In 2010, economists Carmen Reinhart and Kenneth Rogoff released a seminal paper titled “Growth in a Time of Debt,” which had a significant impact on policy in Washington and elsewhere. Their paper’s most important finding was that “median growth rates for countries with public debt over 90 percent of gross domestic product (GDP) are roughly one percent lower than otherwise; average (mean) growth rates are several percent lower.”  Indeed, they found that countries with debt-to-GDP ratios above 90 percent have a slightly negative average growth rate.

For politicians and pundits hoping to discredit public spending, the implications of their paper were all too clear. Taken as an econometric justification for austerity, the Reinhart-Rogoff finding has been one of the most cited stats in the public debate during the Great Recession. Paul Ryan’s “Path to Prosperity” budget notes that their study “found conclusive empirical evidence that [debt] exceeding 90 percent of the economy has a significant negative effect on economic growth.” The Washington Post editorial board has quoted it as the sign of an economic consensus, stating that “debt-to-GDP could keep rising — and stick dangerously near the 90 percent mark that economists regard as a threat to sustainable economic growth.”

Are their findings truly conclusive? Some critics have argued that the causation is backwards, meaning that slower growth leads to higher debt-to-GDP ratios. Josh Bivens and John Irons made this case at the Economic Policy Institute. But their argument assumes that the data used by Reinhart and Rogoff are correct. From the beginning, however, others have complained that Reinhart and Rogoff weren’t releasing the data behind their results (e.g. Dean Baker). Without the data, it was impossible to test their results by replicating them.

In a new paper, “Does High Public Debt Consistently Stifle Economic Growth? A Critique of Reinhart and Rogoff,”  economists Thomas Herndon, Michael Ash, and Robert Pollin of the University of Massachusetts successfully tested the results. After trying to replicate the Reinhart-Rogoff results and failing, they reached out to Reinhart and Rogoff, who were willing to share their data spreadsheet. This allowed the UMass economists to see how how Reinhart and Rogoff’s data were constructed.

Three significant issues in the data stood out: First, Reinhart and Rogoff selectively exclude years of high debt and average growth. Second, they use a debatable method to weight the countries whose data they used. Third, an apparent coding error in their calculations excludes high-debt and average-growth countries. All three create a bias in favor of their result — and without them, the Reinhart-Rogoff study’s controversial result collapses.

Let’s investigate further:

Selective Exclusions. Reinhart-Rogoff use 1946-2009 as their period of measurement, with the main difference among countries being the starting year. In their data set, there are 110 years of data available for countries that have a debt/GDP over 90 percent, but they only use 96 of those years. The paper didn’t disclose which years they excluded — or why.

The UMass researchers reveal that the study excludes Australia (1946-1950), New Zealand (1946-1949), and Canada (1946-1950). Since these countries have high-debt and solid growth, the consequences of excluding them are clear. Canada had debt-to-GDP over 90 percent during this period — and 3 percent growth. New Zealand had a debt/GDP over 90 percent from 1946-1951. If you use New Zealand’s average growth rate across all those years, it is 2.58 percent; if you only use the last year, as Reinhart-Rogoff does, the Kiwi growth rate is -7.6 percent. That’s a big difference, especially considering how they weigh the countries.

Unconventional Weighting. Reinhart-Rogoff divides country years into debt-to-GDP buckets. They then take the average real growth for each country within the buckets. So the growth rates during the 19 years that England is above 90 percent debt-to-GDP are averaged into a single number. Those country numbers are then averaged, equally by country, to calculate the average real GDP growth weight.

If that is difficult to understand, here’s an example: England has 19 years (1946-1964) above 90 percent debt-to-GDP with an average 2.4 percent growth rate. New Zealand has only one year in the sample above 90 percent debt-to-GDP, with a negative growth rate of -7.6. In their final calculation, Reinhart and Rogoff give these two numbers, 2.4 and -7.6 percent, equal weight, as they average the countries equally — even though they have 19 times as many data points for England.

In their original paper, Reinhart and Rogoff don’t discuss or justify this methodology.

Coding Error. As the UMass economists note: “A coding error [in the Reinhart-Rogoff spreadsheet) entirely excludes five countries, Australia, Austria, Belgium, Canada, and Denmark, from the analysis. [Reinhart-Rogoff] averaged cells in lines 30 to 44 instead of lines 30 to 49…This spreadsheet error…is responsible for a -0.3 percentage-point error in RR’s published average real GDP growth in the highest public debt/GDP category.” Belgium, in particular, has 26 years with debt-to-GDP above 90 percent, with an average growth rate of 2.6 percent (though this is only counted as one total point due to the weighting above).

