Talk is cheap, which is why makes sense for business owners to claim prices will increase and / or mass layoffs will result if regulations are put in place. What this really means is that profits will fall, so it is worth it to talk (which, remember, is cheap), and hire lobbyists (which are relatively cheap for big business compared to the benefits they deliver) to support these claims.
In most cases, markets decide pricing. Increase prices, and people can substitute your good for a competitors. Lay people off to make a political statement, and you forego market-share that will be readily snapped up by competitors. In competitive markets, these problems tend to regulate themselves. While true Perfect Competition doesn’t exist in reality, some markets are closer to this ideal than others.
Under perfect competition, there are many buyers and sellers, and prices reflect supply and demand. Also, consumers have many substitutes if the good or service they wish to buy becomes too expensive or its quality begins to fall short.
When a good is necessary for living (healthcare) or for social mobility (college), imperfect markets can price lower income people out.
Rate Review helps protect you from unreasonable rate increases. Insurance companies must now publicly justify any rate increase of 10% or more before raising your premium.
Price controls imposed as part of the ACA are at least partially responsible for the dramatic slowdown in healthcare cost increases over the past few years (the Great Recession was another major factor).
But since health insurance is a composite of a number of inputs, including cost of being seen by a doctor and cost of prescription drugs, each of these inputs would need to be regulated to keep health insurance costs down.
While a college education is not a silver bullet, it is an important element of the social mobility puzzle. As the graph above shows, college costs have skyrocketed in recent decades, leading poorer students to take on increasing levels of debt to afford a degree.
Those who complete their degree still tend to realize a strong return on investment, but the high (and increasing) debt burden is a huge stressor, which likely contributes to poor graduation rates (especially among lower class students). The combination of non-completion (and related low earnings) and high debt can result in an inescapable debt cycle.
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A good proxy for the “necessity” of a good or service is it’s elasticity of demand:
Products that are necessities are more insensitive to price changes because consumers would continue buying these products despite price increases.
The availability of substitutes…is probably the most important factor influencing the elasticity of a good or service. In general, the more substitutes, the more elastic the demand will be.
Imperfect markets result in a lack of substitutes, as barriers to entry result in little competition. Policymakers can start with a matrix of competitiveness and necessity (elasticity of demand); goods and services that are both necessities and exist in highly imperfect markets are primary candidates for price regulation. Two obvious tools for regulating these markets are:
Price controls (making companies justify price increases over a certain threshold)
Tying federal funding to price oversight
Price controls may seem like a blunt tool, but they can actually be quite nuanced. Take the ACA’s “Rate Review”. A company can has an opportunity to make its case that a price increase is justified; if it justified is, the government will allow it. It is in no ones interest to see businesses fail in the name of price control regulation. Such failures hurt the economy, and undermine support for the regulatory policies that lead to their failure.
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What is the American dream? Is it meritocracy and social mobility, or is it the freedom to charge whatever the market will bear regardless of the social cost?
Admitting their are limits to what perfect competition market models can achieve in the real world does not make you a socialist. It makes you a good economist and policy analyst. There is room for these industries to remain private and profitable. That does not mean we cannot regulate them in ways that make them work for society as a whole (considering the social benefits when they are widely available, and the social costs when they are not).
It is the job of politicians to identify these markets and call owners on their bluffs. Failure to do so reinforces power asymmetries that stifle social mobility. The Commerce Department’s mandate should be expanded to help balance the power asymmetry that exists between consumers and producers of necessities in the most imperfect markets.
A Short History of Financial Deregulation in the United States; CEPR
As an economist living in the Post-Great Recession world, I often consider the effects of greater financial sector regulation on overall economic performance.
Given my populist leanings, it may surprise you to hear that I have been conflicted about the merits of greater regulation (or more accurately, the merits of pursuing such reforms now). The argument (in my head) usually goes something like this:
During a period of weak economic growth, which we are now just starting to emerge from, a growth sector such as finance should not be held back. Listening to (part) of the hearing between the Senate Subcommittee and Goldman Execs, who invoked the concepts of economic efficiency and job growth with bravado, this is exactly what financial sector advocates want people to think.
