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The belt-and-suspenders of the Kennedy-Dodd health care bill

kbh — Thu, 11 Jun 2009 20:34:35 +0000

There is much debate about whether a health care reform bill should include a government-run health insurance plan, a so-called “public option.” Advocates argue that such a plan can compete fairly with private health insurance, and that this competition would “keep insurers honest.” They also argue that more choices are a good thing.

I fall in the other camp. I think that government cannot compete on a level playing field with the private sector. Government always has advantages because of its sovereign power. I also think that in most markets there is a range of private health insurance plans competing for business, and so the addition of one more plan is not worth the downsides of government involvement. (I believe that competition is flawed because for most people their employer shops for health plans. I prefer a system in which individuals are shopping for health plans.)

The government cannot compete on a level playing field with private firms:

Fannie Mae and Freddie Mac had competitive advantages relative to their purely private counterparts. They leveraged those advantages to the gain of their management and shareholders until they collapsed and jeopardized the entire financial system.
Ford Motor Company was not bailed out. It is now disadvantaged relative to GM and Chrysler, which benefited from government oversight, funding, and effective rewriting of bankruptcy rules.
Government-provided terrorism reinsurance is preventing private reinsurance from returning to the marketplace.
Most physician- and hospital-reimbursement structures are based on the methodologies of the largest payor in the market, Medicare.
Government-run direct student loans are now crowding out the guaranteed student loan program, in which private banks and financing firms offer loans. The government advantage comes from control over small details of the program that give direct loans a competitive advantage.

(I would appreciate further examples if commenters have any. Updates are in green.)

The ultimate fear of having a government-run “public” option is that it will crowd out private health insurance, and that ultimately most Americans will be getting their insurance from the government.

At the same time, I hope that opponents of Kennedy-Dodd and the developing House Democrats’ health care bills don’t miss a critical point. Even if the public option is successfully stricken from this legislation, the Kennedy-Dodd goals will be largely achieved by other parts of the bill.

Separate from the Kennedy-Dodd language that creates a new public option, other language in the bill:

Gives a government-appointed Medical Advisory Council the ability to determine a standardized package of minimum benefits;
Establishes three tiers of standardized copayments and deductibles, as well as the total dollar value of benefits included relative to an industry average;
Mandate relative premiums for people with different risk profiles;
Gives the Secretary of Health and Human Services authority to set a maximum percentage of administrative expenditures and profits for health plans;
Requires plans to provide incentives for certain models of delivery of medical care; and
Gives State “Gateways” authority to redistribute resources among health plans to account for the risk distribution of their beneficiaries.

If the government determines benefits, cost-sharing, relative premiums, expenses, and profits, and can take funds from one health plan and give them to another, then the insurance function is governmental.

The ultimate fear of a public option would be immediately implemented by other parts of the Kennedy-Dodd bill. Health plans would turn into a version of Fannie Mae and Freddie Mac: they would have (regulated) private profits but public purposes. (A friend points out that the Fannie/Freddie comparison doesn’t work well here. F/F are more about “private profit but public risk.”)

This is a smart tactical move by the authors of the bill. They have a belt (the public option) and suspenders (government control of private insurance). They achieve their policy goal even if they lose the public option.

Killing the public option is essential, but it isn’t enough to prevent government-run health care.

The belt-and-suspenders of the Kennedy-Dodd health care bill

© 2010 Keith Hennessey - Your guide to American economic policy

Working in the West Wing: Doing a TV news interview on the North Lawn

kbh — Fri, 05 Jun 2009 20:27:10 +0000

This is the second in a series of occasional posts about the nitty gritty of working in the West Wing of the White House. I am describing things as they were in the Bush Administration. YMMV in the Obama Administration. Again, it seems a bit silly to write about such trivial details, but given the positive feedback on the first post in this series, here goes.

I did my first TV interview at the beginning of 2008 shortly after being promoted. At first it was stressful, and it took me a while to get used to it. Now that I’m on the outside, I do an occasional interview on CNBC, Fox, or CNN. Today I’d like to describe the mechanics of doing a TV news interview from the North Lawn of the White House. Even though I had worked in the White House for more than five years before my first on-camera interview, I did not know any of this until I actually had to do it.

Today is Jobs Day: the first Friday of the month, when the Labor Department releases the monthly employment report. The employment report is generally the most important economic data point of the month, and the business news channels (CNBC, Bloomberg, and Fox Business) always cover it. They always ask for someone from the Administration to comment on the data and what it means for the economy and the policy agenda. I see the Vice President’s economic advisor, Jared Bernstein, is doing CNBC now. In 2008, CEA Chairman Dr. Ed Lazear and I typically did this duty.

The jobs report is released at 8:30 AM on Friday. As with all economic data releases, Administration officials are embargoed from talking about it publicly for one hour after the release. This gives the markets time to process the data without the Administration’s viewpoint.

For each show broadcasting at 9:30 AM, a network producer negotiates with a staffer in the White House press shop. For us it was Eryn Witcher, a top-notch professional with prior experience in TV news who now works as the communications director at Stanford’s Hoover Institute. Eryn would negotiate with the producers and set Ed and/or me up with interviews.

Ed and I would talk the night before about the upcoming data and what we might say about it on the air. We were among a handful of officials who got the data reports before they were released, so that we could advise the President. Ed and his staff also used that data to prepare the daily “economic data memos” that the President received each morning.

We would generally watch the CNBC commentary immediately after the data release (at 8:30 AM sharp) to see if we had missed anything, and to take a temperature check on the initial market reaction and expert analysis. We would generally be prepped by Ed’s chief of staff, Pierce Scranton, who had an uncanny ability to predict what questions we would be asked, and coached us on how to give a short effective answer. If he wasn’t fighting other fires, Deputy Press Secretary Tony Fratto would also sit in the prep session.

A little after 9 AM someone would do my makeup in my office. Around 9:15 Eryn and I (or Eryn and Ed) would walk out to the North Lawn. You need a good TV tie (no busy patterns), straight collar (I was often scolded for button down collars), and American flag pin. After a while I got my own earpiece that I would bring out with me, so I wouldn’t have to use the common one that everyone else uses. It’s also nice to know you won’t lose the earpiece during the interview.

Each network has a TV camera set up in an area on the North Lawn next to the driveway from Pennsylvania Avenue to the West Wing entrance. The networks semi-permanently set up shop there in 1998 during the Monica Lewinsky scandal, and the gravel-filled area became known as Pebble Beach. It was refurbished during the Bush Administration with slate and the cameras and tripods are covered with heavy green canvas when they’re not being used. It is now referred to as Stonehenge, to which it bears a vague resemblance.

The cameras are in a long line next to each other. Each is set up so that the person on air has the north entrance to the White House residence in the background. Because of the different camera positions, each has a slightly different angle on the White House. On the night of a big Presidential speech from the White House, try quickly switching channels and you can see the different angles.

Here’s a diagram for CNBC (roughly). As always, you can click on the picture for a larger view.

The West Wing is the square building in the lower-left (southwest) corner. The residence is in the lower-right corner, and that’s Pennsylvania Avenue up top.

The blue box surrounds Stonehenge with all the TV cameras. When you’re on CNBC you stand at the red dot, facing the camera at the orange dot. The yellow line shows the camera angle, extended to capture the north entrance to the Residence in the background.

If you look closely, to the right (east) of the blue box you can see the driveway that heads south from the Northwest Appointment Gate to the West Wing entrance. Visitors with appointments in the West Wing walk up this driveway, and you can occasionally see them passing behind someone being interviewed on TV (especially on the evening news broadcasts). If they’re walking from left to right on your screen, they’re arriving at the West Wing. Right to left, they’re leaving.

