Friday, September 26, 2008

McCain's Big Freeze

I was struck by McCain's supposedly "bold" budget proposal to freeze non-entitlement, non-defense program spending (entitlement programs are Social Security and Medicare - and some people include Medicaid in the count, but that's not as important because Medicaid isn't nearly as big as Social Security or Medicare). WOW! What a bold plan! Let's talk a little about this "bold plan"...

Social Security and Medicare are called "entitlement programs" because once you reach age 65 you have the right to claim them. Your age is your eligibility (of course in the case of Social Security you also have to have paid into it for a certain amount of time, but it is guaranteed to everyone that paid into it). Since these programs are guaranteed, and since people are living longer, healthier lives in the United States than they used to, spending growth in these programs has been tremendous since they began. The future growth in these programs is going to dwarf even the growth to date with the retirement of the baby-boomers.

Defense spending growth hasn't been quite as continuous as entitlement program spending; it went down significantly after the Cold War in the 1990's, but obviously it makes up a nice chunk of our budget now with the War on Terror and the Iraq War.

The other thing that's grown significantly for the last several decades has been interest payments on the national debt. That's right guys, we aren't just indebted to our East Asian creditors - we need to pay them interest on top of the principle just like any other debtor. So all though McCain didn't mention it, I'll throw interest payments in, because my guess is that either Obama or McCain would cut entitlements or defense before they stop paying the interest on our debt (the world has enough doubts about our solvency... don't want to cause any more jitters)!

So, when you take all that out of the budget you have two things: what the CBO calls "other mandatory spending," and "discretionary spending". Discretionary spending includes everything from good old fashioned "bridge to nowhere" pork, to child care subsidies, to the National Science Foundation budget. That's where McCain proposes the spending freeze.

Unfortunately for McCain, he's not being as bold as he thinks he is! Non-defense, non-entitlement, non-interest payment spending has been essentially frozen for YEARS because growth in these programs has been crowded out by the growth in defense, entitlement, and interest spending! Take a look at the chart from the GAO, below, and you'll see what I mean:

OK - this is REALLY hard to see, I know - but the white bar at the top is non-entitlement spending (I believe it actually includes defense in this case!). The red, blue, and green bars are interest payments, Medicare, Medicaid, and Social Security. The dashed line is projected government revenues, and the scale for this is spending as a % of GDP. Terrible picture, I know - I tried to find a better one. But I think it illustrates my point: because of the growth in defense, entitlement, and interest spending there has been no growth in other spending anyway! The freeze is already here! In many programs, spending has actually declined already.

The way to solve our long-term fiscal problem is to cut exactly what McCain proposes to let go: defense, entitlements, and interest... and we really don't have many options even there:

Defense: I'm not too excited about the prospect of cutting defense spending. Bringing a safe and responsible conclusion to the Iraq War will certainly save some money, but I agree with Obama that we're just going to have to move at least a portion of that war effort to Afghanistan. In addition, we need to reinvest in our equipment and defense infrastructure that has been worn down by Iraq, AND we need to provide a higher quality system to serve the veterans that will be returning. So I don't see much prospect of reducing defense spending, and I don't think anybody else does.

Interest: Talking about interest is easy. There are only two things to remember: first, we have to pay it - there's no choice involved. Second, the only way to reduce it is to reduce the debt. Period. [Not entirely true... we could always have our mints crank out currency which will reduce the value of our currency... then we can pay them back in worthless bills. But I don't think we want to go this route!]

Entitlements: The 800 pound gorilla in the room. The fact is, we need to cut entitlement spending or raise entitlement taxes. This isn't a debating point, it is quite simply the only way to regain fiscal responsibility. I've worked with Robert Reischauer, one of the biggest budget wonks out there, for the last two years and through him I've met lots of other big budget wonks. Doesn't matter what party they're associated with, they all agree - the solution to the budget problem is dealing with entitlement spending. Nobody owned up to this in the debate, which was telling about how hard it's going to be. Obama did mention one part of Medicare that could be cut - the Medicare Advantage "subsidy". Ever since 1997, Medicare beneficiaries have had the option of enrolling in privately administered Medicare plans, known as "Medicare Advantage". Fine - the idea was to harness the competitiveness of the private market... I can buy that. The problem is, the government ends up paying around 15% more for those plans than they do for "regular" Medicare plans. That's great - cutting that subsidy to the level of other Medicare plans and making beneficiaries pay the difference if they still want the private insurance sounds like a smart idea to me.

The problem is, even Obama didn't demand fundamental reform. I'm NOT an expert on entitlement programs, but even I could suggest:

- First and foremost, freezing physician payments which is one of the fastest growing components of Medicare.