But is there any merit to these claims? Inflating a bubble and calling it growth does not make it so, and certainly does not necessarily benefit the vast majority of people. This conclusion (which may be obvious to some, but given my determination to consider arguments and counter-arguments, consequences and unintended consequences, has to this point eluded me) led me to a much broader question:
It has long been accepted by development economists that GDP growth alone is not a reliable measure of increases in well-being / standard of living. Is it time to consider that paring back GDP growth, in order to set our financial system on more sustainable ground, might be in best interests of the vast majority of Americans?
Before considering these points, we should explore (1) how the financial sector got “too big to regulate”, and (2) why efforts to regulate big banks have proven so lackluster.
In my opinion, the root causes (and therefore solutions) are straightforward:
(1) Intentional deregulation of financial markets to spur economic growth, and;
(2) Lax enforcement of those regulations that are still on the books, due to the “revolving door” between the financial sector and government regulators
(For my readers who want a more in depth look at these issues, I would highly recommend Matt Taibbi’s best-selling book “Griftopia”)
A two-year Senate-led investigation is throwing back the curtain on the outsize and sometimes hidden sway that Wall Street banks have gained over the markets for essential commodities like oil, aluminum and coal.
The Senate’s Permanent Subcommittee on Investigations found that Goldman Sachs and JPMorgan Chase assumed a role of such significance in the commodities markets that it became possible for the banks to influence the prices that consumers pay while also securing inside information about the markets that could be used by their own traders.
Until about 20 years ago, regulated banks faced tight constraints that barred them from owning physical commodities and limited them to trading in financial contracts that were linked to the prices of commodities. But a substantial relaxation of the rules allowed the banks to own actual commodities themselves, known as “physical assets” on Wall Street.
“The warehouse issue is having a profoundly negative impact on our customers’ businesses,” said Nick Madden, the chief supply chain officer at Novelis, a producer of rolled aluminum.
Mr. Madden said that when he first saw The Times article on Goldman’s practices, he didn’t understand why the warehouse company was encouraging long lines for customers wanting to remove their metal.
“Now I see it in black and white and I understand it,” he said, in reference to the subcommittee’s report.
One warehousing source, who is familiar with these transactions, said what he read in the report was “immoral, but not illegal”.
Far from increasing efficiency, it appears that financial intermediation may actually harm related “real” elements of the economy in certain situations.
So deregulation has led to expansion by financial institutions into “physical assets”. But what about regulations that are still on the books? Surely, in the wake of The Great Recession, accountability and transparency have been force-fed down the financial sector’s throat?
Unfortunately, this is not the case. In an attempt to erect a meaningful barrier between the financial institutions and those who regulate them, new legislation has been proposed by Rhode Island Senator Jack Reed:
The New York Fed also oversees some of the nation’s largest financial institutions, and has been questioned in recent years for failing to look with enough rigor at the operations of companies like JPMorgan. The hearing on Friday will address the question of whether Fed regulators may be too soft on the banks they oversee.
“Someone at this institution needs to be directly accountable to Congress,” Reed said in a statement. “This legislation is about holding the New York Fed accountable … It’s just too powerful to be left unchecked.”
The idea of making the job a presidential appointment is not a new one: with Reed’s support it was included in the Senate’s version of Wall Street reform legislation in 2010, although it was not included in the final Dodd-Frank law.
“The perception today, and the perception for years, is there are no fences between the New York Fed and the banks they’re regulating,” said Reed.
After the subcommittee finished questioning Dudley, it turned to the matter of solutions. Columbia University professor David Beim, the author of a harsh internal investigation into the New York Federal Reserve, told the subcommittee that more needs to be done to eliminate the revolving door between the finance industry and the Fed.
“The problem is regulators and bankers form a community,” he said.
Given the dysfunction of our Federal government, making the NY Fed President a presidential appointee subject to congressional approval is by no means a sure fix. But there have been bipartisan efforts to reign in the financial sector; such a move could certainly be part of a more comprehensive financial sector reform agenda.