About 9:15 AM Eryn and I would walk out to Stonehenge. We would greet the cameraman and a producer, and I’d get miked up. All the producers I met were friendly and professional, and the cameraman are universally great. I would stand at the red dot facing the camera. My earpiece cord would clip to the back of my jacket collar. The cameraman would connect an audio cable to that cord, and there’s a small box at about waist high with a volume dial. He attaches a tiny microphone to my lapel and I’m all set.

The cameraman then adjusts the camera for the shot. I’m generally looking at myself on a monitor below the camera: tie is straight, flag pin is upright. (Left and right are reversed from what you’re used to in a mirror. That takes getting used to.) Around 9:25, I’ll hear audio of the show in my earpiece, and then a voice:

Voice 1: Mr. Hennessey, this is [Bob] at CNBC headquarters. Can you hear me?

Me: Yes I can, Bob.

Voice 1: And you can hear the program?

Me: Yes.

Voice 1: Great. Can you count to ten for me, please, so we can do an audio check?

Me: 1,2,3,4,5,6,7,…

Voice 1: That’s perfect. Thank you.

After another minute, another voice, the producer for my segment of the show.

Voice 2: Mr. Hennessey, this is [Tom]. We’re going to a commercial break, and will be going to you in about 2 minutes. You’ll be interviewed by [Erin / Mark / Erin & Mark].

Me: Sounds great. Thank you.

During my first few interviews, the substance wasn’t that difficult for me. I had been prepping principals for interviews and writing talking points for more than 13
years, now I just had to do the talking. The hard parts were the nerves and the physical mechanics:

Look at the camera lens. Don’t let your eyes wander.
Smile.
Try not to “um” and “you know” too much.
Slow down.
Relax.

Also, TV moves very quickly. Long answers don’t work, so I had to train myself to make my point in one or two sentences, rather than four or five. (That’s difficult for me.) If you go on too long, you’ll start hearing the anchor trying to jump in and move things along. And before you know it, you’re done.

After the interview, you unmike, thank the cameraman and producer, and you’re done. If you have another interview, you move down the line and repeat. If not, head inside, take off the makeup, and get feedback from your colleagues and friends who email that they saw you on TV.

I only did a few in-studio interviews, and guest hosted CNBC’s Squawk Box once. I was blown away by the ability of the anchors to multitask, and how quickly they think and react. While one of them is talking on camera, another is checking market news or data on their screen, or scanning email. Their producers are talking to them in their earpieces, and they are talking on camera with each other and the guests. The coordination, reaction times, ability to adapt and improvise, and teamwork among the anchors and their producers are amazing. Beginning that day, and ever since I have developed tremendous respect for those business news anchors hosting live fast-moving discussions. I have enough trouble doing a single five minute segment, and they do it for 2-3 hours five days a week.

Working in the West Wing: Doing a TV news interview on the North Lawn

© 2010 Keith Hennessey - Your guide to American economic policy

Understanding the GM bankruptcy

kbh — Mon, 01 Jun 2009 23:17:03 +0000

Many of you are new to this blog since I wrote extensively about autos six weeks ago. As background, I coordinated the auto loan process for President Bush last fall as the Director of the White House National Economic Council (the position now held by Dr. Lawrence Summers). I wrote a series of posts on the auto loans beginning when the President made his late-March announcements, and continuing into the spring. For reference, here are those posts:

This morning I posted some basic facts on the General Motors announcement. Now it’s time for some analysis. Like my post Understanding the President’s CAFE announcement, this is a monster post. I hope you find it valuable despite its length.

I want to try to tease apart the various questions that get conflated in the public forum. My primary goal is to give you a structure for thinking about the issue. My secondary goal is to persuade you to agree with my views on each question. I will be satisfied if you give me credit for achieving only the primary goal.

Here is how I tease apart the questions:

What are the arguments for further government intervention?
Given these arguments, should the U.S. government intervene further by putting more taxpayer funding at risk to prevent GM from liquidating?
Is the pre-packaged bankruptcy likely to succeed?
Is it fair?
Did the government structure the taxpayer financing correctly?
Will the Administration run GM?

Let’s take them one-by-one.

1. What are the arguments for further government intervention?

Today the President explained why he chose to put another $30.1 B of taxpayer funds at risk to prevent GM from liquidating now. Speaking about his decision on March 30th, he said today:

But I also recognized the importance of a viable auto industry to the well-being of families and communities across our industrial Midwest and across the United States. In the midst of a deep recession and financial crisis, the collapse of these companies would have been devastating for countless Americans, and done enormous damage to our economy — beyond the auto industry. It was also clear that if GM and Chrysler remade and retooled themselves for the 21st century, it would be good for American workers, good for American manufacturing, and good for America’s economy.

This is more expansive than what President Bush argued last December:

In the midst of a financial crisis and a recession, allowing the U.S. auto industry to collapse is not a responsible course of action. The question is how we can best give it a chance to succeed. Some argue the wisest path is to allow the auto companies to reorganize through Chapter 11 provisions of our bankruptcy laws — and provide federal loans to keep them operating while they try to restructure under the supervision of a bankruptcy court. But given the current state of the auto industry and the economy, Chapter 11 is unlikely to work for American automakers at this time.

The distinction is important. President Bush’s arguments were time-dependent: (a) we should try to prevent our weak economy from taking another big hit right now, and (b) let’s buy GM and Chrysler time to get ready to restructure. He also argued (c) that it was unfair to dump a liquidating auto industry on his successor (even if his successor might do something different than he would). It was a “too big to fail now” argument.

Today President Obama made it clear that he made the decision to commit additional funds, if his conditions were met, at the end of March. He then added new reasons to those expressed by President Bush: that America needs “a viable auto industry,” and that it would be good for America if GM and Chrysler survived. While he emphasizes what he would not do, “I refused to let these companies become permanent wards of the state,” President Obama defines a national interest in having auto manufacturers headquartered in the U.S. He reinforced that with his closing line, which was surreal:

And when that happens, we can truly say that what is good for General Motors and all who work there is good for the United States of America.

This is a big expansion of the justification for government intervention in the market. Ford is not failing, and Chrysler is emerging from bankruptcy. President Obama is arguing that American taxpayers need to fund the survival of a third (the biggest) U.S.-based auto manufacturer, because it is important “to the well-being of families and communities across our industrial Midwest and across the United States” and because “it would be good for American workers, good for American manufacturing, and good for America’s economy.” This argument could be extended to almost any large U.S. firm, at almost any time.

My view: I am extremely uncomfortable with the President’s expanded argument for further government intervention. Had the President instead argued, “The economy is beginning to recover, and we cannot jeopardize that with another major shock,” I would have been less uncomfortable with today’s commitment of additional taxpayer funds.

2. Given these arguments, should the U.S. government intervene further by putting more taxpayer funding at risk to prevent GM from liquidating?

The public debate has evolved in the past two months. Earlier this year the question posed was, “Should the Administration bail out GM?” The basic options were “yes,” “no,” and “only if they enter bankruptcy, and if they do they should try to pre-package it.” The President chose the last of these options. The President decided to put $30.1 B of additional taxpayer funding at risk to help prevent GM from liquidating in the near future, and to help them through a restructuring process.

The benefits and costs are similar to what I described in late March. Here’s the updated version:

Benefits

If the firm survives the bankruptcy process intact, it has a higher probability of being viable in the long run (than in a restructuring outside of bankruptcy).
If the firm survives restructuring, the taxpayer has a higher probability of being repaid.
Old equity holders faced the full costs of the firm’s failure (by being wiped out). No additional moral hazard is created.

