'll get much more detail out of Goldman, for what its worth, to judge how true such claims are or may have been at the time.

Interestingly enough, while it seems to me (and several other observers) that the Fed should have had the upper hand in its negotiations, its employees and officials believed otherwise. Reasons given:

· The greatest leverage that FRBNY might have had - the threat of default and an associated AIG bankruptcy - was effectively removed by FRBNY's intervention in September, and intervention that the counterparties understood to mean that the U.S. government would not permit an AIG failure. The officials stated that ethical constraints prevented FRBNY from even suggesting that it would allow bankruptcy when it in fact would not do so.

· In addition, FRBNY was concerned that its use of a threat of an AIG default might introduce doubt into the marketplace about the resolve of the U.S. Government in following through on its commitments in support of financial stability. FRBNY officials felt the introduction of such uncertainty might have been dangerous and potentially expensive for the U.S. economy in light of the precarious market conditions in November, 2008 and the extraordinary official efforts that had been taken to support market functioning.

· FRBNY was further concerned - as it was throughout the AIG rescue - about the reaction of the ratings agencies. While threatening not to support AIG might have been useful for purposes of forcing concessions by the counterparties, it could also have been viewed by the credit rating agencies as an indication that the FRBNY and the U.S. Government was not standing fully behind AIG, which could have had a negative impact on AIG's credit rating.

· As a policy matter, FRBNY was unwilling to use its leverage as the regulator for several of the counterparties to compel concessions, in part because in the negotiations it was acting as a creditor of AIG and not as the counterparties' primary regulator.

· Also as a policy matter, FRBNY was uncomfortable with violating the principle of sanctity of contract.

· The refusal of the French Banks to negotiate concessions played a significant role in complicating FRBNY's efforts. FRBNY views treating all parties equally as one of its "core values," and it did not want to be perceived as making a more favorable deal with the French institutions than with the domestic institutions. Indeed, FRBNY recently suggested that the requiring concessions from some banks while not requiring concessions of others was not consistent with the principles found in Section 4 of the Federal Reserve Act (requiring the Federal Reserve to treat member banks and banks equally) and the principles of national treatment and equality of competitive opportunity in the International Banking Act (requiring that domestic banks and branches of foreign banks be treated equally). (pps. 18-19)

While I sympathize with the no-doubt difficult, if not unprecedented, position in which the staff of the Fed found themselves last fall, I don't agree with their rationale for not pushing harder in negotiations with AIG's counterparties. By the time the Fed asked (why they didn't "tell" or "strongly suggest" is beyond me) the counterparties to take a haircut on the CDS, they'd already ceded the top position at the negotiating table, but instead of standing tall, they folded like a lawn chair.

Could Goldman (and to a lesser extent, the other counterparties) have been more grateful for the Fed's intervention? Absolutely. But that's another story of horrendous public relations, and doesn't materially affect the facts relating to the transactions themselves.

If the American people have any rightful anger, and deserved ire about the AIG swaps "bailout," it should be directed at the AIG and AIGFP employees and executives who were directly responsible for the risk management regime predicated on foolish risks, the Ratings Agencies who didn't recognize the risks until it was too late, and the U.S. representatives from the Fed, Treasury, etc who - as the last line of defense - failed to exercise prudent banking practices in their rush to avert possible catastrophe.

Contrary to some other relatively extreme observers, I've yet to find evidence of any conspiracy here, especially since Occam's Razor indicates there's a much simpler explanation: We're all human, and we all make mistakes, or decisions we wish, with the benefit of hindsight, that we'd made better or differently. The Fed found itself at each step of the way in an unenviable position between a rock (likely AIG bankruptcy) and a hard place (being perceived to funnel bailout funds to the banks through AIG). If they'd gone the other direction, they'd no doubt be suffering similar - or worse - criticism for their actions. All things considered, and all things equal, I think there's far more important things for all of us - taxpayers, Wall Streeters, politicians and regulators, - on which to focus our time and energy.

Is Fox a Real News Operation?

2009-11-20T17:24:17Z

Fox News seems to have a real problem with cutting old footage into new stories. The liberal theory is that this is some sort of concerted conspiracy to imply that 80 million Americans turn out for every Tea Party or Sarah Palin appearance. The conservative line is that they were simply trying to punch up an otherwise dull segment, and/or somehow ran out of footage of the actual event. The latter story makes marginally more sense to me, but only because I cannot imagine that anyone at Fox News--indeed, anyone with a pulse--is stupid enough to imagine that a few shots of excess protesters are enough to marginally improve the chances of Republican victories in 2010 or 2012.

I'm not sure it really matters. Fox News was, I think, justifiably angry when the Obama administration declared that they were not a real news organization. But if you wanted to be treated like a real news organization, you have to abide by the rules that real news organizations follow. One of those rules is that you do not imply that images of one event actually come from an entirely different event. You don't do this for any reason.

