• Federal ReserveInterest RatesUnited StatesEE. UU.
When Jerome Powell took over as chair of the Federal Reserve Board in January of 2018, the Fed had already been on a path of gradually hiking interest rates. They had moved away from the Great Recession zero rate in December of 2015 and had been hiking in quarter point increments at every other meeting. The Federal Funds rate stood at 1.25 percent when Powell took over from his predecessor Janet Yellen.
Powell continued with this path of rate hikes until the fall of 2018, and then he did something remarkable: he lowered rates. He had lowered rates by 0.75 percentage points by the time the pandemic hit in 2020.
This reversal was remarkable because it went very much against the conventional wisdom at the Fed and the economics profession as a whole. The unemployment rate at the time was well under 4.0 percent, a level that most economists argued would lead to higher inflation.
However, Powell pointed out that there was no serious evidence of inflationary pressures in the economy at the time. He also noted the enormous benefits of low unemployment. As many of us had long argued, Powell pointed to the fact that the biggest beneficiaries from low unemployment were the people who were most disadvantaged in the labor.
A 1.0 percentage point drop in the unemployment rate generally meant a drop of 1.5 percentage points for Hispanic workers and 2.0 percent for Black workers. The decline was even larger for Black teens. Workers with less education saw the biggest increase in their job prospects. And, in a tight labor market, employers seek out workers with disabilities and even those with criminal records.
In short, there are huge benefits to pushing the unemployment rate as low as possible, and Powell happily pointed to these benefits as he lowered interest rates even in an environment where the economy was already operating at full employment by standard estimates. Powell was willing to put aside the Fed’s obsession with fighting inflation, even when it wasn’t there.
This was the reason that many progressives, including me, wanted President Biden to reappoint Powell. While Lael Brainard, who was then a Fed governor, would have also been an outstanding pick, as a Republican, Powell’s reappointment faced far fewer political obstacles. There was no risk that one of our “centrist” showboat senators (Manchin and Sinema) might seize on some real or imagined slight and block the nomination.
Powell was also likely to have more leeway as a second term chair in pursuing a dovish interest rate policy. Fed chair is a position where seniority matters a lot, as can be seen by the Greenspan worship that stemmed largely from his long service as Fed chair. Although Brainard was a highly respected economist, she might have a harder time staying the course if the business press pushed for higher rates.
Powell’s Pandemic Policy
Powell did pursue a dovish policy, acting aggressively to support the economy during the pandemic with both a zero federal funds rate, and also extensive quantitative easing that pushed the 10-year Treasury bond rate to under 1.0 percent in the summer of 2020. Low rates helped to spur construction and allowed tens of millions of people to refinance mortgages, saving thousands of dollars a year on interest rates.
As virtually everyone (including me) would now agree, he kept these expansionary policies in place for too long. While Fed policy was not the major factor in the pandemic inflation, it did play a role, especially in the housing market. While most of the rise in house prices and rents was driven by fundamentals in the market (unlike in the bubble years from 2002-2007), there was clearly a speculative element towards the end of 2021 and the start of 2022.
This became evident when the Fed first raised rates in March of 2022. Even though the initial hike was just 0.25 percentage points, the housing market changed almost immediately. Prior to the hike, almost every house immediately got multiple above listing offers. After the hike, many houses received no offers and it became standard for buyers to offer prices well below the asking price.
Given this outcome, it would have been good if the Fed had made this move several months sooner. Speculative runups in house prices are not good news for the economy in general, even if there may be a small number of lucky sellers who might hit the peak of the market.
Anyhow, after having waited too long to raise rates, Powell felt the need to re-establish his status as a determined inflation fighter. He embarked on a series of aggressive three-quarter point rate hikes and repeatedly appealed to the ghost of Paul Volcker.
Powell went farther and faster than many of us felt was warranted. It will take time to see the full effect of past rate hikes on the economy. The rapid rise in rates did create stresses in the banking system, although the failures of the Silicon Valley Bank (SVB) and Signature Bank seem to be largely due to incredibly inept management, coupled with major regulatory failures at the Fed.
While bank failures are always fun, the more important issue is what happens to the real economy. At this point it seems the economy faces greater risk on the downside, with unemployment rising, than with inflation reversing its current downward path.
There has been a clear hit to credit availability as a result of banks tightening standards following the SVB panic. Higher rates are also having their expected effect on loan availability. Housing starts have slowed sharply, although residential construction remains strong due to a large backlog of unfinished homes resulting from supply chain problems during the pandemic.
Higher rates have also put an end to the flood of housing refinancing that helped to support consumption growth through the pandemic. And, non-residential investment has also slowed sharply in recent months.
For these reasons, there are real grounds for expecting a growth slowdown and a resulting rise in the unemployment rate. The other side of the story is that it looks as the Fed has won its war on inflation.
I’ll admit to having been an inflation dove all along, but the facts speak for themselves. We know that housing inflation will slow sharply in the months ahead based on private indexes of marketed housing units. These indexes have been showing much lower inflation, and even deflation, since the late summer. They lead the CPI rental indexes by 6-12 months.
We got the first clear evidence of lower inflation in the CPI rental indexes with the March release, with both rent indexes rising just 0.5 percent, after rising at more than a 9.0 percent annual rate in the prior three months. The CPI rent indexes are virtually certain to show further declines over the course of the year, with rental inflation likely falling below its pre-pandemic pace.
Much has been made of the big bad news items in the March CPI, the 0.4 percent rise in new vehicle prices. This is certainly bad news for the immediate inflation picture as it seems that supply chain problems continue to limit the production of new cars and trucks.
But this is not a long-term inflation issue. We have not forgotten how to build cars and trucks. This is a story where the chip shortage, resulting from a fire at a major semi-conductor factory in Japan, has proved to be more enduring that many had expected. That hardly seems like a good reason to be raising interest rates and throwing people out of work.
The picture for many non-housing services was also positive. In particular, the medical services index fell 0.5 percent in March after dropping 0.7 percent in each of the prior two months. Some of this decline is due to the peculiarities of the way health insurance costs are measured in the CPI, but it is pretty hard to tell a story of excessive inflation in this key sector of the economy.
The March Producer Price Index showed even better news about inflationary pressures at earlier stages of production. The overall final demand index fell by 0.5 percent in March, while the index for final demand for services dropped by 0.3 percent. While there are areas where there seem to be price pressures, the overwhelming picture in this release is one of sharply lower inflation, or even deflation. Clearly higher inflation will not be driven by price pressures at the wholesale level.
Perhaps most importantly, the pace of wage growth has slowed sharply. The annualized rate of growth in the average hourly wage over the last three months is just 3.2 percent, down from a 6.0 percent pace at the start of 2022. This is lower than the pace of wage growth in 2018 and 2019, when inflation was below the Fed’s 2.0 percent target. It is very difficult to tell a story where wage growth is under 4.0 percent, and inflation is still much above the Fed’s target.
Can Powell Change Course Again?
This raises the question as to whether Powell will again follow the path he took in 2019 and reverse course when the data indicate it is appropriate? There is still much uncertainty about the course of the economy at this point. We don’t know the full effect of the fallout from the SVB failure and it’s not clear how much of the impact of past Fed rate hikes is yet to be felt.
That makes a strong argument for a pause at the Fed’s meeting next month, which will come before we get any data from April. However, if we continue to see evidence of economic weakness, as well as slowing inflation, the Fed needs to be prepared to start lowering rates.
Powell was quite vocal in recognizing the Fed’s twin mandate for full employment, as well as price stability, when he lowered rates in 2019. There is no virtue in going overboard in the effort to fight inflation. If the data show that the war on inflation has been won, and we see the prospect of a weakening economy with higher unemployment, it needs to shift course.
Powell went in the right direction four years ago when he bucked the conventional wisdom and lowered rates in 2019. He needs to be prepared to do that again this year.
When Jerome Powell took over as chair of the Federal Reserve Board in January of 2018, the Fed had already been on a path of gradually hiking interest rates. They had moved away from the Great Recession zero rate in December of 2015 and had been hiking in quarter point increments at every other meeting. The Federal Funds rate stood at 1.25 percent when Powell took over from his predecessor Janet Yellen.
Powell continued with this path of rate hikes until the fall of 2018, and then he did something remarkable: he lowered rates. He had lowered rates by 0.75 percentage points by the time the pandemic hit in 2020.
This reversal was remarkable because it went very much against the conventional wisdom at the Fed and the economics profession as a whole. The unemployment rate at the time was well under 4.0 percent, a level that most economists argued would lead to higher inflation.
However, Powell pointed out that there was no serious evidence of inflationary pressures in the economy at the time. He also noted the enormous benefits of low unemployment. As many of us had long argued, Powell pointed to the fact that the biggest beneficiaries from low unemployment were the people who were most disadvantaged in the labor.
A 1.0 percentage point drop in the unemployment rate generally meant a drop of 1.5 percentage points for Hispanic workers and 2.0 percent for Black workers. The decline was even larger for Black teens. Workers with less education saw the biggest increase in their job prospects. And, in a tight labor market, employers seek out workers with disabilities and even those with criminal records.
In short, there are huge benefits to pushing the unemployment rate as low as possible, and Powell happily pointed to these benefits as he lowered interest rates even in an environment where the economy was already operating at full employment by standard estimates. Powell was willing to put aside the Fed’s obsession with fighting inflation, even when it wasn’t there.
This was the reason that many progressives, including me, wanted President Biden to reappoint Powell. While Lael Brainard, who was then a Fed governor, would have also been an outstanding pick, as a Republican, Powell’s reappointment faced far fewer political obstacles. There was no risk that one of our “centrist” showboat senators (Manchin and Sinema) might seize on some real or imagined slight and block the nomination.
Powell was also likely to have more leeway as a second term chair in pursuing a dovish interest rate policy. Fed chair is a position where seniority matters a lot, as can be seen by the Greenspan worship that stemmed largely from his long service as Fed chair. Although Brainard was a highly respected economist, she might have a harder time staying the course if the business press pushed for higher rates.
Powell’s Pandemic Policy
Powell did pursue a dovish policy, acting aggressively to support the economy during the pandemic with both a zero federal funds rate, and also extensive quantitative easing that pushed the 10-year Treasury bond rate to under 1.0 percent in the summer of 2020. Low rates helped to spur construction and allowed tens of millions of people to refinance mortgages, saving thousands of dollars a year on interest rates.
