The Scapegoat by William Holman Hunt

Amid calls for Timothy Geithner’s resignation, Noam Scheiber makes the case on his behalf. I find it convincing, but Ezra Klein seems to be suggesting that Geithner should step down anyway:

Scheiber is right on the merits, I think, but the politics matter. Whether Geithner did his best against a bad hand, he created a public relations disaster by bailing out Wall Street and returning it to wild profitability without doing something, anything, to satiate the public’s desire for retribution against the guys who almost ruined the economy. The downside of not denying the public a piece of Wall Street’s scalp is that vulnerable members of Congress now have little chance but to demand Geithner’s.

And this isn’t just Geithner’s problem, incidentally. It’s true for the whole administration. The bailouts were necessary, but they were also understandably unpopular, and there’s been virtually nothing done to balance the scales. No windfall profits tax, or transaction tax. No breaking up big banks, or capping salaries across the board. Financial regulation has been sold as a constructive discussion with the banks rather than a punitive measure to prevent future wrongdoing. The absurd result is that Republicans are playing the populist card (while quietly blocking financial regulation) and frustrated congresspeople are turning on the administration, because the administration has kept them from turning on the banks.

I recall that early in the administration, Geithner seemed in many ways to be being set up for the fall. The Obama administration’s plan for revamping TARP was “Geithner’s plan” so as to try to distance the popular new president from the unpopular policy he was about to get behind.

It would be cruel, but looking ahead to a congressional fight on financial regulation you can see the case for dumping a guy who doesn’t particularly deserve to be dumped purely for the sake of having a clean start. Then some new guy, who’s basically similar but who’s face wasn’t all over the bailout, can lead the charge for regulatory reform with the administration taking the populist, anti-banker stance and the opposition taking the pro-banker stance and the waters unmuddied by fights about TARP or things done by the NY Fed back in 2008.

Based on the stimulus fight, the budget fight, the climate fight, and the health care right a pretty clear pattern of legislative activity in the 111th Congress has shaped up. First you get an Obama administration proposal. Second, most liberals think it doesn’t really go far enough substantively but politically it’ll be hard to pass. Then uniform Republican opposition emerges. Then you need to deal with a bloc of 40-60 House Democrats and a dozen or so Senate Democrats who demand substantial watering down. Then you get into a kind of trench warfare and if anything passes it does so by the skin of its teeth on highly partisan votes.

Ezra Klein said yesterday morning that he thought financial regulatory reform might be different:

Unlike health-care reform, where Republicans really don’t want a bill and will happily reject all manner of bids, there is reason to believe that both sides want some new financial rules in place. Republicans weren’t any happier than Democrats when the banks held them hostage last year. Joining with the banks to kill financial regulatory reform doesn’t look like a popular move.

He elaborated in the afternoon:

The politics of this, in fact, look to be the reverse of the politics of health-care reform. There, Democrats were fairly united with industry actors, but aggressively opposed by the conservative base, and Republicans ended up siding with their base and their electoral prospects rather than with the pharmaceutical industry. The Republican attack has been populist in nature. On this, you could see the liberal and conservative bases largely agreeing, while industry actors join in opposition. The battle lines might cut the establishment (the Federal Reserve, the banks, etc.) from the grass roots more than they separate the two parties. As my colleague Binya Appelbaum reminds me, “populism” referred to a skepticism of elites setting monetary policy long before it became shorthand for a difference between the left and the right.

Maybe. But I kind of doubt it. Mitch McConnell’s intial response to the Dodd plan seems like a very typical root-and-branch rejection. And the reality is that Tea Party populism is uninformed and completely incoherent. Tea Parties claim to believe they wish the government hadn’t rescued the banking system last fall, but I haven’t seen a single sign at a rally or a single quote from a rallier to suggest support for enhanced regulation. Glenn Beck isn’t calling for enhanced regulation. The Koch family isn’t going to start busing people to pro-regulation rallies.