Here is the Excel spreadsheet, with blue-box marking for formulas missing some data:

So what do the UMass economists conclude in their critique of the Reinhart and Rogoff study? They find that “the average real GDP growth rate for countries carrying a public debt-to-GDP ratio of over 90 percent is actually 2.2 percent, not -0.1 percent as [Reinhart-Rogoff claim].”  That finding depends on including all the years, weighting by number of years, and avoiding that Excel error.  Going further into the data, they are unable to find a breaking point where growth falls quickly and significantly.

The lesson to economists here may be to release all data online, so it can be properly vetted. But beyond that, looking through the data and how much it can collapse because of this or that assumption, it becomes quite clear that there’s no magic number out there. The national debt needs to be thought of as a response to the contingent circumstances we find ourselves in — with mass unemployment, a Federal Reserve desperately trying to gain traction at the lowest possible interest rates, and a gap between what we could be producing and what we are producing.

The past may guide us, however — and what the past says is that right now, what would help is a larger deficit.

Mike Konczal is a Fellow at the Roosevelt Institute.

Cross-posted from the Roosevelt Institute’s Next New Deal blog

The Roosevelt Institute is a nonprofit organization devoted to carrying forward the legacy and values of Franklin and Eleanor Roosevelt.

House Republicans are looking to weaponize the debt ceiling again, while the Obama administration is trying to make removing the threat of default part of any agreement.

Here’s one reason why the debt ceiling needs to go: the conservative intellectual infrastructure cheered on a potential default. I had imagined that there would be a good cop/bad cop dynamic to the right. Very conservative political leaders would be the bad cop, saying that they weren’t afraid to default on the debt, while conservative think tanks would play a version of the good cop, warning of the dire consequences of a default for the economy if their bad cop friend didn’t get his way.

For instance, here’s bad cop Sen. Pat Toomey (R-PA) saying that the markets “would actually accept even a delay in interest payments on the Treasuries,” especially “if it meant that Congress would right this ship, address this fiscal imbalance, and put us on a sustainable path, and that the bond market would rally if it saw we were making real progress towards this.” Missing interest payments is fine; in fact, it is great for the country if it is used to pass the Ryan Plan.

Financial analysts, to put it mildly, disagreed. JP Morgan analysts wrote that “any delay in making a coupon or principal payment by Treasury would almost certainly have large systemic effects with long-term adverse consequences for Treasury finances and the US economy.”

Here’s where the think tanks are fascinating. You could imagine them saying “our partner Toomey is nuts, we can’t control him, and you’d better do what he says or there’s going to be real damage.” But that’s not what they did. It’s best to split the work they did on the debt ceiling in two directions:

1. Technical Default Ain’t No Thang. The first is arguing, like Toomey, that a “technical default” wouldn’t matter, and in fact it could be a great thing if the Ryan Plan passed as a result. How did James Pethokoukis, then of Fortune and now of AEI, deal with a Moody’s report arguing a “short-lived default” would hurt the economy? Pethokoukis: “I guess I would care more about what Moody’s had to say if a) they hadn’t missed the whole financial crisis, b) didn’t want to see higher taxes as part of any fiscal fix and c) if they made any economic sense.” Default doesn’t matter because Pethokoukis doesn’t want taxes to go up, and there’s no economic sense because of an interview he read in the Wall Street Journal.

Others went even further, arguing that the real defaulters are those who, um, don’t want to default on the debt. Here’s the conservative think tank e21 with a staff editorial arguing that “policymakers need to stay focused on the real default issue: whether the terms of the debt limit increase this summer will be sufficiently tough to ensure that the nation’s debt-to-GDP ratio is stabilized and eventually sharply reduced.” All these people who want a clean debt ceiling increase are causing the real default issue. As someone who used to do a lot of credit risk modeling, this is my favorite: “Indeed, those demanding the toughest concessions today actually have a strong pro-creditor bias.” S&P disagreed with whoever wrote that editorial and increased the credit risk (downgraded) based on the threat of this technical default.

