Hillary Is Wrong About the Settlements. By ELLIOTT ABRAMS
The U.S. and Israel reached a clear understanding about natural growth.
The Wall Street Journal, June 25, 2009, p A15
Despite fervent denials by Obama administration officials, there were indeed agreements between Israel and the United States regarding the growth of Israeli settlements on the West Bank. As the Obama administration has made the settlements issue a major bone of contention between Israel and the U.S., it is necessary that we review the recent history.
In the spring of 2003, U.S. officials (including me) held wide-ranging discussions with then Prime Minister Ariel Sharon in Jerusalem. The "Roadmap for Peace" between Israel and the Palestinians had been written. President George W. Bush had endorsed Palestinian statehood, but only if the Palestinians eliminated terror. He had broken with Yasser Arafat, but Arafat still ruled in the Palestinian territories. Israel had defeated the intifada, so what was next?
We asked Mr. Sharon about freezing the West Bank settlements. I recall him asking, by way of reply, what did that mean for the settlers? They live there, he said, they serve in elite army units, and they marry. Should he tell them to have no more children, or move?
We discussed some approaches: Could he agree there would be no additional settlements? New construction only inside settlements, without expanding them physically? Could he agree there would be no additional land taken for settlements?
As we talked several principles emerged. The father of the settlements now agreed that limits must be placed on the settlements; more fundamentally, the old foe of the Palestinians could -- under certain conditions -- now agree to Palestinian statehood.
In June 2003, Mr. Sharon stood alongside Mr. Bush, King Abdullah II of Jordan, and Palestinian Prime Minister Mahmoud Abbas at Aqaba, Jordan, and endorsed Palestinian statehood publicly: "It is in Israel's interest not to govern the Palestinians but for the Palestinians to govern themselves in their own state. A democratic Palestinian state fully at peace with Israel will promote the long-term security and well-being of Israel as a Jewish state." At the end of that year he announced his intention to pull out of the Gaza Strip.
The U.S. government supported all this, but asked Mr. Sharon for two more things. First, that he remove some West Bank settlements; we wanted Israel to show that removing them was not impossible. Second, we wanted him to pull out of Gaza totally -- including every single settlement and the "Philadelphi Strip" separating Gaza from Egypt, even though holding on to this strip would have prevented the smuggling of weapons to Hamas that was feared and has now come to pass. Mr. Sharon agreed on both counts.
These decisions were political dynamite, as Mr. Sharon had long predicted to us. In May 2004, his Likud Party rejected his plan in a referendum, handing him a resounding political defeat. In June, the Cabinet approved the withdrawal from Gaza, but only after Mr. Sharon fired two ministers and allowed two others to resign. His majority in the Knesset was now shaky.
After completing the Gaza withdrawal in August 2005, he called in November for a dissolution of the Knesset and for early elections. He also said he would leave Likud to form a new centrist party. The political and personal strain was very great. Four weeks later he suffered the first of two strokes that have left him in a coma.
Throughout, the Bush administration gave Mr. Sharon full support for his actions against terror and on final status issues. On April 14, 2004, Mr. Bush handed Mr. Sharon a letter saying that there would be no "right of return" for Palestinian refugees. Instead, the president said, "a solution to the Palestinian refugee issue as part of any final status agreement will need to be found through the establishment of a Palestinian state, and the settling of Palestinian refugees there, rather than in Israel."
On the major settlement blocs, Mr. Bush said, "In light of new realities on the ground, including already existing major Israeli populations centers, it is unrealistic to expect that the outcome of final status negotiations will be a full and complete return to the armistice lines of 1949." Several previous administrations had declared all Israeli settlements beyond the "1967 borders" to be illegal. Here Mr. Bush dropped such language, referring to the 1967 borders -- correctly -- as merely the lines where the fighting stopped in 1949, and saying that in any realistic peace agreement Israel would be able to negotiate keeping those major settlements.
On settlements we also agreed on principles that would permit some continuing growth. Mr. Sharon stated these clearly in a major policy speech in December 2003: "Israel will meet all its obligations with regard to construction in the settlements. There will be no construction beyond the existing construction line, no expropriation of land for construction, no special economic incentives and no construction of new settlements."
Ariel Sharon did not invent those four principles. They emerged from discussions with American officials and were discussed by Messrs. Sharon and Bush at their Aqaba meeting in June 2003.
They were not secret, either. Four days after the president's letter, Mr. Sharon's Chief of Staff Dov Weissglas wrote to Secretary of State Condoleezza Rice that "I wish to reconfirm the following understanding, which had been reached between us: 1. Restrictions on settlement growth: within the agreed principles of settlement activities, an effort will be made in the next few days to have a better definition of the construction line of settlements in Judea & Samaria."
Stories in the press also made it clear that there were indeed "agreed principles." On Aug. 21, 2004 the New York Times reported that "the Bush administration . . . now supports construction of new apartments in areas already built up in some settlements, as long as the expansion does not extend outward."
In recent weeks, American officials have denied that any agreement on settlements existed. Secretary of State Hillary Clinton stated on June 17 that "in looking at the history of the Bush administration, there were no informal or oral enforceable agreements. That has been verified by the official record of the administration and by the personnel in the positions of responsibility."
These statements are incorrect. Not only were there agreements, but the prime minister of Israel relied on them in undertaking a wrenching political reorientation -- the dissolution of his government, the removal of every single Israeli citizen, settlement and military position in Gaza, and the removal of four small settlements in the West Bank. This was the first time Israel had ever removed settlements outside the context of a peace treaty, and it was a major step.
It is true that there was no U.S.-Israel "memorandum of understanding," which is presumably what Mrs. Clinton means when she suggests that the "official record of the administration" contains none. But she would do well to consult documents like the Weissglas letter, or the notes of the Aqaba meeting, before suggesting that there was no meeting of the minds.
Mrs. Clinton also said there were no "enforceable" agreements. This is a strange phrase. How exactly would Israel enforce any agreement against an American decision to renege on it? Take it to the International Court in The Hague?
Regardless of what Mrs. Clinton has said, there was a bargained-for exchange. Mr. Sharon was determined to break the deadlock, withdraw from Gaza, remove settlements -- and confront his former allies on Israel's right by abandoning the "Greater Israel" position to endorse Palestinian statehood and limits on settlement growth. He asked for our support and got it, including the agreement that we would not demand a total settlement freeze.
For reasons that remain unclear, the Obama administration has decided to abandon the understandings about settlements reached by the previous administration with the Israeli government. We may be abandoning the deal now, but we cannot rewrite history and make believe it did not exist.
Mr. Abrams, a senior fellow for Middle Eastern Studies at the Council on Foreign Relations, handled Middle East affairs at the National Security Council from 2001 to 2009.
Thursday, June 25, 2009
Wednesday, June 24, 2009
Enron Accounting: CBO and EPA Cooked the Books on Cost Estimates for Waxman-Markey Energy Tax
Enron Accounting: CBO and EPA Cooked the Books on Cost Estimates for Waxman-Markey Energy Tax
IER, June 24, 2009
Later this week, the U.S. House will take up the Waxman-Markey global warming bill, the centerpiece of which is a cap and trade program that advocates argue will reduce U.S. greenhouse gas emissions. The bill features a remarkably aggressive timetable, one that would force businesses to cut emissions by 17% (relative to the 2005 baseline) by the year 2020, and by a cumulative 83% by 2050. On cue, “independent” agencies of the government such as CBO and EPA have announced cost estimates that grossly understate the burden Waxman-Markey will place on most U.S. households.
On June 19, the CBO announced that the cap-and trade program contained in Waxman-Markey would cost households an average of $175 in the year 2020 (measured in today’s dollars). On June 23, in an effort to reassert its green bona fides, the EPA came out with an even lower estimate of $80-$111 per household. But even a cursory examination of the methodologies involved in manufacturing those numbers reveals that even the higher CBO figure is far too optimistic, since it leads citizens to believe that energy prices will only go up modestly because of the new cap and trade program.
In fact, very little related to the consequences of Waxman-Markey can be characterized as “modest.” Households will pay far more than $175 per year due to cap and trade, notwithstanding CBO’s attempts to hide it. The EPA study is misleading in the same fashion, but here we focus on the CBO report which can be read by the layperson and states quite clearly how it comes up with its low cost estimate.
Rags to Riches: How the CBO Transforms a Stealth Tax Into a Phantom Tax Cut
There are several major flaws with the CBO approach, but perhaps the most outrageous example of sleight of hand is the CBO’s focus on after-tax income. Because Waxman-Markey will raise prices more than incomes, households will necessarily become poorer. This will push households into lower tax brackets—and thus have lower tax liabilities to the tune of roughly $8.7 billion. Normal people would consider this to be a downside of Waxman-Markey. CBO is not normal. It considers this $8.7 billion as an addition to total household income—money from heaven!—and goes about celebrating the effect of this policy without saying a thing about the cause.
After explaining that some government benefits are indexed to the Consumer Price Index, which means that federal spending will have to increase owing to Waxman-Markey’s energy price hikes, the CBO study points out the silver lining:
Because the federal income tax system is largely indexed to the consumer price index, an increase in consumer prices with no increase in nominal incomes would also reduce federal income taxes. That effect would increase households’ after-tax income but would also add to the federal deficit. In combination, the effect of price changes on the government’s indexed benefit payments and income tax receipts would convey an estimated $8.7 billion to households. (p. 7)
Beyond the absurdity of translating rising prices into a benefit for households—on the basis that poorer people pay less in taxes—the CBO’s treatment of income tax revenues is inconsistent with its treatment of carbon allowance auction receipts. The CBO study acknowledges that households will pay higher energy prices partly because businesses will “pass on” the cost of buying emission allowances. But CBO didn’t include this component as a net cost to households, because the government could spend the auction receipts and thus recycle some of the money back into households.
But if that’s how the CBO wants to do its accounting, then it can’t credit households with a fictitious $8.7 billion “tax cut.” As the quotation above points out, the falling income tax revenues will simply mean a larger budget deficit if the government doesn’t cut other spending. This extra borrowing by the federal government will push up interest rates and transfer $8.7 billion out of the private capital markets. Households will ultimately lose wealth (in the form of greater public debt) that exactly offsets their alleged gain from falling into lower tax brackets.
Impacts on the “Average” Household
The CBO study admits on page 1 that the greenhouse gas (GHG) emission schedule would raise prices for Americans:
This analysis examines the average cost per household that would result from implementing the GHG cap-and-trade program under H.R. 2454….Reducing emissions to the level required by the cap would be accomplished mainly by stemming demand for carbon-based energy by increasing its price…. Those higher prices, in turn, would reduce households’ purchasing power. (p.1)
However, the CBO’s reported annual cost estimate of $175 per household in the year 2020, does not refer to the tallying up of the price hikes acknowledged in the quotation above. The CBO reduces the “gross cost” by mixing in all of the financial benefits that will accrue to “households” from the cap and trade program:
At the same time, the distribution of emission allowances would improve households’ financial situation. The net financial impact of the program on households…would depend in large part on how many allowances were sold (versus given away), how the free allowances were allocated, and how any proceeds from selling allowances were used. That net impact would reflect both the added costs that households experienced because of higher prices and the share of the allowance value that they received in the form of benefit payments, rebates, tax decreases or credits, wages, and returns on their investments. (pp. 1-2)
The problem should be obvious: If the government spends auction revenues, or hands out “free” allowances that possess high market value, to fund alternative energy boondoggles, the CBO study will carefully chalk that money up as flowing back into the pockets of U.S. “households.”
The CBO’s logic makes sense from a certain point of view: A firm that makes solar panels is owned by shareholders who live in houses, right? So when that solar panel firm sees huge profits in the new scheme, the wealth showered on its owners will accrue to households. Even though all electricity consumers will be paying higher prices, the “average” hit will be mitigated to the extent that some of those consumers happen to be on the receiving end of the cap and trade gravy train.
The CBO’s reasoning may be appropriate in some applications, but it is grossly misleading in the current political context. Citizens may come away from the report believing that their annual expenses will rise only $175 because of Waxman-Markey. The real figure is much higher.
The CBO’s Gross Cost
In contrast to the net cost of “$22 billion—or about $175 per household” (p.2), what does the CBO say about the gross cost, meaning the actual reduction in household purchasing power? In other words, how much of a hit will households take in the form of higher prices and lower wages, before the CBO adds back in all the pork spending and other goodies? They tell us on page 4:
According to CBO’s estimates, the gross cost of complying with the GHG cap-and-trade program delineated in H.R. 2454 would be about $110 billion in 2020…or about $890 per household…(p. 4)
We see that the number reported in the press—“$175 per household by 2020”—represents only 20 percent of the CBO’s projected increase in household costs. The other 80 percent of the gross price hikes is transferred away from unlucky consumers and into the pockets of politically-connected beneficiaries. Since this wealth is redistributed, it’s still in “households” (somewhere) and so the CBO doesn’t report the gross figure, which is five times higher than the number bouncing around the press. But that’s not the end of it. CBO didn’t score anything but the “cap and trade” part of the bill…not the renewable energy mandate, not the additional costs of complying with the bureaucratic nirvana of new standards for energy efficiency of lighting for home art and “personal spas,” etc. In some parts of the country, the “You Must Obey” renewable energy mandate could force significantly higher costs on consumers and businesses.
Winners and Losers
The CBO study acknowledges that its estimates are average figures, and that the impacts on particular sectors will be uneven:
The measure of costs described above reflects the costs that would occur once the economy had adjusted to the change in the relative prices of goods and services. It does not include the costs that some current investors and workers in sectors of the economy that produce energy and energy-intensive goods and services would incur as the economy moved away from the use of fossil fuels….Stock losses would tend to be widely dispersed among investors because shareholders typically diversify their portfolios. In contrast, the costs of unemployment would probably be concentrated among relatively few households and, by extension, their communities. (p.8)
In addition to the negative impact on workers in energy-intensive sectors, the Waxman-Markey bill would also hurt energy consumers to different degrees, depending on which region of the country they lived in. The Southern and Midwestern states are much more reliant on coal and other fossil fuels for their electricity production. Consumers in these regions will see their electricity rates jump higher than in other areas of the country.
Conclusion
Make no mistake: Waxman-Markey is a tax that, to work properly, must find a way to drive up energy prices. CBO bends over backwards to try to disguise this fact, but even they admit Waxman-Markey will increase energy prices.
The CBO’s gross cost estimate of $890 per household is also optimistic. Other studies put the figure at $1,500 per family in higher energy costs. That makes the much lower figure of $175 per household extremely misleading.
Bent on disguising the true costs of Waxman-Markey, CBO performed a deeply flawed analysis. They treat lower household income as a good thing because households will be subject to lower tax rates, even though this will increase the budget deficit and help drive up interest rates making economic growth more difficult.
The CBO is also disingenuous in its treatment of free allowances. The financial benefit of the free allowances will go a small subset of the population (and to overseas investors), but CBO merely averages the benefits across the U.S. population. This is deeply disingenuous and misleading. Households are in for much bigger price hikes than the CBO would lead them to believe.
Despite CBO’s heroic attempts to put a nice gloss on Waxman-Markey, cap and trade is what Rep. Dingell said it was—a tax, and a great big one.
IER, June 24, 2009
Later this week, the U.S. House will take up the Waxman-Markey global warming bill, the centerpiece of which is a cap and trade program that advocates argue will reduce U.S. greenhouse gas emissions. The bill features a remarkably aggressive timetable, one that would force businesses to cut emissions by 17% (relative to the 2005 baseline) by the year 2020, and by a cumulative 83% by 2050. On cue, “independent” agencies of the government such as CBO and EPA have announced cost estimates that grossly understate the burden Waxman-Markey will place on most U.S. households.
On June 19, the CBO announced that the cap-and trade program contained in Waxman-Markey would cost households an average of $175 in the year 2020 (measured in today’s dollars). On June 23, in an effort to reassert its green bona fides, the EPA came out with an even lower estimate of $80-$111 per household. But even a cursory examination of the methodologies involved in manufacturing those numbers reveals that even the higher CBO figure is far too optimistic, since it leads citizens to believe that energy prices will only go up modestly because of the new cap and trade program.
In fact, very little related to the consequences of Waxman-Markey can be characterized as “modest.” Households will pay far more than $175 per year due to cap and trade, notwithstanding CBO’s attempts to hide it. The EPA study is misleading in the same fashion, but here we focus on the CBO report which can be read by the layperson and states quite clearly how it comes up with its low cost estimate.
Rags to Riches: How the CBO Transforms a Stealth Tax Into a Phantom Tax Cut
There are several major flaws with the CBO approach, but perhaps the most outrageous example of sleight of hand is the CBO’s focus on after-tax income. Because Waxman-Markey will raise prices more than incomes, households will necessarily become poorer. This will push households into lower tax brackets—and thus have lower tax liabilities to the tune of roughly $8.7 billion. Normal people would consider this to be a downside of Waxman-Markey. CBO is not normal. It considers this $8.7 billion as an addition to total household income—money from heaven!—and goes about celebrating the effect of this policy without saying a thing about the cause.