As virtually everyone (including me) would now agree, he kept these expansionary policies in place for too long. While Fed policy was not the major factor in the pandemic inflation, it did play a role, especially in the housing market. While most of the rise in house prices and rents was driven by fundamentals in the market (unlike in the bubble years from 2002-2007), there was clearly a speculative element towards the end of 2021 and the start of 2022.
This became evident when the Fed first raised rates in March of 2022. Even though the initial hike was just 0.25 percentage points, the housing market changed almost immediately. Prior to the hike, almost every house immediately got multiple above listing offers. After the hike, many houses received no offers and it became standard for buyers to offer prices well below the asking price.
Given this outcome, it would have been good if the Fed had made this move several months sooner. Speculative runups in house prices are not good news for the economy in general, even if there may be a small number of lucky sellers who might hit the peak of the market.
Anyhow, after having waited too long to raise rates, Powell felt the need to re-establish his status as a determined inflation fighter. He embarked on a series of aggressive three-quarter point rate hikes and repeatedly appealed to the ghost of Paul Volcker.
Powell went farther and faster than many of us felt was warranted. It will take time to see the full effect of past rate hikes on the economy. The rapid rise in rates did create stresses in the banking system, although the failures of the Silicon Valley Bank (SVB) and Signature Bank seem to be largely due to incredibly inept management, coupled with major regulatory failures at the Fed.
While bank failures are always fun, the more important issue is what happens to the real economy. At this point it seems the economy faces greater risk on the downside, with unemployment rising, than with inflation reversing its current downward path.
There has been a clear hit to credit availability as a result of banks tightening standards following the SVB panic. Higher rates are also having their expected effect on loan availability. Housing starts have slowed sharply, although residential construction remains strong due to a large backlog of unfinished homes resulting from supply chain problems during the pandemic.
Higher rates have also put an end to the flood of housing refinancing that helped to support consumption growth through the pandemic. And, non-residential investment has also slowed sharply in recent months.
For these reasons, there are real grounds for expecting a growth slowdown and a resulting rise in the unemployment rate. The other side of the story is that it looks as the Fed has won its war on inflation.
I’ll admit to having been an inflation dove all along, but the facts speak for themselves. We know that housing inflation will slow sharply in the months ahead based on private indexes of marketed housing units. These indexes have been showing much lower inflation, and even deflation, since the late summer. They lead the CPI rental indexes by 6-12 months.
We got the first clear evidence of lower inflation in the CPI rental indexes with the March release, with both rent indexes rising just 0.5 percent, after rising at more than a 9.0 percent annual rate in the prior three months. The CPI rent indexes are virtually certain to show further declines over the course of the year, with rental inflation likely falling below its pre-pandemic pace.
Much has been made of the big bad news items in the March CPI, the 0.4 percent rise in new vehicle prices. This is certainly bad news for the immediate inflation picture as it seems that supply chain problems continue to limit the production of new cars and trucks.
But this is not a long-term inflation issue. We have not forgotten how to build cars and trucks. This is a story where the chip shortage, resulting from a fire at a major semi-conductor factory in Japan, has proved to be more enduring that many had expected. That hardly seems like a good reason to be raising interest rates and throwing people out of work.
The picture for many non-housing services was also positive. In particular, the medical services index fell 0.5 percent in March after dropping 0.7 percent in each of the prior two months. Some of this decline is due to the peculiarities of the way health insurance costs are measured in the CPI, but it is pretty hard to tell a story of excessive inflation in this key sector of the economy.
The March Producer Price Index showed even better news about inflationary pressures at earlier stages of production. The overall final demand index fell by 0.5 percent in March, while the index for final demand for services dropped by 0.3 percent. While there are areas where there seem to be price pressures, the overwhelming picture in this release is one of sharply lower inflation, or even deflation. Clearly higher inflation will not be driven by price pressures at the wholesale level.
Perhaps most importantly, the pace of wage growth has slowed sharply. The annualized rate of growth in the average hourly wage over the last three months is just 3.2 percent, down from a 6.0 percent pace at the start of 2022. This is lower than the pace of wage growth in 2018 and 2019, when inflation was below the Fed’s 2.0 percent target. It is very difficult to tell a story where wage growth is under 4.0 percent, and inflation is still much above the Fed’s target.
Can Powell Change Course Again?
This raises the question as to whether Powell will again follow the path he took in 2019 and reverse course when the data indicate it is appropriate? There is still much uncertainty about the course of the economy at this point. We don’t know the full effect of the fallout from the SVB failure and it’s not clear how much of the impact of past Fed rate hikes is yet to be felt.
That makes a strong argument for a pause at the Fed’s meeting next month, which will come before we get any data from April. However, if we continue to see evidence of economic weakness, as well as slowing inflation, the Fed needs to be prepared to start lowering rates.
Powell was quite vocal in recognizing the Fed’s twin mandate for full employment, as well as price stability, when he lowered rates in 2019. There is no virtue in going overboard in the effort to fight inflation. If the data show that the war on inflation has been won, and we see the prospect of a weakening economy with higher unemployment, it needs to shift course.
Powell went in the right direction four years ago when he bucked the conventional wisdom and lowered rates in 2019. He needs to be prepared to do that again this year.
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• ImmigrationUnited StatesEE. UU.
That is not precisely what the piece said, but that is what is implied by the one statistic on the cost of immigration given in the article. The article told readers:
State officials said health care for undocumented immigrants cost nearly $313 million during the 2020-21 fiscal year, a sum paid by local, state and federal governments.
The person who was in the White House for most of Florida’s 2020-21 fiscal year was Donald Trump. If the health care costs that Florida saw in that year as a result of undocumented immigrants was a major burden, then it would have been the fault of Donald Trump’s policies, not Biden, who didn’t take office until late January 2021.
Since many people may not know offhand how much $313 million is to the state of Florida, it comes to roughly $15 per person for the state’s population. It would be a bit less than 0.3 percent of the state’s budget, although, as the article notes, much of this cost was picked up by the federal government.
That is not precisely what the piece said, but that is what is implied by the one statistic on the cost of immigration given in the article. The article told readers:
State officials said health care for undocumented immigrants cost nearly $313 million during the 2020-21 fiscal year, a sum paid by local, state and federal governments.
The person who was in the White House for most of Florida’s 2020-21 fiscal year was Donald Trump. If the health care costs that Florida saw in that year as a result of undocumented immigrants was a major burden, then it would have been the fault of Donald Trump’s policies, not Biden, who didn’t take office until late January 2021.
Since many people may not know offhand how much $313 million is to the state of Florida, it comes to roughly $15 per person for the state’s population. It would be a bit less than 0.3 percent of the state’s budget, although, as the article notes, much of this cost was picked up by the federal government.
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That was really a sidebar in his piece ridiculing Florida Governor Ron DeSantis’s attack on “woke” money, but it is worth taking a second to appreciate how protecting the rich is so completely the accepted norm in American politics. The piece is directed against DeSantis’s bizarre attack on the idea of a digital currency issued by the Federal Reserve Board.
It’s not clear whether DeSantis has any real concern or is just trying to convince the MAGA crowd that he can be every bit as crazy as their hero Trump, in spite of his Harvard Law degree. However, insofar as there is some discernible issue that is bothering DeSantis, it seems to be that a Fed digital currency may make it more difficult to evade taxes and commit other crimes. So much for “LAW AND ORDER!”
But the part of Krugman’s piece that really needs more attention is his comment in passing on how banks would respond to the prospect of a digital currency from the Fed. The basic story of a digital currency is a simple one. We could all be given transaction accounts at the Fed, from which we could conduct our ordinary business, like paying bills and getting our paychecks, at near zero cost.
This would mean tens of billions in savings annually on bank fees and penalties. It would be an especially big deal for lower income households, who disproportionately pay these fees and often don’t have bank accounts at all.
Krugman comments:
“What it [the Federal Reserve Act] doesn’t say is that any attempt to create such accounts would provoke a firestorm of opposition from the banking industry, which doesn’t want to have to compete for customers with a basically infallible government bank. So if a digital currency were to be created, it would be run through private-sector intermediaries.”
Krugman is just describing the political reality as it is, but this comment really requires a bit of reflection. We have the means to eliminate tens of billions of dollars of waste from the economic system. My guess is that we are talking in the range of 0.2-0.3 percent of GDP, an amount that is around half the size of the annual Food Stamp budget and more than twice the cost of President Biden’s student debt forgiveness program.
But it ain’t going to happen, because it would provoke “a firestorm of opposition from the banking industry.”
Well, many measures for increasing efficiency provoke opposition. Many unions opposed the terms under which China was admitted to the WTO because it would cost hundreds of thousands (actually, millions) of relatively high-paying manufacturing jobs and put downward pressure on the wages of the jobs that remains.
That didn’t matter because the forces that wanted access to cheap labor were far more powerful. Also, the cheap labor lobby had a powerful ally among the intellectual class, nearly all of whom denounced opponents of the WTO as knuckle-scraping Neanderthal protectionists in media outlets like the New York Times, Washington Post, National Public Radio, The Atlantic, etc.
However, the “neoliberal” types who were appalled at the idea that we would allow protectionist barriers to block more open trade with China are just fine with saluting the banking lobby and its efforts to block the Fed from offering digital accounts. There are no editorials denouncing the knuckle-scraping Neanderthal bankers on Wall Street who want us to throw tens of billions annually into the garbage so that they can keep getting paychecks in the millions and tens of millions of dollars. (The CEO of Silicon Valley Bank got $9.9 million for his work in 2021.)
Anyhow, this is just another example how the claim that anyone is a market fundamentalist is a complete lie. It is understandable why the proponents of protectionism for the rich would like to claim their good fortune is just due to the natural workings of the free market; but it is a serious mystery why progressives seem to think it is smart to go along with this obvious nonsense.
Note: This is corrected from an earlier version which put the pay of Silicon Valley Bank’s CEO at $9.9 billion.
That was really a sidebar in his piece ridiculing Florida Governor Ron DeSantis’s attack on “woke” money, but it is worth taking a second to appreciate how protecting the rich is so completely the accepted norm in American politics. The piece is directed against DeSantis’s bizarre attack on the idea of a digital currency issued by the Federal Reserve Board.
It’s not clear whether DeSantis has any real concern or is just trying to convince the MAGA crowd that he can be every bit as crazy as their hero Trump, in spite of his Harvard Law degree. However, insofar as there is some discernible issue that is bothering DeSantis, it seems to be that a Fed digital currency may make it more difficult to evade taxes and commit other crimes. So much for “LAW AND ORDER!”