Enjoying fast, fast broadband in Stockholm (my photo, available under cc license)

It’s pretty well-known at this point* that despite the fact that the Internet was largely invented in the United States and that most of the iconic Internet brands are US companies, that America is only a mediocre performer in terms of quality of broadband access and depth of broadband penetration. These points are, however, often made in a pretty superficial way. This recent major study from the Berkman Center (see more discussion) breaks the information down in a more sophisticated way. That shows that some things aren’t quite as they initially seem—Canada and Norway both look worse, for example—but that the US remains a middling performer.

Their main policy conclusion is that “open access” policies of the sort the United States had in the mid-1990s but then abandoned are common across all the high performing nations:

Our most surprising and significant finding is that “open access” policies—unbundling, bitstream access, collocation requirements, wholesaling, and/or functional separation—are almost universally understood as having played a core role in the first generation transition to broadband in most of the high performing countries; that they now play a core role in planning for the next generation transition; and that the positive impact of such policies is strongly supported by the evidence of the first generation broadband transition.

The importance of these policies in other countries is particularly surprising in the context of U.S. policy debates throughout most of this decade. While Congress adopted various open access provisions in the almost unanimously-approved Telecommunications Act of 1996, the FCC decided to abandon this mode of regulation for broadband in a series of decisions in 2001 and 2002. Open access has been largely treated as a closed issue in U.S. policy debates ever since. Yet the evidence suggests that transposing the experience of open access policy from the first generation transition to the next generation is playing a central role in current planning exercises throughout the highest performing countries. In Japan and South Korea, the two countries that are half a generation ahead of the next best performers, this has taken the form of opening up not only the fiber infrastructure (Japan) but also requiring mobile broadband access providers to open up their networks to competitors.

In leading countries like Sweden and the Netherlands, following the earlier example of the United Kingdom, regulators are addressing the complexities of applying open access policy to next-generation infrastructure by pushing their telecommunications incumbents to restructure their operations and functionally separate their units that sell access to network infrastructure from their units that sell connectivity directly to consumers. Moreover, countries that long resisted the implementation of open access policies, Switzerland and New Zealand, changed course and shifted to open access policies in 2006.

We should do this! The main common denominator, I think, is that the high-performing countries are generally places where electronics manufacturers have more political clout than telecom firms and thus are able to force implementation of these open access policies. The United States, meanwhile, is really shooting ourselves in the foot. The software/media nexus of industries is very important to our economy—these are the things we do well—and we’re letting ourselves be stifled by basically useless telecom firms.

* A certain strain of conservative persists in a perverse effort to try to deny this reality, pointing out irrelevant things like that Sweden is smaller than the U.S. or more urbanized. This is true, but the U.S. contains urban areas that are the exact same size as Stockholm and Göteberg and they have slower internet than those Swedish cities. Meanwhile one of our fastest states—about the same on average as Sweden—is the very rural New Hampshire. Our internet is slower because it’s slower, and it’s clearly slower.

A friend joked yesterday after a frustrating experience dealing with Comcast that “I think we need a public option for cable/wireless companies.”

But there’s a real issue here. The United States gets very mediocre results in terms of broadband price and speed compared to other industrialized countries. It’s true that some of this has to do with the difficulty of wiring a relatively sparsely-populated country. But lots of places in the United States are as dense as Stockholm, and in Sweden the average is 18.2 mbps, which you won’t find anywhere in this country. As Mark Loyd has written:

The United States will not meet President Bush’s goal of universal broadband by the end of 2007—not by a long shot. The number of subscribers to Internet services is growing faster than the adoption of “dial-up,” yet for the most part these subscribers are not connected to the broadband technology Congress described in 1996 as a two-way communications service capable of high-speed delivery of data, voice, and video.

This failure to connect over half the country to advanced telecommunications service is not a technological failure. It is a 21st century public policy failure. In the 1990s, policies established by the Clinton administration to encourage public/private telecommunications partnerships, to connect schools and libraries to the World Wide Web, and to allow competitive service providers onto the networks of the local telephone monopolies all sped up the deployment of broadband around most of the nation. These policies were either deliberately abandoned or hampered by the Bush administration.

The increasing noise from Washington about the lack of a U.S. broadband policy obscures the fact that a policy choice was made by the Bush administration to rely entirely on “market forces” to determine how and where advanced telecommunications services would be deployed. That policy has failed.