After explaining that some government benefits are indexed to the Consumer Price Index, which means that federal spending will have to increase owing to Waxman-Markey’s energy price hikes, the CBO study points out the silver lining:
Because the federal income tax system is largely indexed to the consumer price index, an increase in consumer prices with no increase in nominal incomes would also reduce federal income taxes. That effect would increase households’ after-tax income but would also add to the federal deficit. In combination, the effect of price changes on the government’s indexed benefit payments and income tax receipts would convey an estimated $8.7 billion to households. (p. 7)
Beyond the absurdity of translating rising prices into a benefit for households—on the basis that poorer people pay less in taxes—the CBO’s treatment of income tax revenues is inconsistent with its treatment of carbon allowance auction receipts. The CBO study acknowledges that households will pay higher energy prices partly because businesses will “pass on” the cost of buying emission allowances. But CBO didn’t include this component as a net cost to households, because the government could spend the auction receipts and thus recycle some of the money back into households.
But if that’s how the CBO wants to do its accounting, then it can’t credit households with a fictitious $8.7 billion “tax cut.” As the quotation above points out, the falling income tax revenues will simply mean a larger budget deficit if the government doesn’t cut other spending. This extra borrowing by the federal government will push up interest rates and transfer $8.7 billion out of the private capital markets. Households will ultimately lose wealth (in the form of greater public debt) that exactly offsets their alleged gain from falling into lower tax brackets.
Impacts on the “Average” Household
The CBO study admits on page 1 that the greenhouse gas (GHG) emission schedule would raise prices for Americans:
This analysis examines the average cost per household that would result from implementing the GHG cap-and-trade program under H.R. 2454….Reducing emissions to the level required by the cap would be accomplished mainly by stemming demand for carbon-based energy by increasing its price…. Those higher prices, in turn, would reduce households’ purchasing power. (p.1)
However, the CBO’s reported annual cost estimate of $175 per household in the year 2020, does not refer to the tallying up of the price hikes acknowledged in the quotation above. The CBO reduces the “gross cost” by mixing in all of the financial benefits that will accrue to “households” from the cap and trade program:
At the same time, the distribution of emission allowances would improve households’ financial situation. The net financial impact of the program on households…would depend in large part on how many allowances were sold (versus given away), how the free allowances were allocated, and how any proceeds from selling allowances were used. That net impact would reflect both the added costs that households experienced because of higher prices and the share of the allowance value that they received in the form of benefit payments, rebates, tax decreases or credits, wages, and returns on their investments. (pp. 1-2)
The problem should be obvious: If the government spends auction revenues, or hands out “free” allowances that possess high market value, to fund alternative energy boondoggles, the CBO study will carefully chalk that money up as flowing back into the pockets of U.S. “households.”
The CBO’s logic makes sense from a certain point of view: A firm that makes solar panels is owned by shareholders who live in houses, right? So when that solar panel firm sees huge profits in the new scheme, the wealth showered on its owners will accrue to households. Even though all electricity consumers will be paying higher prices, the “average” hit will be mitigated to the extent that some of those consumers happen to be on the receiving end of the cap and trade gravy train.
The CBO’s reasoning may be appropriate in some applications, but it is grossly misleading in the current political context. Citizens may come away from the report believing that their annual expenses will rise only $175 because of Waxman-Markey. The real figure is much higher.
The CBO’s Gross Cost
In contrast to the net cost of “$22 billion—or about $175 per household” (p.2), what does the CBO say about the gross cost, meaning the actual reduction in household purchasing power? In other words, how much of a hit will households take in the form of higher prices and lower wages, before the CBO adds back in all the pork spending and other goodies? They tell us on page 4:
According to CBO’s estimates, the gross cost of complying with the GHG cap-and-trade program delineated in H.R. 2454 would be about $110 billion in 2020…or about $890 per household…(p. 4)
We see that the number reported in the press—“$175 per household by 2020”—represents only 20 percent of the CBO’s projected increase in household costs. The other 80 percent of the gross price hikes is transferred away from unlucky consumers and into the pockets of politically-connected beneficiaries. Since this wealth is redistributed, it’s still in “households” (somewhere) and so the CBO doesn’t report the gross figure, which is five times higher than the number bouncing around the press. But that’s not the end of it. CBO didn’t score anything but the “cap and trade” part of the bill…not the renewable energy mandate, not the additional costs of complying with the bureaucratic nirvana of new standards for energy efficiency of lighting for home art and “personal spas,” etc. In some parts of the country, the “You Must Obey” renewable energy mandate could force significantly higher costs on consumers and businesses.
Winners and Losers
The CBO study acknowledges that its estimates are average figures, and that the impacts on particular sectors will be uneven:
The measure of costs described above reflects the costs that would occur once the economy had adjusted to the change in the relative prices of goods and services. It does not include the costs that some current investors and workers in sectors of the economy that produce energy and energy-intensive goods and services would incur as the economy moved away from the use of fossil fuels….Stock losses would tend to be widely dispersed among investors because shareholders typically diversify their portfolios. In contrast, the costs of unemployment would probably be concentrated among relatively few households and, by extension, their communities. (p.8)
In addition to the negative impact on workers in energy-intensive sectors, the Waxman-Markey bill would also hurt energy consumers to different degrees, depending on which region of the country they lived in. The Southern and Midwestern states are much more reliant on coal and other fossil fuels for their electricity production. Consumers in these regions will see their electricity rates jump higher than in other areas of the country.
Conclusion
Make no mistake: Waxman-Markey is a tax that, to work properly, must find a way to drive up energy prices. CBO bends over backwards to try to disguise this fact, but even they admit Waxman-Markey will increase energy prices.
The CBO’s gross cost estimate of $890 per household is also optimistic. Other studies put the figure at $1,500 per family in higher energy costs. That makes the much lower figure of $175 per household extremely misleading.
Bent on disguising the true costs of Waxman-Markey, CBO performed a deeply flawed analysis. They treat lower household income as a good thing because households will be subject to lower tax rates, even though this will increase the budget deficit and help drive up interest rates making economic growth more difficult.
The CBO is also disingenuous in its treatment of free allowances. The financial benefit of the free allowances will go a small subset of the population (and to overseas investors), but CBO merely averages the benefits across the U.S. population. This is deeply disingenuous and misleading. Households are in for much bigger price hikes than the CBO would lead them to believe.
Despite CBO’s heroic attempts to put a nice gloss on Waxman-Markey, cap and trade is what Rep. Dingell said it was—a tax, and a great big one.
On the Perils of Negotiating with Terrorists
Negotiating with Terrorists. By Andrew C. McCarthy
The Obama administration ignores a longstanding — and life-saving — policy.
National Review Online, June 24, 2009 4:00 AM
The Obama administration ignores a longstanding — and life-saving — policy.
National Review Online, June 24, 2009 4:00 AM
Bank nationalization will soon be back on the agenda unless the economy picks up
Who Owns the Banks, Round Two? By HOLMAN W. JENKINS, JR.
Bank nationalization will soon be back on the agenda unless the economy picks up.
The Wall Street Journal, page A13
The stress tests came and went, but haven't settled the argument over whether anything short of seizing the biggest banks amounts to recapitulating Japan's experience with zombie banks.
That argument remains relevant -- because bank nationalization will soon be back on the agenda unless the economy picks up.
It would be good to get the parallel straight. Japan's problem wasn't so much zombie banks as zombie borrowers, kept alive with new infusions of money because the political class, speaking for Japanese society, wanted to delay and minimize foreclosures, layoffs and asset fire sales to preserve "harmony." An even more important, but unsung, factor in Japan's so-called lost decade was a relentless series of tax hikes.
Letting U.S. banks slide on their capital ratios is not the same as making "zombie banks." Somebody somewhere has to hold bad loans until they're resolved, either because borrowers make repayment or are forced into liquidation. There's no question that the Obama administration has opted for an unspoken policy of regulatory forbearance with respect to various too-big-to-fail banks. But those banks have no natural reason (aside from political pressure) to keep zombie borrowers alive if it would be financially advantageous to foreclose.
For all that, the Obama stress tests have served a confidence-building purpose -- confidence in Washington, not the banks.
It dispensed with the idea that the problem of how to unwind Washington's massive commitment to the financial sector could somehow be solved at the expense of bank shareholders. That idea was always a distraction -- there was not enough market capitalization in the entire banking sector to make a fig's difference, especially while the prospect of nationalization hung over it.
In climbing down, the Fed and the Obama administration did indeed credit future earnings of the banks with solving a big part of their capital problem. Call it fudge: This is a bet on growth, the only decent solution out there, because neither nationalization nor capital raising by banks can get the Federal Reserve off the hook of inflating away the banking system's massive additional losses on consumer, business and housing loans if growth doesn't come back.
As usual, however, there is no coherence in the administration's approach. Even while it counts on surging bank profits, it attacks the banking system's credit card profits, its mortgage profits, its senior-secured lending profits, etc. This is no way to avoid the rightly frightful prospect of having to add Citigroup and Bank of America to the portfolio of companies Washington is running badly.
Meanwhile, Team Obama is periodically tempted by the pro-nationalizers' claim that giving the big banks time to heal can only stifle recovery by retarding their return to lending. The critics underestimate two things: The dynamism of our financial sector, with plenty of healthy banks, start-ups and foreign investors likely to step into any lending gap if real opportunities for profitable loans present themselves (a difference vs. Japan, whose financial system was relatively closed).
They also underestimate the degree to which the problem is demand for loans rather than supply.
It's good to recall the puzzlement of the early Clinton administration over the "jobless recovery" that prevailed after it took office in 1993. The mystery wasn't the mystery the administration liked to pretend: Business refused to hire or expand out of fear of Bill Clinton's then-pending health-care reforms.
Mr. Obama's own initiatives on climate, labor, taxes and health care are the biggest threat to growth -- thus to the success or disaster of the Fed's giant liquidity bet, failure of which could still send us Argentina's way (as the Fed itself no doubt is discussing in its closed meetings today and yesterday).
Here, a happy happenstance for the nation is that our president is an object of craving utterly independent of the policies he pursues. Mr. Obama, therefore, has an unlikely degree of freedom to throw overboard his agenda and go for growth without fear of his public abandoning him.
From the start, he has seemed uniquely detached and noncommittal about his own policy positions, as if he was entertaining them only to see if they might be useful to him. Let's not underestimate this advantage over lesser politicians, who get trapped by their rhetoric. Let's also hope Mr. Obama takes advantage, becoming the "growth" president and saving the big initiatives for his second term. Otherwise, with the AIG disaster before him, he may be remembered as the president who nonetheless blundered into similar disasters trying to manage Citibank et al.
Bank nationalization will soon be back on the agenda unless the economy picks up.
The Wall Street Journal, page A13
The stress tests came and went, but haven't settled the argument over whether anything short of seizing the biggest banks amounts to recapitulating Japan's experience with zombie banks.
That argument remains relevant -- because bank nationalization will soon be back on the agenda unless the economy picks up.
It would be good to get the parallel straight. Japan's problem wasn't so much zombie banks as zombie borrowers, kept alive with new infusions of money because the political class, speaking for Japanese society, wanted to delay and minimize foreclosures, layoffs and asset fire sales to preserve "harmony." An even more important, but unsung, factor in Japan's so-called lost decade was a relentless series of tax hikes.
Letting U.S. banks slide on their capital ratios is not the same as making "zombie banks." Somebody somewhere has to hold bad loans until they're resolved, either because borrowers make repayment or are forced into liquidation. There's no question that the Obama administration has opted for an unspoken policy of regulatory forbearance with respect to various too-big-to-fail banks. But those banks have no natural reason (aside from political pressure) to keep zombie borrowers alive if it would be financially advantageous to foreclose.
For all that, the Obama stress tests have served a confidence-building purpose -- confidence in Washington, not the banks.
It dispensed with the idea that the problem of how to unwind Washington's massive commitment to the financial sector could somehow be solved at the expense of bank shareholders. That idea was always a distraction -- there was not enough market capitalization in the entire banking sector to make a fig's difference, especially while the prospect of nationalization hung over it.
In climbing down, the Fed and the Obama administration did indeed credit future earnings of the banks with solving a big part of their capital problem. Call it fudge: This is a bet on growth, the only decent solution out there, because neither nationalization nor capital raising by banks can get the Federal Reserve off the hook of inflating away the banking system's massive additional losses on consumer, business and housing loans if growth doesn't come back.
As usual, however, there is no coherence in the administration's approach. Even while it counts on surging bank profits, it attacks the banking system's credit card profits, its mortgage profits, its senior-secured lending profits, etc. This is no way to avoid the rightly frightful prospect of having to add Citigroup and Bank of America to the portfolio of companies Washington is running badly.
Meanwhile, Team Obama is periodically tempted by the pro-nationalizers' claim that giving the big banks time to heal can only stifle recovery by retarding their return to lending. The critics underestimate two things: The dynamism of our financial sector, with plenty of healthy banks, start-ups and foreign investors likely to step into any lending gap if real opportunities for profitable loans present themselves (a difference vs. Japan, whose financial system was relatively closed).
They also underestimate the degree to which the problem is demand for loans rather than supply.
It's good to recall the puzzlement of the early Clinton administration over the "jobless recovery" that prevailed after it took office in 1993. The mystery wasn't the mystery the administration liked to pretend: Business refused to hire or expand out of fear of Bill Clinton's then-pending health-care reforms.
Mr. Obama's own initiatives on climate, labor, taxes and health care are the biggest threat to growth -- thus to the success or disaster of the Fed's giant liquidity bet, failure of which could still send us Argentina's way (as the Fed itself no doubt is discussing in its closed meetings today and yesterday).
Here, a happy happenstance for the nation is that our president is an object of craving utterly independent of the policies he pursues. Mr. Obama, therefore, has an unlikely degree of freedom to throw overboard his agenda and go for growth without fear of his public abandoning him.
From the start, he has seemed uniquely detached and noncommittal about his own policy positions, as if he was entertaining them only to see if they might be useful to him. Let's not underestimate this advantage over lesser politicians, who get trapped by their rhetoric. Let's also hope Mr. Obama takes advantage, becoming the "growth" president and saving the big initiatives for his second term. Otherwise, with the AIG disaster before him, he may be remembered as the president who nonetheless blundered into similar disasters trying to manage Citibank et al.
Tuesday, June 23, 2009
Barney Frank telling Fannie Mae to take more credit risk
Barney the Underwriter. WSJ Editorial
Telling Fannie Mae to take more credit risk.
The Wall Street Journal, page A14
Back when the housing mania was taking off, Massachusetts Congressman Barney Frank famously said he wanted Fannie Mae and Freddie Mac to "roll the dice" in the name of affordable housing. That didn't turn out so well, but Mr. Frank has since only accumulated more power. And now he is returning to the scene of the calamity -- with your money. He and New York Representative Anthony Weiner have sent a letter to the heads of Fannie and Freddie exhorting them to lower lending standards for condo buyers.
You read that right. After two years of telling us how lax lending standards drove up the market and led to loans that should never have been made, Mr. Frank wants Fannie and Freddie to take more risk in condo developments with high percentages of unsold units, high delinquency rates or high concentrations of ownership within the development.
Fannie and Freddie have restricted loans to condo buyers in these situations because they represent a red flag that the developments -- many of which were planned and built at the height of the housing bubble -- may face financial trouble down the road. But never mind all that. Messrs. Frank and Weiner think, in all their wisdom and years of experience underwriting mortgages, that the new rules "may be too onerous."
And in a display of the wit for which Mr. Frank is famous, the letter writers slyly point out that higher lending standards won't reduce taxpayer exposure to bad loans because the Federal Housing Administration has even lower standards for condos. "While the underlying goal may be to reduce taxpayer exposure relating to the current conservatorship of the GSEs [government sponsored entities], such a goal would not have such an effect if it merely results in a shifting of loans from the GSEs to the FHA." Tougher lending standards will merely shift market share from one government program to another, so what's the point in being cautious?
Fannie and Freddie have already lost tens of billions of dollars betting on the mortgage market -- with that bill being handed to taxpayers. They face still more losses going forward, because in the wake of their nationalization last year their new "mission" has become to do whatever it takes to prop up the housing market. The last thing they need is lawmakers like Mr. Frank, who did so much to lay the groundwork for their collapse, telling them to play faster and looser with their lending standards.
Fannie and Freddie have always been political creatures under the best circumstances. But we don't remember anyone electing Mr. Frank underwriter-in-chief of the United States.
Telling Fannie Mae to take more credit risk.
The Wall Street Journal, page A14
Back when the housing mania was taking off, Massachusetts Congressman Barney Frank famously said he wanted Fannie Mae and Freddie Mac to "roll the dice" in the name of affordable housing. That didn't turn out so well, but Mr. Frank has since only accumulated more power. And now he is returning to the scene of the calamity -- with your money. He and New York Representative Anthony Weiner have sent a letter to the heads of Fannie and Freddie exhorting them to lower lending standards for condo buyers.
You read that right. After two years of telling us how lax lending standards drove up the market and led to loans that should never have been made, Mr. Frank wants Fannie and Freddie to take more risk in condo developments with high percentages of unsold units, high delinquency rates or high concentrations of ownership within the development.
Fannie and Freddie have restricted loans to condo buyers in these situations because they represent a red flag that the developments -- many of which were planned and built at the height of the housing bubble -- may face financial trouble down the road. But never mind all that. Messrs. Frank and Weiner think, in all their wisdom and years of experience underwriting mortgages, that the new rules "may be too onerous."