But the part of Krugman’s piece that really needs more attention is his comment in passing on how banks would respond to the prospect of a digital currency from the Fed. The basic story of a digital currency is a simple one. We could all be given transaction accounts at the Fed, from which we could conduct our ordinary business, like paying bills and getting our paychecks, at near zero cost.
This would mean tens of billions in savings annually on bank fees and penalties. It would be an especially big deal for lower income households, who disproportionately pay these fees and often don’t have bank accounts at all.
Krugman comments:
“What it [the Federal Reserve Act] doesn’t say is that any attempt to create such accounts would provoke a firestorm of opposition from the banking industry, which doesn’t want to have to compete for customers with a basically infallible government bank. So if a digital currency were to be created, it would be run through private-sector intermediaries.”
Krugman is just describing the political reality as it is, but this comment really requires a bit of reflection. We have the means to eliminate tens of billions of dollars of waste from the economic system. My guess is that we are talking in the range of 0.2-0.3 percent of GDP, an amount that is around half the size of the annual Food Stamp budget and more than twice the cost of President Biden’s student debt forgiveness program.
But it ain’t going to happen, because it would provoke “a firestorm of opposition from the banking industry.”
Well, many measures for increasing efficiency provoke opposition. Many unions opposed the terms under which China was admitted to the WTO because it would cost hundreds of thousands (actually, millions) of relatively high-paying manufacturing jobs and put downward pressure on the wages of the jobs that remains.
That didn’t matter because the forces that wanted access to cheap labor were far more powerful. Also, the cheap labor lobby had a powerful ally among the intellectual class, nearly all of whom denounced opponents of the WTO as knuckle-scraping Neanderthal protectionists in media outlets like the New York Times, Washington Post, National Public Radio, The Atlantic, etc.
However, the “neoliberal” types who were appalled at the idea that we would allow protectionist barriers to block more open trade with China are just fine with saluting the banking lobby and its efforts to block the Fed from offering digital accounts. There are no editorials denouncing the knuckle-scraping Neanderthal bankers on Wall Street who want us to throw tens of billions annually into the garbage so that they can keep getting paychecks in the millions and tens of millions of dollars. (The CEO of Silicon Valley Bank got $9.9 million for his work in 2021.)
Anyhow, this is just another example how the claim that anyone is a market fundamentalist is a complete lie. It is understandable why the proponents of protectionism for the rich would like to claim their good fortune is just due to the natural workings of the free market; but it is a serious mystery why progressives seem to think it is smart to go along with this obvious nonsense.
Note: This is corrected from an earlier version which put the pay of Silicon Valley Bank’s CEO at $9.9 billion.
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Okay, maybe it’s a Good Friday or Ramadan miracle, but we should be celebrating the Fed’s victory in the war on inflation. If you missed it, you probably have been following the news — which hasn’t widely reported on this.
But, if instead, you looked at the data, you would have noticed that the annual rate of wage growth has slowed to 3.2 percent over the last three months.
The reason why this is such a big deal is that we typically expect the inflation rate to be roughly equal to the rate of wage growth, minus the rate of productivity growth. The annual rate of productivity growth has averaged 1.4 percent since the pandemic, roughly the same as its pre-pandemic pace.
If we take the 3.2 percent rate of wage growth over the last quarter and subtract the 1.4 percent trend rate of productivity growth, we get 1.8 percent inflation. This is below the Fed’s 2.0 target; therefore, we get victory!
There are a few points worth adding. First, the relationship is not immediate. Inflation has been growing at considerably more than a 2.0 percent rate. Many items, most notably rent, have considerable inertia. We know that rent, as measured in the Consumer Price Index and Personal Consumption Expenditure Deflator, will be slowing sharply in the next several months due to a sharp reduction in the rental inflation rate shown by a number of private indexes measuring the rent of marketed units. These indexes lead the government data by six to twelve months.
There are also some remaining supply chain issues, most notably with cars, that might keep prices high for several more months. However, over the course of 2023, we should see slower inflation, and often even deflation in many of these items. For these reasons, given the current pace of wage growth, we can be confident that inflation will slow to the Fed’s target in the not-distant future.
Of course, it is possible that we will see a continuing shift to profits, as we saw in the first year and a half of the pandemic. That can’t be ruled out, but that is not what is generally predicted. Furthermore, an effort to tackle profit-driven inflation, by further depressing wage growth, would be a rather perverse policy. It’s not likely it would enjoy much public support if people were aware that this was the Fed’s strategy.
Finally, wage data are erratic and subject to large revisions. The picture may look different when we get the data for April. But based on the data we have today, we can say the Fed won its battle against inflation. You can include this in the celebration for the religious or non-religious holiday of your choice. It is great news.
Okay, maybe it’s a Good Friday or Ramadan miracle, but we should be celebrating the Fed’s victory in the war on inflation. If you missed it, you probably have been following the news — which hasn’t widely reported on this.
But, if instead, you looked at the data, you would have noticed that the annual rate of wage growth has slowed to 3.2 percent over the last three months.
The reason why this is such a big deal is that we typically expect the inflation rate to be roughly equal to the rate of wage growth, minus the rate of productivity growth. The annual rate of productivity growth has averaged 1.4 percent since the pandemic, roughly the same as its pre-pandemic pace.
If we take the 3.2 percent rate of wage growth over the last quarter and subtract the 1.4 percent trend rate of productivity growth, we get 1.8 percent inflation. This is below the Fed’s 2.0 target; therefore, we get victory!
There are a few points worth adding. First, the relationship is not immediate. Inflation has been growing at considerably more than a 2.0 percent rate. Many items, most notably rent, have considerable inertia. We know that rent, as measured in the Consumer Price Index and Personal Consumption Expenditure Deflator, will be slowing sharply in the next several months due to a sharp reduction in the rental inflation rate shown by a number of private indexes measuring the rent of marketed units. These indexes lead the government data by six to twelve months.
There are also some remaining supply chain issues, most notably with cars, that might keep prices high for several more months. However, over the course of 2023, we should see slower inflation, and often even deflation in many of these items. For these reasons, given the current pace of wage growth, we can be confident that inflation will slow to the Fed’s target in the not-distant future.
Of course, it is possible that we will see a continuing shift to profits, as we saw in the first year and a half of the pandemic. That can’t be ruled out, but that is not what is generally predicted. Furthermore, an effort to tackle profit-driven inflation, by further depressing wage growth, would be a rather perverse policy. It’s not likely it would enjoy much public support if people were aware that this was the Fed’s strategy.
Finally, wage data are erratic and subject to large revisions. The picture may look different when we get the data for April. But based on the data we have today, we can say the Fed won its battle against inflation. You can include this in the celebration for the religious or non-religious holiday of your choice. It is great news.
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The Washington Post apparently lacks access to the Internet, but it bravely struggles on anyhow. This lack of access was apparent in a piece on how Rippling, a payroll company, was struggling to find money to issue paychecks after the FDIC froze its account in the Silicon Valley Bank.
The piece never once mentioned that the FDIC had committed itself to make an advance payment on accounts with more than $250,000 the week after it took over the bank. We don’t know how large this advance payment would have been, but since it seems that FDIC could ultimately cover more than 90 percent of deposits with the bank’s assets, it would likely have been around 70 percent of the money in the accounts.
As the FDIC statement (issued at the time of the seizure) says, it would have also issued a certificate for the remaining funds. This certificate is marketable. Rippling, or any other depositor, would have been able to sell it immediately to an investor to recover a substantial portion of their remaining funds.
This may still have left Rippling with insufficient funds to meet all its payroll obligations, but it clearly would have been much of the way there. It’s too bad the Washington Post doesn’t have access to the Internet, otherwise it likely would have pointed out these facts in its story on Rippling.
The Washington Post apparently lacks access to the Internet, but it bravely struggles on anyhow. This lack of access was apparent in a piece on how Rippling, a payroll company, was struggling to find money to issue paychecks after the FDIC froze its account in the Silicon Valley Bank.
The piece never once mentioned that the FDIC had committed itself to make an advance payment on accounts with more than $250,000 the week after it took over the bank. We don’t know how large this advance payment would have been, but since it seems that FDIC could ultimately cover more than 90 percent of deposits with the bank’s assets, it would likely have been around 70 percent of the money in the accounts.
As the FDIC statement (issued at the time of the seizure) says, it would have also issued a certificate for the remaining funds. This certificate is marketable. Rippling, or any other depositor, would have been able to sell it immediately to an investor to recover a substantial portion of their remaining funds.
This may still have left Rippling with insufficient funds to meet all its payroll obligations, but it clearly would have been much of the way there. It’s too bad the Washington Post doesn’t have access to the Internet, otherwise it likely would have pointed out these facts in its story on Rippling.
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I was surprised to see a Twitter thread last week from Jason Furman in which he said that the labor share of national income in 2022 was actually above its pre-pandemic level. I have been following this issue closely and the labor share of corporate income was still down by more than a percentage point from its 2019 level.
If that sounds trivial, it can be understood the following way: if the wage share rose back to its pre-pandemic level, and it was evenly shared, every worker would have a 1.7 percent increase in real pay. That won’t make anyone rich, but for a full-time full-year worker earning $25 an hour, the increase would be worth $850 a year.
But Jason said there is no prospective dividend like this because the labor share is already above its pre-pandemic level. Jason referred to the labor share of national income, and using this measure, he was right. I looked back to 2000 and saw that the labor share of national income had not fallen anywhere near as much as the labor share of corporate income, as shown below.
Source: Bureau of Economic Analysis and author’s calculations.
The question is: what is going on here? My reason for preferring the labor share of corporate income is that profits and labor compensation are well-defined in the corporate sector. We have a corporation that earns profits and it pays out wages and benefits to workers. The corporate sector is also about 75 percent of the private business sector, so generally what is going on in the corporate sector tells us what is going on in the business sector as a whole.
But not this time. Apparently, there was a large increase in the labor share of income in the non-corporate sector. The Commerce Department has not published data for the non-corporate sector for 2022 yet, but in 2021 the labor share stood at 41.4 percent, up by 2.2 percentage points from its 39.2 percent share in 2019. A further increase in 2022 could certainly be enough to raise the economy-wide labor share above its 2019 level.
So, what do we make of this large rise in the labor share in the non-corporate sector? That’s a difficult question to answer, but it’s certainly peculiar that the labor share in the non-corporate sector would be going in the opposite direction as the labor share in the corporate sector.