It's entirely true that other news organizations have been caught in sleazy tactics, like the infamous habit of wiring cars to explode during auto safety stories. But they were righteously yelled at, and since the advent of the right-wing blogosphere, they seem to do a lot less of it. Now the left-wing blogosphere is fact-checking Fox with the same ferocity, and that's a good thing. We all have a vested interest in better news organizations.

The Other CBO Health Care Report

2009-11-20T16:48:51Z

Shortly after it posted its analysis of the Senate health care bill, the CBO put up a letter to Congressman Paul Ryan (R-WI) analyzing the House's other health care bill: the $200+ billion dollar "fix" (aka repeal) of the Sustainable Growth Rate.

For those of you who haven't been following along at home, the Sustainable Growth Rate was a cost-cutting measure enacted as part of the Balanced Budget Act of 1997. Not to bore you with unnecessary details, it tied the growth in physician reimbursement payments to GDP growth. This worked for a few years, because we had unusually low cost inflation, and unusually high GDP growth. Then those trends reversed, and physicians screamed bloody murder. Starting early this decade, Congress has annually enacted a temporary fix that either holds physician reimbursements steady, or raises them slightly, rather than cutting them as the law demands. Over the years, compound growth means that getting back to the SGR mandated trendline would require massive cuts in reimbursement rates: 21% this year, and according to the CBO, approximately 2% every year thereafter.

Permanent fixes were originally part of the House bill. The problem is, those fixes are, as you can imagine, very, very expensive. They made the bill cost more than $900 billion, and also, not be so deficit neutral. So they took it out and enacted it separately, without any financing measures.

Paul Ryan asked the CBO the natural question: "So what would these bills look like if they were enacted together?" The answer, according to the CBO, is that together they'd increase the deficit by $89 billion over ten years. And those increases would be back loaded: by 2019, they'd be pushing the deficit upward by $23 billion a year. The House health care bill makes the physician reimbursement fix somewhat cheaper. But the physician reimbursement bill makes the house health care bill cost slightly more--which is to say, if it were already law, the estimate of deficit reduction would be about $3 billion lower over the next ten years.

Defenders of the decision to split the bills argue that there's no particular reason that the Medicare physician fix should be tied to the health care bill. I see what they're saying, but I think that's wrong, for a few reasons.

- The provisions of the bills interact; passing them in parallel skews the cost estimates

- Passing the physician reimbursement is the price of AMA support for the bill, which is why they were originally bundled together. The bills have to be passed in parallel--if they don't do the one, they probably can't pass the other. That argues for making them into one bill.

- Failing to pass the cuts would devastate Medicare's GP provider network as physicians pulled out, making it hard to do the cost cuts in other areas.

- Splitting them leaves the physician fix with no financing mechanism.

It would be one thing if they'd found some alternative financing mechanism to pay for the physician fix. But as I see it, they're passing a bill that increases the deficit by $200 billion in order to pass another bill that hopefully reduces it, but by substantially less than $200 billion. That means that passage of this bill is going to increase the deficit.

I suppose you could argue that there's no chance that we're ever going to reduce those reimbursements, so passing the new healthcare bill doesn't actually increase the deficit from what it otherwise would be. Only then you have to explain why we should believe that similarly structured payment cuts will work with all the other providers. Because if Congress cannot, in fact, stick to its guns and allow mandated cost cuts to stand, then the health care bill isn't deficit neutral, is it?

Citi Offers Lower Interest Rates For More Card Usage

2009-11-20T16:00:37Z

In what appears to be a sort of odd answer to Congress' anger over credit card interest rate hikes, Citibank has introduced a new policy that allows some customers to reduce their interest fees -- if they use their card a lot. The idea is that cardholders who meet a minimum spending threshold each month will qualify for an interest rebate, essentially lowering their interest rates. While the move would almost certainly result in greater profits for Citi, it's bad for consumers across-the-board.

There are basically two kinds of credit card users: those who use for convenience and those who use for a short-term loan. The first category pays off their balance each month; the second category runs a balance, incurring interest fees. From Citi's standpoint, you want both of these kinds of consumers to use the card as much as possible. For the convenience users, more usage will result in higher interchange fees -- which are the only way you make money off those customers anyway. For those who use cards for short-term loans, more spending increases the time (and cumulative interest) it takes to pay off their balance.

Let's consider this example from the Associated Press' report:

Of course, consumers could need to spend more than they otherwise would to qualify.

That's the case for Lindsey Pappas, a 25-year-old public relations professional in San Francisco. She received a letter from Citi Wednesday that her interest rate was being hiked to 19.99 percent, up from 14.99 percent.

