A central lesson from this crisis is that small is beautiful.

TO BE NOTED: From the WaPo:

"Geithner on the High Wire
A Rescue Plan Has to Reduce Risk, Not Just Regulate It

By Sebastian Mallaby
Friday, March 27, 2009; A17

In his stunningly ambitious House testimony yesterday, Treasury Secretary Tim Geithner laid out three ways to fix finance. Large players -- be they banks, insurers or hedge funds -- must take less risk. A rejuvenated regulatory machinery must monitor the risks they do take, reining them in when they go too far. And if the first two measures do not prevent the failure of a major institution, the government must have the power to manage its collapse in an orderly fashion.

Geithner's success will depend on being clear that the first line of defense -- prohibiting excessive risk-taking -- is the most important. The financial industry, which makes money from risk, will no doubt argue the opposite. Yes, Mr. Secretary, the industry will say: We love your rejuvenated regulator and your orderly wind-downs. And because you are erecting a wonderful safety net, there's no need to mess with our trapeze act.

It would be nice to be able to agree with this pitch, because trapeze artists bring real benefits. By borrowing large sums, traders magnify the profits they get from funneling the nation's savings to the individuals and companies that use them best. This borrowing, or "leverage," is certainly risky. But it increases the incentive to allocate scarce capital intelligently. More productive capital means more jobs and growth.

Equally, the market for sophisticated derivatives is not just a dangerous casino -- though it certainly can be that. To the contrary, derivatives can actually make some risk vanish, freeing nonfinancial companies to grow. For example, a U.S. exporter might hold back from expanding a factory because of the danger that the dollar will rise, undermining his ability to sell abroad. A U.S. importer might hold back from expanding a store because of the danger the dollar will fall, making imports unattractively expensive. Thanks to currency swaps, these equal and opposing risks can be made to partially cancel one another. The factory and store can move forward with expansion. Again, jobs are created.

Because there are real benefits in sophisticated finance, it would be great to mitigate its risks without hobbling it. Geithner's proposals to eliminate gaps in the regulatory machinery and to shore up swaps trading by moving those transactions into well-capitalized clearinghouses point in the right direction. But regulation will never be perfect. There is no way to escape the basic dilemma: If you want to reduce the risk that finance poses to the real economy, you have to limit the amount of risk that financiers take in the first place.

Consider Geithner's proposal to eliminate overlaps and gaps in financial regulation. As Geithner himself acknowledged, the crazy risks that caused the crisis often occurred at institutions that were fully regulated. London had a unified financial regulator of the sort Geithner advocates; it failed miserably. The promise (both here and in Europe) of a new form of "systemic" regulation will be extremely hard to fulfill. Besides, it is not even clear that the most basic regulatory reforms are politically possible. Members of the congressional committees that oversee the Commodity Futures Trading Commission enjoy the campaign contributions that their power generates, so they have blocked its merger with the Securities and Exchange Commission, even though such a merger would make eminent sense.

What of empowering government to wind down failing financial firms in an orderly fashion? "Orderly" is in reality a euphemism for punishing private creditors in the way they deserve. Under existing rules, the government's takeover of AIG has been perfectly orderly; the problem is that the costs are borne by taxpayers rather than by AIG's traders, bond holders and swaps counterparties, which should have monitored their risks better. But even if the government had enjoyed wider authority, it's not clear that it would have forced private creditors to take losses. After all, government already has broad authority over bank failures. But it has shied away from punishing bond holders of busted banks lest other banks' bond holders panic.

So Geithner's ideas on regulation and wind-downs are sensible, but they won't prevent the next crisis or save taxpayers from the cost. That is why the financial industry must be forced to take less risk. Traders must use less leverage and hold more capital, even if this dulls incentives to allocate savings efficiently. They must be forced to pay a "risk tax" to compensate a public that will foot the bill if they blow up. Moreover, the risk-tax rate must rise as financial firms get bigger. A small hedge fund can blow itself up with crazy leverage and not destabilize the financial system: It should take as much risk as it likes. A big hedge fund, bank or insurer is a different matter. Over the past decade or so, Wall Street has concentrated risk in ever-larger behemoths. A central lesson from this crisis is that small is beautiful.

smallaby@cfr.org"

What's The Bother About Labor Unions?

I want to consider the following point by Sebastian Mallaby in the Washington Post:

"And, given the object lesson from the collapse of the Big Three carmakers, government should think carefully before empowering labor unions further."

Now, I understand that Labor Unions are, in general, an interest group in the US tied to the Democratic Party. I also understand that GOP Senators from Southern States where there are foreign automakers competing with Detroit wouldn't be excited about given a lending hand to Detroit, based on regional politics and the interest's of their constituents. It might be nice to know if those states used what are called "incentives" in order to lure those automakers to those states, which I call government intervention in the market. So far, I understand.

What I don't understand is the bother created by Labor Unions in general. After all, the Labor Unions represent individuals who have freely chosen this representation, and the contracts that they arrive at with their employers are also freely entered into. What's the big problem?