..Six years after the onset of the financial crisis, four years after Dodd Frank and two years after the biggest banks submitted the first drafts of their living wills — the Federal Deposit Insurance Corporation and the Federal Reserve rejected the plans from 11 large banks as “unrealistic or inadequately supported.” The regulators said further that the banks had failed “to make, or even identify” structural and operational changes that would be needed to attempt an orderly resolution.
And yet the regulators are not taking steps to downsize the banks. For that to occur, the F.D.I.C. and the Fed have to agree that living wills are unworkable and that more forcible downsizing is needed. The F.D.I.C. seems to have reached that conclusion; it said flatly that the plans don’t work. But not the Fed, which has told the banks to submit new plans by July 1, 2015. The banks have had four years already. Now they have nearly another year to toy with a process that has utterly failed to produce credible results.
Will anything change between now and next July? Using the history of the last several years as a guide, the biggest banks will be even bigger, more complex and more interrelated by then. They will be undercapitalized and overleveraged. They will be reliant on unstable sources of short-term financing and will be more steeped than ever in speculative derivatives transactions.
In short, they will still be too big to fail, too big to manage and, judging from the Fed’s latest indulgence, too big to regulate.
But as time went on, and the pain of The Great Depression faded in memory, these rules were repealed in the name of economic efficiency / growth. Instead what we got was increasing inequality and the regulatory groundwork which enabled The Great Recession.
We must stop relying on “self-regulation” of the financial sector; the fact that the Fed has given financial institutions so much leeway and time in writing their own “living wills” is indeed disconcerting. Since the collapse and bailout of the financial sector, “Too-Big-To-Fail” financial institutions have only gotten larger, potentially setting the stage for an even more painful recession down the road.
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When growth is the result of over-leveraging, opaque bundling, insider trading, and imaginative accounting, it benefits a select few at the expense of everyone else.
It is past time to question the assertion that tighter regulation of financial markets will lead to a meaningful increase in unemployment / deterioration of standard of living. All evidence points to the contrary; financial regulation would benefit the vast majority, at the expense of a select few who have made their fortunes exploiting loopholes and shady relationships.
The further we get from the financial crisis, the less necessary tighter financial regulation will seem. The “benefits” of having an under-regulated financial market will look that much greater than the “costs” of regulation–until it all comes crashing down.
In February I wrote a blog titled “Helping the Poor and Changing Our Standards, The DoJ vs. S & P“, and promised to keep my readers up to date on this important case. For those who do not wish to reread that whole post, here are the most pertinent details:
“The Justice Department plans to file civil fraud charges against the nation’s largest credit-ratings agency, Standard & Poor’s, accusing the firm of inflating the ratings of mortgage investments and setting them up for a crash when the financial crisis struck.”
“The case is said to focus on about 30 collateralized debt obligations, or C.D.O.’s, an exotic type of security made up of bundles of mortgage bonds, which in turn were composed of individual home loans. According to S.& P., the mortgage securities were created in 2007, at the height of the housing boom. S.& P. was paid fees of about $13 million for rating them.”
“Here’s the role the DoJ will argue S&P played in perpetuating the housing bubble:
“The three major ratings agencies are typically paid by the issuers of the securities they rate — in this case, the banks that had packaged the mortgage-backed securities and wanted to market them. The investors who would buy the securities were not involved in the process but depended on the rating agencies’ assessments.”
“In its complaint against S&P, the Justice Department accused S&P of defrauding Western Federal Corporate Credit Union, and other institutions that purchased certain securities based on the high ratings by S&P.
Some credit unions are required by law to rely on credit ratings issued by firms that included S&P in making its investment decisions, the complaint said.”
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It is my pleasure to inform my readers that a judge has given this case the “green light“, a step towards holding S & P accountable for its role in the financial crisis:
“The U.S. government may proceed with its $5 billion lawsuit accusing Standard & Poor’s of misleading investors by inflating its credit ratings, after a federal judge rejected the rating agency’s effort to dismiss the civil fraud case
In a written decision late on Tuesday, the judge said the government could pursue claims that S&P manipulated ratings to boost profit, and in doing so, concealed credit risks and conflicts of interest.