The Heritage Foundation wrote a white paper saying that you could just “hold the debt limit in place, thereby forcing an immediate reduction in non-interest spending averaging about $125 billion each month,” and that “refusing to raise the debt limit would not, in and of itself, cause the United States to default on its public debt.” Dana Milbank noted that these kinds of shuffling plans would still leave the government short and likely cause a recession. Milbank: “Without borrowing, we’d have to cut Obama’s budget for 2012 by $1.5 trillion. That means even if we shut down the military and stopped writing Social Security checks, the government would still come up about $200 billion short.” The Cato Institute also jumped in with the technical default crowd here.

But that was the reaction from the number-crunching analysts. What about the bosses?

2. Civilization Hangs in the Balance of the Debt Ceiling Fight. Here’s the president of AEI, Arthur C. Brooks, in July 2011: “The battle over the debt ceiling…is not a political fight between Republicans and Democrats; it is a fight against 50-year trends toward statism…No one deserves our political support today unless he or she is willing to work for as long as it takes to win the moral fight to steer our nation back toward enterprise and self-governance.”

Even better, the president of The Heritage Foundation, also in July 2011, compares Democrats to Japan during World War II and then argues: “We must win this fight. The debate over raising the debt limit seems complicated, but it is really very simple. Look beyond the myriad details of the awkward compromises, and you see an epic struggle between two opposing camps….Congress should not raise the debt limit without getting spending under control.”

So the the conservative intellectual infrastructure, which consumes hundreds of millions of dollars a year, looked at the possibility of a debt default and determined it was both inconsequential and also the only way to stop statism in our lifetimes. No wonder the time period around the debt ceiling in 2011 was such a disaster for our economy, killing around 250,000 jobs that should have been created. There’s no reason to assume all the same players won’t play an even worse cop this time around.

There’s no good reason for the debt ceiling, and now there are really bad consequences for its existence. Time to end it.

Mike Konczal is a Fellow at the Roosevelt Institute.

Cross-posted from Rortybomb

The Roosevelt Institute is a nonprofit organization devoted to carrying forward the legacy and values of Franklin and Eleanor Roosevelt.

The big question is not whether to dismantle Dodd-Frank, but whether it gets implemented correctly.

Wednesday’s presidential debate had a relatively detailed discussion of the Dodd-Frank financial reform bill. From a transcript, this is how President Obama described what the bill does:

We said you’ve got — banks, you’ve got to raise your capital requirements. You can’t engage in some of this risky behavior that is putting Main Street at risk. We’ve going to make sure that you’ve got to have a living will so — so we can know how you’re going to wind things down if you make a bad bet so we don’t have other taxpayer bailouts. […] And, you know, I appreciate and it appears we’ve got some agreement that a marketplace to work has to have some regulation. But in the past, Governor Romney has said he just want to repeal Dodd- Frank, roll it back.

And so the question is: Does anybody out there think that the big problem we had is that there was too much oversight and regulation of Wall Street? Because if you do, then Governor Romney is your candidate. But that’s not what I believe.

The sleepy delivery aside, this is a good description. I would have liked to have seen a reference to the CFPB (“cops on the beat protecting consumers”) and derivatives reform (“making sure our financial markets are transparent”), since they are both under serious attack by conservatives. But it’s not bad for a high-level overview.

What was Mitt Romney’s critique of Dodd-Frank?

One is it designates a number of banks as too big to fail, and they’re effectively guaranteed by the federal government. This is the biggest kiss that’s been given to — to New York banks I’ve ever seen. This is an enormous boon for them….We need to get rid of that provision because it’s killing regional and small banks. They’re getting hurt.

Let me mention another regulation in Dodd-Frank. You say we were giving mortgages to people who weren’t qualified. That’s exactly right. It’s one of the reasons for the great financial calamity we had. And so Dodd-Frank correctly says we need to have qualified mortgages, and if you give a mortgage that’s not qualified, there are big penalties, except they didn’t ever go on and define what a qualified mortgage was.

It’s been two years. We don’t know what a qualified mortgage is yet. So banks are reluctant to make loans, mortgages. Try and get a mortgage these days. It’s hurt the housing market because Dodd-Frank didn’t anticipate putting in place the kinds of regulations you have to have. It’s not that Dodd-Frank always was wrong with too much regulation. Sometimes they didn’t come out with a clear regulation.

First off, as Adam Levitin notes, the reason that we don’t have a QM definition is because that requires having a CFPB director. And who has been blocking a CFPB director consistently from the beginning? Senate Republicans. President Obama had to recess-appoint a director in order to get this rule started, much to the chagrin of Republicans. So it is a bit much to block the nominee necessary to start the agency and then complain the agency isn’t getting things done.

