Last week, JP Morgan Chase settled with regulators in both the United States and United Kingdom over massive losses suffered in the 2012 “London Whale” trading fiasco. Chase, America‘s largest bank, fessed up to wrongdoing and agreed to pay a stiff $920 million fine. As part of the agreement, regulators agreed not to pursue further charges against Chase’s top brass.
Thus ends the biggest financial hiccup since Wall Street nearly tanked in 2008. The story begins in April of 2012, when Bruno Iksil, an obscure trader in the big bank’s London unit, got caught in a series of outsized derivatives trades that went bad. Fellow traders dubbed Iksil the “London Whale” for the monstrous size of his bad bets. Chase CEO Jamie Dimon was initially dismissive, calling the burgeoning scandal a “tempest in a teapot.”
Iksil escaped prosecution by cooperating with authorities. But two former employees in the London branch weren’t so lucky and are being prosecuted for falsifying books and regulatory filings in an effort to cover up the trader’s disastrous positions.
“The defendants deliberately and repeatedly lied about the fair value of assets on JPMorgan’s books in order to cover up massive losses that mounted up month after month,” Preet Bharara, the U.S. Attorney for the Southern District of New York, said when announcing the charges. “Those lies misled investors, regulators and the public, and they constituted federal crimes.”
Five years ago this week, a collapsing housing bubble plunged America into its worst financial crisis since the Depression. Wall Street’s near meltdown midwifed both the tea party and the Occupy movement, and triggered a bitter debate about the big banks that continues to this day.
The ongoing controversy over whether we have solved or compounded the “too big to fail” problem may have cost Larry Summers his shot at the Federal Reserve’s big chair. But amid all the focus on the handful of U.S. mega-banks, policymakers have paid scant attention to their little cousins – America’s credit unions.
Now, however, credit unions are drawing fire from the banking industry for their not-for-profit tax status. The banks claim this exemption should be revoked because it gives credit unions an unfair competitive advantage over for-profit banks. “Credit unions were never intended to be untaxed banks, yet that is what many have become,” according to Frank Keating, president and CEO of the American Bankers Association.
Keating’s sentiment is representative of many in the banking industry, but ultimately his words ring hollow. His association boasts a diverse membership of large and small banks. Last time I checked, there aren’t any credit unions that maintain a profitable global derivatives business and an essential investment-banking unit that underwrites multi-billion dollar corporate mergers and acquisitions like some of his members.
Eliminating the tax exemption is a terrible idea that would deal a fatal blow to 6,815 credit unions that provide low-cost financial services to 93.8 million members nationwide. It would also eliminate one of the safest and soundest segments of the financial services industry that stewards more than $1 trillion.
Overhauling the federal tax system is one of the most important steps U.S. political leaders can take to promote economic growth and fairness. It is also that rarest of issues in today’s Washington—one that commands broad support on both sides of the political aisle. For these reasons, the Progressive Policy Institute urges the White House and Congress to give top priority to fixing our broken tax system over the next 12 months.
Everyone knows our tax code is too complicated, too inefficient and too riddled with preferences for special interests. Americans deserve better. PPI believes we need a federal tax system that is simpler and more progressive; that steers investment into productive, job-creating activity; that enables U.S. workers and companies to compete on an even footing in world markets; and, that serves the most basic purpose of any tax system—raising enough revenue to finance the government while ensuring fairness to taxpayers.
Comprehensive tax reform obviously poses daunting political obstacles. Nevertheless, it’s a goal Democrats and Republicans share. The Senate Finance Committee has published 10 papers on various options while the House Ways and Means Committee has organized 11 subgroups to consider different areas of the tax law. Over 1000 comments have been filed. With Sen. Max Baucus retiring this year, and Rep. Dave Camp term-limited as chair of the House Ways and Means Committee, the two most important players on tax policy are strongly motivated to get something done.
This paper will not offer a sweeping blueprint for reform. Instead it focuses on one crucial aspect of reform: Simplification. PPI has long argued that our tax system is too complex and ill-fitted to the needs of middle-class families and small entrepreneurs. They benefit little from the existing array of incentives and loopholes, which are mainly targeted on special interests or people with a level of income and wealth they can only dream about. The code’s byzantine complexity also costs business and individuals hundreds of billions in compliance. In a recently released annual report to Congress, the IRS’s National Taxpayer Advocate, Nina Olson, estimated that individual and business taxpayers spent 6.1 billion hours to complete filings. The bloated federal code contains almost four million words and on average has more than one new provision added to it daily.