It’s no coincidence that the cable company is always a go-to liberal example of private sector dysfunction. I would ditch Comcast in favor of a rival cable company except . . . there isn’t a rival cable company that served by neighborhood. Nor does my window face the right direction for DirectTV. So it’s Comcast or nobody, and thus the quality of Comcast’s offerings and customer service tends to be extremely bad. Appropriate regulation and public investment have a big role to play in this field.

I pointed out yesterday that even conservatives like Ben Bernanke agree on the need for congress to pass some form of “resolution authority” regulation, empowering the government to deal with failing financial institutions that aren’t covered by the FDIC process. That’s clearly a necessary step to dealing with the “too big to fail” issue, and some people even think it’s sufficient.

And then there’s Edward Yingling, the banksters’ top lobbyist, who’s against the idea on the grounds that it “could make it unnecessarily more expensive for them to do business during less turbulent times.” As Pat Garofalo observes “as for ‘unnecessary’ expenditures, I’d like to ask Yingling what he thinks of the $700 billion spent to pull the banking system back from the brink.”

But, look, this is just zealous advocacy on Yingling’s part. It’s clearly preferable for large financial firms that they be allowed to exist in a way that ensures the taxpayers have no choice but to cover their losses in the case of screwups. Anyone with any sense would jump at the chance to privatize profits and socialize losses. It’d just be insane of congress to let them keep getting away with it. Y

Liberals will probably find a fair amount to disagree with in these remarks from Ben Bernanke, especially the lead elements that involve vague assertions about the “economic benefit of multi-function, international (financial) firms.” That said, there’s no reason whatsoever to disagree with this:

Both in answering the question and in his prepared text, Mr. Bernanke again beseeched Congress to act soon to give regulators “resolution authority” to cope with the imminent collapse of a big financial firm other than a bank, and to address other vulnerabilities in the regulatory regime exposed during the crisis.

There’s plenty of room for disagreement as to whether an approach to “too big to fail” that’s centered on this resolution authority point is sufficient. But I think everyone can agree that it’s necessary. And unlike other elements of regulatory reform, this is something that at least might come into play during the current crisis if things get worse. I see no reason why congress couldn’t or shouldn’t move quickly on this point irrespective of controversy over the rest.

Martin Wolf’s ideas for financial regulation:

First, create a set of laws and institutions that make it possible to bankrupt any and all institutions, even in a crisis. Second, make financial institutions safer, with much higher capital requirements, against all activities. Third, prevent off-balance-sheet activities. Fourth, impose dynamic provisioning. Fifth, require huge cushions of contingent capital. Finally, cease to favour debt-finance, throughout the economy.

Kevin Drum likes this a lot.

I’m not sure how much of this can stick in an industry where the product and the inputs (just money, really) can cross international borders so easily. Shut down some antics in London and they move to Zurich.

Relatedly, with a lot of regulatory ideas you need not only to write good rules down on a piece of paper in advance, you need to pull the trigger when the time comes. Say you resolve to “prevent off-balance-sheet activities” and write some rules. Then it’s 2017 and so-and-so at GiantBankCorp finds some kind of loophole. By 2019 everyone’s using this loophole. So some bureaucrat at Treasury says, “hey we should really rule that this amounts to an illegal off-balance-sheet activity and shut it down.” Next Tuesday there’s a story in Roll Call about how a group of GOP House members, joined by a bloc of moderate Democrats and even some liberals from the New York City area have written a letter to the Treasury Secretary warning that the proposed rule would reduce US financial services competitiveness. And you have to understand, this isn’t going to be a front page headline in Roll Call—this is 2019, not 2009, and the general public doesn’t care about banking regulation anymore—it’s buried in some backwater. The only people following the issue are financiers and lobbyist types. And, hey, the Secretary tells himself that the critics aren’t even wrong. Closing the loophole won’t shut the activity down, it’ll just ensure that the loopholes are being exploited out of the London office. Who does that help? What could go wrong?