As to wages, I have no idea if the wages they receive are fair or not, without looking into exactly what they're making and what they do and how much the company makes. Even then, I have no exact feelings about the correct or fair wage compensation. That's up to the people involved.

I don't understand this bother created by people making good money. What's the problem? That's not a bad thing. I would hope that they make as much as they can. So would I.

I also agree with Dean Baker here:

"The Employee Free Choice Act and the Right to a Secret Ballot

Workers do not currently have the right to a secret ballot in elections deciding whether or not they will have a union. The employer has the option to recognize a union based on card check (a majority of workers sign a card indicating their desire to join a union) or to demand an election certified by the National Labor Relations Board. The Employee Free Choice Act that will be considered by Congress in the next session gives this choice to workers.

Under the legislation, workers could organize by card check, but they can also petition to have an election overseen by the NLRB. Therefore it is incorrect for the Post to assert that the bill's "intent [is] to eliminate secret ballots in union elections."

But my bottom line is that I have no opinion about Unions. If people want them, that's fine. If they don't, that's fine as well. As long as people are freely choosing to organize and freely agreeing to a contract with their employer, who is also freely agreeing, I don't have a position one way or another.

This also informs my feelings about CEO pay and Hedge Fund Managers pay. It does seem excessive and the incentives seem poorly designed, but I have no position on what they should make. Again, I'd have to see what they do and how well they do it, and how important they are to their business in general. I have no a priori figure in mind.

I also understand that if, as I said before, I worked at AIG in a division that had been making money throughout this bubble and crisis, I wouldn't be too happy about having to take a pay cut because of other's stupidity. It might well make me feel unappreciated, and I would leave AIG. So, not all of their bonuses are necessarily idiotic.

I know that there are people who have theories of justice, say, that demand certain limits to salaries and wealth and their concentration, which I have some agreement with. I certainly don't want to see concentrations of power, and, if concentrations of wealth lead to that, then that's a problem that needs to be addressed.

My main concern is for the truly needy. In that sense, I agree with Rawls and others who believe that our shared resources should aid the truly needy first. Now, who's truly needy is a matter of opinion in many cases, and whether or not people are derserving of help is another matter of opinion, but I stand by the belief that we should help the truly needy first, as in foreign policy, we should focus, in our human rights aspect of foreign policy, on where the most people are suffering and dying. What good we can do might vary, but we can at least keep our eyes on, and focus enough of our attention on, where the worst human suffering is occurring.

Mallaby On Where We're Going

Mallaby again:

"Central banks, which face fewer political constraints than finance ministries, have rapidly come up with a plan to calm everybody's nerves, though the patient has not yet responded. The Fed's version of the policy comes down to this: If Bank A won't lend to Bank B, let's have Bank A lend to us and then we'll lend to Bank B; and if Banks A and B won't lend to companies C, D and E, then we'll get between them also. In this way, the full faith and credit of the U.S. government can be made to substitute for the lack of faith in private players.

The Fed's plan is already driving extraordinary growth in its borrowing and lending. This is the most sudden expansion in the state's role in the economy at least since the Depression. But the plan is sound. It does not involve printing money or igniting inflation. It shouldn't cost taxpayers much, if anything. Once investors see that the Fed's approach works in practice as well as in theory, there will be at least some reason for the markets to settle down."

I agree, especially here:

"In this way, the full faith and credit of the U.S. government can be made to substitute for the lack of faith in private players."

This is where we've been going.

Add Mallaby To Stimulus List

Add Sebastian Mallaby as being for a stimulus. I'm for it, but concerned on what we spend it on:

"The fastest and fairest way to help ordinary people is via a budget stimulus package. Part of the extra spending should be distributed to state governments, which are having trouble maintaining Medicaid and other programs as recession eats into their tax revenue. Part of the extra spending could go to infrastructure projects, though this tends to be a slow way of getting cash into the economy. But much of the stimulus should be in checks made out directly to citizens. Wall Street is getting its bailout. Main Street deserves one also.

This is not just about politics and fairness. The next stage of this crisis, if financial markets do calm down, will be trouble in the real economy. A new Wall Street Journal poll of economists predicts that U.S. gross domestic product is three months into a contraction that will last until spring -- which implies that the economy is headed for the longest period of shrinkage in more than half a century. There is only so much the Fed can do to fight this recession, especially since banks are too bruised to transmit the tonic of low interest rates rapidly through the economy. For reasons both political and economic, therefore, it is time for a budget stimulus."

Two, Maybe Even Three, Senses Of Regulation

Sebastian Mallaby says the following:

"The financial turmoil has pushed the Obama campaign into the lead, and this is mostly justified. Barack Obama is more thoughtful on the economy than his opponent, and his bench of advisers is superior. But there's a troubling side to the Democratic advance. The claim that the financial crisis reflects Bush-McCain deregulation is not only nonsense. It is the sort of nonsense that could matter. "

You should read the rest of the column to understand why he says that.