If she spends $750 a month, however, she can get a refund for part of the higher interest rate charges.

The problem is that Pappas is trying to pay off a $5,000 balance on the card, so she tries not to charge any money on it.

This gets tricky. Let's say she can afford to charge $500 in regular expenses on her card each month, so would have to spend an additional $250 to lower the rate. For the first month, if that $250 would have paid down her balance at the 20% rate, she'd owe around $80 in interest the next month. But if her balance grew by $250, she'd only owe $65, despite the larger balance, since the interest rate declined.

Of course, the problem is that this path isn't sustainable. After just three months, suddenly her balance would have grown to a size where she'd owe more monthly interest at 15% than if she'd been paying down the card at 20%. And that's what Citi wants. As long as it keeps those balances high, and discourages people from paying off cards, it will make more money -- even with slightly lower interest rates.

So from a fiscal responsibility standpoint, this new policy is pretty bad. Citi is rewarding its customers to spend more money, rather than pay down their balances. But even if consumers could convert a full $750 of their spending to their credit card and still pay down balances as scheduled, they still won't really save money. That's because of interchange.

Interchange fees are paid by merchants, and with more usage, their fees will increase. Reducing interest to encourage consumers to use credit card more often essentially acts as a fee transfer from consumers to merchants. Of course, merchants aren't stupid, so if they see profit margins falling because of this policy, they'll just increase their prices, forcing consumers to ultimately bear the cost anyway. And now even convenience users pay more. So really, under any scenario this policy is ultimately a bad one for consumers.

Obama Flubbed His 1st Stimulus. Can He Pass a 2nd?

2009-11-20T15:40:06Z

Clive Crook tags into the second stimulus debate with this new column in the Atlantic's cousin, National Journal. Crook is a lucid economics writer and his diagnosis of the Democrats' problems from the first stimulus is on target. They made four mistakes:

For a start, if anything, the first stimulus was too small. Second, it was poorly designed: too complicated, insufficiently front-loaded, and too reliant on public spending and not reliant enough on tax cuts. Third, it was oversold: The administration set itself up for failure by promising to "save or create" too many jobs, and by defining success as a much milder rise in unemployment than has transpired.

I think that's just about right. The interesting thing about the tax cuts in the stimulus is that they were front-loaded (it's much easier to start handing out tax rebates than wait for shovel-ready public projects to organize) but they were also designed to be stealthy. The rebates were supposed to appear in workers' paychecks so that Americans would look at their bank statements, see more money than they expected, get a rush of consumerism to the brain and decide that that Pottery Barn table is affordable, after all. Whether it's really stoked demand is an open question that I sense analysts would answer negatively.

Crook is also dead on with this criticism of the administration's job-creation PR:

It will also be necessary to argue that further fiscal stimulus will boost employment -- just as the first one (despite its failings) almost certainly has. But you do not make that case by devoting an official website to the nakedly fraudulent counting of jobs supposedly secured by stimulus money. Those reports, drawn from sources with every reason to cook the books, both overstate and understate the employment effect. They overstate it by attributing jobs that would exist anyway to stimulus money, which invites ridicule. They understate it by ignoring the indirect effects of additional demand on employment. These are most likely large but dispersed throughout the economy and impossible to audit.

Again, 100 yes. But here's where he catches me off. Crook argues that the White House's aversion to speaking openly and honestly about the long-term deficit is spooking voters...

Even if the administration lacks for the moment a detailed plan, it needs, at the very least, to start talking about the tax increases and cuts in spending that will be required once the economy is back on its feet. At the moment, it is saying almost nothing on the subject. This, I think, is the biggest reason that its credibility with voters is running out.

Yes to everything except the last line. If Obama came out with a big speech about the need to raise taxes and cut Medicare spending, I do not foresee a bump in his polling. I foresee an electorate that would respond something like this: (1) "No tax increases, you promised!" (2) "Hands of my health care!" (3) "...and in the middle of a recession!" Reagan didn't get much credit for his tax increases. Neither did Clinton. Bush I arguably lost the election because of his tax bump. I don't think the public is saving bonus points for the first politician to talk about new taxes. But I could be wrong.

Shareholders Object To Goldman's Giant Bonuses

2009-11-20T14:41:30Z

When journalists, pundits and Main Street complain about the ever expanding size of Goldman Sachs' bonuses, the criticisms roll like water off the squid's back. But the Wall Street Journal is reporting that some Goldman shareholders are latest to cry foul. And unlike pretty much everybody else, their opinion actually matters. I think this is kind of fascinating.

Why are shareholders mad? Because if less money went to Goldman's bankers, more could go to investors. The Journal explains:

One frustration: Despite record net income and compensation at Goldman as markets rebound and the firm outmuscles weakened rivals for business, analysts expect its 2009 earnings per share to be 22% lower than in 2007 and roughly equal to its 2006 earnings, according to Thomson Financial.