That said, there are two major complaints here. The first is that Dodd-Frank’s “resolution authority” and regulations for systemically important financial institutions (SIFI) are a “wet kiss” to the banks, and the second is that qualified mortgages are holding up the financial market. Let’s take them in turn.

SIFI and Too Big To Fail

Part of Dodd-Frank’s approach involves creating a graduated system of regulatory burdens for risky financial firms, combined with special resolution authority powers housed at the FDIC to resolve these firms when they fail. This gets attacked by conservatives, an attack Mitt Romney reiterated, because, they believe, it has three problems: (1) it picks a handful of winners, (2) protects those winners from competition through regulations that have no teeth, and (3) gives a signal to the market that these firms will be bailed out again in the future.

To address complaint (1), all bank holding companies with $50 billion or more in consolidated assets are included without a necessary designation, and systemically important financial institutions (SIFI) are included as well after a determination process. So it isn’t just the top five firms, but instead the 35-plus that are all larger in size. If it were an advantage to be declared systemically important, SIFI financial firms would be fighting to get the designation. By all accounts they are not, and indeed they are fighting against this status.

For (2), it makes sense that they are fighting the designation because Dodd-Frank requires more capital and includes more requirements for riskier firms. Take Sec. 165, which requires “large, interconnected financial institutions” to be subject to “prudential standards…more stringent than the standards and requirements applicable to non-bank financial companies and bank holding companies that do not present similar risks to the financial stability of the United States.”

Or Sec. 171, which requires that capital requirements scale with “concentrations in market share for any activity that would substantially disrupt financial markets if the institution is forced to unexpectedly cease the activity.” The idea is that if a firm wants to get bigger or engage in riskier activity, the normal prudential requirements to hold more capital and plan for a failure should scale as well.

For (3), the question is whether it will work or whether the market will think there will be endless bailouts. As I’ve described at length elsewhere, the resolution authority in Dodd-Frank is designed to precommit against bailouts. You need three institutions to approve resolution, who must consider the decision with a bias toward the market and the bankruptcy code. If there’s a liquidation, the FDIC has to wipe out shareholders, hit creditors, fire management and board members, and can’t buy equity in the firm to keep it alive. The problem we face isn’t Dodd-Frank, but Congress and the executive branch passing “TARP: Part Two.”

So how is the market reacting? Jennie Bai, Christian Cabanilla, and Menno Middeldorp of the Federal Reserve Bank of New York wrote a great paper recently that used “Moody’s KMV credit default swap (CDS) implied probability of default to gauge changes in the market perception of the risk that senior bondholders will not be completely repaid.” (Disclosure: In the past, I worked at Moody’s KMV, a well-regarded credit risk firm founded as KMV by three old-school quants, as a financial engineer. As a result, I’m biased towards their probability of default methodologies as a metric.)

What did they find?

Using the results from this regression and the shift in Bloomberg resolution news over our sample, we estimate that the anticipated and actual changes in resolution regime have increased the CDS market’s expectations of default by approximately 20 basis points, which is around a fifth of the average CDS-implied default probability for G-SIFIs in March 2012. While this doesn’t necessarily mean that markets are no longer pricing in any possibility of government support, it does suggest that the new laws have resulted in the CDS market taking into account the view that senior bondholders run a higher risk that they’ll need to share in the costs of bank resolution.

The market is starting to price in the risk that senior bondholders at risky, major financial firms will take hits, and those risks are priced in alongside movements in the resolution authority law. Given that the rules aren’t completed yet and that there are additional ways to bolster them, this is a good sign. Mitt Romney’s attack on the overall plan embodied in Dodd-Frank isn’t the right approach for people serious about tackling Too Big To Fail. The problems we should be worried about are whether there is a good implementation of the law and if it is sufficient for taking down a major firm.

QM

In addition to Adam Levitin’s piece, you should read John Griffith and Julia Gordon of Center for American Progress, writing over at ThinkProgress, who have a piece on the QM issue.

We’re thrilled to hear Romney give such a full-throated defense of the ability-to-repay rule. It’s a welcomed about-face from his recent calls to repeal Dodd-Frank and dismantle the Consumer Financial Protection Bureau, the federal agency that’s responsible for enforcing the rule. That said, Romney has a few key facts wrong.

