Christopher Kutz

We do not yet know what and when the Treasury Department knew about the now-repaid AIG Financial Products bonuses. But the following is plausible: the traders in that unit had convinced their employer that their skills were so important to minimizing the damage to their company, or would be so dangerous in the hands of their competitors, that they were able to extract compensation at least as valuable as the year before, independent of actual performance or retention. Lawyers then drafted apparently bulletproof guarantees that these bonuses would be paid. Treasury, given legislative cover by Congress, saw the bonuses as a distasteful but necessary cost of minimizing the total losses taxpayers would have to bear. Public outrage at this “business necessity,” however, could scupper the entire bailout plan.

Here is another recent story: intelligence professionals asked to use a range of surveillance and interrogation techniques the law clearly prohibited. They were able to persuade their employers that they needed access to these techniques in order to protect national security. Their employers agreed, and asked lawyers to draft documents that purported to protect the operatives from any legal consequences. Their employers may have agreed because they felt hostage to any future attack, if it might be said that they failed to exhaust all options; or because they genuinely believed that these techniques were necessary to security. When the techniques and the enabling legal documents were leaked to the public, the scandal wrought enormous damage to the reputation of the employer, domestically and abroad. Continue reading…

Vincent Fabié

Revamp the business model of credit rating services: We must interpose an independent third-party between issuers and rating agencies to overcome inertia in rating agencies reform — before free-marketers take advantage of the current crisis to promote deregulation approaches.

Everyone knows that we are in the midst of the worst credit crisis since the early 1930s. But what the casual observer may not know is that the system set up to protect investors is flawed to the core. The current crisis was driven, in part, by erroneously positive ratings of bonds backed by subprime residential mortgages. At the heart of the problem is the role of rating agencies and rating-driven regulations. These regulations determine how much capital certain institutions (e.g., insurance companies, banks) need to have available in order to own financial instruments. The safer the investment (i.e., the lower the probability of default), the less capital is required. Consequently, how an investment is rated determines how much capital a regulated institution such as a bank needs on hand. Thus, rating agencies have a profound influence on institutional investments – so profound that the rating agencies are the de facto allocators of capital in our system.

Policy-makers continue to appeal for a critical review of rating services, and some commentators now advocate removing rating-driven regulations entirely. They consider that the problem in the recent crisis was not the wrong ratings in itself but the fact that these ratings were incorporated into law through rating-driven regulations. In this conception, regulators should not have relied on ratings agencies to assess the risk of bond holdings but on markets that would be a better judge of risk and value than any analyst or company. Continue reading…

Kenneth A. Bamberger & Andrew T. Guzman

(Also published in the San Francisco Chronicle, Feb. 25, 2009.)

The Obama administration’s response to the problem of unsafe imports—from tainted foreign-made toys to adulterated drugs—must reflect the realities of globalization.

U.S. regulators possess a full toolbox to police domestic production. When laws mandating product safety aren’t enough, the production process itself is regulated – effectively placing a regulator on the each factory floor. For foreign products, however, American regulation of the production process is often impossible.

The dominant regulatory response to date has been more government inspections, ignoring the fact that there are simply too many imports for inspections to work. There are eight inspectors in the FDA’s new Beijing office, while Chinese exports to the U.S. total $321 billion. Even doubling or tripling the number of inspectors would clearly not be enough.

There is another option: giving U.S. importers incentives to monitor compliance with domestic consumer protection laws. Where imports are likely to pose a threat to consumers, higher legal penalties should be imposed against U.S. companies trading in these products, making these firms liable for the true costs of their foreign activity. Drug companies using foreign supply chains, for example, would face increased administrative penalties if harmful products enter the U.S. Companies would respond by taking safety costs into account when deciding where and how to conduct their business—extending the force of American consumer protection far beyond the formal reach of U.S. law. Companies would compete for the cheapest way to produce safe goods, rather than competing to produce the cheapest goods.

(An article detailing this proposal can be found in the California Law Review (December 2oo8).

Kenneth Bamberger is Assistant Professor of Law and Andrew Guzman is Professor of Law and Director of Graudate Programs.

Barry Eichengreen

(Originally published in the San Francisco Chronicle, Feb. 16, 2009.)

Americans may not realize it, but the biggest threat to economic stability is not falling home prices and retail spending but collapsing world trade. The value of global merchandise exports was down fully 45 percent in November 2008 from 12 months before. This is a terrifying number.