Costs

There are still significant risks to GM’s survival:
- Will GM and the Administration defeat the objecting unsecured creditors in court? (however unfair that might be)
- Will the bankruptcy process conclude quickly (within 90 days)?
- Will GM continue to lose market share? Can GM make cars and trucks that people want to buy?
- Will the new fuel economy and emissions rules restrict GM’s ability to make attractive vehicles?
This is a big new cash outlay from the taxpayer. This costs the taxpayer, and further constrains available TARP funds.

The President made clear his answer to this question on March 30th. At that time he laid out the conditions under which he would provide additional funding, and those conditions were met. No one should be surprised that he is now putting more taxpayer funding at risk. I am surprised that they only need $30 B.

My view: We crossed this bridge back in late March. It is not a new decision today to put more taxpayer funding at risk. I don’t like it, but I am at least glad that some incentives have been restored: the firm has to go through a bankruptcy process, shareholders are wiped out, and management was fired. I remember arguments from last fall and earlier this year that GM should get more taxpayer dollars outside of a bankruptcy process. That would have been far worse, and today’s actions mitigate some moral hazard.

Given the relative strength of the U.S. economy now compared to last December, I would have preferred an outcome of a pre-packaged bankruptcy + private DIP financing, and not exposing taxpayers to any additional risk. If GM is really as viable as GM and the President claim it now is, then they should have no problem convincing capital markets to provide them with short-term financing. (Judge Richard Posner argues this.) I will guess that this was not actually a viable option, because the pre-packaging could only come together with the direct involvement of the government. I think the real options would have been expose taxpayers to $30B more risk, or allow GM to liquidate. I would go with the latter: if GM can’t find private financing, they’re on their own. I assume this means they would liquidate. This would have been harsh and painful for those affected. I believe the consequences of further intervention now are worse for a larger number of people in the long run.

3. Is the pre-packaged bankruptcy likely to succeed?

There are two components to this question:

Is the bankruptcy process likely to be quick and successful?
Will the resulting company succeed without additional taxpayer aid?

I do not feel well-qualified to comment on the first question. The talking heads all repeat that “GM’s bankruptcy is more complicated than Chrysler’s,” with little detail about why. I would point out that the Administration is one for one in this process. Their use of this part of the bankruptcy code (section 363), and the process where the old GM sells the good stuff to a new GM, and then the remaining parts are liquidated, appears to have worked for Chrysler. From my perspective, the burden of proof now shifts to those who argue this bankruptcy will take more than 90 days. I didn’t like it because of the precedent it set, but I wouldn’t bet against the Administration succeeding again.

Other than the “good for GM is good for America” quote, the biggest surprise in the President’s remarks was how heavily he was betting that a restructured GM will succeed. He could easily have taken the posture, “GM has made some hard decisions, and they have a tough road ahead if they want to survive and succeed.” Instead, he attached his own credibility to GM’s future success and said:

So I’m confident that the steps I’m announcing today will mark the end of an old GM, and the beginning of a new GM; a new GM that can produce the high-quality, safe, and fuel-efficient cars of tomorrow; that can lead America towards an energy independent future; and that is once more a symbol of America’s success.

Even with a cleaned up balance sheet and more taxpayer funding, it is by no means certain that GM will survive for the long run. If GM fails in the next few years, the taxpayers will have lost an additional $30.1 B that the President committed today. In addition, the above quote will come back to haunt the President. I understand wanting to set a positive and optimistic tone. I am confused why he did so at such great political risk to himself.

I found it useful to return to my first post on the autos and review what this new pre-packaged bankruptcy + DIP financing does to the wide range of challenges faced by GM:

Revenues

The economic slowdown means fewer vehicles are being purchased from all auto manufacturers, foreign and domestic.

Even apart from the economic slowdown, U.S. auto manufacturers have been losing market share over time.

This is in part because they made a bet on light trucks versus smaller cars. This product mix doesn’t work when gas prices are high. Think of the proliferation of SUV’s in the past 10 years. (Note that this was in part the fault of U.S. government policies. SUV’s are technically light trucks, and so they qualify for lower fuel economy requirements.)

Costs & productivity

The Detroit 3’s ongoing labor costs are higher than those of foreign-based firms. This is still true when you compare an American worker in a GM plant in Michigan, for instance, with an American worker in a Nissan plant in Mississippi.

Productivity is lower in U.S. plants of U.S. firms than it is in U.S. plants of foreign-based firms. Some of this is because of the UAW contract that mandates certain inefficiencies. Some of it is poor management.

The Detroit 3 have huge dealer networks that are costly to the manufacturers. These dealer franchises are often protected by state laws that make it hard for the manufacturers to make these networks smaller and more efficient.

Auto manufacturers face a burdensome and unpredictable legislative and regulatory environment.

Balance sheets

The Detroit 3 have enormous legacy costs from their retirees. Past UAW contracts provided generous benefits that continue to burden these firms. This drains profits (when they earn them) away from productivity-enhancing investments.

So can GM survive, and for how long? Can they profit and flourish, as the President suggests they will?

The Administration and GM argue that a restructured GM can break even in a national market of only 10m vehicles sold in America each year. (We’re now around 9.5m/year. “Normal” is around 16m/year.) If accurate, this is astonishing. This would appear to address all three of the bullets under revenues. Addressed? I’m skeptical. I need to review the assumptions in GM’s new plan, especially about market share.
I have seen no evidence that GM and UAW have reduced significantly GM’s ongoing labor costs to be competitive with the transplants. Maybe I have missed it. Unaddressed.
Productivity is still lower in U.S. plants of U.S. firms that it is in U.S. plants of foreign-based firms. As a result of high compensation costs per worker and low productivity, it appears that labor cost per vehicle produced will still be uncompetitive with the transplants. Unaddressed.
GM’s dealer network is being dramatically reduced. Addressed.
The CAFE and emissions requirements are even more burdensome than predicted, but now have at least some degree of stability, given the national standards. On net, worse than before.
The balance sheets will be relieved of enormous debt and legacy health and pension obligations. Addressed.

My view: I need to look more at what GM is assuming for market share. The removal of the legacy obligations, combined with a big chunk of taxpayer change, will buy then many months of survival.

The Administration is stressing the balance sheet improvements, and they deserve credit for that. Conservative critics focus on the additional burdens of the fuel economy and emissions rules, and they’re right, too.

I would focus even more on the questions asked by several commenters: “Will people want to buy GM cars and trucks?” Additionally, can GM make a profit with still high labor costs, still low productivity, still burdensome work rules, and still slow product development cycles?

I want to GM to survive and be profitable in the long run. Their chances are now drastically improved, assuming they survive bankruptcy. But I don’t know if that’s an improvement from a 1% chance to a 20% chance, or from a 1% chance to an 80% chance. A lot more needs to change beyond just cleaning up the balance sheet, and many of those needed changes are deep-seated in the culture, structures, and processes of America’s third-largest company.

4. Is the pre-packaged bankruptcy fair?

Absolutely not. But I want to be precise in my criticism.

The easiest thing to do in Washington is to criticize the negotiator. “I could have gotten a better deal,” we say. I should begin my expressing my sympathy and offering my congratulations to Steven Rattner and the Obama team for closing what was undoubtedly a complex and difficult set of negotiations. I’m sure this one was not easy, and theirs was a thankless task.

At the same time, I share the concerns of many that the deal was not even-handed, and that the precedent will damage future business lending. I have grave concerns about how far they were willing to stretch bankruptcy processes and the traditional capital structure to get a deal.

First I need to correct the Administration, as well as some bad reporting today by the Washington Post. In last night’s background briefing for the press, an unnamed Senior Administration Official claimed (emphasis added):

Secondly, as you know, the UAW has reached a new agreement with GM and that agreement has been ratified that involves significant concessions by the UAW — concessions that are in virtually every respect more aggressive than what the previous administration demanded in its loan agreement.