And in a display of the wit for which Mr. Frank is famous, the letter writers slyly point out that higher lending standards won't reduce taxpayer exposure to bad loans because the Federal Housing Administration has even lower standards for condos. "While the underlying goal may be to reduce taxpayer exposure relating to the current conservatorship of the GSEs [government sponsored entities], such a goal would not have such an effect if it merely results in a shifting of loans from the GSEs to the FHA." Tougher lending standards will merely shift market share from one government program to another, so what's the point in being cautious?
Fannie and Freddie have already lost tens of billions of dollars betting on the mortgage market -- with that bill being handed to taxpayers. They face still more losses going forward, because in the wake of their nationalization last year their new "mission" has become to do whatever it takes to prop up the housing market. The last thing they need is lawmakers like Mr. Frank, who did so much to lay the groundwork for their collapse, telling them to play faster and looser with their lending standards.
Fannie and Freddie have always been political creatures under the best circumstances. But we don't remember anyone electing Mr. Frank underwriter-in-chief of the United States.
The Pursuit of John Yoo
The Pursuit of John Yoo. WSJ Editorial
Next time the lawsuit may target Obama's advisers.
The Wall Street Journal, page A14
Here's a political thought experiment: Imagine that terrorists stage an attack on U.S. soil in the next four years. In the recriminations afterward, Administration officials are sued by families of the victims for having advised in legal memos that Guantanamo be closed and that interrogations of al Qaeda detainees be limited.
Should those officials be personally liable for the advice they gave President Obama?
We'd say no, but that's exactly the kind of lawsuit that the political left, including State Department nominee Harold Koh, has encouraged against Bush Administration officials. This month a federal judge in San Francisco ruled that a civil suit filed by convicted terrorist Jose Padilla can proceed against former Justice Department lawyer John Yoo for violating the terrorist's rights. Mr. Yoo is one of those who wrote memos laying out the legal parameters for aggressive interrogation of al Qaeda captives. If Mr. Yoo can be sued, why couldn't Obama officials also be held liable for their advice if there's an attack on their watch?
The mention of Mr. Koh is pertinent because the legal outfit suing Mr. Yoo, and other Bush officials in a separate case in South Carolina, is affiliated with Yale Law School. Mr. Koh is the outgoing dean of Yale and has been perhaps the most prominent legal critic of Bush interrogation policies. He once referred to President Bush as the "torturer in chief." Yet now President Obama has nominated Mr. Koh to be State Department legal adviser, who is charged with defending U.S. officials from legal assaults. It's as if Mr. Obama had nominated the AFL-CIO's John Sweeney as U.S. Trade Representative.
At least the Justice Department is still defending Mr. Yoo, as it should since his advice was offered while working for the U.S. government. But that could change if a second part of this exercise in political revenge goes forward. For five years the Justice Department's Office of Professional Responsibility (OPR) has been investigating Mr. Yoo and former Justice lawyers Jay Bybee and Steven Bradbury for alleged misconduct in writing those legal interrogation memos.
Last month, in a leak full of malice aforethought, the press reported that OPR's draft report recommends disciplinary action against the Bush lawyers. If the final report reaches the same conclusion, the left-wing bar will try to have those lawyers disbarred, while liberals in Congress could pursue impeachment against Mr. Bybee, a federal judge on the Ninth Circuit Court of Appeals. In that event, Justice might also stop defending Mr. Yoo in court. A professor at Berkeley Law, Mr. Yoo would have to pay hundreds of thousands of dollars to defend himself.
This is exactly what the anti-antiterror left hopes to accomplish. Having failed to enact their agenda in Congress, or now even via Mr. Obama, their aim is to ruin and bankrupt individuals in the Bush Administration who played key roles in the war on terror. Their goal is to make sure that no one in public life ever again offers advice that disagrees with their view that terrorists should be handled in nonmilitary courts like common burglars.
The May news leak was especially pernicious because it came before the Bush officials or their lawyers had been allowed to respond to OPR's accusations. They are still bound by a pledge of confidentiality. Our guess is that the leak was intended to box in Attorney General Eric Holder, who will ultimately have to sign off on the report.
Mr. Holder knows that former Attorney General Michael Mukasey had rejected the OPR draft in a scathing, 15-page, single-spaced memo. His deputy, Mark Filip, also refused to endorse the OPR draft. Yet OPR lawyers ran out the clock on Mr. Mukasey, hoping that an Obama AG will validate their work.
The leak of a draft report is itself an act of professional irresponsibility worthy of punishment. And the entire exercise is bizarre, since Messrs. Yoo, Bybee and Bradbury were only doing what their superiors and the CIA asked of them. If OPR's lawyers want to claim misconduct, they should target former Attorney General John Ashcroft or President Bush, who personally named Padilla an enemy combatant. But it's so much easier to pick on mid-level officials who lack a platform to fight back. In any case, OPR is supposed to investigate genuine misconduct such as withholding evidence (the Ted Stevens case), not opine on the legal analysis of other, in this case far superior, lawyers.
As for the lawsuit, Padilla's rights were never violated. Mr. Bush's decision to name the so-called "dirty bomber" an enemy combatant was defended in court by executive branch lawyers, who won in the Fourth Circuit. The Bush Administration later transferred Padilla to be tried in a Miami court, and the Supreme Court declined to hear an appeal. Padilla was convicted after receiving every due process protection and is now serving a 17-year prison sentence.
Politics can be vicious, but we have come to a very strange pass when government lawyers acting in good faith can be sued by convicted terrorists and investigated for giving advice solicited by their superiors. Mr. Holder will do the country, and his own colleagues in the Obama Administration, a service if he speaks out against the Padilla lawsuit and puts an end to Justice's part in this nasty exercise.
Next time the lawsuit may target Obama's advisers.
The Wall Street Journal, page A14
Here's a political thought experiment: Imagine that terrorists stage an attack on U.S. soil in the next four years. In the recriminations afterward, Administration officials are sued by families of the victims for having advised in legal memos that Guantanamo be closed and that interrogations of al Qaeda detainees be limited.
Should those officials be personally liable for the advice they gave President Obama?
We'd say no, but that's exactly the kind of lawsuit that the political left, including State Department nominee Harold Koh, has encouraged against Bush Administration officials. This month a federal judge in San Francisco ruled that a civil suit filed by convicted terrorist Jose Padilla can proceed against former Justice Department lawyer John Yoo for violating the terrorist's rights. Mr. Yoo is one of those who wrote memos laying out the legal parameters for aggressive interrogation of al Qaeda captives. If Mr. Yoo can be sued, why couldn't Obama officials also be held liable for their advice if there's an attack on their watch?
The mention of Mr. Koh is pertinent because the legal outfit suing Mr. Yoo, and other Bush officials in a separate case in South Carolina, is affiliated with Yale Law School. Mr. Koh is the outgoing dean of Yale and has been perhaps the most prominent legal critic of Bush interrogation policies. He once referred to President Bush as the "torturer in chief." Yet now President Obama has nominated Mr. Koh to be State Department legal adviser, who is charged with defending U.S. officials from legal assaults. It's as if Mr. Obama had nominated the AFL-CIO's John Sweeney as U.S. Trade Representative.
At least the Justice Department is still defending Mr. Yoo, as it should since his advice was offered while working for the U.S. government. But that could change if a second part of this exercise in political revenge goes forward. For five years the Justice Department's Office of Professional Responsibility (OPR) has been investigating Mr. Yoo and former Justice lawyers Jay Bybee and Steven Bradbury for alleged misconduct in writing those legal interrogation memos.
Last month, in a leak full of malice aforethought, the press reported that OPR's draft report recommends disciplinary action against the Bush lawyers. If the final report reaches the same conclusion, the left-wing bar will try to have those lawyers disbarred, while liberals in Congress could pursue impeachment against Mr. Bybee, a federal judge on the Ninth Circuit Court of Appeals. In that event, Justice might also stop defending Mr. Yoo in court. A professor at Berkeley Law, Mr. Yoo would have to pay hundreds of thousands of dollars to defend himself.
This is exactly what the anti-antiterror left hopes to accomplish. Having failed to enact their agenda in Congress, or now even via Mr. Obama, their aim is to ruin and bankrupt individuals in the Bush Administration who played key roles in the war on terror. Their goal is to make sure that no one in public life ever again offers advice that disagrees with their view that terrorists should be handled in nonmilitary courts like common burglars.
The May news leak was especially pernicious because it came before the Bush officials or their lawyers had been allowed to respond to OPR's accusations. They are still bound by a pledge of confidentiality. Our guess is that the leak was intended to box in Attorney General Eric Holder, who will ultimately have to sign off on the report.
Mr. Holder knows that former Attorney General Michael Mukasey had rejected the OPR draft in a scathing, 15-page, single-spaced memo. His deputy, Mark Filip, also refused to endorse the OPR draft. Yet OPR lawyers ran out the clock on Mr. Mukasey, hoping that an Obama AG will validate their work.
The leak of a draft report is itself an act of professional irresponsibility worthy of punishment. And the entire exercise is bizarre, since Messrs. Yoo, Bybee and Bradbury were only doing what their superiors and the CIA asked of them. If OPR's lawyers want to claim misconduct, they should target former Attorney General John Ashcroft or President Bush, who personally named Padilla an enemy combatant. But it's so much easier to pick on mid-level officials who lack a platform to fight back. In any case, OPR is supposed to investigate genuine misconduct such as withholding evidence (the Ted Stevens case), not opine on the legal analysis of other, in this case far superior, lawyers.
As for the lawsuit, Padilla's rights were never violated. Mr. Bush's decision to name the so-called "dirty bomber" an enemy combatant was defended in court by executive branch lawyers, who won in the Fourth Circuit. The Bush Administration later transferred Padilla to be tried in a Miami court, and the Supreme Court declined to hear an appeal. Padilla was convicted after receiving every due process protection and is now serving a 17-year prison sentence.
Politics can be vicious, but we have come to a very strange pass when government lawyers acting in good faith can be sued by convicted terrorists and investigated for giving advice solicited by their superiors. Mr. Holder will do the country, and his own colleagues in the Obama Administration, a service if he speaks out against the Padilla lawsuit and puts an end to Justice's part in this nasty exercise.
Maine: Finally, a state that cuts tax rates on the rich
Maine Miracle. WSJ Editorial
Finally, a state that cuts tax rates on the rich.
The Wall Street Journal, Jun 23, 2009, p A14
At last, there's a place in America where tax cutting to promote growth and attract jobs is back in fashion. Who would have thought it would be Maine?
This month the Democratic legislature and Governor John Baldacci broke with Obamanomics and enacted a sweeping tax reform that is almost, but not quite, a flat tax. The new law junks the state's graduated income tax structure with a top rate of 8.5% and replaces it with a simple 6.5% flat rate tax on almost everyone. Those with earnings above $250,000 will pay a surtax rate of 0.35%, for a 6.85% rate. Maine's tax rate will fall to 20th from seventh highest among the states. To offset the lower rates and a larger family deduction, the plan cuts the state budget by some $300 million to $5.8 billion, closes tax loopholes and expands the 5% state sales tax to services that have been exempt, such as ski lift tickets.
This is a big income tax cut, especially given that so many other states in the Northeast and East -- Maryland, Massachusetts, New Jersey and New York -- have been increasing rates. "We're definitely going against the grain here," Mr. Baldacci tells us. "We hope these lower tax rates will encourage and reward work, and that the lower capital gains tax [of 6.85%] brings more investment into the state."
These changes alone are hardly going to earn the Pine Tree State the reputation of "pro-business." Neighboring New Hampshire still has no income or sales tax. And last year Maine was ranked as having the third worst business climate for states by the Small Business Survival Committee. Still, no state has improved its economic attractiveness more than Maine has this year.
One question is how Democrats in Augusta were able to withstand the cries by interest groups of "tax cuts for the rich?" Mr. Baldacci's snappy reply: "Without employers, you don't have employees." He adds: "The best social services program is a job." Wise and timely advice for both Democrats and Republicans as the recession rolls on and budgets get squeezed.
Finally, a state that cuts tax rates on the rich.
The Wall Street Journal, Jun 23, 2009, p A14
At last, there's a place in America where tax cutting to promote growth and attract jobs is back in fashion. Who would have thought it would be Maine?
This month the Democratic legislature and Governor John Baldacci broke with Obamanomics and enacted a sweeping tax reform that is almost, but not quite, a flat tax. The new law junks the state's graduated income tax structure with a top rate of 8.5% and replaces it with a simple 6.5% flat rate tax on almost everyone. Those with earnings above $250,000 will pay a surtax rate of 0.35%, for a 6.85% rate. Maine's tax rate will fall to 20th from seventh highest among the states. To offset the lower rates and a larger family deduction, the plan cuts the state budget by some $300 million to $5.8 billion, closes tax loopholes and expands the 5% state sales tax to services that have been exempt, such as ski lift tickets.
This is a big income tax cut, especially given that so many other states in the Northeast and East -- Maryland, Massachusetts, New Jersey and New York -- have been increasing rates. "We're definitely going against the grain here," Mr. Baldacci tells us. "We hope these lower tax rates will encourage and reward work, and that the lower capital gains tax [of 6.85%] brings more investment into the state."
These changes alone are hardly going to earn the Pine Tree State the reputation of "pro-business." Neighboring New Hampshire still has no income or sales tax. And last year Maine was ranked as having the third worst business climate for states by the Small Business Survival Committee. Still, no state has improved its economic attractiveness more than Maine has this year.
One question is how Democrats in Augusta were able to withstand the cries by interest groups of "tax cuts for the rich?" Mr. Baldacci's snappy reply: "Without employers, you don't have employees." He adds: "The best social services program is a job." Wise and timely advice for both Democrats and Republicans as the recession rolls on and budgets get squeezed.
Monday, June 22, 2009
Reviewing the Administration’s Financial Reform Proposals
Reviewing the Administration’s Financial Reform Proposals. By Douglas J. Elliott, Fellow, Economic Studies, Initiative on Business and Public Policy
The Brookings Institution, June 17, 2009
The Obama administration’s financial reform proposals to be announced today are virtually all sensible, necessary reforms. Unfortunately, some bolder steps have been left out, apparently due to the expectation of intense opposition from entrenched interests. The key proposals, as described in leaked “near-final draft” form are:
Regulation has largely focused on ensuring that each financial institution was sufficiently sound in its own right with less attention paid to how the dominos could fall if a major institution fails. Banks and other financial institutions are now so interconnected that problems at one can lead to problems at others which are then magnified throughout the entire system. The level of systemic risk before this crisis was much higher than had been appreciated, spurring the government into significantly more extreme responses than one would have expected to be necessary.
There is a dual response in the proposals to the need for more systemic oversight. First, Treasury will head a new Financial Services Oversight Council (FSOC) whose role will be to identify emerging risks to the system as well as coordinating regulatory activities in general. Second, the Fed will have regulatory power over individual systemically important financial institutions of all types, as discussed later.
This dual approach appears to be a political compromise. The administration’s initial impulse was apparently to give the Fed sole authority over systemic risk regulation, both at the systemwide level and in regard to individual systemically important financial institutions. There would have been the usual consultation with its peers, but nothing like a veto power wielded by the other regulators. However, Congress is not happy with the Fed at the moment. The Fed’s role in the bailouts, especially of AIG, has annoyed many in Congress. This has magnified concerns about the huge financial power of the Fed and its dramatically expanded role in the credit markets, where it operates with little Congressional oversight.
It makes sense to have a regulator responsible for watching over risks to the system as a whole, but there is a real limit to how effective it can be because it would be asked to do something extremely difficult. Ideally, the regulator would spot problems before they spawned bubbles whose bursting would cause great economic pain afterward. However, it is not necessarily easy to spot a bubble in advance, no matter how clear it seems in retrospect. Some things which may appear to be bubbles are not, but rather reflect true long-term changes in the economy. Other trends may be bubbles, but seem as if they were not. For example, what happens if commodity prices go up further and oil reaches $100 a barrel. Is that a commodity bubble or a natural response to tight energy supplies in a recovering world economy? Bubbles almost always start as a reasonable response to changing circumstances – the problem comes when they accelerate beyond reason as investors pile in to a rising market.
The actual powers of the FSOC in practice will matter, as will its approach to using them. At one end of the spectrum, there could effectively be little more than a power to warn about danger, which could be useful, but might not make much difference. At the other end of the spectrum, there would be solid authority to force changes, perhaps by raising capital standards or even limiting certain activities outright. Ironically, the stronger the power, the harder it may be to use. Bubbles grow because there is a widespread belief in the underlying thesis driving the market and investors are profiting from following that belief. Thus, there will be strong resistance to any regulator who argues against the prevailing belief, especially if they are seen as about to destroy a profitable market opportunity that will be argued to be beneficial to society at large. For that reason, there is little risk of the opposite problem, that a systemic regulator will act too strongly or too soon, although this remains a theoretical possibility.
Despite the risks of ineffectiveness, it is better to have a regulator responsible for leaning against the wind when market forces are pushing too hard in a particular direction. Warnings and the threat of specific actions may still help rein in at least some of the excesses associated with bubbles, even if the regulatory actions themselves were to be thwarted. It would be better, however, to have a single regulator play this role rather than a council. The need to win a consensus across all the regulators, with their different views, constituencies, and institutional interests is likely to make it excessively hard to achieve the desired systemic safety.