Economics of Contempt has an excellent post up noting that the Obama administration’s proposed regulatory reforms actually do quite a bit more to deal with the “too big to fail” problem than is generally acknowledged. In particular, along with various regulatory steps, they’re asking for specific “resolution authority” over so-called “Tier-1 Financial Holding Companies. This would create a non-bankruptcy approach to dealing with insolvent big financial firms, much as the FDIC process exists for conventional banks.

But he also notes a substantial flaw in the proposal:

I think the administration makes a big mistake by requiring a separate “systemic risk” determination in order to use the proposed resolution authority for Tier 1 FHCs. This introduces needless uncertainty. Remember, a financial company is a Tier 1 FHC, by definition, if “material financial distress at the company could pose a threat to global or United States financial stability or the global or United States economy during times of economic stress.” An institution thus can’t even be a Tier 1 FHC in the first place if it doesn’t pose a systemic risk. Why require an additional, albeit slightly different, determination of “systemic risk” before the new resolution authority can be used? This will leave the market guessing as to which resolution regime — the Bankruptcy Code or the new resolution authority? — will be used to resolve a distressed Tier 1 FHC. Creditors, unsure which resolution regime will apply and thus how their claims will be treated, will be less likely extend credit at exactly the time we don’t want creditors to be pulling back from a Tier 1 FHC.

I would make the new resolution regime automatically applicable to Tier 1 FHCs. By requiring a second “systemic risk” determination, the administration is essentially saying that there are Tier 1 FHCs that can be resolved in an orderly fashion under the Bankruptcy Code as it’s currently written. You’d be hard-pressed to find any market participant who agrees with that statement (in fact, I don’t believe Tim Geithner honestly believes that statement). I continue to be confused by the insistence on a second “systemic risk” determination.

I think the real problem here isn’t that there’ll be uncertainty about whether or not the Bankruptcy Code will be used. The problem is that given policymakers clearly indicated (and correctly so) unwillingness to resolve big financial firms through bankruptcy, this seems to continue to hold the door open to future bailouts rather than actual use of the new resolution authority.

Either way, the proposal could be greatly improved by making this more automatic.

This, I think, is one of the main reasons you hear more about breaking banks up from people talking to newspapers than you do from policymakers. What, exactly, are Ben Bernanke and Tim Geithner supposed to do at this point?

Which is why, I think, the idea of enhanced capital ratios and special fees is actually a pretty good idea. Greenspan says “I don’t think merely raising the fees or capital on large institutions or taxing them is enough.” He thinks we need to actually break them up. But raising fees and capital requirements can be a way of doing this. The point would be to make the fees and requirements onerous enough that the managers of large financial institutions find it worthwhile to start finding ways to spin things off and shrink. That would produce the goal of smaller firms without having the Treasury Secretary personally step in and reorganize the commanding heights of the economy. The test is that if the fees are imposed and banks don’t start doing this, you need to come back and raise the fees. The fees need to be high enough to generate substantial fee-avoiding behavior, you can’t just say “well, we’ve got some extra revenue so it’s all good.”

We use detailed information about wages, education and occupations to shed light on the evolution of the U.S. financial sector over the past century. We uncover a set of new, interrelated stylized facts: financial jobs were relatively skill intensive, complex, and highly paid until the 1930s and after the 1980s, but not in the interim period. We investigate the determinants of this evolution and find that financial deregulation and corporate activities linked to IPOs and credit risk increase the demand for skills in financial jobs. Computers and information technology play a more limited role. Our analysis also shows that wages in finance were excessively high around 1930 and from the mid 1990s until 2006. For the recent period we estimate that rents accounted for 30% to 50% of the wage differential between the financial sector and the rest of the private sector.

As Ryan Avent points out, there’s a reasonable case to be made that this is actually the Wall Street compensation issue we should be worried about:

Officials in Washington scrutinising the pay packages of TARP recipients are primarily focused on the incentive effects of those pay structures—whether financial pay packages are inducing financial employees to take excessive risks. But the bigger incentive problem may be—almost certainly is—the drain of talent from other fields, into finance. If there were more evidence that this drain was producing significant net benefits for the economy, than there would be less cause to worry. To an increasing number of people, it looks as though the financial sector is recruiting the nation’s best brains and putting them to work endangering the global economy.