This led to large losses for investors and contributed to the 2008 financial crisis, the government contended.
“The government’s complaint alleges, in detail, the ways in which none of S&P’s credit ratings represented the thing that they were supposed to represent, which was an objective assessment of creditworthiness, because business considerations infected the entire rating process,” wrote U.S. District Judge David Carter, in Santa Ana, California.”
“The lawsuit accused the largest U.S. credit rating agency of inflating ratings to win more fees from the issuers and bankers that pay for them.
It also said S&P failed to downgrade ratings for collateralized debt obligations despite knowing they were backed by deteriorating residential mortgage-backed securities.
According to the complaint, S&P rated more than $2.8 trillion of RMBS and nearly $1.2 trillion of CDOs from September 2004 to October 2007.”
“S&P argued that, since the issuer banks had access to the same information and models that S&P analysts did, they could not have been fooled by faulty credit ratings,” Carter wrote.
“This begs the question: If no investor believed in S&P’s objectivity, and every bank had access to the same information and models as S&P, is S&P asserting that, as a matter of law, the company’s credit ratings service added absolutely zero material value as a predictor of creditworthiness?”
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This is indeed welcome news, as I am sure once the case is underway more information will be brought to light. While I do not take a normative stance on credit agencies in general, the effects of large agencies (such as S & P) ratings on financial valuation cannot be overstated.
To the extent that the lawsuit will explore what role S & P played in perpetuating the financial crisis, and then hold S & P accountable for that role, the judges decision is one that benefits society as a whole by overcoming the power-asymmetry / collective action problem(s) individuals face in holding large institutions to account. Since that is essentially what Normative Narratives is all about, I am happy that the judge will let this case go forward. Of course the wheels of justice move very slowly, so it could still be months / years until a final ruling is made/ appeals finish and any money is paid back, but this decision is a step in the right direction. Any money the U.S. government gets from this case should go towards helping people with refinance underwater mortgages; evidence suggests that low-income families were specifically targeted by lenders in the years leading up to the housing market collapse.
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Part of learning from past mistakes is holding the actors who perpetuated / profited from them accountable. Another part of learning from past mistakes is putting safeguards in place to prevent them from occurring again. The former has been addressed on an ad-hoc basis (many would argue not enough has been been done, but lets not allow the unattainable pursuit of perfection get in the way of achievable progress). The later was partially addressed this week with the confirmation of Richard Cordray as the head of the Consumer Financial Protection Bureau:
“The Consumer Financial Protection Bureau was conceived by a Harvard professor, embraced by the Obama administration and pushed into law by Congressional Democrats determined to expand the federal government’s authority to protect borrowers from abusive lending practices”
” [Senator Elizabeth] Warren proposed the creation of a federal agency to protect consumers of financial products in a 2007 article, memorably arguing that the government put more effort into ensuring the safety of toaster ovens than the safety of mortgage loans. The idea resonated with Mr. Obama and his senior advisers, and it became a centerpiece of the administration’s proposal to overhaul financial regulation.”
“‘It is a truly historic day,’ Warren told reporters before the vote. ‘There’s no doubt that the consumer agency will survive beyond the crib. There is now no doubt that the American people will have a strong watchdog in Washington.’”
“…the agency has begun to assert authority over non-bank financial companies, including mortgage and payday lenders, but its actions have been shadowed by uncertainty about the legality of Mr. Cordray’s appointment.”
“‘Today’s action brings added certainty to the industries we oversee and reinforces our responsibility to stand on the side of consumers and see that they are treated fairly in the financial marketplace,’ Mr. Cordray said in a statement.”
It remains to be seen how effective an institution the Consumer Financial Protection Bureau will be. But given the optimism of high ranking officials and the efforts that went into preventing Mr. Cordray’s appointment, it is safe to assume this is big news in the realm of financial reform.
“Despite the political and economic cynics out there, who in their great “wisdom” will tell you nothing is happening to hold powerful interests accountable for their role in the financial crisis, we have learned lessons (albeit incredibly hard learned lessons) and are taking steps to ensure we do not repeat our past mistakes.“
Normative Narratives 