Higher capital and liquidity requirements
The current crisis has reinforced the importance of a strong level of capital at banks and other key financial institutions. Capital represents the portion of a bank’s assets on which no one has a call except the owners of the bank, whose role is to absorb any losses. Thus, it is available to pay for mistakes and misfortunes, which we have vividly seen are a real possibility in this business. The more capital is held, the greater the level of mistakes and bad luck that can be handled.
The administration supports tougher capital requirements, which are clearly needed. The key will be finding the right balance; tough and effective without overshooting. Capital is not free, for the banks or for society. The investors who provide the capital expect a return on their investment which has to be built into the price of loans and other services or taken out of the rate paid to depositors.
Similarly, the administration supports tougher liquidity requirements, since key financial institutions have been forced to the wall because they allowed themselves to become too exposed to the risk of a “run” by creditors. Within limits, it is a useful economic function for banks to borrow short-term and lend long-term, but it needs to be carefully balanced against the risk that short-term borrowings will run off without new creditors being willing to step in at a reasonable price in a time of trouble.
Tougher regulation of systemically important financial institutions
A newly designated group of Tier 1 Financial Holding Companies (Tier 1 FHCs) would be established by the Fed, in consultation with the FSOC. These entities would be required to hold more capital and perhaps bear additional restrictions not applicable to other financial institutions. The theory is that certain financial institutions are so large or interconnected with other key market players that they cannot be allowed to fail. In practical terms, this means that there is an implicit government guarantee covering those institutions and therefore a potentially large cost to taxpayers if they begin to fail. It is reasonable to take regulatory steps to reduce the risk of failure for those institutions below the risk for less significant ones. Those restrictions may also reduce the temptation for smaller institutions to find a way to become too important to fail and thereby gain the same implicit federal guarantee. Expanded “resolution authority,” discussed next, is a key element of regulation being proposed for Tier 1 FHCs.
Expanded resolution authority
Regulators have available an elaborate set of powers to deal with banks that have fallen into trouble, powers that allow intervention well short of when a bank becomes formally insolvent. There is a regime of “prompt corrective action” steps that regulators can require banks to take once they become undercapitalized or hit other severe problems. Federal regulators have much less authority to deal with troubled financial institutions of other types, with the level of authority falling to zero for insurers or hedge funds.
The administration is proposing to give the Federal Reserve and the FDIC powers over systemically important financial institutions, including bank holding companies and Tier 1 FHCs that are not bank holding companies, that are similar to the prompt corrective action powers already enjoyed by regulators of banks. The Fed would be principally responsible for using these powers while the financial institutions remain solvent, with the FDIC taking over any institutions that actually fail.
This would be a major and controversial change to existing regulation and insolvency laws. It seems clearly necessary in regard to bank holding companies, which are standard corporations covered by regular bankruptcy rules, but which are so bound together with their bank subsidiaries as to form one integral whole. My earlier paper, “Pre-emptive Bank Nationalization Would Face Thorny Problems,” discussed some of the serious difficulties in dealing with a bank and its holding company under different legal bases.
There is also a good case for extending bank-like resolution authority to insurers, finance companies, and securities firms that are affiliated with Tier 1 FHCs, although the answer is not as clear-cut as with bank holding companies. Here the arguments for resolution authority are tied quite closely to the basic premise for tougher regulation of Tier1 FHCs in general. If we establish a separate class of Tier 1 FHCs, they will be implicitly guaranteed by the government, giving the taxpayer a greater stake in their health. We therefore need to optimize the way we deal with such entities if they become insolvent, including, preferably, establishing rules and authorities that make it less likely that they will reach insolvency. The prompt corrective action requirements on banks are a sensible way of doing this.
There are two broad arguments against extending resolution authority, as well as numerous more technical concerns. First, some analysts do not think that the separate status should be established in the first place. In part this is because it makes it more likely in their view that taxpayers will have to subsidize failures and in part because it could give an unfair competitive advantage to the largest competitors, leading them to become bigger still. Second, there are fairness issues involved in changing the insolvency regime for investors who have held bonds of the affected institutions for years under the clear understanding that they would be protected by regular bankruptcy law in the event of an insolvency.
I support extending resolution authority, but it is too complex an issue to fully discuss here. I intend to issue a separate paper in the near future expanding on the brief discussion here.
Consolidation of regulatory functions
There are significantly too many bank regulators in the United States. Different banks and bank-like institutions are regulated by: state regulators; the Office of the Comptroller of the Currency (OCC); the Federal Reserve; the Office of Thrift Supervision; the National Credit Union Administration; and, for certain important purposes, the Federal Deposit Insurance Corporation (FDIC). It appeared earlier that the administration would propose significantly reducing the number of bank regulators, perhaps to as few as a single regulator. This thought appears to have died in the face of intense opposition by many in Congress and elsewhere. No one would design the banking regulatory system the way it is now if they were starting from scratch, but there are many entrenched interests who do not want the present system to change.
The Office of Thrift Supervision is the only regulator who appears to have lacked the institutional support to retain their separate existence. The administration has proposed merging them with, and effectively into, the OCC. This move makes sense, but does not provide nearly the advantages the broader consolidation would have brought. Different regulators will inevitably have different approaches, especially as they are generally given substantial independence in order to reduce the politicization of regulatory decisions. These differing approaches can reduce the effectiveness of systemic regulation, in part by opening up the possibility of “regulatory arbitrage,” where financial groups put their various activities into the affiliates which have the softest regulatory requirements. It is true that tighter regulation of consolidated groups at the holding company level will reduce the ability to arbitrage the regulators, but it is unlikely to entail supervision as detailed as that which will occur at the level of the regulated subsidiaries.
Outside of bank regulation, there are two financial market regulators, the Securities and Exchange Commission (SEC) and the Commodities Futures Trading Commission (CFTC). It makes compelling sense to combine them, but the politics are apparently too difficult. (For one thing, the Agriculture committees of the two houses strongly wish to retain authority over a robust CFTC.) Instead, there will be additional fragmentation as some of the consumer protection functions of the SEC will overlap with that of the new consumer protection regulator discussed later.
New regulations for securitizations and derivatives
Many of the losses by financial institutions and other market players came from problems with securitizations of mortgages and other assets or from problems with derivatives, particularly credit default swaps. The administration proposes greater regulation in both areas, in line with previous statements.
The biggest change to securitizations would be a requirement that the originators of the loans underlying the securities retain at least 5% of the risk. The idea of “keeping some skin in the game” is intuitively appealing and should help. However, it is important not to take excessive comfort from this change. Banks will indeed pay more attention to the quality of the assets they securitize if they retain even a small fraction of them. But, the financial incentives in a bull market for those assets will still push them towards taking greater and greater risks, since they will immediately gain most of the benefits through securitization while only having a future risk on a small fraction of the asset pools. Also, banks are not immune to the euphoria that grips the larger markets during an asset bubble. The banks, to their regret, actually retained much of the mortgage risk from the bubble period, sometimes even buying more in the open market.
The administration is also proposing other positive steps related to securitization, including: greater transparency about the assets backing the securities; clearer guidance from the rating agencies about the differences between asset-backed securities and regular corporate debt; and changes to the compensation structure for the parties involved in securitization.
On the derivatives side, the administration had already indicated that it would push for all standardized derivatives to be traded through an organized exchange or cleared through a clearing house. An exchange is a centrally organized marketplace for the purchase and sale of financial products. The best known is probably the New York Stock Exchange, but there are also several prominent exchanges that do a major business in derivatives already. Exchanges bring a real benefit from transparency about the pricing and volume of trades, as well as making it easier for regulators to track trading positions of major parties. In contrast, much of the trading volume in derivatives now takes place “over the counter,” between two counterparties who are not generally required to report details of the trade and who take each other’s credit risk in regard to the transaction. This credit risk is often mitigated by requiring collateral, but it is clear in retrospect that this process was not well-managed in many cases, leaving a large number of institutions very exposed to the credit risk of AIG, for example.
The major exchanges dealing in derivatives use central clearing houses that act as the counterparty to both sides. If A sells an option to B on the exchange, the clearing house would interpose itself, buying from A and selling the option on to B. The sole purpose of this interposition is to eliminate B’s credit exposure to A. If the option becomes valuable over time, B needs A to make good on its promise. If A doesn’t, the clearing house would make good, protecting B. Such clearing houses can also handle trades that were done off of an exchange, which will be an allowed alternative in certain cases.
It should be noted that using a clearing house does not eliminate counterparty risk altogether. The clearing house could become insolvent itself if enough of its counterparties fail to meet their obligations. This should still represent a diminution of the total credit risk in the system, since clearing houses are well-capitalized and operate in a clearly defined business that is easier to manage than a broader business, but there could be extreme circumstances where a government rescue would be required.
The big controversy with derivatives is what to do about customized derivatives. The use of derivatives to manage risk by sophisticated corporations is pervasive. Sometimes those derivatives are significantly cheaper or more effective if they cover the exact risk rather than using one or more standard derivatives to approximate the desired protection. It would be a great shame to lose those efficiencies altogether by banishing customized derivatives, but there is also a fear that financial firms will deliberately sell slightly non-standard derivatives in order to avoid the tougher rules on standardized ones.
This is another area where the devil is in the details. The trick will be to provide incentives or requirements to use standard derivatives where possible, while leaving the ability to use customized ones where they serve a genuine need. The administration’s proposal attempts to strike this balance. It will be interesting to see what comes out the other end of the legislative process, given the combination of a high degree of public anxiety about derivatives combined with a lack of understanding of this complex topic by many who are voicing opinions about the proper course of action.
Stronger consumer protections
The administration has proposed creating a Consumer Financial Protection Agency (CFPA), responsible for all aspects of regulation of mortgages, credit cards, and other consumer-focused financial products, with a few exceptions, such as mutual funds, which are left with the SEC. This appears to be a fairly powerful agency, with the power to set binding regulations, impose fines, etc. It will specifically be authorized to impose an obligation to offer “plain vanilla” products, such as a standardized 30-year fixed rate mortgage, with the possibility that consumers who wish to make another choice will have to specifically waive their right to have the standardized product.
There have been many bad practices that developed in the bubble period which harmed consumers, especially related to sub-prime mortgages. It will be useful to have a clear regulatory focus on eliminating those problems and avoiding others in the future. The critical issue will be the extent to which the CFPA is able to find the right balance between promoting consumer safety and allowing innovation. Everyone can agree on the need for transparency. What is harder is when there are both risks and rewards to a given product, from the consumer’s viewpoint. How much will the CFPA try to protect consumers from taking risks that might actually be legitimate in light of the potential rewards?
Another key issue that will be determined by a combination of legislative wording and regulatory choices over time is the extent to which the CFPA will move out of products that are clearly consumer products into a wider range of financial products. For example, would the CFPA ever find itself imposing regulations on derivative products, perhaps on the basis that some individuals do invest in them? This appears not to be the intent of the proposal, but there will doubtless be gray areas in practice.
Greater international coordination
Finally, the administration has also highlighted the need for greater international regulatory cooperation. This would indeed be useful, particularly if the United States develops tougher rules in some areas than currently exist elsewhere. However, it is not likely that there will be a large effect on U.S. policy from this international cooperation. As has already been seen with the failure to propose significant regulatory consolidation, financial regulation in the United States is a very parochial affair, with entrenched interests fighting their corner with relatively little regard for what is going on in the rest of the world.
Summary
The proposals are generally quite sensible. The unfortunate aspect is that political constraints have caused the administration to stop short of a full solution in certain areas, most notably in the consolidation of regulatory functions into fewer hands. Nonetheless, the country should be better off if these proposals are passed than if we were to remain as we are now.
The Brookings Institution, June 17, 2009
The Obama administration’s financial reform proposals to be announced today are virtually all sensible, necessary reforms. Unfortunately, some bolder steps have been left out, apparently due to the expectation of intense opposition from entrenched interests. The key proposals, as described in leaked “near-final draft” form are:
- A greater focus on systemic risks
- Higher capital and liquidity requirements for financial institutions, especially the largest
- Tougher regulation of systemically important financial institutions
- Expanded “resolution authority” for regulators to take over troubled financial institutions
- Modest consolidation of regulatory functions
- New regulations for securitizations and derivatives
- Stronger consumer protections led by a new Consumer Financial Protection Agency
- Greater international coordination
Regulation has largely focused on ensuring that each financial institution was sufficiently sound in its own right with less attention paid to how the dominos could fall if a major institution fails. Banks and other financial institutions are now so interconnected that problems at one can lead to problems at others which are then magnified throughout the entire system. The level of systemic risk before this crisis was much higher than had been appreciated, spurring the government into significantly more extreme responses than one would have expected to be necessary.
There is a dual response in the proposals to the need for more systemic oversight. First, Treasury will head a new Financial Services Oversight Council (FSOC) whose role will be to identify emerging risks to the system as well as coordinating regulatory activities in general. Second, the Fed will have regulatory power over individual systemically important financial institutions of all types, as discussed later.
This dual approach appears to be a political compromise. The administration’s initial impulse was apparently to give the Fed sole authority over systemic risk regulation, both at the systemwide level and in regard to individual systemically important financial institutions. There would have been the usual consultation with its peers, but nothing like a veto power wielded by the other regulators. However, Congress is not happy with the Fed at the moment. The Fed’s role in the bailouts, especially of AIG, has annoyed many in Congress. This has magnified concerns about the huge financial power of the Fed and its dramatically expanded role in the credit markets, where it operates with little Congressional oversight.
It makes sense to have a regulator responsible for watching over risks to the system as a whole, but there is a real limit to how effective it can be because it would be asked to do something extremely difficult. Ideally, the regulator would spot problems before they spawned bubbles whose bursting would cause great economic pain afterward. However, it is not necessarily easy to spot a bubble in advance, no matter how clear it seems in retrospect. Some things which may appear to be bubbles are not, but rather reflect true long-term changes in the economy. Other trends may be bubbles, but seem as if they were not. For example, what happens if commodity prices go up further and oil reaches $100 a barrel. Is that a commodity bubble or a natural response to tight energy supplies in a recovering world economy? Bubbles almost always start as a reasonable response to changing circumstances – the problem comes when they accelerate beyond reason as investors pile in to a rising market.
The actual powers of the FSOC in practice will matter, as will its approach to using them. At one end of the spectrum, there could effectively be little more than a power to warn about danger, which could be useful, but might not make much difference. At the other end of the spectrum, there would be solid authority to force changes, perhaps by raising capital standards or even limiting certain activities outright. Ironically, the stronger the power, the harder it may be to use. Bubbles grow because there is a widespread belief in the underlying thesis driving the market and investors are profiting from following that belief. Thus, there will be strong resistance to any regulator who argues against the prevailing belief, especially if they are seen as about to destroy a profitable market opportunity that will be argued to be beneficial to society at large. For that reason, there is little risk of the opposite problem, that a systemic regulator will act too strongly or too soon, although this remains a theoretical possibility.
Despite the risks of ineffectiveness, it is better to have a regulator responsible for leaning against the wind when market forces are pushing too hard in a particular direction. Warnings and the threat of specific actions may still help rein in at least some of the excesses associated with bubbles, even if the regulatory actions themselves were to be thwarted. It would be better, however, to have a single regulator play this role rather than a council. The need to win a consensus across all the regulators, with their different views, constituencies, and institutional interests is likely to make it excessively hard to achieve the desired systemic safety.
Higher capital and liquidity requirements
The current crisis has reinforced the importance of a strong level of capital at banks and other key financial institutions. Capital represents the portion of a bank’s assets on which no one has a call except the owners of the bank, whose role is to absorb any losses. Thus, it is available to pay for mistakes and misfortunes, which we have vividly seen are a real possibility in this business. The more capital is held, the greater the level of mistakes and bad luck that can be handled.
The administration supports tougher capital requirements, which are clearly needed. The key will be finding the right balance; tough and effective without overshooting. Capital is not free, for the banks or for society. The investors who provide the capital expect a return on their investment which has to be built into the price of loans and other services or taken out of the rate paid to depositors.
Similarly, the administration supports tougher liquidity requirements, since key financial institutions have been forced to the wall because they allowed themselves to become too exposed to the risk of a “run” by creditors. Within limits, it is a useful economic function for banks to borrow short-term and lend long-term, but it needs to be carefully balanced against the risk that short-term borrowings will run off without new creditors being willing to step in at a reasonable price in a time of trouble.
Tougher regulation of systemically important financial institutions
A newly designated group of Tier 1 Financial Holding Companies (Tier 1 FHCs) would be established by the Fed, in consultation with the FSOC. These entities would be required to hold more capital and perhaps bear additional restrictions not applicable to other financial institutions. The theory is that certain financial institutions are so large or interconnected with other key market players that they cannot be allowed to fail. In practical terms, this means that there is an implicit government guarantee covering those institutions and therefore a potentially large cost to taxpayers if they begin to fail. It is reasonable to take regulatory steps to reduce the risk of failure for those institutions below the risk for less significant ones. Those restrictions may also reduce the temptation for smaller institutions to find a way to become too important to fail and thereby gain the same implicit federal guarantee. Expanded “resolution authority,” discussed next, is a key element of regulation being proposed for Tier 1 FHCs.
Expanded resolution authority
Regulators have available an elaborate set of powers to deal with banks that have fallen into trouble, powers that allow intervention well short of when a bank becomes formally insolvent. There is a regime of “prompt corrective action” steps that regulators can require banks to take once they become undercapitalized or hit other severe problems. Federal regulators have much less authority to deal with troubled financial institutions of other types, with the level of authority falling to zero for insurers or hedge funds.
