Category Archives: Financial Crises

Tyler Cowen on Wealth Taxes

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He writes,

The coming battles over wealth taxation may prove especially bitter and polarizing. Most wealth has already been subjected to income and other taxes, perhaps multiple times. It doesn’t seem fair to the holders of that wealth to suddenly pay additional taxes on assets that they thought were in the clear, and such taxes would signal that previous policy has failed.

Read the whole thing. Almost five years ago, I wrote,

That leaves the option of declaring a national emergency and enacting what is known as a wealth tax or a capital levy. The idea is you undertake a one-time confiscation of assets and promise never to do it again. You hope that this has zero adverse incentive effects but brings in a boatload of money.

Taking Care of Elderly Parents

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Timothy Taylor writes,

Some other high-income countries have government programs to pay for long-term care. Not surprisingly, they spend a substantially greater share of GDP on long-term than does the U.S. In any event, the long-term U.S. budget picture is grim enough that adding another entitlement for the elderly isn’t likely.

As usual, he has useful links, primarily a CBO study.

I have a vision of the year 2025 in which the difference between the rich and everyone else is that the rich can afford to send their children to private schools, pay full fare for the children’s college education, and pay for their own parents’ long-term care. Everyone else will depend on public schools, community colleges and scholarships, and government-provided nursing homes. Otherwise, the lifestyles of the rich and the non-rich will look pretty similar.

Fertility to Increase?

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That is the prediction of Jason Collins.

As those with higher fertility are selected for, the “high-fertility” genotypes are expected to come to dominate the population, causing the fertility rate to return to its pre-shock level. We show that even with relatively low levels of genetically based variation in fertility, there can be a rapid return to a high-fertility state, with recovery to above-replacement levels usually occurring within a few generations. In the longer term, this implies that the proportion of elderly in the population will be lower than projected, reducing the fiscal burden of ageing on developed world governments.

James Hamilton on the Government (off-) Balance Sheet, and me on Scenario Analysis

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He writes,

Adding all the offbalance-sheet liabilities together, I calculate total federal off-balance-sheet commitments came to $70.1 T as of 2012, or about 6 times the size of the on-balance-sheet debt. In other words, the budget impact associated with an aging population and other challenges could turn out to have much more significant fiscal consequences than even the mountain of on-balance-sheet debt already accumulated.

When Hamilton presented this paper a several weeks ago at Cato, Bob Hall and I had exactly the same reaction. The off-balance-sheet liabilities are contingent liabilities. They often take the form of out-of-the-money options. Think of the Pension Benefit Guaranty Corporation. In some states of the world, it will lose a lot of money, and in other states it will break even or make a profit. To report just one number seems uninformative. The same holds for the government’s portfolio and guarantees of mortgages and mortgage-backed securities. The problem cries out for scenario analysis, in which you present possible values for the key drivers (such as interest rates) and possible outcomes (for, say, the ten-year budget outlook).

This led to a testy exchange between me and Douglas Holtz-Eakin, who insisted that Congress wants a single number. It so happened that a couple of weeks ago I was scheduled to give an informal talk at the Congressional Budget Office (which Holtz-Eakin once headed) on a topic of my choice. I chose the topic of scenario analysis.

I said that for the purpose of my talk, we would assume that you could talk to Congress like adults. That is, anyone in a position of responsibility at a large financial corporation could understand scenario analysis. If our elected representatives, who oversee trillions of dollars, cannot handle it, then we have some really big problems. (I think, in fact, that this is the case. As an aside, I would love to have someone who thinks government is not too big explain to me why he is not bothered by the fact that you cannot have an adult conversation with the people who are in charge of it.)

So, assuming that you would not be thrown out of the room for engaging in scenario analysis, the question becomes how one should do it. I thought that the more outspoken people at CBO were a bit defensive. They said that in the case of macroeconomic forecasting, for example, they had white papers that considered many scenarios and that they reported a range of possibilities based on those scenarios. My reply was that this was not a particularly helpful way to communicate scenario analysis–it just creates a sort of smeared picture. Instead, for example, I suggested that in textbook macro terms you could look at the effect of fiscal stimulus under a scenario in which the Fed holds interest rates constant, a scenario in which the Fed uses a Taylor rule, and a scenario under which the Fed targets nominal GDP. Showing those three scenarios probably would be educational.

Returning to off-balance sheet liabilities, key drivers include interest rates, demographics, and the impact of medical technology and practice. I am particularly interested in seeing the effects of interest rates, because I suspect that a rise in interest rates would adversely affect the budget outlook for many of these off-balance-sheet items.

Andrew Biggs on Social Security

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He writes,

A Social Security reform that addressed the program’s structural and fiscal problems would begin by transforming today’s complex benefit formula into a two-part system consisting of a savings account and a flat universal benefit. Such a system could be implemented gradually — applying only to new workers as they entered the work force, and so very incrementally and slowly replacing today’s system without breaking any promises already made to working Americans.

First, everyone in this new system — rich and poor alike — would be given an opportunity and a strong incentive to save for retirement. Each worker would be enrolled automatically in an employer-sponsored retirement account such as a 401(k) or 403(b). Workers would contribute at least 1.5% of pay, matched dollar for dollar by their employers. Universal retirement savings accounts would allow Social Security to focus its efforts: If everyone saved as they should for retirement, Social Security could concentrate its resources on low earners who needed the program the most.