In the term sheet for the December loan we (the Bush Administration) made to General Motors, we set out “targets,” which we took directly from the Corker amendment offered the week prior on the Senate floor:

Reduce outstanding unsecured debt by not less than 2/3 through conversion into equity or other debt;
“Reduce the total amount of compensation, including wages and benefits, paid to their U.S. employees so that, by no later than December 31, 2009, the average of such total amount, per hour and per person, is an amount that is competitive with the average total amount of such compensation, as certified by the Secretary of Labor, paid per hour and per person to employees of Nissan Motor Company, Toyota Motor Corporation, or American Honda Motor Company whose site of employment is in the United States.”
Eliminate the jobs bank.
Apply work rules no later than 12/31/09 “in a manner that is competitive with Nissan … Toyota or Honda in the U.S.”
Not less than half of their VEBA payment should be in the form of stock.

As best I can tell:

They more than accomplished target #1.
They did little to nothing on #2. I have seen no evidence that compensation of current workers has been changed. UAW Chief Ron Gettelfinger claimed in a message to his members, “For our active members these tentative changes mean no loss in your base hourly pay, no reduction in your health care, and no reduction in pensions.” Maybe there’s a distinction between this statement and “total compensation.” If so, it would be great if someone could help me understand this. But it appears GM and UAW did nothing to address target #2.
UAW agreed to #3 in late March.
They made no apparent progress on target #4. I have neither seen nor heard evidence that the work rules have been relaxed. I am happy to be corrected.
They accomplished #5.

It was incorrect for the Senior Administration Official to call these “demands” of the Bush Administration. They were targets, not hard conditions. It is an overstatement to say that they “are in virtually every respect more aggressive than what the previous Administration demanded,” unless “virtually every respect” means “except for compensation and work rules.” (I am happy to be corrected if I have just missed the changes.)

The Washington Post then further flubbed it by writing:

Critics say it is unfair that the restructuring plan gives the union health trust a larger share of the new GM than the bondholders. But administration officials defend the plan, offering several justifications.

First, they note that the terms of the proposed GM restructuring echo the terms laid out by the Bush administration in December, when it extended $13.4 billion in loans to GM.

The Bush administration’s loan agreement required a 50 percent reduction or “haircut” for the union trust, but a 66 percent cut for the bondholders. The Obama deal requires larger cuts for both sides, though more for the bondholders.

The agreement does more than meet three of the five targets laid out by the Administration. It appears to make no progress on the other two targets. Thus the terms do not “echo the terms laid out by the Bush administration in December.”

More importantly, the targets we (Bush team) laid out said nothing about the distribution of equity shares. The criticism is not that the deal doesn’t cut the VEBA enough, or reduce unsecured debt enough. The criticism is that someone lower in the capital structure (UAW’s VEBA) got a much greater equity share than someone higher in the structure (unsecured creditors). It is disingenuous to point to the targets in the Bush Administration’s December loans to justify this inequity.

The deal is unfair to unsecured creditors, because they get a worse deal than someone standing behind them in line (the UAW’s VEBA). It has nothing to do with who those parties are (labor vs. creditors). It is about the importance of maintaining a stable and predictable set of rules to govern the capital structure of a firm, and the value that stability creates for firms’ ability to raise capital. All these arguments boil down to the cardinal rule of waiting in line for the kindergarten bus: it’s not fair to cut in line. If that rule is broken too often, chaos ensues.

The Administration could be arguing, “Sure it’s unfair, but UAW had more leverage on us than the creditors, so we struck the best deal that we could. We needed UAW to sign onto the deal, while we thought we could roll the creditors in court.” This would better justify the disproportionate equity shares than claiming, “This is a fair deal.”

The objecting creditors will now defend their rights in court. If the Chrysler precedent is an example, you should bet against them. It is interesting that the President did not attack them as “speculators” this time, so at least the rhetorical leverage against them is weakened.

My view: I am more concerned with the signals this unfair treatment sends to future investors. I worry that the President’s actions create political risk and will permanently raise the cost of capital for certain firms. I wish I knew whether a different prepackaging was possible, one which would have maintained the precedence of the capital structure and did not stretch the bankruptcy process again. Unfortunately, it is impossible to know.

5. Did the government structure the taxpayer financing correctly?

Judge Richard Posner argues the government should have provided a loan rather than taken an equity stake in GM. The President suggested one reason why they preferred an equity stake: a loan would further burden GM with a stream of near-term interest payments to the government.

I think Judge Posner strikes a nerve with his suggestion. It seems that much of the public discomfort comes from the government now being the owner of GM. It’s the 60% number that made me gasp. It highlights a tradeoff between two goals on which conservatives focus: value for the taxpayer, and avoiding government interference and control. There is a tradeoff between the two.

I believe the U.S. government could auction its equity shares late this year and divest itself completely from General Motors. This would solve the government ownership problem. In doing so, I presume that taxpayers would recoup far less than the $30 B of cash provided.

Question for conservatives: How much of a loss are you willing to take on the $30 B to get the U.S. government out of GM quickly?

My view: I assume there is a non-trivial chance that GM may still fail in the next several years. I like the President’s and his team’s strong language today that this $30 B is the last taxpayer aid, but I would like to reinforce that by ending the government’s ongoing involvement in GM as quickly as possible. I am willing to sacrifice a significant portion of the $30 B to achieve that goal. I therefore recommend that, if GM emerges from bankruptcy, the Administration then establish a much more rapid timetable for selling its equity stake, even if that means the taxpayer loses much of the $30 B. Get us out of GM before the end of 2010. This will strengthen the bulwark against providing additional taxpayer funds if GM fails again.

Note:

Under current law, the authority to provide any firm with additional TARP funding expires December 31, 2009. Correction: Secretary Geithner can, after notifying Congress, extend the TARP authorities to October 3, 2010.
The “set a timeline” argument has direct parallels to a certain national security debate…

6. Will the Administration run GM?

Here I give the Administration credit for good intent and good initial execution. I take at face value the President’s statement that he does not want to run or control GM, and I give him points for saying so explicitly. I am sure there are others, including some in his Administration and some on Capitol Hill, that would love to run GM as Government Motors. I will trust the President when he says he is not one of those people.

I further give the Administration credit for the “Principles for Managing Ownership Stake” they released in today’s fact sheet. While they are being released in the specific context of the U.S. government’s new equity stake in GM, the White House writes more generally “(T)he Obama Administration has established four core principles that will guide the government’s management of ownership interests in private firms.”

The government has no desire to own equity stakes in companies any longer than necessary, and will seek to dispose of its ownership interests as soon as practicable. Our goal is to promote strong and viable companies that can quickly be profitable and contribute to economic growth and jobs without government involvement.

In exceptional cases where the U.S. government feels it is necessary to respond to a company’s request for substantial assistance, the government will reserve the right to set upfront conditions to protect taxpayers, promote financial stability and encourage growth. When necessary, these conditions may include restructurings similar to that now underway at GM as well as changes to ensure a strong board of directors that selects management with a sound long-term vision to restore their companies to profitability and to end the need for government support as quickly as is practically feasible.

After any up-front conditions are in place, the government will protect the taxpayers’ investment by managing its ownership stake in a hands-off, commercial manner. The government will not interfere with or exert control over day-to-day company operations. No government employees will serve on the boards or be employed by these companies.

As a common shareholder, the government will only vote on core governance issues, including the selection of a company’s board of directors and major corporate events or transactions. While protecting taxpayer resources, the government intends to be extremely disciplined as to how it intends to use even these limited rights.