There is at least one possible explanation that doesn’t involve ordinary workers in the non-corporate sector gaining relative to their counterparts in the corporate sector. Most of the businesses (by revenue) in the non-corporate sector are organized as partnerships. This would include private equity and hedge funds. The earnings of the partners in these funds, which often are in the millions or tens of millions, are largely classified as wage income. If these partners were getting more wage income, or simply classifying a larger share of their fund’s earnings as wages, it could lead to a larger labor share of income in the national accounts. That doesn’t especially help the worker in a fast food restaurant owned by a private equity company, but this could explain the rise in the labor share that Jason noted.
This is obviously speculative and there could be a different story here, but in the corporate sector, where we do have solid data, we know the labor share has not recovered to its pre-pandemic level. And, if we want to go back to ancient history, the labor share is still down by 7.2 percentage points from its 2000 level. It would be a useful exercise to sort out what is going on with the labor share in the non-corporate sector, but it doesn’t seem unreasonable to think that the labor share in the corporate sector would at least return to its pre-pandemic level.
I was surprised to see a Twitter thread last week from Jason Furman in which he said that the labor share of national income in 2022 was actually above its pre-pandemic level. I have been following this issue closely and the labor share of corporate income was still down by more than a percentage point from its 2019 level.
If that sounds trivial, it can be understood the following way: if the wage share rose back to its pre-pandemic level, and it was evenly shared, every worker would have a 1.7 percent increase in real pay. That won’t make anyone rich, but for a full-time full-year worker earning $25 an hour, the increase would be worth $850 a year.
But Jason said there is no prospective dividend like this because the labor share is already above its pre-pandemic level. Jason referred to the labor share of national income, and using this measure, he was right. I looked back to 2000 and saw that the labor share of national income had not fallen anywhere near as much as the labor share of corporate income, as shown below.
Source: Bureau of Economic Analysis and author’s calculations.
The question is: what is going on here? My reason for preferring the labor share of corporate income is that profits and labor compensation are well-defined in the corporate sector. We have a corporation that earns profits and it pays out wages and benefits to workers. The corporate sector is also about 75 percent of the private business sector, so generally what is going on in the corporate sector tells us what is going on in the business sector as a whole.
But not this time. Apparently, there was a large increase in the labor share of income in the non-corporate sector. The Commerce Department has not published data for the non-corporate sector for 2022 yet, but in 2021 the labor share stood at 41.4 percent, up by 2.2 percentage points from its 39.2 percent share in 2019. A further increase in 2022 could certainly be enough to raise the economy-wide labor share above its 2019 level.
So, what do we make of this large rise in the labor share in the non-corporate sector? That’s a difficult question to answer, but it’s certainly peculiar that the labor share in the non-corporate sector would be going in the opposite direction as the labor share in the corporate sector.
There is at least one possible explanation that doesn’t involve ordinary workers in the non-corporate sector gaining relative to their counterparts in the corporate sector. Most of the businesses (by revenue) in the non-corporate sector are organized as partnerships. This would include private equity and hedge funds. The earnings of the partners in these funds, which often are in the millions or tens of millions, are largely classified as wage income. If these partners were getting more wage income, or simply classifying a larger share of their fund’s earnings as wages, it could lead to a larger labor share of income in the national accounts. That doesn’t especially help the worker in a fast food restaurant owned by a private equity company, but this could explain the rise in the labor share that Jason noted.
This is obviously speculative and there could be a different story here, but in the corporate sector, where we do have solid data, we know the labor share has not recovered to its pre-pandemic level. And, if we want to go back to ancient history, the labor share is still down by 7.2 percentage points from its 2000 level. It would be a useful exercise to sort out what is going on with the labor share in the non-corporate sector, but it doesn’t seem unreasonable to think that the labor share in the corporate sector would at least return to its pre-pandemic level.
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I’m on the road (literally driving from southern Utah to western Oregon) but I thought I should quickly weigh in on the scare stories we heard yesterday after the release of the 2023 Social Security and Medicare Trustees Reports. I’ll make four quick points:
The Problem is Largely Accounting
Starting with the accounting, Social Security is a program we have decided to fund from dedicated taxes, primarily the 6.2 percent tax employers and employees pay on the first $160,200 of income. (Part of the program’s problem is that the share of wage income going over the cap, and avoiding taxation, rose from 10.0 percent in 1982 to almost 20 percent today. This is because of the huge upward redistribution of wage income over the last forty years.)
Most other items in the budget are not funded by a dedicated tax. If they were, we would have had many scary moments in the past and possibly in the future. For example, government spending on education increased from 1.3 percent in 1946 to a peak of 3.8 percent of GDP in 1970. This 2.5 percentage point increase in spending to accommodate the baby boomers’ needs when we were kids, is far larger than the 1.8 percentage point projected increase in spending in Social Security from 2000 to 2040, the peak pressure of the baby boomers’ retirement.
If we had funded education from a dedicated tax and were looking at accurate projections of future spending in 1946, it would have looked far more scary than the Social Security projections do now. In the same vein, many people want the U.S. to have a Cold War with China. China’s economy is already more than 20 percent larger than ours and is growing considerably more rapidly. (The Soviet economy peaked at around 60 percent of the size of the U.S. economy.)
We are currently spending a bit more than 3.0 percent of GDP on the military. We spent 6.0 percent of GDP during the Reagan military buildup in the 1980s. If we went to this level of spending, or higher, to match the spending of a larger enemy, the projections would look much worse than anything we see with Social Security.
We’ve Already Seen Most of the Cost Increase
The Social Security trust fund built up a large surplus in the years when most of the baby boomers were in the labor force. This trust fund is helping to cover the current costs of the program. However, the cost themselves have been rising for the last fifteen years.
We went from spending 4.19 percent of GDP on Social Security in 2000 to spending 5.22 percent of GDP this year, an increase of 1.03 percentage points. This cost is projected to increase further to 6.03 percentage points by 2040, a rise of 0.81 percentage points.
This increased cost will impose some burden on the economy, but less than the increased burden we have seen to date. So, the idea that we are looking at some horror story down the road doesn’t make any sense, unless we think we are already living a horror story.
It’s Not True that Our Only Choices are Raising Taxes or Cutting Benefits
Contrary to what NPR told us yesterday (“Patching the program will require higher taxes, lower benefits or some combination of the two”), there is an alternative. Historically, Social Security has been funded by its designated taxes, as noted earlier. But, if we are changing the law, we can also change this feature of Social Security.
We could have it funded in part from general revenue, like the military or almost every other program. There are reasons we may not want to make this switch, but it is wrong for NPR and others to tell us that it is not a possible option. It is.
Can we spend more from general revenue without raising some taxes? That is an open question. From an economic standpoint, it doesn’t matter whether spending comes from past surplus accumulated in the trust fund or whether it’s simply an appropriation from general revenue. As noted above, we have already seen most of the burden associated with the retirement of the baby boomers; perhaps we could see the additional burden without any additional taxes.
If the economy’s main problem is secular stagnation (a lack of demand) as economists like Larry Summers argued before the pandemic, there is little reason to believe that the additional deficits associated with higher Social Security spending will be a major problem. This would especially be the case if artificial intelligence leads to the huge productivity boom that many analysts are predicting.
The Untold Great Story on Medicare
The Trustees Report released yesterday showed a further improvement in Medicare’s finances. This is a huge deal that has gone largely unreported. In 2000, the Medicare Hospital Insurance Trust Fund was projected to face costs of 1.91 percent of GDP this year and 2.54 percent of GDP in 2040. In the most recent report, we are projected to spend 1.52 percent of GDP this year and 2.12 percent in 2040 — a savings of 0.39 percentage points of GDP this year and 0.42 percentage points for 2040.
These savings have hugely helped the program and meant that we have far more resources to spend elsewhere. People pushing scare stories probably don’t want to promote these facts, but that is the world.
Anyhow, there are clearly issues with how we will deal with the retirement of the baby boomers, but the situation is not nearly as dire as many would like us to believe.
I’m on the road (literally driving from southern Utah to western Oregon) but I thought I should quickly weigh in on the scare stories we heard yesterday after the release of the 2023 Social Security and Medicare Trustees Reports. I’ll make four quick points:
The Problem is Largely Accounting
Starting with the accounting, Social Security is a program we have decided to fund from dedicated taxes, primarily the 6.2 percent tax employers and employees pay on the first $160,200 of income. (Part of the program’s problem is that the share of wage income going over the cap, and avoiding taxation, rose from 10.0 percent in 1982 to almost 20 percent today. This is because of the huge upward redistribution of wage income over the last forty years.)
Most other items in the budget are not funded by a dedicated tax. If they were, we would have had many scary moments in the past and possibly in the future. For example, government spending on education increased from 1.3 percent in 1946 to a peak of 3.8 percent of GDP in 1970. This 2.5 percentage point increase in spending to accommodate the baby boomers’ needs when we were kids, is far larger than the 1.8 percentage point projected increase in spending in Social Security from 2000 to 2040, the peak pressure of the baby boomers’ retirement.
If we had funded education from a dedicated tax and were looking at accurate projections of future spending in 1946, it would have looked far more scary than the Social Security projections do now. In the same vein, many people want the U.S. to have a Cold War with China. China’s economy is already more than 20 percent larger than ours and is growing considerably more rapidly. (The Soviet economy peaked at around 60 percent of the size of the U.S. economy.)
We are currently spending a bit more than 3.0 percent of GDP on the military. We spent 6.0 percent of GDP during the Reagan military buildup in the 1980s. If we went to this level of spending, or higher, to match the spending of a larger enemy, the projections would look much worse than anything we see with Social Security.
We’ve Already Seen Most of the Cost Increase
The Social Security trust fund built up a large surplus in the years when most of the baby boomers were in the labor force. This trust fund is helping to cover the current costs of the program. However, the cost themselves have been rising for the last fifteen years.
We went from spending 4.19 percent of GDP on Social Security in 2000 to spending 5.22 percent of GDP this year, an increase of 1.03 percentage points. This cost is projected to increase further to 6.03 percentage points by 2040, a rise of 0.81 percentage points.
This increased cost will impose some burden on the economy, but less than the increased burden we have seen to date. So, the idea that we are looking at some horror story down the road doesn’t make any sense, unless we think we are already living a horror story.
It’s Not True that Our Only Choices are Raising Taxes or Cutting Benefits
Contrary to what NPR told us yesterday (“Patching the program will require higher taxes, lower benefits or some combination of the two”), there is an alternative. Historically, Social Security has been funded by its designated taxes, as noted earlier. But, if we are changing the law, we can also change this feature of Social Security.