- Raise the eligibility age for both programs

- Eliminate the FICA tax cap. I'm not sure exactly what it is now, but it's somewhere around $100,000. You have to pay something like 7.5% of your taxable income into Social Security up to $100,000 right now. After $100,000, your income isn't taxed!!! Why is this? This means that the rich actually pay a LOWER tax rate than the poor when it comes to Social Security! Now, I know there are legitimate ethical cases against a progressive income tax... but who in their right minds supports a REGRESSIVE tax??? Raising or eliminating this cap would help things out.

- Cut benefits. Yes - my specific suggestions and expertise end here, and I have to offer the non-descript "cut benefits". Someone more familiar with the program than I can get into the specifics.

We can do this - we need to have the strength to take on the entitlement programs. That will make substantially more difference than any pork-cutting programs that McCain and Obama propose. Nobody embraced this, although Obama made it clear that he was open to reducing some entitlements. I hope he's just holding his tongue because saying "I'm going to cut Social Security" would be the kiss of death on the campaign trail. Perhaps he'll be more energetic on this front than he lead on. But don't be fooled by that little discussion they had on the budget... McCain wasn't being bold at all - he was essentially describing the status quo. And Obama didn't offer a whole lot either.

Krugman's insights on the crisis...

I'm cutting and pasting a Paul Krugman post in it's entirety, because I think it's scary and insightful. I don't buy all his criticisms of Republicans, but nevertheless this is a good summary of the current impasse (which I would blame on Republicans... at least a faction of them):

"A few more thoughts about the incredible scene described in today’s Times (great reporting, by the way):

In the Roosevelt Room after the session, the Treasury secretary, Henry M. Paulson Jr., literally bent down on one knee as he pleaded with Nancy Pelosi, the House Speaker, not to “blow it up” by withdrawing her party’s support for the package over what Ms. Pelosi derided as a Republican betrayal.

“I didn’t know you were Catholic,” Ms. Pelosi said, a wry reference to Mr.
Paulson’s kneeling, according to someone who observed the exchange. She went on:
“It’s not me blowing this up, it’s the Republicans.”

Mr. Paulson sighed. “I know. I know.”

How did we get to this point? It’s the culmination of many past betrayals. First of all, we have the Republican Study Committee blowing things up with a complete nonsense proposal — solving the crisis with a holiday on capital gains taxes. How is that possible? Well, if a party runs on economic nonsense for 25 years, eventually many of its foot soldiers will be people who actually believe the nonsense.

More specifically, though, the failure to get a deal reflects the betrayals of the Bush years. Democrats weren’t going to trust Henry Paulson, because behind him they see the ghost of Colin Powell (and Paulson’s “all your bailout are belong to me” proposal, aside from being bad economics, showed an incredible tone-deafness.)

And after the way the Bushies and their allies double-crossed the Democrats again and again in the aftermath of 9/11 — demand national unity, then accuse you of being soft on terrorists anyway — there’s no way Pelosi and Reed will do the responsible but unpopular thing unless the Republicans agree to share ownership.

So what we now have is non-functional government in the face of a major crisis, because Congress includes a quorum of crazies and nobody trusts the White House an inch.

As a friend said last night, we’ve become a banana republic with nukes."


Holey moley - it's the end of an era!

Japan posts a trade deficit... the first in 26 years!

You have to choose...

The last two weeks, I've been frustrated with people (mostly Democrats, honestly) who insist that we have to punish Wall Street execs and help homeowners in this legislation. Steve Pearlstein of the Washington Post sums up my thoughts on this perfectly this morning:

"You can try to prevent a financial meltdown or you can teach Wall Street a lesson, but you can't do both at the same time. So which will it be?"

We need to understand that there are two problems we're dealing with right now -

1. The first is that NOBODY is willing to lend money to anybody else, because they have no clue how much their assets are worth and they have no clue how reliable borrowers are. Wall Street is a deer caught in the headlights, unable to move right now - and when that happens money doesn't get pumped through our economy, with consequences potentially as disastrous as blood not pumping through the human body.

2. The second problem, of course, is the irresponsible lending habits of those Wall Street firms and the irresponsible borrowing habits of many American consumers that got us here in the first place. Contrary to popular belief, banks didn't "trick people" into getting mortgages they can't afford any more than homeowners tricked the banks into lending to them! Nobody tricked anybody and everybody cut corners.

The solution to the first problem is for the government to pump an unprecedented amount of money into the bloodstream of the American economy and do something to relieve fears of these "mortgage backed securities". The solution to the second problem is to withhold money from the economy and let the banks deal with their own mortgage backed securities and reap what they sow.

In other words, THE SOLUTIONS TO THE TWO PROBLEMS ARE DIAMETRICALLY OPPOSED TO EACH OTHER!!!! If House Republicans or sheepish Democrats want to focus on the second problem, we should just pass this legislation without them, because there is no way to achieve both objectives in the same piece of legislation.