The administration is proposing to give the Federal Reserve and the FDIC powers over systemically important financial institutions, including bank holding companies and Tier 1 FHCs that are not bank holding companies, that are similar to the prompt corrective action powers already enjoyed by regulators of banks. The Fed would be principally responsible for using these powers while the financial institutions remain solvent, with the FDIC taking over any institutions that actually fail.
This would be a major and controversial change to existing regulation and insolvency laws. It seems clearly necessary in regard to bank holding companies, which are standard corporations covered by regular bankruptcy rules, but which are so bound together with their bank subsidiaries as to form one integral whole. My earlier paper, “Pre-emptive Bank Nationalization Would Face Thorny Problems,” discussed some of the serious difficulties in dealing with a bank and its holding company under different legal bases.
There is also a good case for extending bank-like resolution authority to insurers, finance companies, and securities firms that are affiliated with Tier 1 FHCs, although the answer is not as clear-cut as with bank holding companies. Here the arguments for resolution authority are tied quite closely to the basic premise for tougher regulation of Tier1 FHCs in general. If we establish a separate class of Tier 1 FHCs, they will be implicitly guaranteed by the government, giving the taxpayer a greater stake in their health. We therefore need to optimize the way we deal with such entities if they become insolvent, including, preferably, establishing rules and authorities that make it less likely that they will reach insolvency. The prompt corrective action requirements on banks are a sensible way of doing this.
There are two broad arguments against extending resolution authority, as well as numerous more technical concerns. First, some analysts do not think that the separate status should be established in the first place. In part this is because it makes it more likely in their view that taxpayers will have to subsidize failures and in part because it could give an unfair competitive advantage to the largest competitors, leading them to become bigger still. Second, there are fairness issues involved in changing the insolvency regime for investors who have held bonds of the affected institutions for years under the clear understanding that they would be protected by regular bankruptcy law in the event of an insolvency.
I support extending resolution authority, but it is too complex an issue to fully discuss here. I intend to issue a separate paper in the near future expanding on the brief discussion here.
Consolidation of regulatory functions
There are significantly too many bank regulators in the United States. Different banks and bank-like institutions are regulated by: state regulators; the Office of the Comptroller of the Currency (OCC); the Federal Reserve; the Office of Thrift Supervision; the National Credit Union Administration; and, for certain important purposes, the Federal Deposit Insurance Corporation (FDIC). It appeared earlier that the administration would propose significantly reducing the number of bank regulators, perhaps to as few as a single regulator. This thought appears to have died in the face of intense opposition by many in Congress and elsewhere. No one would design the banking regulatory system the way it is now if they were starting from scratch, but there are many entrenched interests who do not want the present system to change.
The Office of Thrift Supervision is the only regulator who appears to have lacked the institutional support to retain their separate existence. The administration has proposed merging them with, and effectively into, the OCC. This move makes sense, but does not provide nearly the advantages the broader consolidation would have brought. Different regulators will inevitably have different approaches, especially as they are generally given substantial independence in order to reduce the politicization of regulatory decisions. These differing approaches can reduce the effectiveness of systemic regulation, in part by opening up the possibility of “regulatory arbitrage,” where financial groups put their various activities into the affiliates which have the softest regulatory requirements. It is true that tighter regulation of consolidated groups at the holding company level will reduce the ability to arbitrage the regulators, but it is unlikely to entail supervision as detailed as that which will occur at the level of the regulated subsidiaries.
Outside of bank regulation, there are two financial market regulators, the Securities and Exchange Commission (SEC) and the Commodities Futures Trading Commission (CFTC). It makes compelling sense to combine them, but the politics are apparently too difficult. (For one thing, the Agriculture committees of the two houses strongly wish to retain authority over a robust CFTC.) Instead, there will be additional fragmentation as some of the consumer protection functions of the SEC will overlap with that of the new consumer protection regulator discussed later.
New regulations for securitizations and derivatives
Many of the losses by financial institutions and other market players came from problems with securitizations of mortgages and other assets or from problems with derivatives, particularly credit default swaps. The administration proposes greater regulation in both areas, in line with previous statements.
The biggest change to securitizations would be a requirement that the originators of the loans underlying the securities retain at least 5% of the risk. The idea of “keeping some skin in the game” is intuitively appealing and should help. However, it is important not to take excessive comfort from this change. Banks will indeed pay more attention to the quality of the assets they securitize if they retain even a small fraction of them. But, the financial incentives in a bull market for those assets will still push them towards taking greater and greater risks, since they will immediately gain most of the benefits through securitization while only having a future risk on a small fraction of the asset pools. Also, banks are not immune to the euphoria that grips the larger markets during an asset bubble. The banks, to their regret, actually retained much of the mortgage risk from the bubble period, sometimes even buying more in the open market.
The administration is also proposing other positive steps related to securitization, including: greater transparency about the assets backing the securities; clearer guidance from the rating agencies about the differences between asset-backed securities and regular corporate debt; and changes to the compensation structure for the parties involved in securitization.
On the derivatives side, the administration had already indicated that it would push for all standardized derivatives to be traded through an organized exchange or cleared through a clearing house. An exchange is a centrally organized marketplace for the purchase and sale of financial products. The best known is probably the New York Stock Exchange, but there are also several prominent exchanges that do a major business in derivatives already. Exchanges bring a real benefit from transparency about the pricing and volume of trades, as well as making it easier for regulators to track trading positions of major parties. In contrast, much of the trading volume in derivatives now takes place “over the counter,” between two counterparties who are not generally required to report details of the trade and who take each other’s credit risk in regard to the transaction. This credit risk is often mitigated by requiring collateral, but it is clear in retrospect that this process was not well-managed in many cases, leaving a large number of institutions very exposed to the credit risk of AIG, for example.
The major exchanges dealing in derivatives use central clearing houses that act as the counterparty to both sides. If A sells an option to B on the exchange, the clearing house would interpose itself, buying from A and selling the option on to B. The sole purpose of this interposition is to eliminate B’s credit exposure to A. If the option becomes valuable over time, B needs A to make good on its promise. If A doesn’t, the clearing house would make good, protecting B. Such clearing houses can also handle trades that were done off of an exchange, which will be an allowed alternative in certain cases.
It should be noted that using a clearing house does not eliminate counterparty risk altogether. The clearing house could become insolvent itself if enough of its counterparties fail to meet their obligations. This should still represent a diminution of the total credit risk in the system, since clearing houses are well-capitalized and operate in a clearly defined business that is easier to manage than a broader business, but there could be extreme circumstances where a government rescue would be required.
The big controversy with derivatives is what to do about customized derivatives. The use of derivatives to manage risk by sophisticated corporations is pervasive. Sometimes those derivatives are significantly cheaper or more effective if they cover the exact risk rather than using one or more standard derivatives to approximate the desired protection. It would be a great shame to lose those efficiencies altogether by banishing customized derivatives, but there is also a fear that financial firms will deliberately sell slightly non-standard derivatives in order to avoid the tougher rules on standardized ones.
This is another area where the devil is in the details. The trick will be to provide incentives or requirements to use standard derivatives where possible, while leaving the ability to use customized ones where they serve a genuine need. The administration’s proposal attempts to strike this balance. It will be interesting to see what comes out the other end of the legislative process, given the combination of a high degree of public anxiety about derivatives combined with a lack of understanding of this complex topic by many who are voicing opinions about the proper course of action.
Stronger consumer protections
The administration has proposed creating a Consumer Financial Protection Agency (CFPA), responsible for all aspects of regulation of mortgages, credit cards, and other consumer-focused financial products, with a few exceptions, such as mutual funds, which are left with the SEC. This appears to be a fairly powerful agency, with the power to set binding regulations, impose fines, etc. It will specifically be authorized to impose an obligation to offer “plain vanilla” products, such as a standardized 30-year fixed rate mortgage, with the possibility that consumers who wish to make another choice will have to specifically waive their right to have the standardized product.
There have been many bad practices that developed in the bubble period which harmed consumers, especially related to sub-prime mortgages. It will be useful to have a clear regulatory focus on eliminating those problems and avoiding others in the future. The critical issue will be the extent to which the CFPA is able to find the right balance between promoting consumer safety and allowing innovation. Everyone can agree on the need for transparency. What is harder is when there are both risks and rewards to a given product, from the consumer’s viewpoint. How much will the CFPA try to protect consumers from taking risks that might actually be legitimate in light of the potential rewards?
Another key issue that will be determined by a combination of legislative wording and regulatory choices over time is the extent to which the CFPA will move out of products that are clearly consumer products into a wider range of financial products. For example, would the CFPA ever find itself imposing regulations on derivative products, perhaps on the basis that some individuals do invest in them? This appears not to be the intent of the proposal, but there will doubtless be gray areas in practice.
Greater international coordination
Finally, the administration has also highlighted the need for greater international regulatory cooperation. This would indeed be useful, particularly if the United States develops tougher rules in some areas than currently exist elsewhere. However, it is not likely that there will be a large effect on U.S. policy from this international cooperation. As has already been seen with the failure to propose significant regulatory consolidation, financial regulation in the United States is a very parochial affair, with entrenched interests fighting their corner with relatively little regard for what is going on in the rest of the world.
Summary
The proposals are generally quite sensible. The unfortunate aspect is that political constraints have caused the administration to stop short of a full solution in certain areas, most notably in the consolidation of regulatory functions into fewer hands. Nonetheless, the country should be better off if these proposals are passed than if we were to remain as we are now.
Does the "Smart Grid" Have a Smartest-Guys-in-the-Room Problem?
Does the "Smart Grid" Have a Smartest-Guys-in-the-Room Problem? By Ken Maize
Master Resource, June 19, 2009
[...]
However politically incorrect my conclusion, I’m convinced that the “smart grid” is not smart and even dumb. It diverts attention from what is a more important objective–a strong grid. And it politicizes in the very area where we need more consumer-driven, free-market incentives.
Following the Northeast grid collapse of 2003, the Electric Power Research Institute (EPRI) popped out the smart grid concept, largely the brainchild of then EPRI’s CEO Kurt Yeager. The blueprint was for an interconnected intelligent network reaching from the generating station to your toaster, able to talk up-and-down the line, matching supply and demand seamlessly.
Sounds cool, but doesn’t stand up to analysis in my judgment.
Where Did ‘Smart Grid’ Come From?
The idea of a smart grid has been laying around in bits and pieces for many years. I recall visiting Southern California Edison (SEC) in the 1980s where a group of us energy reporters visited the utility’s “smart house.” It kinda reminded me of the Betty Furness advertisements for Westinghouse kitchens when I grew up in Pittsburgh in the 1950s and 1960s. SCE assured us that the smart house, connected to the utility over phone lines (this was pre-World Wide Web) and through radio signals, would dominate home construction in the coming years. (Enron would have a ’smart house’ a decade later to awe visitors to 1400 Smith Street in Houston, but that’s another story.)
Didn’t happen, for lots of reasons, most of them good. It didn’t make economic sense for consumers (although it did for the utility — remember all-electric “gold medallion” homes?). It was way too technologically optimistic, assuming communications protocols that really didn’t exist, and appliances that weren’t remotely ready to talk to each other and the utility. Heck, this was largely before cell phones were making a big impact in the market.
Fast forward to the 21st Century. The grid has shown that it is in trouble. The Internet has demonstrated the utility of Vint Cerf’s IP communications protocol. EPRI is facing an existential moment (what the heck is our role here?). Presto! The smart grid. It controls power flows, adjusts supply demand on the fly, instantly corrects for frequency and power imbalances. It slices, it dices, it’s the latest, biggest, best Ronco product of all time. We can get Billy Mays (no relation, he spells it differently) to peddle it on late-night cable.
Rescuing Dumb Renewables
The concept of the smart grid (if not the reality) also fits into the allegedly new paradigm of renewables. We want lots of power from the wind and the sun (water doesn’t count). But the places where the winds blows a lot and the sun shines a lot are a long way away from where there are a lot of people.
Hence proposals to build a transcontinental, high-voltage (AC and DC) backbone grid on top of the existing transmission and distribution network (which former energy secretary Bill Richardson famously and erroneously called a “third world” grid following the 2003 grid collapse). What’s a trillion dollars or so to bring unreliable power to market?
So here is the Big Green Grid Dream: tie renewables to consumers, with a smart grid to govern (Big Brother?) usage. We could imbue the entire grid — high-voltage transmission and lower-voltage distribution with smarts, from the generator to the substation to the refrigerator. It’s the Big Rock Candy Mountain–or Dream Green Machine.
Another Problem: Cybersecurity
Another problem with the concept of a smart grid (which most advocates assume will use IP/TCP communications protocols) is cybersecurity. It’s hard to bring down a dumb but strong grid in a cyber attack. The smarter it is, the more vulnerable it becomes. There was a report in the Wall Street Journal not long ago that hackers from China and Russia had successfully penetrated the U.S.”grid,” which was undefined in the article.
I don’t believe it, and no other mainstream media outlet backed up the story. But the “smarter” the grid becomes, the more likely such hacking becomes. That’s a real problem.
The Legacy Problem
The U.S. transmission grid (and I’m talking about the big pipes — 365 kV and above) has clear weaknesses. We don’t have a U.S. grid, but loosely-interconnected regional grids. East and West don’t meet very easily. Texas is an island unto itself. Florida is aspiring to the same. Without strong physical interconnections, it’s impossible to dispatch and control a national grid. So a lot of “smart grid” is putting the cart before the horse.
Color Me Skeptical
I don’t buy any part of it, and it ain’t going to happen. It’s what I have described elsewhere as lemon-meringue pie-in-the-sky. Among other problems, the costs are simply unknown, and who will bear them is also unknown. Most of what I’ve seen implicitly suggests that taxpayers will get the check, since customers would revolt if the costs showed up on their monthly bills.
I’ve tuned into recent FERC discussions about grid issues, and heard what I think is a lot of nonsense about smart grids. I’d rather our regulators and policy makers were focusing on muscle, not brains. It’s heavy lifting we need, not heavy thinking.
—————————————
Ken Maize is executive editor of MANAGING POWER magazine and editor of POWER Blog. He was the founder and editor of Electricity Daily (1993-2006) and a reporter and editor at The Energy Daily for a dozen years, starting on March 28, 1979, the date of the Three Mile Island problem. Contact address: kmaize@hughes.net.
Master Resource, June 19, 2009
[...]
However politically incorrect my conclusion, I’m convinced that the “smart grid” is not smart and even dumb. It diverts attention from what is a more important objective–a strong grid. And it politicizes in the very area where we need more consumer-driven, free-market incentives.
Following the Northeast grid collapse of 2003, the Electric Power Research Institute (EPRI) popped out the smart grid concept, largely the brainchild of then EPRI’s CEO Kurt Yeager. The blueprint was for an interconnected intelligent network reaching from the generating station to your toaster, able to talk up-and-down the line, matching supply and demand seamlessly.
Sounds cool, but doesn’t stand up to analysis in my judgment.
Where Did ‘Smart Grid’ Come From?
The idea of a smart grid has been laying around in bits and pieces for many years. I recall visiting Southern California Edison (SEC) in the 1980s where a group of us energy reporters visited the utility’s “smart house.” It kinda reminded me of the Betty Furness advertisements for Westinghouse kitchens when I grew up in Pittsburgh in the 1950s and 1960s. SCE assured us that the smart house, connected to the utility over phone lines (this was pre-World Wide Web) and through radio signals, would dominate home construction in the coming years. (Enron would have a ’smart house’ a decade later to awe visitors to 1400 Smith Street in Houston, but that’s another story.)
Didn’t happen, for lots of reasons, most of them good. It didn’t make economic sense for consumers (although it did for the utility — remember all-electric “gold medallion” homes?). It was way too technologically optimistic, assuming communications protocols that really didn’t exist, and appliances that weren’t remotely ready to talk to each other and the utility. Heck, this was largely before cell phones were making a big impact in the market.
Fast forward to the 21st Century. The grid has shown that it is in trouble. The Internet has demonstrated the utility of Vint Cerf’s IP communications protocol. EPRI is facing an existential moment (what the heck is our role here?). Presto! The smart grid. It controls power flows, adjusts supply demand on the fly, instantly corrects for frequency and power imbalances. It slices, it dices, it’s the latest, biggest, best Ronco product of all time. We can get Billy Mays (no relation, he spells it differently) to peddle it on late-night cable.
Rescuing Dumb Renewables
The concept of the smart grid (if not the reality) also fits into the allegedly new paradigm of renewables. We want lots of power from the wind and the sun (water doesn’t count). But the places where the winds blows a lot and the sun shines a lot are a long way away from where there are a lot of people.
Hence proposals to build a transcontinental, high-voltage (AC and DC) backbone grid on top of the existing transmission and distribution network (which former energy secretary Bill Richardson famously and erroneously called a “third world” grid following the 2003 grid collapse). What’s a trillion dollars or so to bring unreliable power to market?
So here is the Big Green Grid Dream: tie renewables to consumers, with a smart grid to govern (Big Brother?) usage. We could imbue the entire grid — high-voltage transmission and lower-voltage distribution with smarts, from the generator to the substation to the refrigerator. It’s the Big Rock Candy Mountain–or Dream Green Machine.