We could have it funded in part from general revenue, like the military or almost every other program. There are reasons we may not want to make this switch, but it is wrong for NPR and others to tell us that it is not a possible option. It is.
Can we spend more from general revenue without raising some taxes? That is an open question. From an economic standpoint, it doesn’t matter whether spending comes from past surplus accumulated in the trust fund or whether it’s simply an appropriation from general revenue. As noted above, we have already seen most of the burden associated with the retirement of the baby boomers; perhaps we could see the additional burden without any additional taxes.
If the economy’s main problem is secular stagnation (a lack of demand) as economists like Larry Summers argued before the pandemic, there is little reason to believe that the additional deficits associated with higher Social Security spending will be a major problem. This would especially be the case if artificial intelligence leads to the huge productivity boom that many analysts are predicting.
The Untold Great Story on Medicare
The Trustees Report released yesterday showed a further improvement in Medicare’s finances. This is a huge deal that has gone largely unreported. In 2000, the Medicare Hospital Insurance Trust Fund was projected to face costs of 1.91 percent of GDP this year and 2.54 percent of GDP in 2040. In the most recent report, we are projected to spend 1.52 percent of GDP this year and 2.12 percent in 2040 — a savings of 0.39 percentage points of GDP this year and 0.42 percentage points for 2040.
These savings have hugely helped the program and meant that we have far more resources to spend elsewhere. People pushing scare stories probably don’t want to promote these facts, but that is the world.
Anyhow, there are clearly issues with how we will deal with the retirement of the baby boomers, but the situation is not nearly as dire as many would like us to believe.
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There is a standard tale of politics where conservatives want to leave things to the market, whereas the left want a big role for government. The right likes to tell this story because it advantages them politically, since most people tend to have a positive view of the market. The left likes to tell it because they are not very good at politics and have an aversion to serious thinking.
The Silicon Valley Bank (SVB) bailout is yet another great example of how the right is just fine with government intervention, as long as the purpose is making the rich richer. Left to the market, the outcome in this case was clear. The FDIC guaranteed accounts up to $250k. This meant that the government’s insurance program would ensure that everyone got the first $250,000 in their account returned in full.
The amounts above $250,000 were not insured. This is both a matter of law and a matter of paying for what you get. The FDIC charges a fee on the first $250,000 in an account based on the size and strength of the bank. This fee ranges from 0.015 percent to 0.40 percent annually, depending on the size and riskiness of the bank. Most people would not see the insurance fee directly, because it is charged to bank, but we can be sure that the bank passes this cost on to its depositors.
However, these fees only apply to the first $250,000 in an account. This means that people who had more than $250,000 in an account were not paying for insurance. Nonetheless, when they needed insurance from the government, they got it, even though they didn’t pay for it.
As we are now hearing, in many cases this handout ran into the tens of millions, or even billions, of dollars, almost all of it going to the very richest people in the country. Compare these depositors’ sense of entitlement to a government handout, to the outrage over President Biden’s proposal to forgive $10,000 of student loan debt. (To be clear, depositors likely would have gotten 80 to 90 percent of their money back in any case.)
In the case of SVB, rich depositors could not bother themselves with taking steps to ensure that their money was parked in a safe place. This is in spite of the fact that almost all of them pay people to help them manage their money.
By contrast, in the case of student loan debt, many 18-year-olds may have misjudged their future labor market prospects. This sort of error would not be surprising given the economic turmoil we have seen since the collapse of the housing bubble and the Great Recession.
Making the Rich Richer with Drugs and Vaccines
The idea that the purpose of government is to make the rich richer pervades every aspect of economic policy. When we were confronted with a worldwide pandemic, the government spent billions of dollars to quickly develop effective vaccines and treatments. And then, after developing them, we gave private companies like Moderna intellectual property rights over the product.
Naturally, this sent Moderna’s stock soaring and made at least five Moderna executives into billionaires. Only children and elite intellectuals could think the extreme inequality we see in this story has anything to do with the market, but we will get the same tale again and again. The right wants to accept market outcomes, while the left wants to use the government to address inequality.
It’s striking that even now the government is acting to make the Moderna crew still richer. Moderna and Pfizer have announced that they want to charge between $110 and $130 a shot for their new Covid booster.
Peter Hotez and Elena Bottazzi, two highly respected researchers at Baylor University and Texas Children’s Hospital, developed a simple to produce, 100 percent open-source Covid vaccine. It uses well-established technologies that are not complicated (unlike mRNA). Their vaccine has been widely used in India and Indonesia, with over 100 million people getting the vaccine to date.
If we want to see the vaccine used here it would need to be approved by the Food and Drug Administration (FDA). In principle, the FDA could rely on the clinical trials used to gain approval in India, but it indicated that they want a U.S. trial. (In fairness, India’s trials are probably lower quality.)
However, the government could fund a trial of Hotez-Bottazzi vaccine (Corbevax) with pots of money left over from Operation Warp Speed, or alternatively from the budgets of National Institutes of Health or other agencies like Biomedical Advanced Research and Development Authority (BARDA). With tens of billions of dollars of government money going to support biomedical research each year, the ten million or so needed for a clinical trial of Corbevax would be a drop in the bucket.
The arithmetic on this is incredible. Shots of Corbevax cost less than $2 a piece in India. If it costs two and a half times as much in the U.S., that still puts it at $5 a shot. That implies savings of more than $100 a shot.
That means that if we get 100,000 people to take the Corbevax booster, rather than the Modern-Pfizer ones (Pfizer is planning to also charge over $100 for its booster), we’ve covered the cost of the trials. If we get 1 million to take Corbevax, we’ve covered the cost ten times over, and if 10 million people get the Corbevax booster, we will have saved one hundred times the cost of the clinical trial.
But for now, we are not going this route. Remember, the purpose of government is to make the rich richer.
This is a huge story in the pharmaceutical industry more generally. We will spend close to $550 billion this year on prescription drugs. These drugs would almost certainly cost less than $100 billion a year if they were sold in a free market without government-granted patent monopolies or related protections.
The differences of $450 billion is roughly half the size of the military budget and more than four times what we will spend on the Food Stamp program. It comes to more than $3,000 per household each year, and yes, it mostly goes to people at the top end of the income distribution.
We would have to replace the roughly $100 billion a year that the industry spends on research, but we would almost certainly come out way ahead in that story, as with the Hotez-Bottazzi vaccine.
In addition, by making drugs cheap, we will end the crisis that many people face in trying to come up with the money to pay for life-saving drugs. We would also eliminate the enormous incentive that patent-protected drug prices give drug companies to lie about the safety and effectiveness of their drugs.
Structuring Finance to Serve the Market, not the Rich
We don’t need to have a financial system that has periodic bank collapses and makes millionaires and billionaires out of top bank executives. This is a policy choice by a government committed to making the rich richer.
The most obvious solution would be to have the Federal Reserve Board give every person and corporation in the country a digital bank account. The idea is that this would be a largely costless way for people to carry on their normal transactions. They could have their paychecks deposited there every two weeks or month. They could have their mortgage or rent, electric bill, credit card bill, and other bills paid directly from their accounts.
This sort of system could be operated at minimal cost, with the overwhelming majority of transactions handled electronically, requiring no human intervention. There could be modest charge for overdrafts, that would be structured to cover the cost of actually dealing with the problem, not gouging people to make big profits.
Former Fed economist (now at Dartmouth), Andy Levin, has been etching the outlines of this sort of system for a number of years. The idea would be to effectively separate out the banking system we use for carrying on transactions from the system we use for saving and financing investment.
We would have the Fed run system to carry out the vast majority of normal financial transactions, replacing the banks that we use now. However, we would continue to have investment banks, like Goldman Sachs and Morgan Stanley, that would borrow on financial markets and lend money to businesses, as well as underwriting stock and bond issues. While investment banks still require regulation to prevent abuses, we don’t have to worry about their failure shutting down the financial system.
Not only would the shift to Fed banking radically reduce the risk the financial sector poses to the economy, it would also make it hugely more efficient. We waste tens of billions of dollars every year maintaining the structure of a financial system that technology has made obsolete.
The current system also makes some people incredibly rich, even when they fail disastrously. Greg Becker, the President and Chief Executive Officer, earned $9,922,000 in SVB’s 2021 fiscal year (the most recent year for which I could find the data). That would be roughly 684 times what a minimum wage worker would earn for a full year’s work. (Top execs at the largest banks can earn three or four times this amount.)
If we think that a worker has a 45-year working lifetime, then Mr. Becker pulls down more in a year than what a minimum wage worker would get in 15 working lifetimes. The CEOs at Lehman and Bear Stearns, two of the huge failed banks in the financial crisis, walked away with hundreds of millions of dollars for their work.
So, the basic story is that the government has designed a financial system designed to redistribute massive amounts of money to the rich. We could have a hugely more efficient system, but since that would end the gravy train for those at the top, it is not on the political agenda.
The Big Lie: Conservatives Don’t Like Big Government
As this bailout should make clear is that, contrary to what the media tell us, conservatives love big government. They just think that the focus of big government should be making the rich as rich as possible, not helping ordinary people and securing the economy and society.
To be clear, I do think this bailout was necessary given the fragility of the economy at present (unlike the 2008-09 bailout, that was sold with the lie that we faced a Second Great Depression). However, we need to get our eye on the ball here.
The idea that conservatives like the market and not the government is unadulterated crap. It is a myth that they use to conceal the ways they have rigged the market to make income flow upward. Unfortunately, virtually the entire left has agreed to go along with this absurd myth. Moments like the bailout of the rich depositors at SVB make the truth about conservatives and the market apparent to all. (And yes, this is the point of Rigged [it’s free].)
There is a standard tale of politics where conservatives want to leave things to the market, whereas the left want a big role for government. The right likes to tell this story because it advantages them politically, since most people tend to have a positive view of the market. The left likes to tell it because they are not very good at politics and have an aversion to serious thinking.
The Silicon Valley Bank (SVB) bailout is yet another great example of how the right is just fine with government intervention, as long as the purpose is making the rich richer. Left to the market, the outcome in this case was clear. The FDIC guaranteed accounts up to $250k. This meant that the government’s insurance program would ensure that everyone got the first $250,000 in their account returned in full.