If I were an investor that would likely annoy me too. After all, Goldman Sachs is a corporation, so it should be rewarding its investors in proportion to its success.

The WSJ says that Goldman's somewhat sneaky use of temporary employees and consultants to make their per employee bonuses appear smaller than they actually are also has shareholders fuming:

The figure is a lightning rod for criticism of Goldman because its staff is on pace to earn about $717,000 apiece for 2009. Excluding temporary employees and consultants would increase compensation per employee to about $775,000.

For decades Goldman and its Wall Street brethren have been arguing that enormous bonus pools are necessary to retain the best talent. I don't think shareholders are necessarily disagreeing with that maxim here. Instead, they're more concerned with getting those bonus sizes out of the stratosphere, even if only a little closer to earth, so that shareholders can be rewarded in better proportion. Besides, if Goldman's per employee bonus number was reduced a bit, the rest of the Street still wouldn't be able to compete with it's comp numbers, so I highly doubt its talent would have any greener pastures to flee to anyway.

This development is also notable because it marks the first time I've heard of that it isn't the angry masses with pitchforks complaining about Goldman's bonuses -- it's their own shareholders, many of whom are a lot closer to the Wall Street crowd than the Main Street crowd.

There would be a couple nice consequences for Goldman listening to its shareholders on this one. First, it would boost their share value, making their equity more attractive. And don't forget: Goldman pays a fair chunk of its bonuses in shares, so that would actually benefit its employees too. Second, obviously its shareholders would be happier, which is an end most corporations strive for. Finally, it might help to calm the angry mobs.

I think this issue is particularly interesting in the case of Goldman, because it was one of the last major investment banks to convert from a partnership to a corporation. While that should mark a major change in corporate culture, this incident makes it appear that its management still isn't used to putting shareholders first. If its bankers really have no intention of appeasing shareholders, then one option might be to convert back to a partnership -- then its employees would be entitled to every cent of its earnings. Of course, getting there wouldn't be easy, but it's really their only way out of ignoring the shareholders' voice.

Can We Kill Unemployment With 1000 Paper Cuts?

2009-11-19T21:59:07Z

With unemployment at 10.2%, pressure is mounting on the president from many corners (including this page, if my rants may politely be called "pressure") to stoke job creation. Will he do something about joblessness? Almost certainly, says the Wall Street Journal's economics editor David Wessel. Will it that stimulus be as big as Obama's liberal critics hope? Don't hold your breath, he says.

Wessel predicts a flurry of stealth stimuli. In other words, death to joblessness by a thousand paper cuts. My gut tells me that a series of small job-focused measure would be the most political palatable thing to do. But my eyes see a report that Democratic Rep. Steny Hoyer is predicting a larger jobs package on Obama's desk my Christmas. Of course, the last time we heard about hard deadlines for progressive bills it was Obama calling for a health care bill before the official end of summer, and that deadline has seen more extensions than a 2009 jobless benefit.

House v. Senate: Who Should We Tax for Health Care?

2009-11-19T21:20:55Z

I'm interested in how the Senate health care bill raises taxes to pay for health care differently from the House version. The ever-useful Howard Gleckman at TaxVox has a good breakdown:

Reid proposes $370 billion in new tax revenues over the next decade. $150 billion would come from a 40 percent excise tax on high-cost employer-sponsored insurance. Fees on makers of branded drugs and medical devices and on insurance companies would raise another $100 billion. Boosting the Medicare payroll tax by 0.5 percent on wages in excess of $200,000 ($250,000 for couples) would bring in another $55 billion. Among the cats and dogs: $15 billion from an increase in the floor on deductible medical expenses from 7.5 percent to 10 percent, and $6 billion from an excise tax on cosmetic surgery (the tummy tuck tax).

Reid picked very different revenue sources than the House. It would raise far more in taxes--about $540 billion through 2019. And 85 percent--$460 billion-- would come from a 5.4 percent surtax on incomes in excess of $500,000 ($1 million for couples).

When we see the House/Senate blend in a few weeks, we're going to get a blend of revenue raisers. I'm with Gleckman here in preferring the Senate's approach. It's not merely that Reid expands the burden of paying for reform beyond the $500K crowd, and I feel uncomfortable merely soaking the rich to pay for our reforms. It's also that his main tax is a policy. The excise tax, as I've written, is a clever way to encourage employers to switch to less expensive plans and put the savings into their workers' compensation as taxable income. As for the other taxes, I suppose the Medicare payroll tax increase for the rich is a step toward the inevitable compromise to include some kind of surtax in the final bill. Also, I like me some sin taxes, but a cosmetic surgery tax? Meh.