As Romney points out, the ability-to-repay rule has not yet taken effect as regulators are still defining the “Qualified Mortgage” exemption. But the Republican candidate neglected to mention that the final rule isn’t due until January 2013 — a deadline regulators appear to be on pace to meet. The Consumer Financial Protection Bureau submitted its proposed rule back in April and is currently hashing through public comments.

Romney seems to imply some sort of negligence or malfeasance from the Obama administration that is preventing the rule from being completed. Alas, no scandal here. The Dodd-Frank law is actually quite clear about what type of loan should be considered a “Qualified Mortgage.” The loan must be well-underwritten with verified income, employment, and debt information. Loan payments can’t exceed a certain percentage of the borrower’s net monthly income. The loan can’t contain risky features like negative amortization, interest-only payments, or balloon payments. The list goes on.

It’s a shame the debates didn’t include anything on foreclosures or the housing market more generally, but the Dodd-Frank discussion was a pleasant surprise.

Cross-posted from Rortybomb

As you’ve likely heard, Mitt Romney was recorded at a fundraiser saying “there are 47 percent who are with [President Obama], who are dependent upon government, who believe that they are victims, who believe the government has a responsibility to care for them, who believe that they are entitled to health care, to food, to housing, to you-name-it […] These are people who pay no income tax.”

The right is splitting over whether or not the 47 percent argument is worth defending. It’s important to understand that, while it is true that 47 percent of households don’t pay federal income tax, the distribution of the tax burden isn’t what the 47 percent theory is about. The 47 percent theory is all about grand political battles. My colleague Mark Schmitt has one examination of where this theory comes from here, Brian Beutler also investigates the background of the 47 percent meme, and Kevin Drum offers a history of the Earnd Income Tax Credit here.

Digging into different arguments, there are two distinct parts to a good 47 percent theory. The first is who creates and sustains the 47 percent as a political agent. This can’t be the bipartisan set of policymakers who wanted to provide income support through work requirements as well as expand certain credits, particularly the child credit; it needs to be agents with specific, outside political goals. Those who pay little or no income tax are a coherent group that acts like a special interest or a class. Instead of the young and the old, as well as the working poor moving into and out of the EITC, this group of people is stable enough that it can act as a coherent political class, but it needs to be created and sustained. Who made it?

Let’s start at the beginning. Where does this meme start?

1. Trickle On Trickle Down: The Lucky Duckies of the Wall Street Journal Editorial Page: Let’s look at the Wall Street Journal‘s opinion page, November 20, 2002, “The Non-Taxpaying Class: Those lucky duckies”:

“Who are these lucky duckies? They are the beneficiaries of tax policies that have expanded the personal exemption and standard deduction and targeted certain voter groups by introducing a welter of tax credits for things like child care and education […] The 1986 tax reform, for example, with its giant increase in the personal exemption and standard deduction, took six to seven million people off the tax rolls […] This complicated system of progressivity and targeted rewards is creating a nation of two different tax-paying classes: those who pay a lot and those who pay very little. And as fewer and fewer people are responsible for paying more and more of all taxes, the constituency for tax cutting, much less for tax reform, is eroding. Workers who pay little or no taxes can hardly be expected to care about tax relief for everybody else. They are also that much more detached from recognizing the costs of government.
All of which suggests that the last thing the White House should do now is come up with more exemptions, deductions and credits that will shrink the tax-paying population even further.”

This argument was developed in future editorals. A few weeks later, in  “Lucky Duckies Again: Look at who won’t pay taxes under Bush’s plan”, the Journal noted that “No doubt the Bush team proposed this tilt toward lower income taxpayers to mute the class-warrior critics, not that we’ve noticed any lower decibel level.”

Who? Interestingly enough, this looks like an internal fight among conservatives and Republicans. That’s how Krugman read it at the time, and it seems obvious from that last sentence. The Bush tax cuts are going to be across all families, and the editorial is warning that this is the wrong approach. It should focus just on the rich, corporations, and capital income holders. The editorial is clear that they don’t want to raise taxes on those who are exempted from the federal income tax; they just fear that these across-the-board tax cuts will knock a lot of people out of the system.

This was a correct assertion, as this number skyrocketed after the George W. Bush tax cuts. To whatever extent the Bush team didn’t want to do this, they felt boxed in politically. As a top Bush administration official later told Ezra Klein, “Do you think we wanted to include a welfare payment to people who don’t pay taxes and call it a tax cut? No. But that’s what we needed to do to get it done.”

