David R. Henderson  

Obama on Leno

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Deception and Signaling... Good News for Social Security ...

I just finished watching my DVR of President Obama on NBC's "The Tonight Show with Jay Leno." There were some interesting highlights. Of course, Obama was charming: he does that very well. If I judged him only by looks, tone, and humor, as I think most people will do, I would give him an A+. Particularly charming was the way he made fun of the fact that the Secret Service insisted that he take a motorcade rather than walk less than half a mile.

But there was actually economic content in the interview also, and not just what appeared to be Obama's prepared lines, but also his response to a bit of a curve ball that Leno threw him. Incidentally, isn't it interesting that comedians are asking some of the tougher questions being asked of politicians and pundits? Jon Stewart, for example, of the Daily Show, asked Alan Greenspan, "If we believe in free markets, why do we have a Fed?" (here at the 2:25 point)

Leno put his finger on what is so wrong about the special 90 percent tax that the House of Representatives voted to impose after the fact on a particular group of people and gave Obama a chance to justify it. Leno gave him a 2-3 minute break to think about his answer. When they came back after the ads, Obama didn't justify it and said that he would like instead to raise the top marginal income tax rate to where it was through most of the 1990s, that is, 39.6 percent. Here's where I fault Leno, though. Given that he asked a tough question and Obama stated his preference for a higher tax rate on all high-income people, Leno should have asked Obama if he would veto this law. Incidentally, the 90 percent tax is also imposed after the fact, which makes it an ex post facto law and, therefore, unconstitutional. Not that that typically matters in Washington.

Obama also hinted that he would impose federal usury laws. Here's that segment:

Here's the dirty little secret, though. Most of the stuff that got us into trouble was perfectly legal. And that is a sign of how much we've got to change our laws -- right? We were talking earlier about credit cards, and it's legal to charge somebody 30 percent on their credit card, and charge fees and so forth that people don't always know what they're getting into. So the answer is to deal with those laws in a way that gives the average consumer a break.
When you buy a toaster, if it explodes in your face there's a law that says your toasters need to be safe. But when you get a credit card, or you get a mortgage, there's no law on the books that says if that explodes in your face financially, somehow you're going to be protected.

The above segment is interesting in so many ways. First, as noted, in the first paragraph, Obama seems to be advocating federal usury laws. It was usury laws in California in the early 1970s that prevented me from getting a credit card with a limit of even $250. Second, Obama seems to be saying that high interest rates are the problem. Most people have thought that the bubble was due to low interest rates. Third, Obama seems not to understand, or maybe care about, moral hazard, as his toaster analogy shows. If your getting overextended on your credit cards means that you're not protected, you're less likely to get overextended on your credit cards. Consistent with that lack of understanding of moral hazard, in laying out, fairly well, actually, how AIG got in a heap of trouble, Obama never said a word about the fact one reason AIG could take such risks is that politicians like Obama and McCain would bail them out if things went bad.


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CATEGORIES: Finance , Regulation



COMMENTS (27 to date)
Matt C. writes:

The only thing that a toaster and credit cards have in common is that you entered into a contractual obligation with the retailer or credit card provider. The retailer agrees to give you the toaster if you agree to the toaster. The credit card company agrees to a credit limit and they have provided all of the details.

Really, if the toaster blows up because you just kept stuffing bread in and not taking any out who's fault is it that you didn't read the instructions? When the credit card company provides the fee and rate disclosures it's just like an instruction booklet. Neither company, the toaster manufacturer nor the credit card company, can make you read something. There has to be some individual responsibility.

Charlie writes:

"Consistent with that lack of understanding of moral hazard, in laying out, fairly well, actually, how AIG got in a heap of trouble, Obama never said a word about the fact one reason AIG could take such risks is that politicians like Obama and McCain would bail them out if things went bad."

This seems to be the one claim that no one tries to back with evidence or even consider relevant magnitudes. AIG has lost 98.25% of its market value since the beginning of 2007. The owners of AIG have lost nearly everything. The people being bailed out are people that are AIG's counterparties. What model says that a 2% stop loss will have a great magnitude of behavior change on the part of AIG shareholders?

Also, consider the assumption being made that companies knew the government would bailout these companies that were "too big to fail" shouldn't this whole thing have been predictable ex ante then? How ridiculous does it sound to say that 1 year, 2 years or 5 years from now the current policy environment was completely predicatble or at least conditionally predicatble. If it was, would libertarian bloggers really be as upset as they are now?

If this was predictable ex ante and counterparties knowing they would be bailed out, changed their decisions, shouldn't you have been saying 5 years ago that we needed tremendous new financial regulation? Since you knew a bail out would happen, shouldn't you have been advising a massive curtailing of systemic risk limiting the too big part? Were you?