Nothing remotely comparable has ever happened before – not even in the Great Depression of the 1930s.

This is a body blow to an already staggering U.S. economy. U.S. exports in the fourth quarter of last year fell by more than 25 percent in constant dollars. California is being hit especially hard: outbound container traffic from the Ports of Long Beach and Los Angeles was down 30 percent in December 2008 from a year earlier.

It’s not surprising that when global growth slows, trade growth slows. But this trade implosion is unprecedented even for a major recession.

The explanation is the disruption to the financial system. Exporters need bank credit to transport their goods and insure them while in transit. And trade credit has dried up completely in the financial crisis. Banks desperate for liquidity are unwilling or unable to extend it to exporters.

The irony is that trade credit is virtually without risk; it is collateralized by the goods whose export it finances. But this also means that there is a solution.

The International Monetary Fund and World Bank could quickly establish a Global Export-Import Bank. They could float, say, $2 trillion of bonds making use of their AAA-credit rating and extend credit directly to exporters.

This is something they should have done yesterday.

Barry Eichengreen is Professor of Economics and Political Science at UC Berkeley.

Christopher Kutz

(Originally published in the Los Angeles Times, Feb. 17, 2009.)

The government should devise a simpler system to deal with household employees.

Stories about “nanny tax” problems accompany every presidential transition, with much schadenfreude about the plight of those wealthy enough to pay people to perform their household work.

No doubt some appointees who didn’t pay Social Security taxes for their household employees acted out of bad faith. Some may be genuinely surprised by the low level at which tax liability strikes. California tax liability starts when you pay someone $750 over a three-month period to work in your home, using your equipment and supplies; federal tax liability kicks in slightly higher, at $1,000 a quarter. For a housecleaner paid $150 a week, an employer owes about $1,600 a year to the federal and state government.

But we should not underestimate the number of people who, in good faith, would like to pay their appropriate share of taxes but are confused and frustrated by the obstacles government puts in their way. Given the difficulties, it is hard to believe the government really wants us to pay these taxes. Money is being left on the table. Continue reading…

Christopher Edley, Jr.

(Originally published in collaboration with Blue Sky in the San Francisco Chronicle, Feb. 16, 2009.)

We may need more economic stimulus options soon. Because most state constitutions have some requirement for balancing their operating budgets, they can’t borrow their way through hard times the way the feds can. That’s both good and bad.

If California, for example, could borrow when revenues fall, it would help meet expenditure demands for programs the public wants and needs, rain or shine. Of course, it’s best to balance borrowing with enough fiscal discipline to retire the debt when times are good. What is needed is a kind of “rainy day fund,” but financed with medium-term borrowing instead of savings.

To overcome the complications of state constitutions and legislative politics, this fund should be federal. In a recession, when a state’s revenues drop more than a certain percentage, the state would be entitled to a federal loan to cover a portion – say half – of the gap. The state would repay the loan before the next recession hits through cuts in federal matching funds for highways and Medicaid, which the state would raise with some combination of improved post-recession revenues, new taxes and state spending cuts. Run the program with a council: the Treasury secretary, the Office of Management and Budget director, and the nonpolitical head of the Federal Reserve as chairman.

Why should the feds help Californians, who choose to tie themselves up in ballot initiatives, super-majority requirements in their Legislature, Proposition 13, and other forms of sadomasochistic civics? A Rainy Day Borrowing entitlement would balance human needs, economic recovery and only moderate enabling of dysfunction in California and elsewhere.

Christopher Edley Jr. is Dean of the School of Law.

Jacob Hacker

(orginally printed in the Christian Science Monitor, Feb. 3, 2009)

If we heed lessons of the past, we can achieve universal coverage.

The economic stimulus package just passed by the House contains much to jump-start our economy in the next few years. And congressional moves to expand Medicare eligibility and healthcare for children (through SCHIP) are commendable. But these steps still leave largely unaddressed the most fundamental long-term threat to economic security that President Barack Obama vowed to tackle during the campaign: our crumbling framework of medical financing.