Consequences? The editorial warned that this policy would buy them no room with the “class-warrior critics,” and that’s probably a fair assessment. Repealing the Bush tax cuts has been a consistent goal for Democrats, and their preferred approach is even worse than the Wall Street Journal could have imagined. The Journal just wanted tax cuts on those making over $250,000, and warned about cutting at the bottom end of the spectrum because of the lucky duckies. Now the situation is reversed, and President Obama is looking to keep the tax cuts for those making under $250,000 and repeal the rest.

There’s the idea that as a policy matter workers will simply not care for cutting taxes or for tax reform more broadly. This is why Romney can say “So our message of low taxes doesn’t connect.” But this isn’t played up in apocalyptic terms. The editorials seemed more concerned that the federal tax code will retain its progressivity under this tax cut, rather than the lucky duckies initating a new culture war. This is in stark opposition to:

2. The Battle: Right Wing Think Tanks and the New Culture War: Let’s jump forward, and see how the expensive, Washington D.C. think tanks react to President Obama. President Obama is a wonky technocrat, and much of his policy borrows from conservative policy of the 1990s (health care) or bipartisan policy of the 2000s (cap-and-trade) or policy that was new and open to debate (post-crisis financial regulations). The new president of the American Enterprise Institute, Arthur C. Brooks, writes a book calledThe Battle: How the Fight between Free Enterprise and Big Government Will Shape America’s Future. How does he think of the 47 percent? Focusing on “long-term strategies to keep the young in the 30 percent coalition,” he writes:

Federal tax policies are ensuring that an increasing number of people in our society will never develop a pocketbook interest in free enterprise. Even as they grow older, develop their careers, and earn more money, many will never pay a dollar in federal income tax because they’ll never catch up with an increasingly progressive tax system.

To put a modern twist on an old axiom, a man who is not a socialist at 20 has no heart. But a man who is still a socialist at 40 has no head-or pays no taxes. The current trend will increase the percentage of Americans who are permanent net takers from our society, who use more in public resources than they contribute, and for whom a free-enterprise system of entrepreneurship and limited government holds few obvious personal rewards. In a nutshell, the strategy is to make fewer and fewer people pay all the taxes and bear the brunt of paying for a growing government […] After President Obama’s budget stimulus and the proposed tax changes of 2011 […] this proportion will increast to almost 47 percent. […]

Simply stated, in the future there will be fewer and fewer people with “skin in the game.” Nonpayers will outnumber the payers. We will enventually reach a threshold beyond which most Americans have no economic incentive to defend free enterprise because it is so far from their interest to do so. The young sympathizers of socialism today may be the grown-up defenders of socialism tomorrow.

As Mark Schmitt wrote, “this theory that we’re headed toward a radical egalitarian state is being developed is the American Enterprise Institute, the oldest of the conservative think tanks and one that, much like Romney, has forsaken the traditional business-minded conservatism of, say, the first President Bush, for hard conservatism in which everything is a grand showdown of incompatible worldviews.” And The Battlewas the first statement that President Obama was at the vanguard of a new culture war on economic issues. Instead of wanting a government that consumes 25 percent of GDP and has a public welfare state versus one that consumes 19 percent and has a private welfare state, he is the economic equivalent of Robert Mapplethorpe. The right takes this book seriously; the author of the most prominent critical review of the book from the right was canned from his think tank job a month after it came out.

Who? The “30 percent” are the ones behind this expansion of people who don’t pay federal income taxes, and they’ll continue to expand it. Now before you think you wandered into a Wu-Tang song, we should clarify Brooks’ definition of the 30 percent and the 70 percent. The 30 percent are a group of people who“reject the free enterprise system culturally.” The free enterprise system stands in “stark contrast to European-style social democracy.” The 30 percent “twists equality of opportunity into equality of outcome.” Any idea that American liberalism stands in contrast to free market laissez-faire and Marxism isn’t explored; the 30 percent are entirely the bad guys, waiting to fundamentally change the country. Jonathan Chait wrote an excellent review of the book here,

Consequences? The big consequence is that this locks young people into socialism and the intellectual space of the 30 percent coalition, building their power. Having never paid taxes, they and others who benefit will think of government as free. So the 30 percent are then capable of continuing to seize more centralized control of the economy and defeat the cultural forces of free enterprise. The Battle is obsessed with how President Obama won in 2008; one conclusion is that the 30 percent doesn’t need to win people over intellectually, but just needs to keep enough people not paying taxes so that they’ll form a coherent base, particularly the young. But the 30 percent culture allows Romney to note that those who oppose his message “are dependent upon government [and] believe that they are victims.”