Read the whole thing. To me, it comes across as centrist. But he would described as a nutter by most of the people who I would describe as nutters.

Outlaw Private Short-term Debt?

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That seems to be what John Cochrane is advocating.

In the 19th century, private banks issued currency. A few crises later, we stopped that and gave the federal government a monopoly on currency issue. Now that short-term debt is our money, we should treat it the same way, and for exactly the same reasons.

Read the whole thing. He argues against the conventional approach to financial regulation, which is to allow banks to issue risk-free liabilities with an explicit or implicit government guarantee and try to regulate their risk-taking on the asset side.

While I agree with those who favor a financial system with more equity and less debt, I would prefer a different approach to getting from here to there. I would like to phase out the subsidies to debt finance. These subsidies include deposit insurance, too-big-to-fail, and the favorable tax treatment of debt. All of these ideas are fairly drastic relative to current policy, but they are less drastic than outlawing outright the contracts that create short-term debt.

Consider this recent paper by Harry DeAngelo and Rene M. Stulz.

Debt and equity are not equally attractive sources of bank capital. Debt has a strict advantage because it has the informational insensitivity property – immediacy, safety, and ease of valuation – desired by those seeking liquidity. High bank leverage is accordingly optimal when the MM model is modified to include a price premium to induce (socially valuable) liquidity production.

Or, in my terms, the nonfinancial sector wants to issue risky liabilities and hold safe assets, and the financial sector accommodates this by doing the reverse.

Another recent essay, Taming the Megabanks, comes from James Pethokoukis.

The Baby Boom and Entitlements

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Stephen C. Goss testified about the rise in the disability rolls,

Demographic changes, principally the drop in the birth rate after the baby boom, have dramatically changed the age distribution of the population. This change has increased the cost of the DI program as a percent of taxable payroll (and as a percent of GDP) over the past 20 years in much the same way that it will raise OASI and Medicare costs over the next 20 years. Disability insured rates and incidence rates have increased substantially for women, further contributing to higher DI cost. However, all of these trends have stabilized or are expected to do so in the future.

For progressives, this is good news and bad news. The good news is that this analysis suggests that the rise in disability reflects the aging of Baby Boomers, rather than what Casey Mulligan calls the redistribution recession.

The bad news is that the Baby Boom really does have predictable adverse effects on the entitlements budget. As the Boomers hit the prime age for disability, up went the disability rolls. Coming next? The Baby Boomers reaching the age of eligibility for retirement benefits and for Medicare. As Andrew Biggs points out, this is in fact the main driver of increased Medicare spending going forward.

Hamilton, Hooper, Greenlaw, Mishkin

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I thought I linked to their paper before, but I cannot find the post.*

we calculate the level of the primary government surplus that would be necessary to keep debt from continually growing as a percentage of GDP. We argue that if this required surplus is sufficiently far from a country’s historical experience and politically plausible levels, the government will begin to pay a premium to international lenders as compensation for default or inflation risk.

This sounds a lot like my Guessing the Trigger Point paper, in which I say that a key variable is the “pain threshold,” which is my term for “politically plausible levels” of the required fiscal adjustment.

I heard Jim present a different paper, on estimating the off-balance-sheet liabilities of the U.S. government, at a recent Cato event. I questioned the usefulness of an exercise that tries to come up with a single number, when so many of these liabilities are contingent (the government has written a lot of put options). Douglas Holtz-Eakin shot back that policy makers cannot handle multiple possibilities. They need one number.

Fine, then. If policy makers cannot handle something that is essential to financial management in any public corporation in America, tell me why we want them to manage trillions of dollars?

*Ah, here is where I linked before.

Freddie, Fannie Profits

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The Washington Post reported (a few weeks ago) that Fannie Mae has made large profits that will go to the U.S. Treasury.

I expect these profits to continue, because the business model right now is excellent. The government is saying to mortgage originators:

1. Do not originate any loans that do not comply with our rules.

2. We cannot tell you what the rules are yet, because they are not final (it’s only been, what, 3 years since Dodd-Frank passed?)

3. But Freddie and Fannie have an exemption, so anything they will take you can originate and we won’t bother you.

Freddie and Fannie do not have to worry much about credit risk, because the housing market bottomed out a while ago, so we are unlikely to see another house price collapse.

Freddie and Fannie are borrowing at Treasury rates, so they enjoy a nice, juicy margin. And the Fed is still holding onto a lot of mortgage securities, which helps keep their prices up.

The one fly in the ointment is that Freddie and Fannie probably are exposing taxpayers to more interest-rate risk. That is, all those 4 percent mortgages that the government is holding on our behalf will not look so profitable if the Treasury’s cost of borrowing should go up to, say, 6 percent. That is already the worst possible scenario from a government solvency standpoint. In that sense, from a taxpayer point of view, Freddie and Fannie are risk-aggravating. Meanwhile, enjoy the windfall.

James Hamilton points out that another fly in the ointment is that a lot of Fannie’s profits are actually tax deductions that come at the expense of the Treasury.