Now is the time to fix it. The window of opportunity for comprehensive action is open wider than at any time for decades. But without quick action, it will close, and America’s businesses, workers, and families will continue to suffer at the hands of a healthcare nonsystem that costs far too much, leaves far too many at economic risk, and does far too little to improve our nation’s health. Continue reading…

Robert Reich

(originally published in the Los Angeles Times, Jan. 26, 2009)

America, and its faltering economy, need unions to restore prosperity to the middle class.

Why is this recession so deep, and what can be done to reverse it?

Hint: Go back about 50 years, when America’s middle class was expanding and the economy was soaring. Paychecks were big enough to allow us to buy all the goods and services we produced. It was a virtuous circle. Good pay meant more purchases, and more purchases meant more jobs.

At the center of this virtuous circle were unions. In 1955, more than a third of working Americans belonged to one. Unions gave them the bargaining leverage they needed to get the paychecks that kept the economy going. So many Americans were unionized that wage agreements spilled over to nonunionized workplaces as well. Employers knew they had to match union wages to compete for workers and to recruit the best ones.

Fast forward to a new century. Now, fewer than 8% of private-sector workers are unionized. Corporate opponents argue that Americans no longer want unions. But public opinion surveys, such as a comprehensive poll that Peter D. Hart Research Associates conducted in 2006, suggest that a majority of workers would like to have a union to bargain for better wages, benefits and working conditions. So there must be some other reason for this dramatic decline. Continue reading…

Michael Pollan

(originally printed in the New York Times Magazine, October 12, 2008)

Dear Mr. President-Elect,

It may surprise you to learn that among the issues that will occupy much of your time in the coming years is one you barely mentioned during the campaign: food. Food policy is not something American presidents have had to give much thought to, at least since the Nixon administration — the last time high food prices presented a serious political peril. Since then, federal policies to promote maximum production of the commodity crops (corn, soybeans, wheat and rice) from which most of our supermarket foods are derived have succeeded impressively in keeping prices low and food more or less off the national political agenda. But with a suddenness that has taken us all by surprise, the era of cheap and abundant food appears to be drawing to a close. What this means is that you, like so many other leaders through history, will find yourself confronting the fact — so easy to overlook these past few years — that the health of a nation’s food system is a critical issue of national security. Food is about to demand your attention.

Complicating matters is the fact that the price and abundance of food are not the only problems we face; if they were, you could simply follow Nixon’s example, appoint a latter-day Earl Butz as your secretary of agriculture and instruct him or her to do whatever it takes to boost production. But there are reasons to think that the old approach won’t work this time around; for one thing, it depends on cheap energy that we can no longer count on. For another, expanding production of industrial agriculture today would require you to sacrifice important values on which you did campaign. Which brings me to the deeper reason you will need not simply to address food prices but to make the reform of the entire food system one of the highest priorities of your administration: unless you do, you will not be able to make significant progress on the health care crisis, energy independence or climate change. Unlike food, these are issues you did campaign on — but as you try to address them you will quickly discover that the way we currently grow, process and eat food in America goes to the heart of all three problems and will have to change if we hope to solve them. Let me explain. Continue reading…

Hal R. Varian

In an editorial published in the Wall Street Journal (January 7, 2009), I argue that the economic stimulus policies should emphasize firm investment incentives.  We want to come out of this recession with a higher consumer savings rate than we have seen in the past and this necessitates a higher level of investment.  Direct stimulus of consumption is problematic because consumers are likely to be cautious in spending. Public infrastructure investment can be subject to political compromise and is frequently too late to be effective.  Private investment, on the other hand, generates future productivity.  While investment tax credits and accelerated depreciation may not be as popular politically as tax cuts or stimulus spending, they may be a more effective strategy for economic recovery.
The editorial can be found at:

http://online.wsj.com/article/SB123129443022559731.html#printMode.

Hal Varian is a professor in the Schools of Information and Business, and the Department of Economics; he is also chief economist for Google.

Lee Schruben

If the government wants to insure people spend any future stimulus money “wisely”, don’t send cash, send discount coupons – for specific types of items, with expiration dates. Either the money will be spent as intended to stimulate the economy, or not – and the government would at least still have its money.

For example: spending billions to help American automobile makers PUSH out cars more efficiently won’t help much if local dealers are badly overstocked. Significant new-car discount coupons might help PULL some of those cars off the lots.

The last cash stimulus (100% discounts on anything) did not work all that well. Somewhat smaller, more specific, timed discount coupons might work better.