3. The Hammock. During the Q&A part of this 2011 Paul Ryan speech at Heritage (19m35s), Ryan noted:

I think it’s 49 percent of people who don’t pay taxes today, though there are other taxes. Here’s the danger I think we have. We’re coming close to a tipping point in America where we might have a net majority of takers versus makers in society and that could become very dangerous if it sets in as a permanent condition. Because what we’ll end up doing is we will convert our safety net system – which is necessary I believe, to help people who can’t help themselves, to help people who are down on their luck get back on their feet – we could turn that into a hammock that ends up lulling people into lives of dependency and complacency, which drains them of the incentives and the will to make the most of their lives.

Who? The do-gooders who created the social safety net.  It’s too generous, too unconditional and not tied enough to work. In a practical way, it is the safety net itself that is creating this condition. Rather than the correct interpretation that people who are not paying taxes are receiving income support that requires work or various, purposely chosen tax credits, this indicts everything from health care to unemployment insurance (which, by definition, you needed to have worked to receive). This is a smart approach, because while going after the “30 percent” isn’t really a political platform, dramatically reducing the social safety net is.

Consequences? It’s not clear what “complacency” means in this condition, but dependency means that more and more income will come from the government. As this happens, their ability to take personal responsibility will fall apart. People will be beyond the ability to help themselves, hypnotized as they are by the siren’s call of the welfare state. This is why Romney can say “I’ll never convince them that they should take personal responsibility and care for their lives.”

4. Takers and Public Choice:

From Reason Magazine a while ago:

DeMint: Almost half of Americans are getting something from government, and the other half are paying for it. And we’re on a track where 60 percent are getting something from government and 40 percent are paying for it. You can’t sustain a democracy with that mix.

Reason: Because the 60 percent is going to be voting a bigger and bigger share of the 40 percent’s money?

DeMint: It’s hard to win elections when you’re talking about limited government if the constituents want more from government. You see that phenomenon on display in Greece. When the country is going down in flames, there are still people in the street, demonstrating for more government benefits. We’ve got to understand we’re in trouble, that we don’t have much time.

Or this from Steve Doocey on Fox and Friends: “Coming up! A controversial question. With 47% of Americans not paying taxes – 47% – should those who don’t pay be allowed to vote?”

Who? The 47 percent themselves. As predicted by Public Choice theory, those at the bottom half of the income scale vote into office people willing to take from the top half of the income scale. Since the average is above the median in income, there’s always redistribution from the average to the median to be done. Here the intellectuals of the 30 percent, or the welfare state, or GOP strategy are all secondary; the ravages of democracy are the culprit.

Consequences? The system eventually collapses into itself, as those at the margin work less and also join in demanding more. DeMint alludes to Greece, where the collapse of the government seems almost to be part of the plan to then take over the state, which is consistent with the right’s conspiracy theory of the Cloward-Piven strategy. But this focus on stop-gating the median voter allows for Romney to think “What I have to do is convince the 5 to 10 percent in the center that are independents.”
Presumably there are more. What else is missing?

Cross-posted from Rortybomb

Mike Konczal is a fellow with the Roosevelt Institute

Republicans might not repeal Dodd-Frank outright, but they’d eliminate the system of rules that make it work.

It was just announced that Tim Pawlenty will become the head of the bank lobbying group Financial Services Roundtable. The powerful financial lobbying group, which represents groups like JP Morgan and Bank of America among other big financial sector players, appears to be aligning itself more closely with the Republican Party and betting on the idea that Republicans will control at least part of Congress. But what do they want? Earlier in the year, I argued in Washington Monthly that they’d like to repeal the core parts of financial reform.

Recently, Phil Mattingly had an article at Bloomberg Businessweek about how the GOP and Mitt Romney would approach Dodd-Frank. This is with a hat-tip to Reihan Salam who notes that this article “has confirmed something I’ve heard from well-informed insiders” and makes additional arguments [1]. So it seems well-sourced.

Mattingly’s argument is that it is unlikely that the Republicans will outright repeal Dodd-Frank. “Instead, President Romney would likely try to give the financial industry something it wants more: a diluted financial reform law that would relax restrictions on some of its most profitable—and riskiest—investments but maintain enough government oversight to give the banks cover.”