Given that I trust the President’s statements on this point, the risks here are unintended consequences, from within his own Administration and from the Congress. They are big risks, and these are dangerous waters. I hope the Administration treads carefully.

My view: Given the undesirable situation of government equity stakes in, and even controlling ownership of, firms like GM and AIG, as well as potentially Citigroup and other banks, these are good principles. They are also easy to monitor. It is interesting and good that the White House fact sheet says, “The [UAW’s] VEBA will have the right to select one independent director and will have no right to vote its shares or other governance rights.” (emphasis added)

I urge the President to:

Enshrine the principles from today’s fact sheet in the term sheets for the taxpayer investments in GM (and other firms). We did this last December in the GM and Chrysler term sheets. Tie yourself to the mast. This will give you an easy excuse later when someone pressures you to vote those shares in a way that conflicts with the taxpayer’s interest.
Set clear rules for Administration contacts with GM – it’s probably best to funnel all contacts through specific Treasury or NEC officials on the autos task force. No freelancing phone calls to the Administration-appointed directors or “informal chats” with them from White House staff, or from DOT, EPA, USTR, DOE, even State. Put a firewall around interactions with GM.
Come out hard and quickly against the first proposal from a Member of Congress to leverage the ownership stake for a non-taxpayer goal. Nip it in the bud, especially if the idea comes from a friend.

It’s easy to criticize a huge decision like the one made by the President today. I strongly disagree with where we are headed, and I am concerned with the precedent that this deal sets for capital investment in American firms. The alternative, however, is that you have to be willing to allow GM to fail. I would be willing to do so, and it is therefore easy for me to express my views. In summary, they are:

I am extremely uncomfortable with the President’s expanded argument for today’s government intervention.
My first choice would have been to push GM to get private DIP financing. Assuming that was infeasible, I would have recommended denying GM the DIP financing, even if that meant they would liquidate. The economy is sufficiently healthier now than it was last December that I would be willing to risk the additional shock. But I agree the President crossed this bridge at the end of March.
I would bet in favor of GM emerging from bankruptcy, and against them surviving as an intact firm for 5 years without additional taxpayer funding.
The pre-packaging deal was unfair to unsecured creditors, to the benefit of UAW retirees. The Administration loses credibility with me by trying to argue this was a fair deal. They would have been more credible if they had argued it was the only deal they could get. I worry that the President’s actions create political risk and will permanently raise the cost of capital for certain U.S. firms.
If a loan rather than an equity purchase had been possible, I would have preferred that – I find Judge Posner’s arguments persuasive. Given the equity investment, I urge the Administration to divest as quickly as possible, even if it means a loss to the taxpayer.
Given the undesirable situation of the U.S. government owning GM and other large firms, the Administration’s new “Principles for Managing Ownership Stake” are solid. They need to lock them in, and corral or beat back all those people who work in the Executive Branch and Congress who have other goals in mind for GM and will be tempted to exert some leverage.

I thank you for making it through this extremely long post, and again want to thank all of the fantastic commenters. If you dislike the President’s announcement, I urge you to consider this question: Suppose the deal announced today were the only possible pre-packaged bankruptcy, and your choice was to take it or allow GM to liquidate now. What would you do?

Understanding the GM bankruptcy

© 2010 Keith Hennessey - Your guide to American economic policy

Should bank stress test results be public?

kbh — Fri, 24 Apr 2009 17:48:29 +0000

Today the 19 largest banks are getting the results of their stress tests from their regulators. Should these results be made public?

This is not a simple question.

The big upside is that markets will have more information, and that all market participants will have access to the same information. This can allow investors, counterparties, and customers to evaluate the health and stability of the banks with which they are doing business. I have a default presumption that more information more widely disseminated is a good thing.

Downside 1: Some banks might be just above the bubble but rank low. They may still be healthy enough to survive and eventually succeed, but if they are disclosed to be among the weakest, that disclosure may cause a run of depositors, counterparties, or investors. This could push some marginal banks over the edge and cause them to fail.

This is not a trivial concern. Last September there were reports that investors were “testing” even the clearly healthiest investment banks (JPM Chase, Goldman Sachs) shortly after Lehman’s fail. Senior policymakers remember that vividly, when panic might have destroyed banks that on paper were solid. From the perspective of the policymakers who have the information, it is easy to understand why they may be highly risk averse. From their perspective, not disclosing the information may appear to be the safer course.

There is a response to this downside. Banks that do well in the stress tests have an incentive to let the world know that. It may be hopeless for policymakers to think they can protect the weaker banks by not having the government release the information, because the strong banks will do it implicitly by shouting their good news.

Downside 2: The stress tests might not be well-designed. If they are poorly designed, overly optimistic, or just misinterpreted by the market, then the government could be injecting bad information into the market. Government may not be smart enough to design the tests to provide enough useful information to the markets.

More importantly, any stress test is highly imperfect, and there is a risk that the results would create a sense of false certainty. I read a lot of market commentary while working in the White House, and was amazed at how frequently high-level market commentaries completely misinterpreted or misread data that we released (much less policy statements).

This is a close call, and people whom I respect advise in different directions. I fall back on my default presumption / instinct, which is to release the information. There is a small probability of a really bad outcome (a panic/run), and a much larger probability of a good outcome with no run and somewhat better informed markets. I also think it is easy for policymakers to overestimate the amount of control they have over the situation.

The Wall Street Journal reports the following game plan:

Today the regulators are giving results to the banks privately, and asking them not to disclose them. They are also releasing the test methodology.
10 days from now, the regulators will release results of the stress tests, although “regulators also have not decided how much information will be disclosed May 4.”

On the whole, this game plan makes sense to me. I am not sure they will be able to hold out for 10 days, and my instinct is that they should release more information rather than less. I hope market participants will take the time to understand just how imperfect this information will be.

By the way, I presume that the decision to leak that they expect to release the results was made after they knew the results of the tests. This suggests that the results are generally good. If the stress tests showed that half of the banks would fail, I presume they would not be signaling a future release.

Should bank stress test results be public?

© 2010 Keith Hennessey - Your guide to American economic policy

Four unpleasant options for TARP funding

kbh — Mon, 13 Apr 2009 15:15:07 +0000

Despite Secretary Geithner’s statement to the contrary, I still think the Administration is running out of room within the $700 B Troubled Assets Relief Program (TARP). In my last four posts on TARP funding (1 2 3 4), I have stuck to what I think I can demonstrate analytically. I am now going to shift to some educated guessing about what may be going on within the Administration that is contributing to confusion on the outside. The prior posts involved math, while now I am analyzing people, so I am far less certain about what you read here than when I walked through the TARP arithmetic.

I think the senior economic policymakers in the Administration are overconstrained and have several bad options in front of them. This is not an unusual situation, but to a certain extent they put themselves into this box by spending TARP money on every problem that popped up. $50 B on housing, $5 B on auto parts suppliers, $15 B on small business loans, additional unspecified sums for GM and Chrysler, and new as well as old mortgage-backed securities — things add up. I think they’re in a box.

The box has three sides:

They have created expectations among various constituencies for programs announced over the past two months. These expectations would consume most of the remaining $700 B of TARP funds. If their new programs are successful, they will want to expand them to further strengthen financial institutions and markets. If they are unsuccessful, they will need more TARP funds to try something else.
They are justifiably afraid of asking Congress for more TARP funds.
They could create some room for themselves by taking taxpayer funds back from some of the healthy big banks, but they may be worried about the signals that sends about the others.

It appears that they are testing all three sides of this triangular box to figure out which is their least worst option.

Senior Administration policymakers are operating in an ever-changing financial, economic, and legislative environment. When they developed the President’s budget in February, asking Congress for more TARP funds probably seemed difficult but not necessarily impossible. In that circumstance, it was reasonable and responsible for them to put a $250 B placeholder in their budget for a potential future TARP request.