The code is so complex that nearly 60 percent of taxpayers hire paid preparers and another 30 percent rely on commercial software to prepare their returns.
In fact, according to PricewaterhouseCoopers, only four nations have more pages of “primary tax legislation” than does the United States. And the World Bank’s www.doingbusiness.org ranks 61 nations as having tax systems friendlier to business than does the United States, while the World Economic Forum puts the U.S. tax system in 107th place in a ranking of the efficiency of 117 national tax regimes.
Congress perennially fiddles with the code, and it takes a full-time army of lobbyists to keep track of all the changes: the Treasury Department reports that there have been more than 14,400 revisions since 1986. It is imperative, then, that any comprehensive overhaul of the federal tax system not make the code even bigger and more complicated. Tax reform without dramatic simplification should not be considered genuine reform.
Last week, New York Attorney General Eric Schneiderman started looking into the controversial new practice of issuing workers debit cards in lieu of paychecks. The practice first came to light last month when an employee of a McDonald’s franchise in Pennsylvania sued over being forced to accept pay in the form of debit cards. Soon after, the New York AG’s office sent inquiries about debit card payroll practices to several companies, along with a request to see a list of fees associated with the cards.
Some of the companies that were contacted by the AG’s office were high profile brands such as Wendy’s, Costco, Darden Restaurants and Walmart. As the list suggests, these are enormous corporations with lots of hourly workers. Instead of a physical paycheck or direct deposit, workers get debit cards they can use to purchase items or access cash via ATMs.
So far so good. But workers soon discovered that such transactions are often laden with income–reducing fees on common transactions such as balance inquiries and even penalties for periods of inactivity…
Mortgage rates have been scraping the cellar floor in recent years, bottoming out at around 3.5 percent for 30-year loans. Economics 101 says cheap money can’t last forever and, sure enough, goverment backed mortgage giant Freddie Mac reported last week that fixed rates jumped, now up a full percentage point, to 4.5 percent
For the average homebuyer, that’s not trivial. On a $270,000 loan, roughly the national median price of a single family home, it will boost monthly interest payments by around $125 a month. That could be just enough to deter a first-time homebuyer or to eat into the savings of families trying to refinance their homes before rates get any higher.
In housing finance circles, there’s been a lively debate over the recent surge in housing prices: Is the sector’s recovery real – that is, built on market fundamentals? Or are we seeing yet another housing bubble inflated by the Fed’s policy of monetary easing?
Surging interest rates – and all indications are they aren’t going back down – will likely give us the answer by testing the resilience of U.S. housing markets. Here are some key indicators housing experts will be keeping their eyes on:
What happens to credit that many claim is already too tight? The idea that credit is too tight – that capable borrowers can’t get mortgage loans despite low interest rates – is widespread, but is it really true? In fact, the real issue may be bank origination capacity, not credit.
Credit rating agencies (CRAs) are supposed to be hard-eyed accountants whose job is to assess credit risk. But they also got swept up in the euphoria that swelled the housing bubble, failing with the Fed and other market participants to predict the extent of the housing crash. That’s partly because they over-extended the use of AAA-ratings, the highest “grade” given to a structured financial product, which falsely indicated low-risk assets.
Senator Al Franken (D-Minn.) has introduced an amendment to make credit raters more transparent and accountable. But while this amendment has the right intention, whether it could actually work is another question. Even Sen. Franken himself doesn’t seem all that confident that his measure will work. “I would like to emphasize that we hold no pride in authorship,” Franken said in an e-mailed statement. “We will applaud the implementation of any proposal or set of proposals that ultimately protect consumers and the American public.”[i]
The Franken Amendment essentially calls on the Securities and Exchange Commission (SEC) to create an oversight board of the rating agencies. The private sector rating agencies and investment firms would have majority representation. The board would oversee a process where a random firm is selected to conduct the initial evaluation of each new financial product that requires a CRA review. Under the proposal, issuers of new securities aren’t allowed to be involved in this part of the process.
But a public-private coordinated oversight board tucked within the SEC is destined for failure. If the pendulum swung too far in one direction prior to 2007, with issuers and most players underestimating risk, this move swings the pendulum right back. A structure like this is confusing to markets and will easily be seen as the federal government granting a guaranteed seal of approval on all ratings. Even risky debt might be seen as a viable investment inviting dangerous behavior fraught with moral hazard. The market needs to create the appropriate amount of risk, with appropriate public oversight; this proposed set up will
only exacerbate it. Continue reading “Rating the Credit Raters”→
There is an intense debate as to whether the student debt crisis is a bubble or not. The short answer: yes, but it’s more like a balloon. And the good thing about balloons is that they don’t have to burst; there is an option to deflate them slowly.