Imagine a world in which being the owner of one of these telephone psychic scam operations discovered that high-skill fake-psychics could produce more earnings than a low-skill fake-psychic. He might start recruiting more people from top schools. And other firms would notice that this one guy moving up the skill chain was producing benefits, and begin doing the same himself. Over time, competition between firms would drive compensation in the psychic sector up and a greater-and-greater share of the high-skill workforce would start draining out of other fields and into psychic work. This would, in turn, seem likely to create a less productive economy over time. Some people would be arguing that the high wages in the psychic sector are, as such, proof that the psychics are generating social value. But nobody looks at the actually existing psychic industry and infers from the fact that psychics are able to earn income that psychics possess real ability to forecast the future. Rather, we recall that as Larry Summers famously argued “there are idiots”.

Kevin Drum wonders what can be done about the ratings agencies:

Beyond that, I’m also a bit flummoxed about what the answer to the ratings agency problem might be. There’s probably a reasonable regulatory solution for fraud and negligence, but there seems to be wide agreement that the real problem is incentives: since issuers are the ones paying for ratings, it’s inevitable that agencies are going to lean into the wind to provide ratings the issuers like. I’ve read dozens of proposals for ratings agency reform, but the only one that really gets at this fundamental conflict-of-interest problem is to simply do away with them and turn debt rating into a government function. I’m a little skeptical of that, though, since it’s not at all clear to me that a government agency could hire the kind of talent it takes to keep up with Wall Street’s rocket scientists. What’s more, it’s not at all clear to me that anyone — Fed regulators included — would have rated SIVs much differently during the boom years than the ratings agencies did.

I’ve been told by people working in finance that in their opinion it would be feasible to use regulation to simply switch the payment scheme around and make it so that buyers of securities rather than issuers were the ones paying the ratings agencies. It’s not totally clear to me that that’s correct (for any given security you have one seller and many potential buyers so it seems it would be much more efficient to have the sellers pay) but that’s what I was told.

But I think the larger issue with the ratings agencies isn’t so much that they’re underregulated as it is that regulations we’ve put on other actors in the marketplace have created a ratings agency cartel. The underlying the premise of the idea that private ratings agencies can work is that agencies that fail to do a good job will fail as businesses. That can’t happen if there are only three ratings agencies and it’s impossible for new competitors to enter the market. As Mark Calabria explains in a paper whose general conclusions I wouldn’t embrace:

The modern regulation of credit rating agencies began with the SEC’s revision of its capital rules for broker-dealers in 1973. Under the SEC’s capital rules, a broker-dealer must write down the value of risky or speculative securities on its balance sheet to reflect the level of risk. In defining the risk of held securities, the SEC tied the measure of risk to the credit rating of the held security, with unrated securities considered the highest risk. Bank regulators later extended this practice of outsourcing their supervision of commercial bank risk to credit rating agencies under the implementation of the Basel capital standards.

The SEC, in designing its capital rules, was concerned that, in allowing outside credit rating agencies to define risk, some rating agencies would be tempted to simply sell favorable ratings, regardless of the true risk. To solve this perceived risk, the SEC decided that only Nationally Recognized Statistical Rating Organizations would have their ratings recognized by the SEC and used for complying with regulatory capital requirements. In defining the qualifications of an NRSRO, the SEC deliberately excluded new entrants and grandfathered existing firms, such as Moody’s and Standard and Poor’s.

In trying to address one imagined problem, a supposed race to the bottom, the SEC succeeded in creating a real problem, an entrenched oligopoly in the credit ratings industry. One result of this oligopoly is that beginning in the 1970s, rating agencies moved away from their historical practice of marketing and selling ratings largely to investors, toward selling the ratings to issuers of debt. Now that they had a captive clientele, debt issuers, the rating agencies quickly adapted their business model to this new reality.

The damage would have been large enough had the SEC stopped there. During the 1980s and 1990s, the SEC further entrenched the market control of the recognized rating agencies. For instance, in the 1980s the SEC limited money market funds to holding securities that were investment grade, as defined by the NRSROs. That requirement was later extended to money market fund holdings of commercial paper. Bank regulators and state insurance commissioners followed suit in basing their safety and soundness regulations on the use of NRSRO-approved securities.