That's not to say we should never deal with the second problem - we absolutely should. But the second problem has been with us for months now, and it will be with us for months even if we get through this current crisis. We need to deal with it later - through aid to homeowners, FBI investigations, greater regulation insuring transparency, etc... but LATER. For the time being, we should get rid of these so called "golden parachutes" to the extent that we can and lock up the big-time execs if they did anything illegal. But it makes no sense to make the banks themselves suffer at the same time that we try to help the banks. If you're a parent and your kid gets himself into a dangerous situation, the first thing you do is extract him from that dangerous situation, and only after he's safe do you light into him about how stupid it was to do that. Same principle applies here.
Obama has already shown an acknowledgement of this, which I like a lot. Part of the proposed legislation that Democrats were pushing for is to allow bankruptcy judges to renegotiate the terms of mortgages for homeowners going into default. The banking industry howled at that proposal, Democrats insisted on it... Obama said that it was absolutely inappropriate right now because the immediate problem is saving the banking industry, not tying their hands behind their backs.

Thursday, September 25, 2008


David Ignatius has a great article in the post on what Keynes would do to respond to the financial crisis. Of course, he doesn't give any specific Keynesian policy suggestions, but he does outline why considering issues of liquidity preference, animal spirits, and investor psychology trumps Friedmanesque quantity theory of money logic at a time like this.

To his analysis, I only want to add a quote from The General Theory itself:

"For my own part I am now somewhat skeptical of the success of a merely monetary policy directed towards influencing the rate of interest. I expect to see the State, which is in a position to calculate the marginal efficiency of capital goods on long views and on the basis of the general social advantage, taking an even greater responsibility for directly organizing investment; since it seems likely that the fluctuations in the market estimation of the marginal efficiency of different types of capital, calculated on the principles I have described above, will be too great to be offset by any practicable changes in the rate of interest."
Interestingly enough, one of Keynes's biggest champions today - Paul Krugman - has been quite skeptical this week about the state's ability to do exactly what Keynes thinks it can do - provide a better estimate of the "marginal efficiency of capital" than the market. I think Krugman's concerns have been overblown, though. He knows like everyone else that these assets are underpriced now. Krugman isn't worried that the state can't properly price the assets... he's worried that if they do properly price them they'll end up forking over a bunch of money to the banks with no strings attached.

Wednesday, September 24, 2008

McCain Transparency

It seems to me that all these things McCain has been pulling:

1. Outrage that Obama called Palin a "pig"
2. Accusing Obama of wanting to raise taxes on working Americans
3. Promoting Palin as someone who "said no to the bridge to nowhere"

and most recently...

4. Dumping Friday's debate to rush to Washington to deal with the financial crisis

are completely insincere and to me completely transparent. I understand that campaigns stretch the truth sometimes... Obama does that when he talks about McCain wanting to stay in Iraq "for 100 years". And there are other instances where McCain simply stretches the truth rather than promoting outright lies. But also prominent in the McCain campaign have been these instances where you just have to think "how can McCain SAY THAT and keep a straight face? There's no way even HE could believe that!"

Am I just being paranoid here? Am I just being cynical? Or is this stuff really as transparent as it appears to be to me?

Such a shame... I've always liked the guy, but there have been SO MANY cheap shots lately. I'm glad Obama said the debate should go on, and that he didn't just cave into McCain's ridiculousness.

Of course we need to work out a solution to this crisis... but that's not a free pass to get you out of a debate.

Alternatives to the $700B Paulson-Bernanke Fund

The Washington Post presents a good summary of other solutions to the Wall Street crisis that have been proposed by economists. This is refreshing. I've confessed my ignorance of what to do before on this blog, but I feel like I know enough to acknowledge a good proposal when I hear one - and I liked all of these (just couldn't come up with them myself!). I especially like the idea of an investment fund that the Post suggests. It's the most similar to the Bush plan, which the president should like. It can be a permanent fixture to help in future crises like this (and issue that Sen. Bayh made a big deal about in yesterday's Senate hearing), and it injects capital without letting banks off the hook for bad loans. Now, that of course opens the possibility that bank failures won't stop with this investment fund - but they should hurt the economy less (I believe that's the right way to think about it...).
In other news, I think Paul Krugman volunteered to be Obama's Treasury Secretary today... still a little hazy on that one.
A Washington Post-ABC poll gives Obama a 9 point lead among likely voters, but because of the Electoral College system, I'm not sure how that translates into his actual changes. The race remains close in several very important states.
One race that is not close is the Virginia Senate race, where Warner leads Gilmore by 30 points!

Sunday, September 21, 2008

Krugman on the bailout

I'm no finance economist, so in the last two weeks I've been left with reading what other experts have been writing, nodding my head "that sounds right," or shaking my head "that sounds wrong," without too much creative, original thought. I'll continue that tradition today and reference a good post by Paul Krugman - world renowned Princeton trade economist and regular New York Times colmunist.

My response to the bailout has been "yes - we need to put a stop to this cascade of bank failures" - but other than that I haven't really been able to comment intelligently. Krugman does a better job than that, so I'll let him enlighten you today.