In some ways the ongoing student debt crisis has the classic symptoms of a bubble. There is an artificial inflation of value (here, tuition) that is in part fueled by low-cost funding (here, government-issued student aid). The latest Federal Reserve numbers show student debt is now a staggering $1 trillion and climbing. Yet the real earnings of young college grads are falling, down 15 percent since 2000. Already student loan defaults are at 11 percent and rising. Moreover, the true default rate is actually higher because of post-graduation grace periods. Not surprisingly, the Wall Street Journal reported earlier this week that student loan debt is now crowding out other borrowing and spending.
In other ways the student debt crisis is different—potentially worse—than the typical financial bubble. First, student debt is uncollateralized. There’s no home or property that can be reclaimed in default. Second, student debt cannot be discharged in bankruptcy, or restructured to meet the repayment ability of struggling debt owners. And most importantly, the majority (85 percent) of student debt is owned by the government. That means taxpayers are directly on the hook for $850 billion in potential losses. Worse, the government doesn’t really have the option to cut back on loan issuances or raise interest rates because that would go against equal access and opportunity.
The fact that the government holds the majority of student debt is what could transform this bubble into a controlled balloon—a balloon that can be deflated slowly. We know where most student debt is; it is not as spread out across unknown entities like subprime mortgage debt.
This week we released a preliminary proposal for the creation of private-sector student debt investment fund (SDIF) that would purchase existing student loans, refinance the debt at today’s historically low interest rates, and apply a discount to the loan amount. This could be the release valve that deflates the balloon, by reducing the financial burden to debt holders and transferring risk. That could free up government resources to address another important issue—rising tuition.
New research by the firm HelloWallet finds that more than a quarter of Americans who have an employer-sponsored retirement plan are raiding these accounts for other uses.
According to HelloWallet’s report, Americans are withdrawing more than $70 billion a year from their retirement savings—and often paying big penalties to do so. On top of regular income taxes, early withdrawals are subject to a 10 percent additional tax penalty, which depending on the bracket, could eat up nearly half of a person’s withdrawal.
For many people, employer-sponsored retirement plans are the only mechanism “forcing” them to save. Yet the retirement-only focus of the current system isn’t versatile enough to meet people’s real needs—especially to cope with emergencies such as a job loss or a horrifically expensive car repair.
The depth and breadth of this ”leakage” from Americans’ retirement accounts means it’s time to rethink the kinds of savings accounts that all Americans should own. In particular, new ways to encourage emergency savings could help ensure that 401(k)s don’t continue to be an expensive, last-resort piggybank for so many Americans. Continue reading “Is Your 401(k) Obsolete?”→
With the “fiscal cliff” likely to be averted, consumers are gearing up for the Holiday season. Retail designated shopping days “Black Friday,” “Small Business Saturday,” and “Cyber Monday” all saw an increase in sales, a good sign of consumer optimism heading into December.
Small businesses depend on retail spending days like these, and on consumer optimism throughout the year. And a big part of successfully growing their business is to have adequate access to financing. But “tight credit” and “small business” have been tied together by politicians and pundits as headwinds to economic recovery. Last year, PPI contributor Brian Martin wrote “The Credit Gap: Easing the Squeeze on the Smallest Business” showing how increasing lending caps at credit unions would unleash billions to the smallest small businesses (50 employees or less) and allow new growth and hiring opportunities with no taxpayer assistance.
So PPI is spotlighting Martin’s paper. We urge Congress to pass the Credit Union Small Business Jobs Bill, S. 2231 [introduced Senator Mark Udall (D-CO)]. This bipartisan bill would raise the credit union member business lending cap to 27.5% of assets and could provide up to $13 billion to small businesses in the first year alone. This could create over 140,000 new jobs at no cost to taxpayers.
Bill Gross of Pimco has just written a piece where he argues that the real return on stocks in the future will be much lower than the long-term historical average of 6.6%:
Yet the 6.6% real return belied a commonsensical flaw much like that of a chain letter or yes – a Ponzi scheme. If wealth or real GDP was only being created at an annual rate of 3.5% over the same period of time, then somehow stockholders must be skimming 3% off the top each and every year. If an economy’s GDP could only provide 3.5% more goods and services per year, then how could one segment (stockholders) so consistently profit at the expense of the others (lenders, laborers and government)?