I want to make a point about regulation. On the one hand, regulation can be seen as inhibiting the free market, keeping businesses from doing things that would enhance the economy. On the other, regulation can be seen as forcing more conservative business practices on the free market, in order to enhance the economy.

I see regulation through the eyes of taxpayers who are the ultimate guarantors of our financial system in a crisis. If the taxpayers are going to have to foot the bill in the end when crises like this one occur, then I think that it is entirely appropriate that taxpayers put constraints on businesses and business practices in order to guarantee that business in this country in some areas is conducted in a more conservative manner.

So, if you don't want the government to be the ultimate guarantor, then I can see arguing against regulation, since the losses will be borne by businesses. But if not, then government can put in place constraints on what is really their investment.

I agree with Mallaby that it is a real concern that the reaction to this crisis, as in all crises, will be over-regulation. I do not agree that the reaction should be no regulation, but rather minimal and effective regulation to obviate the occurrence of crises.

There is also a lot of talk about socialism, etc., but that is a lot of nonsense. We will continue to have a free market and pursue free trade, however imperfectly. In the real world that is all that we can expect.

My View On Progressive Taxation

Andrew Sullivan gives his views on progressive taxation, which is basically my position:

"To put it as plainly as I can: I don't believe in a governmental attempt to engineer a substantively "fair" society through taxation. I see taxation as a necessary evil to pay for those few social goods that private individuals cannot provide for themselves. And the mode of taxation, in my view, should be as simple and as market-friendly as possible and should treat citizens equally, irrespective of their incomes. I believe in formal equality and a very limited state, not substantive equality and the welfare state. I know this is pie-in-the-sky, given our current Byzantine tax code and the entrenchment of certain socialistic assumptions in our political culture. I don't expect any radical change any time soon. But I'm not going to enable this kind of thinking without a challenge to it.

So yes: a flat tax so far as possible for as many as possible and no deductions. That's my goal. How that differentially impacts the lives of citizens should not be government's primary concern.

Government's primary concern is to raise money as efficiently and as leanly and as equally as possible. I'm happy with the government then setting up programs to assist the poor, to provide better education for those at the bottom, safety-net healthcare and better policing. i.e. to gear spending toward social ends that might help the poor the most. These are measurable, practical goods. What I'm not happy with is the assumption that tax policy should really be about redistributing wealth, and engineering substantive economic outcomes. Yes, of course, at lower income levels, a 20 percent flat income tax will be more onerous proportionally than at higher incomes. So what? Why should that even concern a government that is not aiming to socially engineer more substantive equality? and the alternative - skewing taxes to target success - is an absurd set of incentives to put into a growing society.

Am I heartless? I hope not. I just don't believe that having a heart is what government should be about. It's what the rest of us should be about. This, of course, is my core disagreement with Obama who does indeed have a notion that government has a right and a duty to take money away from those whom he believes can "afford" it and give it to those who "deserve" it. I don't believe in a government with that much power and that lofty a social goal. "

As I say, I largely agree. However, I don't lose a lot of sleep about the issue because of the following from Sebastian Mallaby:

"But those bad effects must be weighed against a good one: Higher tax rates mean a lower budget deficit. According to the Tax Policy Center, over the course of a decade Obama's plan would result in a national debt $1.2 trillion smaller than you would get under McCain's plan. Less government borrowing ultimately means lower interest rates and more private investment. This positive effect may well outweigh the blow to growth and jobs from weaker work incentives.

Tax hikes, in other words, are not automatic job destroyers. Joel Slemrod of the University of Michigan, a top expert on this subject, says bluntly, "There is no compelling evidence that a low-tax strategy is better for the economy over the medium or long run." Just look at the Clinton era. In 1993, the top marginal rate (income tax plus Medicare) was raised to 42.5 percent -- the same rate that Obama proposes but minus the candidate's proposed increase in the payroll tax. During the rest of the Clinton period, the economy generated millions of new jobs, and careful academic postmortems find that the 1993 tax hike caused little to no damage to the incentives of top earners.

So McCain's swipe at Obama's tax plan was something other than straight talk. As a share of the economy, Obama's plan would create an overall tax burden similar to the one that existed in Ronald Reagan's time. It would not choke off job creation; rather, it would slow the growth of the deficit and soften inequality. But the really depressing thing is that McCain himself once knew that. He opposed the Bush tax cuts before he supported them, saying that they would deepen inequality. But now he touts a tax reduction that is larger and more radical than even President Bush proposed, and he slams his opponent for holding the view that he himself held until recently."

So, here's the situation. I believe that we should pay as we go. The assets of the government and people of the U.S. vastly exceeds government spending. We don't need to borrow. It's not like a mortgage. You should only take a mortgage if you don't have the cash. Paying interest isn't a good idea unless you have to.

So, in theory, I'm with Andrew Sullivan. In reality, I'll take Mallaby's tax code over huge deficits, caused by a system in which every group tries to get the other to pay for things.

No budget deficits. Period.

Look. The rich are good to pay more under any system. Get used to it.