Another Problem: Cybersecurity
Another problem with the concept of a smart grid (which most advocates assume will use IP/TCP communications protocols) is cybersecurity. It’s hard to bring down a dumb but strong grid in a cyber attack. The smarter it is, the more vulnerable it becomes. There was a report in the Wall Street Journal not long ago that hackers from China and Russia had successfully penetrated the U.S.”grid,” which was undefined in the article.
I don’t believe it, and no other mainstream media outlet backed up the story. But the “smarter” the grid becomes, the more likely such hacking becomes. That’s a real problem.
The Legacy Problem
The U.S. transmission grid (and I’m talking about the big pipes — 365 kV and above) has clear weaknesses. We don’t have a U.S. grid, but loosely-interconnected regional grids. East and West don’t meet very easily. Texas is an island unto itself. Florida is aspiring to the same. Without strong physical interconnections, it’s impossible to dispatch and control a national grid. So a lot of “smart grid” is putting the cart before the horse.
Color Me Skeptical
I don’t buy any part of it, and it ain’t going to happen. It’s what I have described elsewhere as lemon-meringue pie-in-the-sky. Among other problems, the costs are simply unknown, and who will bear them is also unknown. Most of what I’ve seen implicitly suggests that taxpayers will get the check, since customers would revolt if the costs showed up on their monthly bills.
I’ve tuned into recent FERC discussions about grid issues, and heard what I think is a lot of nonsense about smart grids. I’d rather our regulators and policy makers were focusing on muscle, not brains. It’s heavy lifting we need, not heavy thinking.
—————————————
Ken Maize is executive editor of MANAGING POWER magazine and editor of POWER Blog. He was the founder and editor of Electricity Daily (1993-2006) and a reporter and editor at The Energy Daily for a dozen years, starting on March 28, 1979, the date of the Three Mile Island problem. Contact address: kmaize@hughes.net.
The Potential Gas Committee has raised its gas resource estimate for the US
U.S. Gas Resources: Julian Simon Lives! (Malthus, Hotelling, Hubbert are wrong again). By Michael Lynch
Master Resource, June 22, 2009
The Potential Gas Committee has issued its new biennial gas resource estimate for the United States and once again raised its estimate, this time by 15%, or from 1,321 trillion cubic feet (Tcf) to 1,525 Tcf. This equates to a 70-year domestic cushion, given annual U.S. consumption of 20 Tcf. The evaluation of available shale gas, production of which is now soaring, played a major role in this re-evaluation and potently demonstrates how new technology (aka human ingenuity, what the late Julian Simon called the ultimate resource) creates resources, refuting the static fixity/depletion view of the mineral-resource world.
Few realize that the PGC has been raising the estimates of conventional resources throughout history, even as the United States has consumed large amounts of natural gas. Thus gas has been and is an expanding resource, not a depleting one.
In 1966, the PGC’s estimate of ultimately recoverable resource (i.e., including cumulative production) was 1,283 Tcf, versus the current estimate of approximately 2,600 Tcf, including 1,100 Tcf of cumulative production. While that includes several hundred Tcf of shale gas and coal-bed methane (CBM), conventional gas resources have surpassed 2,000 Tcf and are far beyond even the most optimistic estimates of a quarter century ago.
An excellent summary of those estimates can be found in the Office of Technology Assessment’s U.S. Natural Gas Availability: Conventional Gas Supply Through the Year 2000, which noted that the pessimistic projections for production in 2000 were about 9 Tcf. Total production that year proved to be over twice that amount, at 18.7 Tcf, of which less than 2 Tcf were shale gas and CBM.
In fact, resource estimates from that era have proved wildly pessimistic. A review of URR estimates from 11 different sources, including M. King Hubbert and Richard Nehring, found none that came close to current levels, with the highest at 1,800 Tcf. Indeed, five of the nine estimates of lower-48 remaining undiscovered resources came in below 200 Tcf, whereas production since then has been 500 Tcf.
Against this background, we have any number of pundits decrying the optimists arguments that resources will be sufficient for our needs, pointing to a few years of elevated prices, and encouraging the building of numerous—now idle—LNG import terminals. Even more, arguments that global gas resources are somehow constrained should be put to bed.
Master Resource, June 22, 2009
The Potential Gas Committee has issued its new biennial gas resource estimate for the United States and once again raised its estimate, this time by 15%, or from 1,321 trillion cubic feet (Tcf) to 1,525 Tcf. This equates to a 70-year domestic cushion, given annual U.S. consumption of 20 Tcf. The evaluation of available shale gas, production of which is now soaring, played a major role in this re-evaluation and potently demonstrates how new technology (aka human ingenuity, what the late Julian Simon called the ultimate resource) creates resources, refuting the static fixity/depletion view of the mineral-resource world.
Few realize that the PGC has been raising the estimates of conventional resources throughout history, even as the United States has consumed large amounts of natural gas. Thus gas has been and is an expanding resource, not a depleting one.
In 1966, the PGC’s estimate of ultimately recoverable resource (i.e., including cumulative production) was 1,283 Tcf, versus the current estimate of approximately 2,600 Tcf, including 1,100 Tcf of cumulative production. While that includes several hundred Tcf of shale gas and coal-bed methane (CBM), conventional gas resources have surpassed 2,000 Tcf and are far beyond even the most optimistic estimates of a quarter century ago.
An excellent summary of those estimates can be found in the Office of Technology Assessment’s U.S. Natural Gas Availability: Conventional Gas Supply Through the Year 2000, which noted that the pessimistic projections for production in 2000 were about 9 Tcf. Total production that year proved to be over twice that amount, at 18.7 Tcf, of which less than 2 Tcf were shale gas and CBM.
In fact, resource estimates from that era have proved wildly pessimistic. A review of URR estimates from 11 different sources, including M. King Hubbert and Richard Nehring, found none that came close to current levels, with the highest at 1,800 Tcf. Indeed, five of the nine estimates of lower-48 remaining undiscovered resources came in below 200 Tcf, whereas production since then has been 500 Tcf.
Against this background, we have any number of pundits decrying the optimists arguments that resources will be sufficient for our needs, pointing to a few years of elevated prices, and encouraging the building of numerous—now idle—LNG import terminals. Even more, arguments that global gas resources are somehow constrained should be put to bed.
How to Get The Fed Out Of Its 'Box'
How to Get The Fed Out Of Its 'Box'. By FREDERIC S. MISHKIN
A commitment to fiscal discipline could enable expansionary monetary policy.
The Wall Street Journal, Jun 22, 2009, p A15
When the Federal Open Market Committee meets this Tuesday and Wednesday, the Federal Reserve will face a serious dilemma.
Since the last committee meeting six weeks ago, the 10-year U.S. Treasury yield has risen by around 70 basis points (0.70%), with the result that the interest rate on 30-year mortgages has risen by a similar amount. The rise in long-term interest rates is particularly worrisome, because it has the potential to choke off economic recovery and lead to further deterioration in the housing market. That would put an already weakened financial system under stress. Does the situation call for the Fed to expand its purchases of Treasury bonds to lower long-term interest rates?
To answer this question, we need to look at why long-term interest rates have risen. Here, there is good news and bad news. One cause of the rise in long-term rates is the more positive economic news of the past couple of months, particularly in financial markets. The bad news is that long-term interest rates are higher because of concerns about the deteriorating fiscal situation, with massive budget deficits expected for the indefinite future. To fund these budget deficits, the Treasury has to sell large quantities of bonds both now and in the future, causing bond prices to fall and interest rates to rise. The increased supply of Treasury debt puts pressure on the Fed to buy it up.
Although an expansion of Treasury bond purchases by the Fed would have the benefit of lowering long-term interest rates temporarily to stimulate the economy, in the current environment it could be dangerous for two reasons. First, it might suggest that the Fed is willing to monetize Treasury debt. The Fed does not, and should not, want to make it easy for the Treasury to sell its debt and thereby be an enabler of fiscal irresponsibility. Second, if the Fed loses its credibility to resist pressures to monetize the debt it could cause inflation expectations to shift upward, thereby leading to a serious problem down the road.
The Fed is boxed in. The slack in the economy that is likely to persist for a very long time suggests the need for stimulative monetary policy to lower long-term interest rates through the purchase of Treasurys. The fiscal situation argues against this policy action, because it would weaken the Fed's inflation-fighting credibility.
How can the Fed get out of the box and pursue the expansionary monetary policy that is needed right now? The answer is that the Obama administration and Congress have to get serious about long-run fiscal sustainability. Large budget deficits naturally occur during severe recessions when tax revenue undergoes a substantial decline. In addition, fiscal stimulus to promote economic recovery when the economy is in a severe recession is a sensible prescription.
However, the failure to take steps to get future budgets under control is a recipe for disaster. Not only does it make it difficult for the Fed to take the actions needed to promote economic recovery, but it may even make the fiscal stimulus package less effective. After all, if you know that the government is issuing a lot of debt that has to be paid back someday you can expect to pay much higher taxes in the future. With the prospect of higher taxes, you will be less likely to spend today.
How can the Obama administration and Congress help the Fed do its job and help the fiscal stimulus package work? It needs to address exploding spending on entitlements -- Social Security and particularly Medicare -- which are causing future deficit projections to be so bleak.
One possibility is to establish a nonpartisan commission on entitlement reform, along the lines of the National Commission on Social Security in the early 1980s. It produced recommendations that for a time helped put Social Security on a more solid footing. Another is taxing health-care benefits as part of any package to reform health care. Taxing health-care benefits would not only generate large amounts of revenue. It would also increase the incentive for people to lower the costs of their health care. There are surely many other ways to promote more fiscal responsibility.
The Fed can assist this process. It could indicate that implementing measures that would promote fiscal sustainability will be rewarded with Federal Reserve actions to bring long-term Treasury rates down. Deals like this have been successfully made in the past. In the current extremely difficult economic environment, we surely need such a deal now.
Mr. Mishkin, an economics professor at Columbia University, is a former member of the Board of Governors of the Federal Reserve and the author of "Monetary Policy Strategy" (MIT Press, 2007).
A commitment to fiscal discipline could enable expansionary monetary policy.
The Wall Street Journal, Jun 22, 2009, p A15
When the Federal Open Market Committee meets this Tuesday and Wednesday, the Federal Reserve will face a serious dilemma.
Since the last committee meeting six weeks ago, the 10-year U.S. Treasury yield has risen by around 70 basis points (0.70%), with the result that the interest rate on 30-year mortgages has risen by a similar amount. The rise in long-term interest rates is particularly worrisome, because it has the potential to choke off economic recovery and lead to further deterioration in the housing market. That would put an already weakened financial system under stress. Does the situation call for the Fed to expand its purchases of Treasury bonds to lower long-term interest rates?
To answer this question, we need to look at why long-term interest rates have risen. Here, there is good news and bad news. One cause of the rise in long-term rates is the more positive economic news of the past couple of months, particularly in financial markets. The bad news is that long-term interest rates are higher because of concerns about the deteriorating fiscal situation, with massive budget deficits expected for the indefinite future. To fund these budget deficits, the Treasury has to sell large quantities of bonds both now and in the future, causing bond prices to fall and interest rates to rise. The increased supply of Treasury debt puts pressure on the Fed to buy it up.
Although an expansion of Treasury bond purchases by the Fed would have the benefit of lowering long-term interest rates temporarily to stimulate the economy, in the current environment it could be dangerous for two reasons. First, it might suggest that the Fed is willing to monetize Treasury debt. The Fed does not, and should not, want to make it easy for the Treasury to sell its debt and thereby be an enabler of fiscal irresponsibility. Second, if the Fed loses its credibility to resist pressures to monetize the debt it could cause inflation expectations to shift upward, thereby leading to a serious problem down the road.
The Fed is boxed in. The slack in the economy that is likely to persist for a very long time suggests the need for stimulative monetary policy to lower long-term interest rates through the purchase of Treasurys. The fiscal situation argues against this policy action, because it would weaken the Fed's inflation-fighting credibility.
How can the Fed get out of the box and pursue the expansionary monetary policy that is needed right now? The answer is that the Obama administration and Congress have to get serious about long-run fiscal sustainability. Large budget deficits naturally occur during severe recessions when tax revenue undergoes a substantial decline. In addition, fiscal stimulus to promote economic recovery when the economy is in a severe recession is a sensible prescription.
However, the failure to take steps to get future budgets under control is a recipe for disaster. Not only does it make it difficult for the Fed to take the actions needed to promote economic recovery, but it may even make the fiscal stimulus package less effective. After all, if you know that the government is issuing a lot of debt that has to be paid back someday you can expect to pay much higher taxes in the future. With the prospect of higher taxes, you will be less likely to spend today.
How can the Obama administration and Congress help the Fed do its job and help the fiscal stimulus package work? It needs to address exploding spending on entitlements -- Social Security and particularly Medicare -- which are causing future deficit projections to be so bleak.
One possibility is to establish a nonpartisan commission on entitlement reform, along the lines of the National Commission on Social Security in the early 1980s. It produced recommendations that for a time helped put Social Security on a more solid footing. Another is taxing health-care benefits as part of any package to reform health care. Taxing health-care benefits would not only generate large amounts of revenue. It would also increase the incentive for people to lower the costs of their health care. There are surely many other ways to promote more fiscal responsibility.
The Fed can assist this process. It could indicate that implementing measures that would promote fiscal sustainability will be rewarded with Federal Reserve actions to bring long-term Treasury rates down. Deals like this have been successfully made in the past. In the current extremely difficult economic environment, we surely need such a deal now.
Mr. Mishkin, an economics professor at Columbia University, is a former member of the Board of Governors of the Federal Reserve and the author of "Monetary Policy Strategy" (MIT Press, 2007).
Treasury's reform plan gives the credit raters a pass
A Triple-A Punt. WSJ Editorial
Treasury's reform plan gives the credit raters a pass.
The Wall Street Journal, Jun 22, 2009, p A14
If world-class lobbying could win a Stanley Cup, the credit-ratings caucus would be skating a victory lap this week. The Obama plan for financial re-regulation leaves unscathed this favored class of businesses whose fingerprints are all over the credit meltdown.
The government-anointed judges of risk at Standard & Poor's, Moody's and Fitch inflicted upon investors the AAA-rated subprime mortgage-backed security. They also inflicted upon the world's nest eggs the even more opaque AAA-rated collateralized debt obligation (CDO). Without the ratings agency seal of approval -- required by SEC, Federal Reserve and state regulation for many institutional investors -- it would have been nearly impossible to market the structured financial products at the heart of the crisis. Yet Team Obama suggests only that regulators reduce the agencies' favored role "wherever possible."
It's a revealing phrase, implying that there are situations when it's appropriate to rely on ratings from the big three instead of actually analyzing a potential investment. Can anyone name one? Probably not, which makes one wonder how the ratings-agency lobby could be so effective.
The truth is that the strongest defenders of this flawed system are mutual funds, state pension administrators and the federal regulators now managing the various bailout programs. Digging into the underlying assets in a pool of mortgages or judging the credit risk in a collection of auto loans is hard work. But putting taxpayer or investor money in something labeled "triple-A" is easy. Everyone is covered if the government's favorite credit raters have signed off.
The Obama plan also calls for regulators to "minimize" the ability of banks to use highly-rated securities to reduce their capital requirements when they have not actually reduced their risks. Minimize, not eliminate? Does the Treasury believe that some baseline level of fakery is acceptable in bank financial statements? To review, a critical ingredient in the meltdown was the Basel banking standards pushed by the Federal Reserve. Among other problems, Basel allowed Wall Street firms to claim that highly-rated mortgage-backed securities on their books were almost as good as cash as a capital standard.
The Obama plan does make plenty of vague suggestions, similar to those proposed by the rating agencies themselves, to improve oversight of the ratings process and better manage conflicts of interest. The Obama Treasury has even adopted the favorite public relations strategy of the ratings agency lobby: Blame the victim. "Market discipline broke down as investors relied excessively on credit rating agencies," says this week's Treasury reform white paper. After regulators spent decades explicitly demanding that banks and mutual funds hold securities rated by the big rating agencies, regulators now have the nerve to blame investors for paying attention to the ratings.
Even the Fed, which until recently would accept as collateral only securities that had been rated by S&P, Moody's or Fitch, has lately acknowledged the flaws in this approach. The New York Fed has anointed two more firms, DBRS and Realpoint, to judge the default risk of commercial mortgage-backed securities eligible for the Term Asset-Backed Securities Loan Facility (TALF). Since the passage of a 2006 law intended to promote competition, the SEC has also approved new firms to rate securities that money market funds and brokerages are required to hold.
But inviting more firms to become members of this exclusive club isn't the answer. As long as government requires investors to pay for a service, and then selects which businesses may provide it, it's unlikely investors will get their money's worth. History says it's more likely that investors who use the agencies' "investment-grade" ratings as a guide will be exposed to severe losses -- ask people who went long on Enron and WorldCom.
It's time to let markets decide how to judge creditworthiness. One lesson of the crisis is that the unregulated credit default swap (CDS) market provided a more accurate measurement of the risk of financial firms than the government's chosen ratings system. Apparently even the largest provider of these government-required ratings, S&P, has taken this lesson to heart. The company recently introduced a new "Market Derived Signals" model that incorporates the prices of CDS contracts "to create a measure that facilitates the interpretation of market information."
This looks like a signal that even the prime beneficiaries of a government policy believe that the policy failed. So why won't the Obama Administration embrace real reform?