The amounts above $250,000 were not insured. This is both a matter of law and a matter of paying for what you get. The FDIC charges a fee on the first $250,000 in an account based on the size and strength of the bank. This fee ranges from 0.015 percent to 0.40 percent annually, depending on the size and riskiness of the bank. Most people would not see the insurance fee directly, because it is charged to bank, but we can be sure that the bank passes this cost on to its depositors.
However, these fees only apply to the first $250,000 in an account. This means that people who had more than $250,000 in an account were not paying for insurance. Nonetheless, when they needed insurance from the government, they got it, even though they didn’t pay for it.
As we are now hearing, in many cases this handout ran into the tens of millions, or even billions, of dollars, almost all of it going to the very richest people in the country. Compare these depositors’ sense of entitlement to a government handout, to the outrage over President Biden’s proposal to forgive $10,000 of student loan debt. (To be clear, depositors likely would have gotten 80 to 90 percent of their money back in any case.)
In the case of SVB, rich depositors could not bother themselves with taking steps to ensure that their money was parked in a safe place. This is in spite of the fact that almost all of them pay people to help them manage their money.
By contrast, in the case of student loan debt, many 18-year-olds may have misjudged their future labor market prospects. This sort of error would not be surprising given the economic turmoil we have seen since the collapse of the housing bubble and the Great Recession.
Making the Rich Richer with Drugs and Vaccines
The idea that the purpose of government is to make the rich richer pervades every aspect of economic policy. When we were confronted with a worldwide pandemic, the government spent billions of dollars to quickly develop effective vaccines and treatments. And then, after developing them, we gave private companies like Moderna intellectual property rights over the product.
Naturally, this sent Moderna’s stock soaring and made at least five Moderna executives into billionaires. Only children and elite intellectuals could think the extreme inequality we see in this story has anything to do with the market, but we will get the same tale again and again. The right wants to accept market outcomes, while the left wants to use the government to address inequality.
It’s striking that even now the government is acting to make the Moderna crew still richer. Moderna and Pfizer have announced that they want to charge between $110 and $130 a shot for their new Covid booster.
Peter Hotez and Elena Bottazzi, two highly respected researchers at Baylor University and Texas Children’s Hospital, developed a simple to produce, 100 percent open-source Covid vaccine. It uses well-established technologies that are not complicated (unlike mRNA). Their vaccine has been widely used in India and Indonesia, with over 100 million people getting the vaccine to date.
If we want to see the vaccine used here it would need to be approved by the Food and Drug Administration (FDA). In principle, the FDA could rely on the clinical trials used to gain approval in India, but it indicated that they want a U.S. trial. (In fairness, India’s trials are probably lower quality.)
However, the government could fund a trial of Hotez-Bottazzi vaccine (Corbevax) with pots of money left over from Operation Warp Speed, or alternatively from the budgets of National Institutes of Health or other agencies like Biomedical Advanced Research and Development Authority (BARDA). With tens of billions of dollars of government money going to support biomedical research each year, the ten million or so needed for a clinical trial of Corbevax would be a drop in the bucket.
The arithmetic on this is incredible. Shots of Corbevax cost less than $2 a piece in India. If it costs two and a half times as much in the U.S., that still puts it at $5 a shot. That implies savings of more than $100 a shot.
That means that if we get 100,000 people to take the Corbevax booster, rather than the Modern-Pfizer ones (Pfizer is planning to also charge over $100 for its booster), we’ve covered the cost of the trials. If we get 1 million to take Corbevax, we’ve covered the cost ten times over, and if 10 million people get the Corbevax booster, we will have saved one hundred times the cost of the clinical trial.
But for now, we are not going this route. Remember, the purpose of government is to make the rich richer.
This is a huge story in the pharmaceutical industry more generally. We will spend close to $550 billion this year on prescription drugs. These drugs would almost certainly cost less than $100 billion a year if they were sold in a free market without government-granted patent monopolies or related protections.
The differences of $450 billion is roughly half the size of the military budget and more than four times what we will spend on the Food Stamp program. It comes to more than $3,000 per household each year, and yes, it mostly goes to people at the top end of the income distribution.
We would have to replace the roughly $100 billion a year that the industry spends on research, but we would almost certainly come out way ahead in that story, as with the Hotez-Bottazzi vaccine.
In addition, by making drugs cheap, we will end the crisis that many people face in trying to come up with the money to pay for life-saving drugs. We would also eliminate the enormous incentive that patent-protected drug prices give drug companies to lie about the safety and effectiveness of their drugs.
Structuring Finance to Serve the Market, not the Rich
We don’t need to have a financial system that has periodic bank collapses and makes millionaires and billionaires out of top bank executives. This is a policy choice by a government committed to making the rich richer.
The most obvious solution would be to have the Federal Reserve Board give every person and corporation in the country a digital bank account. The idea is that this would be a largely costless way for people to carry on their normal transactions. They could have their paychecks deposited there every two weeks or month. They could have their mortgage or rent, electric bill, credit card bill, and other bills paid directly from their accounts.
This sort of system could be operated at minimal cost, with the overwhelming majority of transactions handled electronically, requiring no human intervention. There could be modest charge for overdrafts, that would be structured to cover the cost of actually dealing with the problem, not gouging people to make big profits.
Former Fed economist (now at Dartmouth), Andy Levin, has been etching the outlines of this sort of system for a number of years. The idea would be to effectively separate out the banking system we use for carrying on transactions from the system we use for saving and financing investment.
We would have the Fed run system to carry out the vast majority of normal financial transactions, replacing the banks that we use now. However, we would continue to have investment banks, like Goldman Sachs and Morgan Stanley, that would borrow on financial markets and lend money to businesses, as well as underwriting stock and bond issues. While investment banks still require regulation to prevent abuses, we don’t have to worry about their failure shutting down the financial system.
Not only would the shift to Fed banking radically reduce the risk the financial sector poses to the economy, it would also make it hugely more efficient. We waste tens of billions of dollars every year maintaining the structure of a financial system that technology has made obsolete.
The current system also makes some people incredibly rich, even when they fail disastrously. Greg Becker, the President and Chief Executive Officer, earned $9,922,000 in SVB’s 2021 fiscal year (the most recent year for which I could find the data). That would be roughly 684 times what a minimum wage worker would earn for a full year’s work. (Top execs at the largest banks can earn three or four times this amount.)
If we think that a worker has a 45-year working lifetime, then Mr. Becker pulls down more in a year than what a minimum wage worker would get in 15 working lifetimes. The CEOs at Lehman and Bear Stearns, two of the huge failed banks in the financial crisis, walked away with hundreds of millions of dollars for their work.
So, the basic story is that the government has designed a financial system designed to redistribute massive amounts of money to the rich. We could have a hugely more efficient system, but since that would end the gravy train for those at the top, it is not on the political agenda.
The Big Lie: Conservatives Don’t Like Big Government
As this bailout should make clear is that, contrary to what the media tell us, conservatives love big government. They just think that the focus of big government should be making the rich as rich as possible, not helping ordinary people and securing the economy and society.
To be clear, I do think this bailout was necessary given the fragility of the economy at present (unlike the 2008-09 bailout, that was sold with the lie that we faced a Second Great Depression). However, we need to get our eye on the ball here.
The idea that conservatives like the market and not the government is unadulterated crap. It is a myth that they use to conceal the ways they have rigged the market to make income flow upward. Unfortunately, virtually the entire left has agreed to go along with this absurd myth. Moments like the bailout of the rich depositors at SVB make the truth about conservatives and the market apparent to all. (And yes, this is the point of Rigged [it’s free].)
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The grant of copyright monopolies is a mechanism the government uses to support creative work. It is far from the only mechanism. The government funds creative work through agencies like the National Endowments for the Arts and Humanities, the Corporation for Public Broadcasting, and indirectly through its support of colleges and universities. It also provides support through the charitable contribution tax deduction, which subsidizes contributions that wealthy people choose to make to organizations that support creative work at the rate of almost 40 cents on the dollar.
The fact that copyright is just one of many tools for supporting creative work should be a central part of any discussion about ramping up in enforcement rules. Incredibly, this simple fact is altogether absent from a Washington Post column, by T Bone Burnett and Jonathan Taplin, arguing for the need for enhanced enforcement measures in the era of artificial intelligence (AI).
Copyright, AI and the Internet Age
Burnett and Taplin are concerned that AI programs will be able to freely surf the web, grabbing and recycling copyrighted material, without making any payments to the people who created the material. This is a very realistic concern.
As Burnett and Taplin point out, file sharing over the web has already cut sales of recorded music almost in half. (Actually, as a percent of GDP, the decline would be close to 70 percent.) The spread of AI programs is virtually certain to lead to even further declines in the future. Their response to this threat is to call for “new laws and regulations governing AI and safeguarding the human core of creative artistry.”
It’s important to realize that we already have created new laws and regulations to protect copyright in the Internet Age. Specifically, Congress passed the Digital Millennial Copyright Act (DMCA) in 1998 to establish rules for enforcing copyright on the Internet.
The DMCA requires website owners and Internet platforms to promptly remove infringing material after they have been notified by the person claiming infringement in order to protect themselves from an infringement suit. This threat is taken very seriously, since the law provides for statutory damages, and also legal fees.
This is a big deal. The actual damages resulting from most alleged acts of infringement would be trivial. Spotify compensates performing artists at an average rate of 0.4 cents per stream. That means that if the unauthorized posting of a copyrighted song allowed for 10,000 people to play the piece, the actual damages would be in the neighborhood of $40.
No one would pursue a lawsuit for such a small amount of money. However, the statutory damages allowed under the law can run into the thousands of dollars for even minor acts of infringement. In addition, a successful lawsuit can mean the defendant also has to pay several thousand dollars in legal fees.
As a result of these large potential damages, websites and platforms take removal notices very seriously. In fact, there is evidence that we see over-removal, with websites and platforms removing material where the notice may not properly represent someone with a legitimate copyright claim, or the material may reasonably qualify as “fair use.”
Whether or not we actually see over-removal, it is clear that copyright enforcement on the web imposes a substantial cost on society. Not only does it prevent direct acts of infringement, it also requires that third parties (the website or platform) police items that others post.
This cost is important to keep in mind when we consider Burnett and Taplin’s call for “new laws and regulations” to protect copyrighted material from AI. Almost by definition this means still larger costs for a mechanism that is providing relatively little revenue for creative workers.