The legislative environment is now much more hostile. It would not surprise me if, for the moment, they have ruled out asking Congress for more TARP funds, and are instead trying to figure out how to create as much room as possible within their existing constraint.

Commenter Wayne Marr asked a good question.

… But the main point is that Obama and team (Larry, Christy, Austan, Geithner, etc) can simply go to [the] well (Congress) since Democrats can pass pretty much what they want. The recovery plan was not named the “Great Bailout:” but the “American Reconstruction and Recovery Plan” or some such nonsense for a reason.

Why not another funding program called “The Better Banking Plan for the 21th Century” to provide more cash for technically insolvent banks? Or those that posed a systemic risk? So does it really matter that we have 30B left of TARP or 100B left for TARP?

While I generally agree that the President has tremendous leverage to get Congress to pass his agenda on a wide range of topics, I seriously doubt that is the case here:

95 of 235 House Democrats voted no the first time on TARP (on September 29, 2008), and 63 House Democrats voted no on the successful vote four days later. Speaker Pelosi now has a significantly larger majority (254), but she would still need Republican votes.
TARP is far more unpopular now than last Fall.
President Obama could undoubtedly get some House D votes who we (the Bush Administration) could not, but not enough to pass such a bill.
I surmise that House Republicans are in no mood to go out of their way to help the majority or the White House, given how aggressively the Speaker and White House have been in passing other legislation without their input. That does not mean that all of them would vote no, merely that the Administration will have a hard sell to make.
Finally, even if she had the votes, I would bet heavily against the Speaker bringing up such a bill if she thought the vote would be partisan, because she would conclude that such a vote would expose her House Democrats to too great of a political risk in the next election. I think that she thinks that she would need bipartisan cover from Republicans as a condition for bringing such a bill to the floor.

As background, the Temporary Asset-Backed Securities Loan Facility (TALF) is what the Fed and Treasury are doing together to keep securitization markets going for things like student loans and car loans. They now want to expand it to include securitizations for new mortgages, and to use it to buy toxic mortgage-backed securities. TALF was created during the Bush Administration. This is the second major expansion since President Obama took office.

PPIP is the Public-Private Investment Partnership, Secretary Geithner’s plan to buy toxic assets from banks. It has two parts, one of which works in conjunction with the Fed, and the other with the FDIC.

Secretary Geithner’s comments that they have $135 B of room left in the TARP is testing side #1 of the triangular box to its maximum possible extent. In an attempt to convince people that they have sufficient room, to reassure both markets and the Congress, I think his staff put together the biggest number they could plausibly say with a straight face. They have not, to my knowledge, explained what $135 B of room would mean for the TALF and buying toxic assets, and I fear that such an answer would tremendously disappoint market participants who are expecting a $1+ trillion TALF and a $100 B PPIP. If the Administration has made policy decisions that lock in $135 B of room, then they have scaled something way back beyond what they had previously said publicly.

The Administration faces a choice: scale back these two programs to be smaller than what they had previously suggested to market participants, or squeeze something else hard to create more room within the $700 B limit.

The other option is to get some TARP funds back from the healthiest big banks. Since the law allows the Administration to recycle returned funds for other purposes, every invested dollar repaid can be spent again.

Certain large banks (e.g., JP Morgan Chase and Goldman Sachs) are publicly signaling that they would like to repay the Treasury. It is hard to blame them, considering the political and legislative environment. Martha MacCallum of Fox News pushed me on this point, correctly pointing out that it seems un-American to dissuade banks from paying back the taxpayer.

The banks are reportedly being told “not yet” by the Administration. I will guess that the Administration is concerned about something that worried some of our experts – if healthy banks return their funds, then investors will conclude that every bank who is not returning their funds must therefore be unhealthy.

This logic becomes strained, however, when those banks find other avenues for signaling to the market that they are healthy, as they are doing now by screaming “WE WANT TO GIVE IT BACK.”

At some point the banking policy concern may be overwhelmed by the near-impossibility of getting more funding from Congress and the policy and political undesirability of scaling back on PPIP, TALF, or the housing commitment. If this happens, then the Administration will happily start accepting funds from banks. The numbers are large enough that this could create room for them to do other things, and as a long-run policy matter, we want the taxpayer to be paid back. These are supposed to be temporary investments in the banks, in which public capital substitutes for private capital that was unwilling to show up last Fall.

There is another outside-the-box possibility that I am sure the White House has considered. Part of their resource constraint arises from having made a $50 B TARP commitment to housing.

They could push this program out of the TARP, and ask Congress for these housing funds anew. It would be much easier for a heavily Democratic Congress to pass $50 B for housing than for them to pass the same amount (or much more) for “Wall Streeet banks.”

I would oppose such a request, because I oppose this housing spending inside or outside of TARP. But I’m sure they could pass it, given their large partisan majorities in both bodies. This option would cause the White House political pain on its left, which pushed hard for these programs, and could cause FDIC Chairman Bair heartburn, given her impassioned support for these housing programs.

Things probably look a little different to the folks sitting inside the West Wing and at Treasury than I have described here, but I would wager heavily that a discussion at least similar to this is ongoing within the senior ranks of the Administration. As long as that decision is unresolved, it will be confusing as we try to interpret statements like Secretary Geithner’s that he has $135 B of room within the $700 B TARP allocation. Those policymakers need to balance the benefits of decision-making flexibility with the costs and repercussions, from markets and/or Congress, of the bad news when it is eventually delivered. They may be waiting for the right time to signal that a previous commitment will be scaled back, or instead for the right time to ask Congress for more funds. I think it is better for market participants and Congress to have early clarity, especially if it’s bad news.

In my experience, it is better to deliver the bad news as soon as you have made the decision. Rip off the band-aid quickly.

I will end with a thought experiment. Suppose my analysis is roughly correct. It is easy to figure out what you don’t want to do. It is much more difficult to decide what you do want to do. If the President asked you for your recommendation, what would it be?

Scale back on PPIP and TALF as necessary to avoid having to ask Congress for more funds.
Ask Congress for more funds. Follow-up: how much more?
Tell banks that you welcome them repaying the Treasury early.
Push housing outside of TARP and make a separate request of Congress for those funds.
Wait and hope.

Let’s not hide $1.4 trillion of IOU’s

kbh — Wed, 08 Apr 2009 14:02:14 +0000

Yesterday on his blog the President’s Budget Director, Peter Orszag, asks himself and then answers the question, “How much does the federal government owe?”

This sounds like a technical question of concern only to “those of us wearing the green eyeshades,” but the Director’s suggested answer has dangerous ramifications, and could mislead or at least confuse taxpayers and financial market participants.

The Director’s answer makes the federal debt appear $1.4 trillion smaller than the way it is traditionally measured. He argues that we should, in effect, ignore 1.4 million million dollars borrowed by the federal government. That is breathtaking.

Let’s look at the Director’s argument and why I think it’s dangerous.

Most budget experts focus on debt held by the public, which Director Orszag accurately describes as “the amount that the federal government owes to others.” I will expand on that a bit with some concrete numbers:

Take the total amount the Federal government will spend this year. Specifically, we’re looking at cash paid by the U.S. government to someone outside the government in 2009. A budget wonk would call these outlays. I’ll use the nonpartisan Congressional Budget Office’s numbers for current law, so I get $3.85 trillion of outlays for 2009. That is way (way) above historic norms, in part due to the financial stabilization efforts, and in part due to the new “stimulus” law.
Now take the amount the Federal government will collect in revenues this year. This is cash coming into the U.S. government from someone outside it. Almost all of this is taxes. CBO says this is $2.186 trillion of revenues for 2009.
If the U.S. government is paying out $3.85 trillion in cash (outlays) this year, but collecting “only” $2.186 trillion in cash, then we need to come up with the difference somewhere. That difference is $1.667 trillion for 2009. This is what CBO says is the federal budget deficit for 2009.
The U.S. government gets this cash by issuing IOU’s to people outside the government, aka Treasury bonds. The government gets cash from anyone who buys Treasury bonds – individuals, firms, and foreign governments.
The debt held by the public is simply the accumulation of these IOU’s. It is the sum of money owed by the U.S. government to others. (Update: See the caveat at the bottom.)