This kind of situation could conceivably work if there were a large number of NRSROs but instead there are only three. And they essentially have the entire market in global finance captive. It’s a recipe for disaster.

Two quotes from Barney Frank talking to Ezra Klein:

What’s the most important part of financial regulation?

Limiting securitization. I believe the single biggest issue here is that people invented ways to lend money without worrying if they got paid back or not by securitizing the loan. When I was younger, the theory was if you had a high risk tolerance, you went into stocks. If you were safe and stodgy, you bought debt. But debt became the volatile aspect here.

[...]

One theory of the crisis is that the problem wasn’t traders and their high tolerance for risk. It was people fooling themselves into thinking this stuff was safe by slapping a triple-A rating on everything.

I agree; the theory has always been that people bought debt because it was safer. The basic problem was that 30 years ago when people lent other people money, they expected to be paid back by the people they lent money to. So they were very careful. Two years ago, most loans were being made by people who were going to sell those loans to other people and didn’t expect to be paid back.

This relates back to what I was saying about executive compensation. It’s true that the compensation schemes prevailing at many financial institutions seemed to involve bad incentives, but the real issue is why didn’t the market sort that out? Why don’t investors demand to be working with firms whose key employees don’t face those incentives? And similarly with securitization. The mysterious thing isn’t that people made bad loans that they were able to package and sell off, the mysterious thing is that they found buyers for the securities.

Ultimately this looks to me to go back to the ratings agencies, an issue Frank sort of dodged. But the ratings agencies are private for-profit companies that also enjoy a kind of government-sponsored monopoly status. In theory their behavior should be subject to market discipline, but in practice it’s not. They screwed up badly. But while lots of companies have gone bankrupt and lots of people have lost their jobs, the ratings agencies are all still in business. And no new competitors are coming to the fore and there’s no real way for anyone to break into the industry.

One of the under-discussed elements of financial regulation is the question of personnel. To have an effective regulatory regime, you need to not only have good rules on the books you need effective personnel. There are a few aspects to this. One you need a sufficient quantity of people to actually keep up with what’s happening. Two, the people need to be sufficiently smart and well-informed to figure out what’s happening. Three, the job has to be worth doing for some reason other than to gain experience before cashing in and flipping to the other side—nobody’s going to do a good job if the incentives are to do a bad job. Last, the people running the agency need to be prestigious enough to win political battles. Everyone understands that it’s politically problematic to be seen as ignoring advice from generals; it’s not clear that anyone fears paying a price for not listening to career staff at the Office of the Comptroller of the Currency.

Felix Salmon describes Joe Stiglitz describing Poland’s efforts to grapple with some of these issues. They employ a screen-door submarine innovative compensation model:

Stiglitz is a fan of the Polish framework. Poland, he says, has one overall regulator, which then has separate commissions with solid institutional knowledge for each of the areas, like insurance and banking, which need to be regulated. He also like the way that the Poles index the salary of the regulator to salaries in the financial sector. Financial-sector salaries are taxed at a set percentage to fund the regulator’s salary, ensuring that the regulator’s salary keeps up with financial-sector wage inflation.

There’s some logic to this. At the same time, it seems a bit perverse to give regulators such a direct incentive to see the regulatees’ salaries get up as high as possible. We probably do need higher salaries for select elements of the civil service. But I would emphasize that fundamentally public sector careers are rarely made attractive primarily through financial methods. Military officers in the United States don’t make a ton of money, but they’re very well-respected. And since they’re well-respected, it’s an attractive career for a lot of people. And since it’s an attractive career for a lot of people, it attracts people worthy of respect. You see a similar virtuous circle with teachers in Finland.

What’s wrong with financial-industry compensation? In a nutshell, bank executives are lavishly rewarded if they deliver big short-term profits — but aren’t correspondingly punished if they later suffer even bigger losses. This encourages excessive risk-taking: some of the men most responsible for the current crisis walked away immensely rich from the bonuses they earned in the good years, even though the high-risk strategies that led to those bonuses eventually decimated their companies, taking down a large part of the financial system in the process.