An Alternative to Copyright
Rather than developing new laws and enforcement mechanisms to protect the relatively small revenue stream produced by copyright monopolies, we might look to alternative mechanisms for supporting creative work. We could go the route of increased funding for agencies like the National Endowments for the Art and Humanities, but this would raise political issues over who gets to decide what work is funded.
An alternative would be to build on the mechanism we already have in place with the charitable contribution tax deduction. As currently structured, this contribution benefits a small share of the population, since the vast majority of taxpayers take the standard deduction, which means they are not able to benefit from the charitable contribution tax deduction at all.
The deduction is also regressive, with higher income taxpayers effectively able to get a far larger subsidy for their contributions than middle income households. And of course, most of the contributions are not going for creative work.
But we could build on the basic logic of the charitable deduction where we give a public subsidy for individuals’ support of what very broadly are considered socially desirable ends. However, instead of making it a deduction, we could make it a refundable tax credit, and specify that the money go to support creative workers. (I outline this system in somewhat more detail in chapter 5 of Rigged [it’s free].)
On the first point, if some billionaire decides to give $100 million to their favorite church, the taxpayers are on the hook for $37 million of this payment, which is the reduction in their tax liability. Under a tax credit system, we would give every person the same amount, say $100 to $200, to contribute to whatever creative worker, or organization supporting creative workers, they want.
This would provide an enormous amount of money to support creative work. If we assume 70 percent of adults decide to use this free money, it would mean $17.5 billion to $35 billion a year, roughly 0.07 percent to 0.14 percent of GDP. The latter figure is more than twice as much as what is now paid for recorded music.
The condition for being eligible to get the money is that a creative worker or organization has to register with the I.R.S., or other designated agency, saying what it is they do. This is similar to what tax-exempt organizations must do now. They must say they are a church, a research organization, or charity providing food to the poor. The I.R.S. does not evaluate whether they are a good church or a good charity; its only obligation is to ensure that the organization is not committing fraud and is in fact what it claims.
In this case, a person would say they are a musician, singer, or some other type of creative worker (the law would have to specify how broadly this would be defined). If they are getting money as an organization, they would have to say that they support country music, mystery writers, or some other type of creative work. Just as is the case with tax-exempt organizations now, the government would not evaluate the quality of the work, just that the person or organization does what they claim.
There would also be another condition. If you get money through the tax credit system, you are not also eligible for copyright monopolies. The government gives you one subsidy, not two.
The neat part about this aspect of the system is that it is self-enforcing. There would be a public record of everyone getting money through the tax credit system. If any of these people subsequently tried to claim copyright infringement, their case would be immediately dismissed, since they were not eligible to get copyrights. This sort of subsidy would generate an enormous amount of material that could be freely distributed over the web, with no concerns about copyright.
It’s true that this system would lead to public support for work that people didn’t like. Virtually everyone would likely be able to identify something supported through the tax credit system that they found objectionable, and perhaps highly objectionable.
But this is also the case with the current system with the charitable deduction. Many of us find the activities of some organizations that get millions, or even billions, of tax subsidized dollars highly objectionable. We would have the same story here, but an organization that got a large amount of money would need to have a large number of people who supported it, not just a single billionaire.
There are issues that need to be addressed in constructing this sort of tax credit system. It can be sliced and diced in thousands of different ways. Should we make the dollar amount larger or smaller? Perhaps we should also allow a match, where if a person decides to contribute $100 of their own money, the government throws in another $100 or even $200.
We also have to decide which work qualifies. Presumably music and writing are obvious (how about journalism – seems very important), but what about movies or television shows? How about video games? I would argue for making the boundaries as large as plausible, which would presumably make a case for a larger credit, but this is the sort of thing that would need to be debated.
The key point is that we have options other than trying to revive a 500-year-old copyright system that is already on life support. Our creative workers may not be very creative when it comes to designing mechanisms to support their work, but the rest of us have to be.
The grant of copyright monopolies is a mechanism the government uses to support creative work. It is far from the only mechanism. The government funds creative work through agencies like the National Endowments for the Arts and Humanities, the Corporation for Public Broadcasting, and indirectly through its support of colleges and universities. It also provides support through the charitable contribution tax deduction, which subsidizes contributions that wealthy people choose to make to organizations that support creative work at the rate of almost 40 cents on the dollar.
The fact that copyright is just one of many tools for supporting creative work should be a central part of any discussion about ramping up in enforcement rules. Incredibly, this simple fact is altogether absent from a Washington Post column, by T Bone Burnett and Jonathan Taplin, arguing for the need for enhanced enforcement measures in the era of artificial intelligence (AI).
Copyright, AI and the Internet Age
Burnett and Taplin are concerned that AI programs will be able to freely surf the web, grabbing and recycling copyrighted material, without making any payments to the people who created the material. This is a very realistic concern.
As Burnett and Taplin point out, file sharing over the web has already cut sales of recorded music almost in half. (Actually, as a percent of GDP, the decline would be close to 70 percent.) The spread of AI programs is virtually certain to lead to even further declines in the future. Their response to this threat is to call for “new laws and regulations governing AI and safeguarding the human core of creative artistry.”
It’s important to realize that we already have created new laws and regulations to protect copyright in the Internet Age. Specifically, Congress passed the Digital Millennial Copyright Act (DMCA) in 1998 to establish rules for enforcing copyright on the Internet.
The DMCA requires website owners and Internet platforms to promptly remove infringing material after they have been notified by the person claiming infringement in order to protect themselves from an infringement suit. This threat is taken very seriously, since the law provides for statutory damages, and also legal fees.
This is a big deal. The actual damages resulting from most alleged acts of infringement would be trivial. Spotify compensates performing artists at an average rate of 0.4 cents per stream. That means that if the unauthorized posting of a copyrighted song allowed for 10,000 people to play the piece, the actual damages would be in the neighborhood of $40.
No one would pursue a lawsuit for such a small amount of money. However, the statutory damages allowed under the law can run into the thousands of dollars for even minor acts of infringement. In addition, a successful lawsuit can mean the defendant also has to pay several thousand dollars in legal fees.
As a result of these large potential damages, websites and platforms take removal notices very seriously. In fact, there is evidence that we see over-removal, with websites and platforms removing material where the notice may not properly represent someone with a legitimate copyright claim, or the material may reasonably qualify as “fair use.”
Whether or not we actually see over-removal, it is clear that copyright enforcement on the web imposes a substantial cost on society. Not only does it prevent direct acts of infringement, it also requires that third parties (the website or platform) police items that others post.
This cost is important to keep in mind when we consider Burnett and Taplin’s call for “new laws and regulations” to protect copyrighted material from AI. Almost by definition this means still larger costs for a mechanism that is providing relatively little revenue for creative workers.
An Alternative to Copyright
Rather than developing new laws and enforcement mechanisms to protect the relatively small revenue stream produced by copyright monopolies, we might look to alternative mechanisms for supporting creative work. We could go the route of increased funding for agencies like the National Endowments for the Art and Humanities, but this would raise political issues over who gets to decide what work is funded.
An alternative would be to build on the mechanism we already have in place with the charitable contribution tax deduction. As currently structured, this contribution benefits a small share of the population, since the vast majority of taxpayers take the standard deduction, which means they are not able to benefit from the charitable contribution tax deduction at all.
The deduction is also regressive, with higher income taxpayers effectively able to get a far larger subsidy for their contributions than middle income households. And of course, most of the contributions are not going for creative work.
But we could build on the basic logic of the charitable deduction where we give a public subsidy for individuals’ support of what very broadly are considered socially desirable ends. However, instead of making it a deduction, we could make it a refundable tax credit, and specify that the money go to support creative workers. (I outline this system in somewhat more detail in chapter 5 of Rigged [it’s free].)
On the first point, if some billionaire decides to give $100 million to their favorite church, the taxpayers are on the hook for $37 million of this payment, which is the reduction in their tax liability. Under a tax credit system, we would give every person the same amount, say $100 to $200, to contribute to whatever creative worker, or organization supporting creative workers, they want.
This would provide an enormous amount of money to support creative work. If we assume 70 percent of adults decide to use this free money, it would mean $17.5 billion to $35 billion a year, roughly 0.07 percent to 0.14 percent of GDP. The latter figure is more than twice as much as what is now paid for recorded music.
The condition for being eligible to get the money is that a creative worker or organization has to register with the I.R.S., or other designated agency, saying what it is they do. This is similar to what tax-exempt organizations must do now. They must say they are a church, a research organization, or charity providing food to the poor. The I.R.S. does not evaluate whether they are a good church or a good charity; its only obligation is to ensure that the organization is not committing fraud and is in fact what it claims.
In this case, a person would say they are a musician, singer, or some other type of creative worker (the law would have to specify how broadly this would be defined). If they are getting money as an organization, they would have to say that they support country music, mystery writers, or some other type of creative work. Just as is the case with tax-exempt organizations now, the government would not evaluate the quality of the work, just that the person or organization does what they claim.
There would also be another condition. If you get money through the tax credit system, you are not also eligible for copyright monopolies. The government gives you one subsidy, not two.
The neat part about this aspect of the system is that it is self-enforcing. There would be a public record of everyone getting money through the tax credit system. If any of these people subsequently tried to claim copyright infringement, their case would be immediately dismissed, since they were not eligible to get copyrights. This sort of subsidy would generate an enormous amount of material that could be freely distributed over the web, with no concerns about copyright.
It’s true that this system would lead to public support for work that people didn’t like. Virtually everyone would likely be able to identify something supported through the tax credit system that they found objectionable, and perhaps highly objectionable.
But this is also the case with the current system with the charitable deduction. Many of us find the activities of some organizations that get millions, or even billions, of tax subsidized dollars highly objectionable. We would have the same story here, but an organization that got a large amount of money would need to have a large number of people who supported it, not just a single billionaire.
There are issues that need to be addressed in constructing this sort of tax credit system. It can be sliced and diced in thousands of different ways. Should we make the dollar amount larger or smaller? Perhaps we should also allow a match, where if a person decides to contribute $100 of their own money, the government throws in another $100 or even $200.
We also have to decide which work qualifies. Presumably music and writing are obvious (how about journalism – seems very important), but what about movies or television shows? How about video games? I would argue for making the boundaries as large as plausible, which would presumably make a case for a larger credit, but this is the sort of thing that would need to be debated.
The key point is that we have options other than trying to revive a 500-year-old copyright system that is already on life support. Our creative workers may not be very creative when it comes to designing mechanisms to support their work, but the rest of us have to be.