Nothing I have said so far is the slightest bit controversial, but this is where Director Orszag and I part ways. Tuesday he wrote:

As I said at the beginning of this post, I think the most meaningful measure of federal debt is debt held by the public net of financial assets. If I take a $100 loan from my bank and stick that amount into my bank account without spending any of it, my family and I aren’t poorer, because even as I owe $100 to my bank, my bank owes $100 to me. On net, and as long as the new asset is equal in value to the new liability, there’s no change in my overall financial state. There’s a similar effect when the federal government borrows money in order to invest in financial assets.

Suppose I tweak the Director’s metaphor to make it better fit the current situation and illustrate my point. If he takes a $100 loan from his bank and invests it in the business of his deadbeat neighbor Alan I. Gorp, he still owes the bank $100. The bank cannot loan that $100 to anyone else. His (the government’s) borrowing has “crowded out” borrowing by someone else. And who knows how much his $100 investment will be worth next month? We should care not just about his net position, but also about his total liabilities, and especially about how much he (the government) is borrowing from the bank (private sector).

In normal times this would not be a big difference, because the U.S. government in large part stays away from owning financial assets. Now, however, the federal government is buying equity stakes in banks and other large financial firms, and issuing loans to financial and non-financial firms. Director Orszag’s numbers show that the U.S. government owned $506 billion of financial assets last year, and will buy another $915 billion this year. (I’m subtracting “Debt net of financial assets” from “Debt held by the public” on Table S-1 of the President’s budget.) Those are huge numbers, and have a huge effect on what figure you cite for the federal debt.

If you look at the traditional measure of debt held by the public, which you’ll remember is the sum of all IOU’s (Treasury bonds) issued by the Federal government, then under the President’s budget and using OMB numbers, that’s equal to $8.36 trillion. Compared to one year of our entire national output (GDP), that’s almost 59% of GDP.

If, however, you net out OMB’s estimate of the value of the financial assets, then the debt held by the public net of financial assets, is “only” $6.94 trillion, equivalent to almost 49% of GDP. That’s still a big bad number, but it’s $1.4 trillion and 10% of GDP less bad than the debt held by the public numbers. That’s a convenient way to make the problem look much smaller. Director Orszag argues that it is also the “most meaningful measure of current federal debt.”

Here is his key paragraph:

As the federal government has acted to stabilize the financial sector amidst the worst financial crisis since the Great Depression, the federal government has purchased significant financial assets—such as preferred equity stakes in Fannie Mae and Freddie Mac. The federal government will likely take a loss on these purchases, but the assets have value. And just as what my bank owes me should be netted against what I owe the bank in determining the health of my personal finances, the value of these assets should be netted against publicly held debt in determining the health of the government’s finances. … Debt held by the public net of financial assets is the most meaningful measure of current federal debt … (emphasis added)

I disagree with this last statement, but I think I understand why he says it. From his perspective of the federal budget, he’s netting out some of his liabilities with a somewhat liquid asset that he now holds and hopes someday to sell. He concedes the point, however, that he is including some assets and liabilities with his new measure, but excluding others. This makes his new metric suspect.

From the perspective of the U.S. economy, the “netting” comes from different places. The U.S. Treasury has to issue $905 billion of Treasury bonds this year to raise the cash to buy those financial assets. This makes it harder for private firms and individuals to borrow, because they are competing with the government for cash, so they have to pay a higher interest rate. Those funds are then invested in other parts of the economy.

Another way to see why this is a poor metric is to imagine that the U.S. government were to borrow another trillion dollars by issuing even more Treasuries, and then immediately buy one trillion dollars of credit default swaps with the cash raised. According to Director Orszag’s preferred measure, nothing would have changed, because the two transactions would net out. But clearly we would have just had a major impact on the U.S. (and global) financial economies. U.S. government borrowing in these enormous amounts hurts financial markets, no matter what is done with the funds raised.

Director Orszag touches on another problem with his new metric when he writes “The federal government will likely take a loss on these purchases, but the assets have value.” He’s right, but the value of the particular assets being purchased by the government is highly uncertain. How much is he counting as the value of the $19.4 B loaned (so far) to General Motors? I sure hope he is not counting it at face value. What about the $70 B “invested” in AIG, or the $5.5 B in Chrysler? Any private firm valuing these assets would say their values need to be discounted.

The values of these financial assets are highly uncertain and depend heavily on what assumptions OMB uses about the likelihood of them being repaid. For people to trust this metric, they need to understand how it is calculated, which means that OMB should divulge the discounts they are applying to their financial assets. I will guess that he does not want to divulge those assumptions. I wouldn’t if I had his job.

I think the most meaningful measure of current federal debt is still debt held by the public. I think the public policy debate can be further informed by also disclosing the estimated value of the financial assets held by the U.S. government. But policymakers should not net out the two and use that measure instead of the one that most directly measures how much the U.S. government is borrowing from the private sector. This is particularly true when that new measure hides $1.4 trillion of debt borrowed by the U.S. government from the private sector.

Director Orszag, and those measuring his performance, should continue to use debt held by the public as the most meaningful measure of current federal debt. Budget projections will account for that measure to come down over time as the financial assets are sold and funds recouped.

Net measures can hide meaningful information. This is a theme I will return to often. Any time someone in economic policy gives you a net figure, see if you can learn something more by asking about the components that make up the net calculation.

The President’s Budget is titled “A New Era of Responsibility.” In his February 24th Address to the Congress, the President said,

The only way this century will be another American century is if we confront … the mountain of debt they stand to inherit. That is our responsibility.

A new era of responsibility does not begin with hiding $1.4 trillion of that mountain of debt. These IOU’s will not go away just because we ignore them.

Update (12:20 PM Wed): A friend corrects my statement that the debt is simply the accumulation of past deficits. It’s not. The Credit Reform Act measures credit subsidies (like for federal loan or loan guarantee programs) differently than it measures cash flows, and the deficit does not capture “means of financing and cash management, like when Treasury borrows funds and deposits the cash at the Fed.” I stand corrected on these points. I don’t think this changes my logic above about whether to net out the purchase or sale of financial assets.

The President’s strong free trade language in Strasbourg

kbh — Mon, 06 Apr 2009 21:51:48 +0000

I would like to compliment and thank President Obama for saying this in Strasbourg, France last Friday:

As we take these steps, we also affirm that we must not erect new barriers to commerce; that trade wars have no victors. We can’t give up on open markets, even as we work to ensure that trade is both free and fair. We cannot forget how many millions that trade has lifted out of poverty and into the middle class. We can’t forget that part of the freedom that our nations stood for throughout the Cold War was the opportunity that comes from free enterprise and individual liberty.

I know it can be tempting to turn inward, and I understand how many people and nations have been left behind by the global economy. And that’s why the United States is leading an effort to reach out to people around the world who are suffering, to provide them immediate assistance and to extend support for food security that will help them lift themselves out of poverty.

All of us must join together in this effort, not just because it is right, but because by providing assistance to those countries most in need, we will provide new markets, we will drive the growth of the future that lifts all of us up. So it’s not just charity; it’s a matter of understanding that our fates are tied together — not just the fate of Europe and America, but the fate of the entire world.