He then goes on to argue that:
The Siegel constant of 6.6% real appreciation, therefore, is an historical freak, a mutation likely never to be seen again as far as we mortals are concerned.
In a world of slow innovation, Gross is likely to be correct. The economy grows slowly, and it becomes difficult to justify compensating risk capital if risks are not paying off.
The calculation changes, however, if we have big disruptive innovations. Big disruptive innovations offer risk on both the upside and the downside. On the upside, disruptive innovations create a wave of high-growth companies that drive the stock market higher. On the downside, disruptive innovations offer the distinct possibility of driving existing companies out of business, once again accentuating risk. Continue reading “Why Bill Gross is Wrong: Innovation and Long-term Returns on Equity”→
The Atlantic highlights PPI’s proposal to create “HomeK” accounts for home buyers to aid in the purchase of new homes. The article further suggests that such accounts could replace mortgage interest deductions.
The mortgage interest deduction probably isn’t going anywhere soon. Voters are far too fond of it, and politicians are loathe to nix a popular sort-of-kind-of-middle-class entitlement. But while the tax break might be beloved by the people who actually show up on election day, it’s also a highly regressive giveaway to the top 20 percent of American households, who reap 75 percent of the benefit, as my colleague Matt O’Brien wrote yesterday.
So let’s say policy wonks could wave a magic wand and make the mortgage interest deduction disappear. How could we replace the thing? Even though everyone has sobered up a bit about it thanks housing bust, home ownership still has a lot of economic virtues we should want to encourage. For instance, it’s one of the few ways a large portion of this country actually saves. And we really don’t want Americans saving any less than they already are.
Several California counties are considering a controversial proposal to use their eminent domain powers to offer relief to underwater homeowners. The plan is quietly being shopped to counties hit hardest by the housing crisis, and it seems local politicians are listening.“We have a very large problem that’s causing severe economic problems and part of our exploring ways to deal with it is hearing from people like those representatives of the securities industry,” said San Bernardino County Chief Executive Officer Greg Devereaux.
This has provoked a sharp reaction from Wall Street banks. In a letter to San Bernardino Supervisors, a coalition of securities investors said “Such an action would likely significantly reduce access to credit for mortgage borrowers in the San Bernardino area and other areas that undertake similar actions.”
It’s hard not to sympathize with the the Riverside-San Bernardino-Ontario metro area, where half the mortgages are underwater and the unemployment rate for May was 11.8%. And some progressives may find it hard to be sensitive to the plight of the Wall Street banks that hold most of the underwater mortgages in San Bernardino.
But the basic policy question here is whether the proposed cure would be worse than the disease. Using government’s eminent domain powers to force investors to eat the losses on underwater mortgages is a very drastic remedy to the problem of negative equity. While it could ease the burden on some homeowners, it could also drive private investment out of California housing markets. This would only prolong the housing slump and deepen the state’s economic malaise.
I found myself reacting to the Libor scandal more strongly than a lot of the earlier revelations of financial institutions misdeeds. First, the banks were just blatant out-and-out lying about a simple number.
Second, their lying led to a distortion of a crucial piece of publicly available data–the Libor rate. In a market economy, intentional misrepresentation of a market price is not a victimless crime –in fact, the victims are everyone who relied on that price to make decisions. That includes regulators who presumably watched Libor as one of their guides to the amount of stress in the global banking system. Here’s a chart of Libor across the key period (downloaded fromhttps://www.fedprimerate.com ).
I found myself reacting to the Libor scandal more strongly than a lot of the earlier revelations of financial institutions misdeeds. First, the banks were just blatant out-and-out lying about a simple number.
Second, their lying led to a distortion of a crucial piece of publicly available data–the Libor rate. In a market economy, intentional misrepresentation of a market price is not a victimless crime –in fact, the victims are everyone who relied on that price to make decisions. That includes regulators who presumably watched Libor as one of their guides to the amount of stress in the global banking system. Here’s a chart of Libor across the key period (downloaded fromhttps://www.fedprimerate.com ).
Would Libor have shown more signs of stress sooner if it wasn’t being manipulated in 2007 and 2008? And would banks, regulators, and investors reacted sooner? We’ll never know.
But this confirms what I’ve written in the past–the financial crisis was in part a data crisis, where all sorts of numbers were sending misleading signals. In particular, the strength of the financial position of the banks was overstated.