The Federal Reserve, now awakened from its Greenspan-era slumber, understands this problem — and proposes doing something about it. According to recent reports, the Fed’s board is considering imposing new rules on financial-firm compensation, requiring that banks “claw back” bonuses in the face of losses and link pay to long-term rather than short-term performance. The Fed argues that it has the authority to do this as part of its general mandate to oversee banks’ soundness.

This makes sense to me, though I’m moderately skeptical it can really be made to work in practice.

But I do think it’s worth dwelling on the fact that this really a pretty odd situation. Who doesn’t the market take care of this problem itself? It really seems like investors would be reluctant to deal with financial institutions that are organized this way. It seems like there was a reason the major investment banks were traditionally organized as partnerships—partnerships don’t have these incentives, and people should prefer to do business with institutions that don’t have these incentives. But the market’s not working like that. And it’s worth trying to understand why. If regulators start playing cat-and-mouse with compensation shenanigans, the mice are probably going to wind up winning. But if there’s some specific thing that’s preventing market discipline from adequately aligning incentives, we ought to be trying to find out what it is and what can be done about it.

The idea of reforming compensation practices at financial firms is even more in the air in Germany than in the United States, and this is apparently something Angela Merkel has been talking up in advance of the election. I wouldn’t really mind if we did this, but I’m pretty skeptical. For one thing, the empirical evidence that this is really the issue is quite weak. For another thing, clearly the reason bankers pay themselves so much money is that banking firms make so much money. They’re not going to just pile the money up on the roof and light it on fire. Huge finance profits imply huge finance compensation packages. Adopting new rules around compensation seems likely to create a few hours of extra work as people try to figure out how to get around the rules.

Conversely, if we adopted a new regulatory scheme that was effective at controlling bad behavior, that would probably reduce financial sector profits and lead to more reasonable salaries.

All that said, what I think people really need to do is confront the fact that obscene banker compensation is really a social justice issue rather than a financial regulation issue. Which is to say the sky-high pay seems wrong just as such rather than because there’s a specific bad incentives issue that needs to be corrected. And the solution to this is just taxes. When I met yesterday with some smug, arrogant, unapologetic Germany bankers I found it much less infuriating that meeting with smug, arrogant, unapologetic American bankers because I know the Germans are paying higher taxes and those taxes are going to finance a much more generous welfare state (bailouts for normal people, if you will) than we enjoy in the United States.

While nobody I’ve spoken to in Germany thinks Barack Obama’s appeasement is going to lead to Russian domination of the continent, several people have expressed the view—commonly heard from French and German officials—that they’re very perturbed by the fact that the Obama administration hasn’t yet acted to stiffen regulations on hedge funds.

Certainly that was the view of the panel we heard from yesterday at the Deutsches Aktieninstitut, a kind of in-house think tank for German firms interested in capital markets. The strange thing about this is that while I agree this should be done (and in fact I believe the administration’s proposals address this point) it’s very hard to understand the centrality they’re giving it since as best I can tell hedge funds simply didn’t play a major role in bringing on this crisis. When I put that point to the panel, they pointed to the fact that a substantial number of hedge funds have gone under in the past 18 months. But this it seems to me points in the other direction—hedge funds that have made bad bets have failed largely because they’ve been allowed to fail; unlike other forms of financial institutions it’s deemed acceptable to let them fail. The institutions we really need to worry about regulating are the ones that we don’t intend to let fail. That’s where the really bet one-sided bets with privatized profits and socialized losses are taking place.

Well, hold on a second, George. Here — here’s what’s happening. You and I are both paying $900 bucks on average — our families — in higher premiums because of uncompensated care. Now, what I’ve said is that, if you can’t afford health insurance, you certainly shouldn’t be punished for that. That’s just piling on. If, on the other hand, we’re giving tax credits — we’ve set up an exchange, you are now part of a big pool, we’ve driven down the costs, we’ve done everything we can, and you actually can afford health insurance, but you’ve just decided, You know what? I want to take my chances, and then you get hit by a bus, and you and I have to pay for the emergency room care, that’s…

What it’s saying is, is that we’re not going to have other people carrying your burdens for you any more than the fact that right now everybody in America, just about, has to get auto insurance. Nobody considers that a tax increase. People say to themselves, that is a fair way to make sure that, if you hit my car, that I’m not covering all the costs.