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An item in Ezra Klein’s NYT column yesterday really grabbed by attention. Ezra cited a Wall Street Journal column that claimed that the Federal Reserve Board’s stress tests would not have detected Silicon Valley Bank’s (SVB) problems, because its stress tests did not consider interest rate risk.
This struck me as close to crazy. How could a stress test not consider interest rate risk? I recalled the stress tests that the Fed and Treasury performed very publicly in March of 2009, in the middle of the financial crisis. These tests did not consider interest rate risk for the simple reason that, at that point in time, soaring interest rates seemed about as likely as a Martian invasion.
I had not been following the Fed’s stress tests since that time, but I assumed that they did adjust them for circumstances. I recall back in 2002, when I first became concerned about the housing bubble, being on a radio show with the chief economist from Fannie Mae. He assured me that they could not have serious problems with a decline in housing prices, since they regularly stress test their assets. Their tests included a large rise in interest rates. (When the bubble finally burst, Fannie Mae, along with Freddie Mac, collapsed in the summer of 2008 and have been in conservatorship ever since.)
Anyhow, this exchange led me to believe that regulators applied some common sense to their stress test exercises and examined how bank assets would fare in all bad, but plausible, circumstances. In the years 2020-21, when 10-year Treasury rates were at times flirting with 1.0 percent, a sharp rise in interest rates had to be seen as a plausible, even if unlikely, possibility.
Incredibly, the Fed stress tests did not consider this scenario. This means that the Fed’s stress tests would not have detected the vulnerability of SVB to the sort of jump in interest rates that we have seen over the last year. That means that it is possible that, even if Dodd-Frank had not been weakened in 2018 to reduce the regulation to which SVB was subject, the Fed still would not have detected its problems.
I said “possible,” rather than asserting that the Fed would not have caught the bank’s vulnerabilities, because even without a stress test some items should have been apparent to anyone giving the bank careful scrutiny, as would have been required before the 2018 law weakening Dodd-Frank.
First and foremost, the bank had well over 90 percent of its liabilities in uninsured deposits. That has to be a red flag to any bank regulator. These are the deposits that are more likely to run in a crisis, since insured deposits have no reason to flee. Also, most banks have more of their liabilities in the form of bonds or other fixed term debt that cannot run.
The fact that the bank’s customers were highly concentrated in a single industry, the tech sector, also should have been a red flag. This is especially the case because tech has a long history as being a boom-bust industry.
Third, the bank’s assets had nearly tripled in size from the fourth quarter of 2019 to the fourth quarter of 2021. Again, any regulator with some clear eyes should have been asking if SVB was doing anything risky to bring about such extraordinary growth. As an old line goes, they should use their University of Chicago common sense: “If what we’re doing is not risky, why is the good lord being so nice to us?”
Anyhow, I mention these points since it still seems likely to me that if the Fed was applying the strict scrutiny to SVB, that had been required before the passage of the 2018 law weakening Dodd-Frank, it would have caught the bank’s vulnerabilities and required measures to shore up its capital and/or reduce its deposits. However, the stress tests the Fed was using would have been utterly worthless in detecting its problems.
This should be an important reminder that regulation does not necessarily solve market problems. Sometimes liberals seem to work from the assumption that if the market outcomes are getting things wrong, somehow bringing in the government will set things right.
This is often not the case. When I think back to my exchange with Fannie Mae’s chief economist, he insisted that a nationwide plunge in house prices was not even a possibility, since the country had never seen anything like that. While that was partly true (they did fall sharply in the Great Depression), we also had never seen the sort of nationwide run-up in house prices we were experiencing at the time.
But the key point was that he could not even consider the possibility that we were seeing a housing bubble, where house prices were being driven by irrational exuberance, rather than the fundamentals of the market. That was true of almost all the economists I encountered in those years. Even my friends largely did not buy the story, although they might politely nod when I made the case.
Anyhow, if we had more thoroughgoing regulation of the financial system in the years when the housing bubble was growing, there is little reason to think the regulators necessarily would have caught the financial system’s problems. After all, if the house price growth we saw in the bubble years made sense, then the banks’ behavior would not have been especially risky.
To my view, while we need government regulators in many circumstances, the most important part of the story is to structure the market to get the incentives right. That is why I have argued for a system where the Fed gives everyone an account which they can use for getting their paychecks, paying their bills, and other transactions.
This would be enormously more efficient than the current system, eliminating tens of billions in fees paid annually to the banks. The amount saved could be two or three times the price of Biden’s student loan debt forgiveness. It would also eliminate the problem of bankers sitting on huge pots of money where they can make great fortunes by taking big risks.
This is also the story with the pharmaceutical industry. If we paid for the development costs upfront, as we already do with more than $50 billion a year going to the National Institutes of Health, we would not only make drugs cheap (all drugs would be available as generics the day they are approved), we would also eliminate the incentive for drug companies to lie about their safety and effectiveness.
I have my longer tirade on this topic in chapter 5 of Rigged [it’s free], along with a discussion of other sectors. (See also here.) But the key point is that we can’t count on government regulation to right the wrongs of a badly structured market. Regulators can both make mistakes and also be corrupted by the industry they are regulating.
The most important reform is to structure the markets right in the first place, so that we can minimize the need for regulatory oversight. We need regulation in many circumstances, but even the best regulation will not correct the problems of a badly structured market.
An item in Ezra Klein’s NYT column yesterday really grabbed by attention. Ezra cited a Wall Street Journal column that claimed that the Federal Reserve Board’s stress tests would not have detected Silicon Valley Bank’s (SVB) problems, because its stress tests did not consider interest rate risk.
This struck me as close to crazy. How could a stress test not consider interest rate risk? I recalled the stress tests that the Fed and Treasury performed very publicly in March of 2009, in the middle of the financial crisis. These tests did not consider interest rate risk for the simple reason that, at that point in time, soaring interest rates seemed about as likely as a Martian invasion.
I had not been following the Fed’s stress tests since that time, but I assumed that they did adjust them for circumstances. I recall back in 2002, when I first became concerned about the housing bubble, being on a radio show with the chief economist from Fannie Mae. He assured me that they could not have serious problems with a decline in housing prices, since they regularly stress test their assets. Their tests included a large rise in interest rates. (When the bubble finally burst, Fannie Mae, along with Freddie Mac, collapsed in the summer of 2008 and have been in conservatorship ever since.)
Anyhow, this exchange led me to believe that regulators applied some common sense to their stress test exercises and examined how bank assets would fare in all bad, but plausible, circumstances. In the years 2020-21, when 10-year Treasury rates were at times flirting with 1.0 percent, a sharp rise in interest rates had to be seen as a plausible, even if unlikely, possibility.
Incredibly, the Fed stress tests did not consider this scenario. This means that the Fed’s stress tests would not have detected the vulnerability of SVB to the sort of jump in interest rates that we have seen over the last year. That means that it is possible that, even if Dodd-Frank had not been weakened in 2018 to reduce the regulation to which SVB was subject, the Fed still would not have detected its problems.
I said “possible,” rather than asserting that the Fed would not have caught the bank’s vulnerabilities, because even without a stress test some items should have been apparent to anyone giving the bank careful scrutiny, as would have been required before the 2018 law weakening Dodd-Frank.
First and foremost, the bank had well over 90 percent of its liabilities in uninsured deposits. That has to be a red flag to any bank regulator. These are the deposits that are more likely to run in a crisis, since insured deposits have no reason to flee. Also, most banks have more of their liabilities in the form of bonds or other fixed term debt that cannot run.
The fact that the bank’s customers were highly concentrated in a single industry, the tech sector, also should have been a red flag. This is especially the case because tech has a long history as being a boom-bust industry.
Third, the bank’s assets had nearly tripled in size from the fourth quarter of 2019 to the fourth quarter of 2021. Again, any regulator with some clear eyes should have been asking if SVB was doing anything risky to bring about such extraordinary growth. As an old line goes, they should use their University of Chicago common sense: “If what we’re doing is not risky, why is the good lord being so nice to us?”
Anyhow, I mention these points since it still seems likely to me that if the Fed was applying the strict scrutiny to SVB, that had been required before the passage of the 2018 law weakening Dodd-Frank, it would have caught the bank’s vulnerabilities and required measures to shore up its capital and/or reduce its deposits. However, the stress tests the Fed was using would have been utterly worthless in detecting its problems.
This should be an important reminder that regulation does not necessarily solve market problems. Sometimes liberals seem to work from the assumption that if the market outcomes are getting things wrong, somehow bringing in the government will set things right.
This is often not the case. When I think back to my exchange with Fannie Mae’s chief economist, he insisted that a nationwide plunge in house prices was not even a possibility, since the country had never seen anything like that. While that was partly true (they did fall sharply in the Great Depression), we also had never seen the sort of nationwide run-up in house prices we were experiencing at the time.
But the key point was that he could not even consider the possibility that we were seeing a housing bubble, where house prices were being driven by irrational exuberance, rather than the fundamentals of the market. That was true of almost all the economists I encountered in those years. Even my friends largely did not buy the story, although they might politely nod when I made the case.
Anyhow, if we had more thoroughgoing regulation of the financial system in the years when the housing bubble was growing, there is little reason to think the regulators necessarily would have caught the financial system’s problems. After all, if the house price growth we saw in the bubble years made sense, then the banks’ behavior would not have been especially risky.
To my view, while we need government regulators in many circumstances, the most important part of the story is to structure the market to get the incentives right. That is why I have argued for a system where the Fed gives everyone an account which they can use for getting their paychecks, paying their bills, and other transactions.
This would be enormously more efficient than the current system, eliminating tens of billions in fees paid annually to the banks. The amount saved could be two or three times the price of Biden’s student loan debt forgiveness. It would also eliminate the problem of bankers sitting on huge pots of money where they can make great fortunes by taking big risks.
This is also the story with the pharmaceutical industry. If we paid for the development costs upfront, as we already do with more than $50 billion a year going to the National Institutes of Health, we would not only make drugs cheap (all drugs would be available as generics the day they are approved), we would also eliminate the incentive for drug companies to lie about their safety and effectiveness.
I have my longer tirade on this topic in chapter 5 of Rigged [it’s free], along with a discussion of other sectors. (See also here.) But the key point is that we can’t count on government regulation to right the wrongs of a badly structured market. Regulators can both make mistakes and also be corrupted by the industry they are regulating.
The most important reform is to structure the markets right in the first place, so that we can minimize the need for regulatory oversight. We need regulation in many circumstances, but even the best regulation will not correct the problems of a badly structured market.
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