The President’s words have meaning, especially when he is speaking overseas. It is particularly important that he said this in France. French farm subsidies and politics are a key stumbling block on the road to a Doha global free trade agreement.

I wish the President’s negotiators had pushed for language like this in the final G-20 statement.

The President’s strong free trade language in Strasbourg

© 2010 Keith Hennessey - Your guide to American economic policy

What happened to FREE markets in London?

kbh — Fri, 03 Apr 2009 21:29:10 +0000

Thanks to Reuters’ MacroScope blog for noticing:

Keith Hennessey, a former top economic adviser to President George W. Bush, saw this one coming. He rightly predicted that the Group of 20 would drop a key word from its communique at the conclusion of the London Summit: Free.

Here is my original post from Wednesday: A quick guide to the G-20 summit.

Unfortunately the problem is even bigger than just dropping the word “free” before “markets.” Let’s compare the text of the November G-20 leaders’ declaration and the April G-20 leaders’ declaration.

Here is the key paragraph from the November summit, hosted in Washington by President Bush. Thanks to President Bush’s negotiators, led by his “Sherpa,” Dan Price, and Treasury Under Secretary for International Affairs Dave McCormick, the following text is incredible. Last November, I wrote about this paragraph: “Let’s look at some important wins in the actual text of the declaration. Formerly Communist China and Russia (along with all the other participating nations) agreed to the following text.”

12. We recognize that these reforms will only be successful if grounded in a commitment to free market principles, including the rule of law, respect for private property, open trade and investment, competitive markets, and efficient, effectively regulated financial systems. These principles are essential to economic growth and prosperity and have lifted millions out of poverty, and have significantly raised the global standard of living. Recognizing the necessity to improve financial sector regulation, we must avoid over-regulation that would hamper economic growth and exacerbate the contraction of capital flows, including to developing countries.

Let’s parse it a bit:

“… a commitment to free market principles …”
“… rule of law …”
“… respect for private property …”
“… open trade and investment …”
“… competitive markets …”
“… and efficient, effectively regulated financial systems.”
“… we must avoid over-regulation that would hamper economic growth and exacerbate the contraction of capital flows …”

Now let’s examine yesterday’s text:

3. We start from the belief that prosperity is indivisible; that growth, to be sustained, has to be shared; and that our global plan for recovery must have at its heart the needs and jobs of hard-working families, not just in developed countries but in emerging markets and the poorest countries of the world too; and must reflect the interests, not just of today’s population, but of future generations too. We believe that the only sure foundation for sustainable globalisation and rising prosperity for all is an open world economy based on market principles, effective regulation, and strong global institutions.

Parsing this new language:

“… a commitment to free market principles …” has been replaced by “… based on market principles …”. Note that the word “free” is nowhere in the document.
“… rule of law …” is nowhere in the document
“… private property …” is nowhere in the document
“… open trade and investment …” has been replaced by “… open world economy …” (This one is fine, I think.)
“… competitive markets …” and the word “competitive” are nowhere in the document
“… efficient, effectively regulated financial systems” has been replaced by “effective regulation, and strong global institutions.”
The over-regulation caution is gone.

What makes this so disappointing is that all G-20 nations agreed to the November text. It should have been an extremely easy lift for negotiators from capitalist countries to insist that this leaders’ declaration merely repeat what the leaders agreed to last November.

Wednesday I wrote, “In the short run, it is easy to see how a negotiator might give this up for a more concrete immediate objective. In the long run, few things are as important.”

CNN interview today

kbh — Fri, 03 Apr 2009 21:23:31 +0000

Heidi Collins of CNN interviewed former Clinton Labor Secretary Robert Reich and me this morning around 10:30 AM on CNN Newsroom.

To my surprise, Secretary Reich and I agreed on a lot. We both came out strong against protectionism, and complimented the G-20 leaders for making a strong statement about this. We’ll see if the leaders follow through this time.

Heidi also asked me about the auto loans. I said I was surprised (and not in a good way) that the Wagoner firing decision was made in the West Wing. That creates an impression that politics, rather than economics or policy, may be involved in the decision. We were careful during the Bush Administration to have decisions about individual firm’s CEO’s made outside the White House.

I complimented the President for using the word “free” so much, and for talking about free trade in Strasbourg today, especially given the setback for “free markets” in the G-20 statement.

Secretary Reich and I parted ways on the budget. I argued that we needed much less spending and not to raise taxes. Especially with long-term entitlement spending pressures building, we need to start cutting spending now.

He responded that in the short run, government is the only possible spender, since neither consumers nor businesses are doing so. Had I had time, I would have observed that the spending bills so far, which claim to be short-term stimulus, spend most of their money in 2010 and later. That’s not short-term macro stimulus. That’s just increased government spending.

Jobs Day

kbh — Fri, 03 Apr 2009 17:47:53 +0000

The Bureau of Labor Statistics released the March employment report at 8:30 am. Here is the least you need to know:

Net payroll employment declined in March by 663,000 jobs.
That’s a terrible number, and in line with expectations.
The unemployment rate increased from 8.1% to 8.5%.

Much of the press coverage talks about “5.1 million jobs lost since the beginning of 2008.” I think that using January 2008 as a start date gives an incomplete and possibly misleading picture. The past fifteen months can be divided into two parts. For the first nine months, the economy was shrinking slightly and employment was declining at a disappointing but not panic-inducing rate. For the last six months, beginning in September as the financial market crisis came to a head, the bottom fell out of the employment market. Take at look at the sudden drop in employment beginning as the market crashes in September. This is the best example that what happens on Wall Street affects what happens on Main Street.

Employment was clearly shrinking in the first 8-9 months of 2008. But the huge employment losses immediately followed the financial crisis. I include September in the first segment because the employment data was collected for that month before the fateful two weeks in the markets. 2008 was a bad economic year, but it’s the fourth quarter of 2008 and the first quarter of 2009 that were disastrous.

This matters because, if the diagnosis is different, then the solutions may be different. If the principal cause of the severity of this recession is the financial crisis, then that would suggest that the most important and urgent element of the solution is to fix the problems in financial institutions and financial markets.

Nobody would or should be happy if the economy were losing 137K jobs per month. But that would be a huge improvement compared to the 600K+ jobs lost over each of the past six months. By the same logic, you use different tools and prioritize different policies if the principal cause of the severe decline in growth and employment is the financial sector trouble. This may sound obvious, but I don’t think it is a given in the Washington policy debate. Everyone says “severe recession,” and then immediately jumps to “huge stimulus” or (“we need a second stimulus”). Fiscal and monetary stimulus can undoubtedly increase GDP growth, but they cannot solve the problems in financial institutions and financial markets.

This is why I try to remind myself to talk about economic problems and a financial crisis. It is also one reason why I am much more concerned about whether the Administration’s new financial policies will work, than whether their spending bill will stimulate GDP growth. In my view, if the financial problems are not fixed, we’re still in trouble almost no matter what else happens. This means I’m in line with Fed Chairman Bernanke, who included a crucial if clause in his March 3rd testimony to the Senate Budget Committee:

Although the near-term outlook for the economy is weak, over time, a number of factors should promote the return of solid gains in economic activity in the context of low and stable inflation. The effectiveness of the policy actions taken by the Federal Reserve, the Treasury, and other government entities in restoring a reasonable degree of financial stability will be critical determinants of the timing and strength of the recovery. If financial conditions improve, the economy will be increasingly supported by fiscal and monetary stimulus, the beneficial effects of the steep decline in energy prices since last summer, and the better alignment of business inventories and final sales, as well as the increased availability of credit.