Treasury's reform plan gives the credit raters a pass.
The Wall Street Journal, Jun 22, 2009, p A14
If world-class lobbying could win a Stanley Cup, the credit-ratings caucus would be skating a victory lap this week. The Obama plan for financial re-regulation leaves unscathed this favored class of businesses whose fingerprints are all over the credit meltdown.
The government-anointed judges of risk at Standard & Poor's, Moody's and Fitch inflicted upon investors the AAA-rated subprime mortgage-backed security. They also inflicted upon the world's nest eggs the even more opaque AAA-rated collateralized debt obligation (CDO). Without the ratings agency seal of approval -- required by SEC, Federal Reserve and state regulation for many institutional investors -- it would have been nearly impossible to market the structured financial products at the heart of the crisis. Yet Team Obama suggests only that regulators reduce the agencies' favored role "wherever possible."
It's a revealing phrase, implying that there are situations when it's appropriate to rely on ratings from the big three instead of actually analyzing a potential investment. Can anyone name one? Probably not, which makes one wonder how the ratings-agency lobby could be so effective.
The truth is that the strongest defenders of this flawed system are mutual funds, state pension administrators and the federal regulators now managing the various bailout programs. Digging into the underlying assets in a pool of mortgages or judging the credit risk in a collection of auto loans is hard work. But putting taxpayer or investor money in something labeled "triple-A" is easy. Everyone is covered if the government's favorite credit raters have signed off.
The Obama plan also calls for regulators to "minimize" the ability of banks to use highly-rated securities to reduce their capital requirements when they have not actually reduced their risks. Minimize, not eliminate? Does the Treasury believe that some baseline level of fakery is acceptable in bank financial statements? To review, a critical ingredient in the meltdown was the Basel banking standards pushed by the Federal Reserve. Among other problems, Basel allowed Wall Street firms to claim that highly-rated mortgage-backed securities on their books were almost as good as cash as a capital standard.
The Obama plan does make plenty of vague suggestions, similar to those proposed by the rating agencies themselves, to improve oversight of the ratings process and better manage conflicts of interest. The Obama Treasury has even adopted the favorite public relations strategy of the ratings agency lobby: Blame the victim. "Market discipline broke down as investors relied excessively on credit rating agencies," says this week's Treasury reform white paper. After regulators spent decades explicitly demanding that banks and mutual funds hold securities rated by the big rating agencies, regulators now have the nerve to blame investors for paying attention to the ratings.
Even the Fed, which until recently would accept as collateral only securities that had been rated by S&P, Moody's or Fitch, has lately acknowledged the flaws in this approach. The New York Fed has anointed two more firms, DBRS and Realpoint, to judge the default risk of commercial mortgage-backed securities eligible for the Term Asset-Backed Securities Loan Facility (TALF). Since the passage of a 2006 law intended to promote competition, the SEC has also approved new firms to rate securities that money market funds and brokerages are required to hold.
But inviting more firms to become members of this exclusive club isn't the answer. As long as government requires investors to pay for a service, and then selects which businesses may provide it, it's unlikely investors will get their money's worth. History says it's more likely that investors who use the agencies' "investment-grade" ratings as a guide will be exposed to severe losses -- ask people who went long on Enron and WorldCom.
It's time to let markets decide how to judge creditworthiness. One lesson of the crisis is that the unregulated credit default swap (CDS) market provided a more accurate measurement of the risk of financial firms than the government's chosen ratings system. Apparently even the largest provider of these government-required ratings, S&P, has taken this lesson to heart. The company recently introduced a new "Market Derived Signals" model that incorporates the prices of CDS contracts "to create a measure that facilitates the interpretation of market information."
This looks like a signal that even the prime beneficiaries of a government policy believe that the policy failed. So why won't the Obama Administration embrace real reform?
Is Government Health Care Constitutional? The right to privacy conflicts with rationing and regulation
Is Government Health Care Constitutional? By DAVID B. RIVKIN JR. and LEE A. CASEY
The right to privacy conflicts with rationing and regulation.
The Wall Street Journal, Jun 22, 2009, p A15
Is a government-dominated health-care system unconstitutional? A strong case can be made for that proposition, based on the same "right to privacy" that underlies such landmark Supreme Court decisions as Roe v. Wade.
The details of this year's health-care reform bill are still being hammered out. But the end result is sure to be byzantine in complexity. Washington will have immense say over how, when and through whom Americans are treated. Moreover, despite the administration's public pronouncements about painless cuts in wasteful spending, only the most credulous believe that some form of government-directed health-care rationing can be avoided as a means of controlling costs.
The Supreme Court created the right to privacy in the 1960s and used it to strike down a series of state and federal regulations of personal (mostly sexual) conduct. This line of cases began with Griswold v. Connecticut in 1965 (involving marital birth control), and includes the 1973 Roe v. Wade decision legalizing abortion.
The court's underlying rationale was not abortion-specific. Rather, the justices posited a constitutionally mandated zone of personal privacy that must remain free of government regulation, except in the most exceptional circumstances. As the court explained in Planned Parenthood v. Casey (1992), "these matters, involving the most intimate and personal choices a person may make in a lifetime, choices central to personal dignity and autonomy, are central to the liberty protected by the Fourteenth Amendment. At the heart of liberty is the right to define one's own concept of existence, of meaning, of the universe, and the mystery of human life."
It is, of course, difficult to imagine choices more "central to personal dignity and autonomy" than measures to be taken for the prevention and treatment of disease -- measures that may be essential to preserve or extend life itself. Indeed, when the overwhelming moral issues that surround the abortion question are stripped away, what is left is a medical procedure determined to be "necessary" by an expectant mother and her physician.
If the government cannot proscribe -- or even "unduly burden," to use another of the Supreme Court's analytical frameworks -- access to abortion, how can it proscribe access to other medical procedures, including transplants, corrective or restorative surgeries, chemotherapy treatments, or a myriad of other health services that individuals may need or desire?
This type of "burden" analysis will be especially problematic for a national health system because, in the health area, proper care often depends upon an individual's unique physical and even genetic history and characteristics. One size clearly does not fit all, but that is the very essence of governmental regulation -- to impose a regularity (if not uniformity) in the application of governmental power and the dispersal of its largess. Taking key decisions away from patient and physician, or otherwise limiting their available choices, will render any new system constitutionally vulnerable.
It is true, of course, that forms of rationing already exist in our current system. No one who has experienced the marked reluctance to treat aggressively lethal illnesses in the elderly can doubt that. However, what may be permissible for private actors -- including doctors and insurance companies -- is not necessarily lawful when done by the government.
Obviously, the government does not have to pay for any and all services individual citizens may desire. And simply refusing to approve a procedure or treatment under applicable reimbursement rules, as under the government-run Medicare and Medicaid, does not make the system unconstitutional. But if over time, as many critics fear, a "public option" health insurance plan turns into what amounts to a single-payer system, the constitutional issues regarding treatment and reimbursement decisions will be manifold.
The same will be true of a quasi-private system where the government claims a large role in defining acceptable health-insurance coverage and treatments. There will be all sorts of "undue burdens" on the rights of patients to receive the care they may want. Then the litigation will begin.
Anyone who imagines that Congress can simply avoid the constitutional issues -- and lawsuits -- by withdrawing federal court jurisdiction over the new health system must think again. A brief review of the Supreme Court's recent war-on-terror decisions, brought by or on behalf of detained enemy combatants, will disabuse that notion. This area of governmental authority was once nearly immune from judicial intervention. Over the past five years, however, the Supreme Court (supposedly the nonpolitical branch) has unapologetically transformed itself into a full-fledged, policy-making partner with the president and Congress.
In the process, the justices blew past specific congressional efforts to limit their jurisdiction and involvement like a hot rod in the desert. Questions of basic constitutionality (however the court may define them) cannot now be shielded from judicial review.
It is, of course, impossible to predict how and when the courts will ultimately rule on the new health system. Much depends on the details and the extent to which reasonable and practical private alternatives to the national plan remain. In crafting the law, however, its White House and congressional sponsors must keep privacy -- that near absolute right to personal autonomy they have so often praised and promoted -- squarely before them. The only thing that is certain today is that the courts, and not Congress, will have the last word.
The right to privacy conflicts with rationing and regulation.
The Wall Street Journal, Jun 22, 2009, p A15
Is a government-dominated health-care system unconstitutional? A strong case can be made for that proposition, based on the same "right to privacy" that underlies such landmark Supreme Court decisions as Roe v. Wade.
The details of this year's health-care reform bill are still being hammered out. But the end result is sure to be byzantine in complexity. Washington will have immense say over how, when and through whom Americans are treated. Moreover, despite the administration's public pronouncements about painless cuts in wasteful spending, only the most credulous believe that some form of government-directed health-care rationing can be avoided as a means of controlling costs.
The Supreme Court created the right to privacy in the 1960s and used it to strike down a series of state and federal regulations of personal (mostly sexual) conduct. This line of cases began with Griswold v. Connecticut in 1965 (involving marital birth control), and includes the 1973 Roe v. Wade decision legalizing abortion.
The court's underlying rationale was not abortion-specific. Rather, the justices posited a constitutionally mandated zone of personal privacy that must remain free of government regulation, except in the most exceptional circumstances. As the court explained in Planned Parenthood v. Casey (1992), "these matters, involving the most intimate and personal choices a person may make in a lifetime, choices central to personal dignity and autonomy, are central to the liberty protected by the Fourteenth Amendment. At the heart of liberty is the right to define one's own concept of existence, of meaning, of the universe, and the mystery of human life."
It is, of course, difficult to imagine choices more "central to personal dignity and autonomy" than measures to be taken for the prevention and treatment of disease -- measures that may be essential to preserve or extend life itself. Indeed, when the overwhelming moral issues that surround the abortion question are stripped away, what is left is a medical procedure determined to be "necessary" by an expectant mother and her physician.
If the government cannot proscribe -- or even "unduly burden," to use another of the Supreme Court's analytical frameworks -- access to abortion, how can it proscribe access to other medical procedures, including transplants, corrective or restorative surgeries, chemotherapy treatments, or a myriad of other health services that individuals may need or desire?
This type of "burden" analysis will be especially problematic for a national health system because, in the health area, proper care often depends upon an individual's unique physical and even genetic history and characteristics. One size clearly does not fit all, but that is the very essence of governmental regulation -- to impose a regularity (if not uniformity) in the application of governmental power and the dispersal of its largess. Taking key decisions away from patient and physician, or otherwise limiting their available choices, will render any new system constitutionally vulnerable.
It is true, of course, that forms of rationing already exist in our current system. No one who has experienced the marked reluctance to treat aggressively lethal illnesses in the elderly can doubt that. However, what may be permissible for private actors -- including doctors and insurance companies -- is not necessarily lawful when done by the government.
Obviously, the government does not have to pay for any and all services individual citizens may desire. And simply refusing to approve a procedure or treatment under applicable reimbursement rules, as under the government-run Medicare and Medicaid, does not make the system unconstitutional. But if over time, as many critics fear, a "public option" health insurance plan turns into what amounts to a single-payer system, the constitutional issues regarding treatment and reimbursement decisions will be manifold.
The same will be true of a quasi-private system where the government claims a large role in defining acceptable health-insurance coverage and treatments. There will be all sorts of "undue burdens" on the rights of patients to receive the care they may want. Then the litigation will begin.
Anyone who imagines that Congress can simply avoid the constitutional issues -- and lawsuits -- by withdrawing federal court jurisdiction over the new health system must think again. A brief review of the Supreme Court's recent war-on-terror decisions, brought by or on behalf of detained enemy combatants, will disabuse that notion. This area of governmental authority was once nearly immune from judicial intervention. Over the past five years, however, the Supreme Court (supposedly the nonpolitical branch) has unapologetically transformed itself into a full-fledged, policy-making partner with the president and Congress.
In the process, the justices blew past specific congressional efforts to limit their jurisdiction and involvement like a hot rod in the desert. Questions of basic constitutionality (however the court may define them) cannot now be shielded from judicial review.
It is, of course, impossible to predict how and when the courts will ultimately rule on the new health system. Much depends on the details and the extent to which reasonable and practical private alternatives to the national plan remain. In crafting the law, however, its White House and congressional sponsors must keep privacy -- that near absolute right to personal autonomy they have so often praised and promoted -- squarely before them. The only thing that is certain today is that the courts, and not Congress, will have the last word.
Sunday, June 21, 2009
Yes, We Can Expand Access to Higher Ed
Yes, We Can Expand Access to Higher Ed. By PETER MCPHERSON and DAVID SHULENBURGER
More college degrees will be good for the economy.
The Wall Street Journal, Jun 20, 2009, p A11
For generations, the United States has led the world in higher education. But today the U.S. has fallen to ninth in the proportion of young adults (age 25-34) who attain college degrees among the countries belonging to the Organization for Economic Cooperation and Development. In Japan, Korea and Canada, more than 50% of young adults hold college degrees. Only 41% do in the United States. The question is: Should we do more?
Our nation's economic future depends on it. Our educational advantage made us the world's leader in discovery, invention and innovation. Our labor force has been able to perform better and receive higher wages because of its intellectual capital. But as that capital lags behind that of its competitors, our country's prominence is at risk.
The bottom line is that education affects economics. The more educated a work force is the more value it adds to society. We can chart this by looking at the way income levels vary with educational degrees. Since 1980, the gap between the earnings of those with bachelor's degrees and those with just high-school diplomas has widened. The ratio between the median earnings of men with the former and men with the latter grew to 1.99 in 2007 from 1.43 in 1980.
In today's harsh economy, there is a strong correlation between education and employment. In May 2009, those with bachelor's degrees have an unemployment rate of 4.8%; associate's degree, 7.7%; high-school degree, 10.0%; and less than high-school degree, 15.5%.
Given the impact education has on the economy, the U.S should set a goal of college degrees for at least 55% of its young adults by 2025. This is in line with President Barack Obama's statement that "by 2020, America will once again have the highest proportion of college graduates in the world." This goal would require graduating an additional 875,000 students per year -- a 42% increase of people with at least an associate's or bachelor's degree.
History suggests higher education can meet this goal within the next 15 years. In the 15 years following World War II, post-secondary enrollment expanded by 82%. And in the baby-boomer period of 1962-76, enrollment expanded by a whopping 174%.
The path we foresee resembles what happened during the baby-boomer period. Then, in the heat of the Cold War, the imperative to make technological progress led the nation's universities to expand. As the nation's youth came to understand that they needed more education, the government made education a priority. The sobering lessons from the current economic situation could contribute to a similar pattern of thought and action.
We propose to: 1) enroll a higher percentage of high-school graduates, now 64%; 2) increase the number of adults returning to college; and 3) increase college graduation rates while maintaining educational quality.
To realize these goals, the historic partnership between higher education and the state and the federal government should be re-established. It is the only way that this country will increase its number of degree holders by 42%, a task that will obviously require more resources than public universities and colleges currently have.
The administration and Congress have taken the first steps to expand the number of degree holders, including increasing Pell Grant funding and GI educational benefits. These steps will help more low- and middle-income students attend college.
Figures suggest that the goal is attainable and important for the competitiveness of our people and country. Though some states are currently cutting funding to education, higher education needs help now. Our goal should not wait for better times.
Mr. McPherson, former chairman of Dow Jones & Company, is president of the Association of Public and Land-grant Universities, where Mr. Shulenburger is vice president.
More college degrees will be good for the economy.
The Wall Street Journal, Jun 20, 2009, p A11
For generations, the United States has led the world in higher education. But today the U.S. has fallen to ninth in the proportion of young adults (age 25-34) who attain college degrees among the countries belonging to the Organization for Economic Cooperation and Development. In Japan, Korea and Canada, more than 50% of young adults hold college degrees. Only 41% do in the United States. The question is: Should we do more?
Our nation's economic future depends on it. Our educational advantage made us the world's leader in discovery, invention and innovation. Our labor force has been able to perform better and receive higher wages because of its intellectual capital. But as that capital lags behind that of its competitors, our country's prominence is at risk.
The bottom line is that education affects economics. The more educated a work force is the more value it adds to society. We can chart this by looking at the way income levels vary with educational degrees. Since 1980, the gap between the earnings of those with bachelor's degrees and those with just high-school diplomas has widened. The ratio between the median earnings of men with the former and men with the latter grew to 1.99 in 2007 from 1.43 in 1980.
In today's harsh economy, there is a strong correlation between education and employment. In May 2009, those with bachelor's degrees have an unemployment rate of 4.8%; associate's degree, 7.7%; high-school degree, 10.0%; and less than high-school degree, 15.5%.
Given the impact education has on the economy, the U.S should set a goal of college degrees for at least 55% of its young adults by 2025. This is in line with President Barack Obama's statement that "by 2020, America will once again have the highest proportion of college graduates in the world." This goal would require graduating an additional 875,000 students per year -- a 42% increase of people with at least an associate's or bachelor's degree.
History suggests higher education can meet this goal within the next 15 years. In the 15 years following World War II, post-secondary enrollment expanded by 82%. And in the baby-boomer period of 1962-76, enrollment expanded by a whopping 174%.
The path we foresee resembles what happened during the baby-boomer period. Then, in the heat of the Cold War, the imperative to make technological progress led the nation's universities to expand. As the nation's youth came to understand that they needed more education, the government made education a priority. The sobering lessons from the current economic situation could contribute to a similar pattern of thought and action.