Lee Schruben is Professor of Industrial Engineering and Operations Research.

Jacob S. Hacker

(originally published in The New Republic, Dec. 31, 2008)

As we move deeper into the recession, most economists are urging President-elect Obama to spend big money right away in order to stimulate and prop up the economy. The sticking point for a lot of people, however, is the long-term budget picture, especially given that Obama is planning to keep most of his predecessor’s tax cuts. How are we going to drop huge sums of money on job creation and fiscal stimulus right now without continuing to suffer through yawning budget deficits years down the road?In fact, we have a magic bullet for short-term spending and long-term saving–health care reform. During the campaign, skeptics complained that a health care overhaul would involve a lot of upfront costs and that the saving would only come later. But that’s exactly what we need right now. Health care involves major spending in the near future, but, more than other initiatives, it will put a brake on federal outlays in the far future. Continue reading…

Barry Eichengreen

(originally published in Swiss Business Week, Nov. 24, 2008)

In the wake of the “Second Bretton Woods Conference,” expectations have fallen to earth. It should now be possible to discard overheated rhetoric about the end of Anglo-Saxon capitalism and get to work. The work in question should center on strengthening the financial system. The G20 summit on November 15th and even more the crisis that caused that summit to be convened remind us that purely national regulation is inadequate. The cross-border spillovers and negative externalities thrown off by subpar (one is tempted to say “subprime”) regulation are simply too great. At the same time there is no appetite for a global regulator, as President Bush and a series of “unnamed Treasury officials” reminded us in the run-up to November 15th. We will get a global regulator at about the same time we get a global army and a global police force.

Given that neither national nor supranational regulation is feasible, the challenge is to carve out something in between. This is where the intellectual challenge and interesting issues lie. What has been done along these lines to date – the Basel Committee of Banking Supervisors and the Financial Stability Forum – is not enough or we wouldn’t be in the current mess. Nor is it obvious that a College of Supervisors along the lines suggested by the members of the European Union will differ significantly from the status quo. The idea and its name will make the academics among us think of department meetings in our own colleges where every member of the faculty gets a say and at the end of which nothing much is decided. Continue reading…

Christopher Kutz

(originally published in the San Jose Mercury News, Nov. 27, 2008)

There has been much blame for the market meltdown in recent weeks on reckless bankers, brokers, and investors. Demands for reduction in executive pay have stemmed from the huge costs to taxpayers. The poster-child is AIG, which planned to pay out $630 million in managerial compensation, even as it drew on its federally-funded $122 billion credit line. States and the Treasury Department have proposed rules to freeze bonus payments for executives.

The crisis has shown that there is a need for greater regulation. Even Alan Greenspan has acknowledged limits to the market’s ability to self-correct. But there may also be room for a market-based reform – moreover, a reform that cuts more deeply than the Treasury proposal to limit the pay of the three most highly paid executives. Continue reading…

John Quigley

The foreclosure crisis is at the heart of the more general economic crisis. Protecting homeowners at risk of foreclosure is therefore an obvious priority. Here I outline a plan to ameliorate the foreclosure crisis, using the FHA’s mortgage authority to force lenders to recognize the actual values of homes and thus to restructure loans accordingly. The plan has four basic elements.

1) All those who purchased homes after a specified date are eligible, period. There is no distinction between those in arrears and those current in payment. There is neither time nor reason for a fight about moral hazard.

2) Participating homeowners will pay a small amount to register and receive an appraisal of current house value from the Federal Government.

3) If the household is able to make payments on a new first mortgage with a 40 year term for this appraised value, using standard underwriting criteria, then the household will be offered a new FHA mortgage. This new mortgage will be structured as interest-only for an initial period of years. This mortgage will be guaranteed, and premiums will be paid into the existing Mutual Insurance Fund administered by FHA.

The mortgage under these new terms will be reported to the master servicer, who will replace the existing contract with the new contract. Servicers will inform the owners of securities in any pool containing parts of the previous mortgage, and servicers will continue to pass on payments made by homeowners under the new contract to owners of existing mortgage pools or other securities.

4) In addition, when the new contracts mature or are terminated, any capital gain, net of costs, will be divided, with a small fraction accruing to the homeowner. The residual gain, net of costs, will be transmitted to the servicer who will distribute it to the owners of securities or pools in which the mortgage is bundled.

Continue reading…