So what would the Republicans try to dilute and remove? Mattingly:

“Wall Street wants to loosen rules governing the swaps market, which generated $7 billion in revenue in the first quarter of 2012, according to government records. The banks would also get rid of restrictions on bank investment in private equity and hedge funds, pare back the power of the new federal consumer protection agency, and block the Volcker Rule, which bars banks from trading with money from their own accounts, a practice that can put customer deposits at risk. […]

Wall Street doesn’t oppose everything in the law. Banks support the “resolution authority” that spells out how and when the government can seize and wind down struggling banks before they catastrophically fail.”

So they want to go after derivatives rules (swaps), the Volcker Rule and the related law on restrictions on hedge fund investments, and also the CFPB. It’s important to understand this isn’t like removing random parts of the bill, as strict as they may be, but is instead gutting the core logic of the law. It’s the equivalent of Republicans saying they’d keep the Obamacare bill, but stop the exchanges, remove the individual mandate, and lose the ban on pre-existing conditions while getting rid of the means-tested subsidies and Medicaid expansion. We’d understand that all of the parts of this system are interconnected and inseparable; the ban requires everyone to be in the market, which requires subsidies and well-developed markets.

Let’s make sure we understand how derivatives, the Volcker Rule, and the CFPB all work together. Imagine that we’re car engineers, and we want to design a car and road system so that if the car crashes, it does so as safely as possible. There are four things we can do. We can put airbags and seatbelts in the car and other cars so that when it does crash the damage is limited and controlled. We can design the car with things like a brake override system so that if it hits a rough patch the driver can keep control of it and make it less likely to crash.  We can put some speed limits on the road, as well as clear traffic signals to guide cars from running into each other. And we can have some protection for pedestrians, like cops watching for DUIs or barriers to prevent cars from driving into crowds of people. Easy, right?

Now let’s think of Dodd-Frank. There are the legal powers that deploy to resolve a firm if it fails, like an airbag, which are called resolution authority. This allows the FDIC to take down a failed financial firm as if it were a bank, subject to serious rules and restrictions.  And, like requiring certain car features, there are specific policies for large, systemically risky financial firms, like enhanced capital requirements, limits to investments in risky hedge-funds, and the Volcker Rule, which are designed to make it less likely for a firm to crash.

Dodd-Frank also introduces speed limits and rules of the road in the financial sector, designed to make the system as a whole less likely to crash or spiral out of control when a panic does happen. One primary place it does that is through derivatives regulations. And “cops on the beat” is the metaphor for the Consumer Financial Protection Bureau.

So there’s Dodd-Frank law to allow a firm to fail, law to make it less likely a financial firm fails, laws to prevent the interconnected financial markets from going into crisis if a firm does fail, and law to gives consumers a representative in dealing with the regulatory field. This is like thinking of Dodd-Frank as a system of deterrence, detection, and resolution, a related model we’ve developed elsewhere.

If Wall Street and the Republicans are looking to seriously gut the Volcker Rule, derivatives, and the CFPB, then they’re looking to gut the entire logic of the bill. Interestingly, they are less interested in “resolution authority,” the legal process to fail a financial firm. This is evidently no problem with everything else removed, perhaps because they believe congressional bailouts will then happen. This should remind us that resolution authority is strengthened and made more credible by other strong regulations, including things not in Dodd-Frank, like size caps or Glass-Steagall. Preventing these dilutions is crucial to building a regulatory system for the financial sector that works in the 21st century.

[1] Reihan notes that banks “also understand that [Dodd-Frank] favors incumbents over new entrants, particularly incumbents with the legal acumen and lobbying resources to shape the emerging regulatory regime. My strong preference, very much in line with conservative and libertarian sensibilities, would be for a financial reform that would aim to facilitate rather than stymie entry.”

I’d like to see more on how Dodd-Frank as blocking new firm entry works. While this is a generic complaint of regulations in general, I’m not sure in what ways it applies to Dodd-Frank. Parts of Dodd-Frank actually are designed to scale up with size and risk, e.g. Sec. 171 requires capital requirements to scale with “concentrations in market share for any activity that would substantially disrupt financial markets if the institution is forced to unexpectedly cease the activity,” which is not for new entries. The idea is to hold larger and riskier firms to tougher standards and higher capital, which is regulation that scales with size.

Cross-Posted from Rortybomb

Mike Konczal is a fellow with the Roosevelt Institute