Not being a politicians, I can just note that we generally speak the English language in the United States and we’ve never previously taken the word “tax” to include all regulations that increase some people’s costs of buying stuff. Nobody says, for example, that a minimum parking regulation on new development is “really” a tax on non-drivers or that the Americans With Disabilities Act is “really” a tax on people who aren’t in wheelchairs.

That said, the kernel of a good point lurking in these question is that realistically the practical alternative to higher taxes is often more regulation. And in particular one major consequence of the extreme aversion to taxation embedded in the American political culture is that it creates large incentives for politicians to try to do things through regulatory mandates rather than taxes. One of the major sources of the political appeal of cap and trade is that it’s not a tax. Conversely, one of the major elements of the campaign against cap and trade is to try to insist that it should be called “cap and tax.” This is ultimately a very destructive way of talking about politics—it’s simply not the case that it’s in general preferable to do things through regulation rather than through taxes and spending. Oftentimes the most efficient way to have the government accomplish something is to just charge taxes and spend the money.

Lisa Jackson

Ted suggests that I might want to start taking my cues from Katherine Weymouth and offer some cheerier stories:

Also, Matt, I think *your* readers might appreciate some cheerier stories. My suggestions:

“Relax: The EPA has Got This!”

“Getting Around the U.S. Senate: Unitary Executive Theory for Progressives”

Heart-warming pictures of Bo. Also.

This seems like as good a time as mention to mention that yesterday Dave Roberts wrote up a good primer on the Environmental Protection Agency’s regulatory authority under the Clean Air Act to try to tackle climate change. The bottom line:

But no one should be under any illusions. The NSR/PSD/BACT approach is grossly suboptimal for the job that needs doing. It might have the intended effect—killing coal plants—but there’s potential for unintended effects as well, including substantial political blowback.

The key thing, I think, is that it’s hard to see this being politically sustainable. Given the right circumstances, this can be a feature rather than a bug. If political conditions are such that congress doesn’t want to take about climate change, deploying a little EPA regulatory authority will help focus minds and get people focused on the issue again. Alternatively, if political conditions are such that congress is close to enacting a climate change bill you could see deploying a little EPA regulatory authority pushing it over the edge. But if the issue is that the climate fight has just been waged and lost decisively in congress, then it’s hard for me to see how EPA regulation really offers a viable alternative since the political blowback would likely be intense.

Glenn Beck

David Frum observes the insanity of conservative attacks on Cass Sunstein:

In other words: Horowitz agrees that Beck’s attack on Sunstein was false. Yet that falsehood does not worry Horowitz. The country is “under assault.” (As the broadcaster Mark Levin has said, President Obama is “literally at war” with the American people.) In a war, truth must yield to the imperatives of victory. Any conservative qualms about the untruth of Beck’s defamation of Sunstein amounts to “appeasement” – an appeasement that will end with the left decapitating the right. This is the language and logic of Leninism. There is no truth or falsehood comrades, there is only service to the revolution or betrayal of the revolution. [...]

… even in Leninist terms, Beck’s attack on Sunstein was stupid and counter-productive. Every legal conservative who cares about the issues of regulation and deregulation agrees that Cass Sunstein is the very best choice for the OIRA job to be hoped from a Democratic president. Had conservative opposition somehow derailed the Sunstein nomination, President Obama’s next appointment would almost certainly have been worse – very possibly, a lot worse.

This doesn’t actually especially remind me of any distinctively Leninist ideas so much as Carl Schmitt’s thought on the primacy of the friend/enemy distinction. Sunstein is “on the other team” so it makes sense to try to destroy him even though his views on the issues covered by the OIRA job aren’t very liberal and some environmentalists regarded his appointment as a betrayal.

The larger issue is that it’s dangerous for political movements to let themselves be led by entertainers whose primary interest is in attracting an audience. Politics is a practical business, about accomplishing concrete goals and winning elections in an environment in which most people don’t care about politics very much. Becoming a successful cable news or talk radio host is about attracting a relatively small audience of die-hard fans and whipping them into various frenzies.