The question is whether the Libor scandal is a vestige of the past, or a sign of future troubles to come. My sense is that we’ll see a lot more opportunities for manipulation of private data to send misleading public signals. Forget about financial markets for the moment. I’m thinking now about the way that websites continually try to game Google’s search algorithms in order to get a higher ranking. Hotels and restaurants have a big incentive to try and manipulate their reviews on consumer sites such as Yelp. App developers have an incentive to game their reviews on the Apple and Google app stores.
Will the bad information drive out the good? Or can we build information aggregation mechanisms that are more difficult to manipulate?
President Obama has proposed a National Infrastructure Bank, a simple declarative sentence that left most listeners wondering what he meant. The confusion arises partly because the administration did not follow up the president’s remarks with a specific proposal, but also because the operations of such a bank have never been fully fleshed out. Felix Rohatyn and I have elsewhere laid out the broad outline of how such a bank would function,1 and that description serves as a good starting point for our expectations regarding the president’s proposal and what Bank-type proposals generally ought to do.
As many writers have noted, American infrastructure is depreciating rapidly – we are likely well below the replacement rate of investment in roads, mass transit, airports, ports, rail, and water assets. The logical implication is that we need to invest more. But more investment in and of itself will not move us towards having the right mix of infrastructure assets in place.
The current mix results from one of two selection processes. The first is devolution to the states (for example the cost-sharing grants delivered by the Highway Trust Fund), and the second is selection by Federal agencies (e.g., the Corps of Engineers). At worst, these processes lead to politically motivated outcomes, either because state governments favor some projects for wholly non-economic reasons, or because the Congress can muscle the selection process from the federal agencies. The most recent transportation authorization bill, passed in 2005, made the word “earmark” famous by incorporating a stunning $24 billion of them – the price of having a law passed. Insofar as we have given the task of project selection to the political process, it would be surprising if this kind of event didn’t happen, not that it sometimes does.
Politicized project selection is one of several problems associated with the current process. But it is one of the reasons why a National Infrastructure Bank is so important and so urgently needed: not just because a bank might be able to lever federal dollars, but because it can use the existing dollars more wisely and obtain a higher public return.
What follows, then, is a description of the role a National Infrastructure Bank could play, taken from the perspective of the specific problems in the current process it might solve. This perspective also allows us to evaluate the administration’s proposal.
In a nutshell, Rohatyn and I propose that we collapse all of the federal “modal” transportation programs into the Bank. Any entity – whether state, local, or federal – would have standing to come to the Bank with a proposal requiring federal assistance. The Bank would be able to negotiate the level and form of such assistance based on the particulars of each project proposal. It could offer cash participation or loan guarantees, underwriting or credit subsidies, or financing for a subordinated fund to assure creditors. Any project requiring federal resources above some dollar threshold (on a credit scoring basis) would have to be approved by the Bank. Additionally, we imagine that some part of the funding for existing modal programs would be converted into block grants sent directly to the states and large cities to be spent on projects too small for the Bank’s oversight. Such grants could also be used for those programs desired by the states that do not pass muster on terms proposed by the Bank.
This is more a vision of infrastructure policy than a blueprint for the immediate future. Admittedly, it will take years and a meticulous reorganization to produce this configuration. But the best way to measure our progress in infrastructure policy (and the merits of the administration’s proposal) is not to see how quickly we adopt the Bank’s specific features, but to see how the Bank addresses the underlying infrastructure policy flaws it is designed to fix.
In a classic example of a “slippery slope,” Congress once again is looking for easy pickings by increasing guarantee fees (g-fees) that Fannie Mae and Freddie Mac charge lenders to guarantee their mortgage lending. Last December, Congress raised the GSE’s g-fee by 10 basis points for 10 years. The goal was to raise almost $36 billion to pay for the extension of the payroll tax cut. Although this was supposed to be a one-time revenue plug, some lawmakers called for extending the new fees (at a slightly decreased rate) for an eleventh year to pay for restoration and clean up of the Gulf coast.
We understand it’s difficult for Congress to find “pay fors” for important initiatives at a time when Republicans have dug in their heels against tax increases for any purpose, even debt reduction. But treating g-fees as a piggy bank is ill-advised. Here’s why: Raising g-fees will compound the weakness of an already anemic lending environment, discourage home refinancing and lower housing demand.
In a classic example of a “slippery slope,” Congress once again is looking for easy pickings by increasing guarantee fees (g-fees) that Fannie Mae and Freddie Mac charge lenders to guarantee their mortgage lending. Last December, Congress raised the GSE’s g-fee by 10 basis points for 10 years. The goal was to raise almost $36 billion to pay for the extension of the payroll tax cut. Although this was supposed to be a one-time revenue plug, some lawmakers called for