We propose to: 1) enroll a higher percentage of high-school graduates, now 64%; 2) increase the number of adults returning to college; and 3) increase college graduation rates while maintaining educational quality.
To realize these goals, the historic partnership between higher education and the state and the federal government should be re-established. It is the only way that this country will increase its number of degree holders by 42%, a task that will obviously require more resources than public universities and colleges currently have.
The administration and Congress have taken the first steps to expand the number of degree holders, including increasing Pell Grant funding and GI educational benefits. These steps will help more low- and middle-income students attend college.
Figures suggest that the goal is attainable and important for the competitiveness of our people and country. Though some states are currently cutting funding to education, higher education needs help now. Our goal should not wait for better times.
Mr. McPherson, former chairman of Dow Jones & Company, is president of the Association of Public and Land-grant Universities, where Mr. Shulenburger is vice president.
Our revolutionary leaders wanted the best from their children
Founding Fathers. By Barbara Dafoe Whitehead
Our revolutionary leaders wanted the best from their children.
The Wall Street Journal, June 20, 2009, p A13
Barack Obama is a doting father who says that one of the greatest pleasures of his presidency is eating dinner with his daughters on the nights when he is in town.
Some of the nation's Founding Fathers were not so lucky. Doting dads though they were, patriotic service forced them to live apart from their families for years at a time. Benjamin Franklin, John Adams and Thomas Jefferson, the three Founders who spent the most time abroad, missed milestone events. Franklin was a no-show at his daughter's wedding and his wife's funeral. Adams was in Philadelphia when his wife, Abigail, gave birth to a stillborn daughter. While in France, Jefferson received word that his 2-year-old daughter had died of whooping cough. The news came seven months after her funeral.
Trans-Atlantic separations proved too painful to bear. Whenever possible, the Founders took their children with them or sent for the children once they had established a household abroad. John Adams set off on his maiden voyage to England accompanied by his 9-year-old son, John Quincy. On a second crossing he brought along sons John Quincy and Charles. His teenage daughter, Abigail, arrived in France with her mother a few years later. Benjamin Franklin's son, William, and his two grandsons, Temple Franklin and Benny Bache, were part of the Franklin overseas ménage at various times. A new widower, Jefferson took his elder daughter, Patsy, along with him on his diplomatic mission to France and later sent for his younger daughter, Polly.
The children were not always thrilled to go. Charles Adams sobbed inconsolably as he boarded the ship with his father. Eight-year-old Polly begged her father to let her remain at home in Virginia with her beloved aunt: "I am very sorry you sent for me," she bravely wrote. "I don't want to go to France." Still she went, accompanied on the journey by a 14-year-old babysitter named Sally Hemings. Upon arrival in London, the homesick girl spent the next month in the temporary care of Abigail Adams until her father sent a French-speaking manservant to fetch her. Abigail pointedly reminded Jefferson that the experience was traumatic for the child who, once again, was faced with separation from a mother figure and sent off to live with a father she did not know.
Nor was the arrangement a piece of cake for their fathers. In addition to the all-consuming diplomatic responsibilities of winning allies and funders for the Revolution, these lone fathers had to raise Revolutionary Kids. Chief among their responsibilities was securing an elite European education for their young offspring while protecting them from the temptations and dissipations of living abroad. The Founders' children and grandchildren kept company with an aristocratic power elite, savored Continental fads and fashions, and learned to speak fluent French.
It was all too easy, their fathers worried, for the Revolutionary Kids to abandon the republican virtues of industry and frugality and, even worse, to lose their native language. "It is a mortification to me," John Adams wrote to John Quincy, "that you write better in a foreign language than in your mother tongue."
To protect their children from corrupting influences, therefore, the Founding Fathers had to part with them again. Franklin dispatched his 9-year-old grandson, Benny Bache, to school in Switzerland for five years. The Adams sons attended schools in Holland. The Jefferson daughters were placed in a convent in Paris.
Yet no matter how devoted, the Founding Fathers were not inclined, as today's parents are, to lavish their students with praise. "Good job" was not in their vocabulary. "Take care you never spell a word wrong," Jefferson admonished his younger daughter. "Remember too . . . not to go out without your bonnet because it will make you very ugly and then we should not love you so much."
Nor did the Founding Fathers leave it up to their children to "make good choices." Instead, they moralized endlessly on the perils of indolence, time-wasting and thriftlessness. Jefferson reproved Patsy: "If at any moment, my dear, you catch yourself in idleness, start from it as you would from the precipice of a gulph." John Adams lectured John Quincy, hardly a slouch of a student, to "lose no Time. There is not a moral Percept of clearer Obligation or of greater Import."
When Benny Bache asked his grandfather for a gold watch, Franklin responded tartly: "You should remember that I am at a great Expence for your education . . . and you should not tease me for things that can be of little or no Service to you."
Even the profligate Thomas Jefferson embraced the virtue of frugality. When Patsy appealed for extra money, her father refused: "The rule I wish to see you governed by is of never buying anything which you have not money in your pocket to pay for. Be assured that it gives much more pain to the mind to be in debt, than to do without any article whatever which we may seem to want."
Judged by today's psychological standards, these 18th century fathers sound harsh and unfeeling. Yet to see the Founding Fathers as flesh-and-blood dads, to glimpse their struggles to rear their children at a time of grave uncertainty and peril, is to appreciate their service and sacrifice anew. Founding a nation meant more than winning a war. It also called upon the nation's Founders to pass on the passion for freedom, educational excellence and civic virtue to their children and grandchildren.
John Adams said it best in a letter to Abigail: "The education of our children is never out of my Mind . . . Fire them with Ambition to be useful and make them disdain to be destitute of any useful or ornamental knowledge or accomplishment. Fix their Ambition upon great and solid objects."
Ms. Whitehead is director of the John Templeton Center for Thrift and Generosity at the Institute for American Values and co-editor of "Franklin's Thrift: The Lost History of a American Virtue," just published by Templeton Press.
Our revolutionary leaders wanted the best from their children.
The Wall Street Journal, June 20, 2009, p A13
Barack Obama is a doting father who says that one of the greatest pleasures of his presidency is eating dinner with his daughters on the nights when he is in town.
Some of the nation's Founding Fathers were not so lucky. Doting dads though they were, patriotic service forced them to live apart from their families for years at a time. Benjamin Franklin, John Adams and Thomas Jefferson, the three Founders who spent the most time abroad, missed milestone events. Franklin was a no-show at his daughter's wedding and his wife's funeral. Adams was in Philadelphia when his wife, Abigail, gave birth to a stillborn daughter. While in France, Jefferson received word that his 2-year-old daughter had died of whooping cough. The news came seven months after her funeral.
Trans-Atlantic separations proved too painful to bear. Whenever possible, the Founders took their children with them or sent for the children once they had established a household abroad. John Adams set off on his maiden voyage to England accompanied by his 9-year-old son, John Quincy. On a second crossing he brought along sons John Quincy and Charles. His teenage daughter, Abigail, arrived in France with her mother a few years later. Benjamin Franklin's son, William, and his two grandsons, Temple Franklin and Benny Bache, were part of the Franklin overseas ménage at various times. A new widower, Jefferson took his elder daughter, Patsy, along with him on his diplomatic mission to France and later sent for his younger daughter, Polly.
The children were not always thrilled to go. Charles Adams sobbed inconsolably as he boarded the ship with his father. Eight-year-old Polly begged her father to let her remain at home in Virginia with her beloved aunt: "I am very sorry you sent for me," she bravely wrote. "I don't want to go to France." Still she went, accompanied on the journey by a 14-year-old babysitter named Sally Hemings. Upon arrival in London, the homesick girl spent the next month in the temporary care of Abigail Adams until her father sent a French-speaking manservant to fetch her. Abigail pointedly reminded Jefferson that the experience was traumatic for the child who, once again, was faced with separation from a mother figure and sent off to live with a father she did not know.
Nor was the arrangement a piece of cake for their fathers. In addition to the all-consuming diplomatic responsibilities of winning allies and funders for the Revolution, these lone fathers had to raise Revolutionary Kids. Chief among their responsibilities was securing an elite European education for their young offspring while protecting them from the temptations and dissipations of living abroad. The Founders' children and grandchildren kept company with an aristocratic power elite, savored Continental fads and fashions, and learned to speak fluent French.
It was all too easy, their fathers worried, for the Revolutionary Kids to abandon the republican virtues of industry and frugality and, even worse, to lose their native language. "It is a mortification to me," John Adams wrote to John Quincy, "that you write better in a foreign language than in your mother tongue."
To protect their children from corrupting influences, therefore, the Founding Fathers had to part with them again. Franklin dispatched his 9-year-old grandson, Benny Bache, to school in Switzerland for five years. The Adams sons attended schools in Holland. The Jefferson daughters were placed in a convent in Paris.
Yet no matter how devoted, the Founding Fathers were not inclined, as today's parents are, to lavish their students with praise. "Good job" was not in their vocabulary. "Take care you never spell a word wrong," Jefferson admonished his younger daughter. "Remember too . . . not to go out without your bonnet because it will make you very ugly and then we should not love you so much."
Nor did the Founding Fathers leave it up to their children to "make good choices." Instead, they moralized endlessly on the perils of indolence, time-wasting and thriftlessness. Jefferson reproved Patsy: "If at any moment, my dear, you catch yourself in idleness, start from it as you would from the precipice of a gulph." John Adams lectured John Quincy, hardly a slouch of a student, to "lose no Time. There is not a moral Percept of clearer Obligation or of greater Import."
When Benny Bache asked his grandfather for a gold watch, Franklin responded tartly: "You should remember that I am at a great Expence for your education . . . and you should not tease me for things that can be of little or no Service to you."
Even the profligate Thomas Jefferson embraced the virtue of frugality. When Patsy appealed for extra money, her father refused: "The rule I wish to see you governed by is of never buying anything which you have not money in your pocket to pay for. Be assured that it gives much more pain to the mind to be in debt, than to do without any article whatever which we may seem to want."
Judged by today's psychological standards, these 18th century fathers sound harsh and unfeeling. Yet to see the Founding Fathers as flesh-and-blood dads, to glimpse their struggles to rear their children at a time of grave uncertainty and peril, is to appreciate their service and sacrifice anew. Founding a nation meant more than winning a war. It also called upon the nation's Founders to pass on the passion for freedom, educational excellence and civic virtue to their children and grandchildren.
John Adams said it best in a letter to Abigail: "The education of our children is never out of my Mind . . . Fire them with Ambition to be useful and make them disdain to be destitute of any useful or ornamental knowledge or accomplishment. Fix their Ambition upon great and solid objects."
Ms. Whitehead is director of the John Templeton Center for Thrift and Generosity at the Institute for American Values and co-editor of "Franklin's Thrift: The Lost History of a American Virtue," just published by Templeton Press.
A warning from Copenhagen
A warning from Copenhagen. By stefan
Real Climate, Jun 21, 2009
In March the biggest climate conference of the year took place in Copenhagen: 2500 participants from 80 countries, 1400 scientific presentations. Last week, the Synthesis Report of the Copenhagen Congress was handed over to the Danish Prime Minister Rasmussen in Brussels. Denmark will host the decisive round of negotiations on the new climate protection agreement this coming December.
The climate congress was organised by a "star alliance" of research universities: Copenhagen, Yale, Berkeley, Oxford, Cambridge, Tokyo, Beijing - to name a few. The Synthesis Report is the most important update of climate science since the 2007 IPCC report.
So what does it say? Our regular readers will hardly be surprised by the key findings from physical climate science, most of which we have already discussed here. Some aspects of climate change are progressing faster than was expected a few years ago - such as rising sea levels, the increase of heat stored in the ocean and the shrinking Arctic sea ice. "The updated estimates of the future global mean sea level rise are about double the IPCC projections from 2007″, says the new report. And it points out that any warming caused will be virtually irreversible for at least a thousand years - because of the long residence time of CO2 in the atmosphere.
Perhaps more interestingly, the congress also brought together economists and social scientists researching the consequences of climate change and analysing possible solutions. Here, the report emphasizes once again that a warming beyond 2ºC is a dangerous thing:
Temperature rises above 2ºC will be difficult for contemporary societies to cope with, and are likely to cause major societal and environmental disruptions through the rest of the century and beyond.
(Incidentally, by now 124 nations have officially declared their support for the goal of limiting warming to 2ºC or less, including the EU - but unfortunately not yet the US.)
Some media representatives got confused over whether this 2ºC-guardrail can still be met. The report's answer is a clear yes - if rapid and decisive action is taken:
The conclusion from both the IPCC and later analyses is simple - immediate and dramatic emission reductions of all greenhouse gases are needed if the 2ºC guardrail is to be respected.
Cause of the confusion was apparently that the report finds that it is inevitable by now that greenhouse gas concentrations in the atmosphere will overshoot the future stabilization level that would keep us below 2ºC warming. But this overshooting of greenhouse gas concentrations need not lead temperatures to overshoot the 2ºC mark, provided it is only temporary. It is like a pot of water on the stove - assume we set it to a small flame which will make the temperature in the pot gradually rise up to 70ºC and then no further. Currently, the water is at 40ºC. When I turn up the flame for a minute and then back down, this does not mean the water temperature will exceed 70ºC, due to the inertia in the system. So it is with climate - the inertia here is in the heat capacity of the oceans.
From a natural science perspective, nothing stops us from limiting warming to 2ºC. Even from an economic and technological point of view this is entirely feasible, as the report clearly shows. The ball is squarely in the field of politics, where in December in Copenhagen the crucial decisions must be taken. The synthesis report puts it like this: Inaction is inexcusable.
Related links
Press release of PIK about the release of the synthesis report
Copenhagen Climate Congress - with webcasts of the plenary lectures (link on bottom right - my talk is in the opening session part 2, just after IPCC chairman Pachauri)
Nobel Laureate Meeting in London - a high caliber gathering in May that agreed on a remarkable memorandum which calls for immediate policy intervention: "We know what needs to be done. We can not wait until it is too late." The new U.S. Energy Secretary Steven Chu participated over the full three days in the scientific discussions - how many politicians would have done that?
Real Climate, Jun 21, 2009
In March the biggest climate conference of the year took place in Copenhagen: 2500 participants from 80 countries, 1400 scientific presentations. Last week, the Synthesis Report of the Copenhagen Congress was handed over to the Danish Prime Minister Rasmussen in Brussels. Denmark will host the decisive round of negotiations on the new climate protection agreement this coming December.
The climate congress was organised by a "star alliance" of research universities: Copenhagen, Yale, Berkeley, Oxford, Cambridge, Tokyo, Beijing - to name a few. The Synthesis Report is the most important update of climate science since the 2007 IPCC report.
So what does it say? Our regular readers will hardly be surprised by the key findings from physical climate science, most of which we have already discussed here. Some aspects of climate change are progressing faster than was expected a few years ago - such as rising sea levels, the increase of heat stored in the ocean and the shrinking Arctic sea ice. "The updated estimates of the future global mean sea level rise are about double the IPCC projections from 2007″, says the new report. And it points out that any warming caused will be virtually irreversible for at least a thousand years - because of the long residence time of CO2 in the atmosphere.
Perhaps more interestingly, the congress also brought together economists and social scientists researching the consequences of climate change and analysing possible solutions. Here, the report emphasizes once again that a warming beyond 2ºC is a dangerous thing:
Temperature rises above 2ºC will be difficult for contemporary societies to cope with, and are likely to cause major societal and environmental disruptions through the rest of the century and beyond.
(Incidentally, by now 124 nations have officially declared their support for the goal of limiting warming to 2ºC or less, including the EU - but unfortunately not yet the US.)
Some media representatives got confused over whether this 2ºC-guardrail can still be met. The report's answer is a clear yes - if rapid and decisive action is taken:
The conclusion from both the IPCC and later analyses is simple - immediate and dramatic emission reductions of all greenhouse gases are needed if the 2ºC guardrail is to be respected.
Cause of the confusion was apparently that the report finds that it is inevitable by now that greenhouse gas concentrations in the atmosphere will overshoot the future stabilization level that would keep us below 2ºC warming. But this overshooting of greenhouse gas concentrations need not lead temperatures to overshoot the 2ºC mark, provided it is only temporary. It is like a pot of water on the stove - assume we set it to a small flame which will make the temperature in the pot gradually rise up to 70ºC and then no further. Currently, the water is at 40ºC. When I turn up the flame for a minute and then back down, this does not mean the water temperature will exceed 70ºC, due to the inertia in the system. So it is with climate - the inertia here is in the heat capacity of the oceans.
From a natural science perspective, nothing stops us from limiting warming to 2ºC. Even from an economic and technological point of view this is entirely feasible, as the report clearly shows. The ball is squarely in the field of politics, where in December in Copenhagen the crucial decisions must be taken. The synthesis report puts it like this: Inaction is inexcusable.
Related links
Press release of PIK about the release of the synthesis report
Copenhagen Climate Congress - with webcasts of the plenary lectures (link on bottom right - my talk is in the opening session part 2, just after IPCC chairman Pachauri)
Nobel Laureate Meeting in London - a high caliber gathering in May that agreed on a remarkable memorandum which calls for immediate policy intervention: "We know what needs to be done. We can not wait until it is too late." The new U.S. Energy Secretary Steven Chu participated over the full three days in the scientific discussions - how many politicians would have done that?
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