The Snob writes:

OK, but what if your toaster blew up because you woke up at 7:30 instead of 7:00 one morning?

What I have an issue with is the use of teaser rates that reset from 6% to 28% because one payment is one day late. If down-regulating the ability of card issuers to do that sort of thing means they send out fewer wacky offers to people, I'm perfectly OK.

Jesse writes:

AIG has lost 98.25% of its market value since the beginning of 2007.

Thank you thank you thank you thank you.

I guess when you have a deep need to believe that it's all the government's fault, then even the simplest facts become hard to understand.

David R. Henderson writes:

Charlie writes: This seems to be the one claim that no one tries to back with evidence or even consider relevant magnitudes. AIG has lost 98.25% of its market value since the beginning of 2007. The owners of AIG have lost nearly everything. The people being bailed out are people that are AIG's counterparties. What model says that a 2% stop loss will have a great magnitude of behavior change on the part of AIG shareholders?

My response: Good point, Charlie. I stand corrected.

Charlie writes: Also, consider the assumption being made that companies knew the government would bailout these companies that were "too big to fail" shouldn't this whole thing have been predictable ex ante then? How ridiculous does it sound to say that 1 year, 2 years or 5 years from now the current policy environment was completely predicatble [sic] or at least conditionally predicatble [sic]. If it was, would libertarian bloggers really be as upset as they are now?

My response: When something happens that has a small percent of happening, we can say it was predictable, but that doesn't mean we predicted it. I don't get your point here.

Charlie writes: If this was predictable ex ante and counterparties knowing they would be bailed out, changed their decisions, shouldn't you have been saying 5 years ago that we needed tremendous new financial regulation?

My response: No. I don't believe in massive regulation. I believe in not having the doctrine of "too big to fail."

Charlie writes: Since you knew a bail out would happen, shouldn't you have been advising a massive curtailing of systemic risk limiting the too big part? Were you?

My response: I didn't know a bailout would happen. Even if I had, I would not have advocated regulation. I would have advocated ending the doctrine of "too big to fail."


Charlie writes:

"Charlie writes: Since you knew a bail out would happen, shouldn't you have been advising a massive curtailing of systemic risk limiting the too big part? Were you?

My response: I didn't know a bailout would happen. Even if I had, I would not have advocated regulation. I would have advocated ending the doctrine of "too big to fail.""

Look, I respect this opinion and you are not the only smart person that has it, but will you please speak to this counter-argument?


If we think of the "too big to fail" doctrine in game theory terms, can it ever be time consistent? Whether we think bailouts will occur because they are optimal ex post (after collapse) or they happen due to political considerations, won't they alway happen ex post? And since they will always happen, shouldn't our ex ante strategy take that into consideration.

Even if we think we could limit bailouts to only occurring with some probability, p, it seems the point still stands. What evidence is there that we could get p really low? What sort of institution or commitment technology would need to be put in place and who has proposed it? Would it be credible?

I guess I'm asking, what makes you think ending the doctrine of too big to fail is in the feasible set?

Charlie writes:

"Charlie writes: Also, consider the assumption being made that companies knew the government would bailout these companies that were "too big to fail" shouldn't this whole thing have been predictable ex ante then? How ridiculous does it sound to say that 1 year, 2 years or 5 years from now the current policy environment was completely predicatble [sic] or at least conditionally predicatble [sic]. If it was, would libertarian bloggers really be as upset as they are now?

My response: When something happens that has a small percent of happening, we can say it was predictable, but that doesn't mean we predicted it. I don't get your point here."

The argument seems to rest on two assumptions:
1. It was predictable that if large financial firms failed, they would be bailed out.

2. This bailout doctrine caused people to act so irresponsibly that the financial system collapsed. Thus, that the U.S. gov't is stepping in now, actually caused the financial collapse a year before.

But it seems if that were true, then it would have been obvious ex ante (1 year, 2 year, 5 years ago) that this doctrine existed and that this doctrine causes significant moral hazard consequences to collapse a financial system, then it follows financial collapse should also have been predictable ex ante. That was the point I was making, I think, in fact, though if we were speaking ex ante (before the crisis) we would seriously discount this argument. For one thing, I think if we were speaking in 2005, we would have a very hard time predicting what the "too big to fail" doctrine would look like in 2009. We would probably also argue that there are other counterveiling incentives to prevent excessive risk taking (like losing 98% of your market value).

David R. Henderson writes:

Charlie,

You write: "I guess I'm asking, what makes you think ending the doctrine of too big to fail is in the feasible set?"

My response: It depends on what you mean by "feasible." If you mean "likely to be adopted," then it might not be feasible. But if that's your meaning of feasible, then tell me the specific regulations you would advocate that would have prevented the problem and that you think you can trust government officials to enforce and not undercut. Remember that a bunch of people turned in Madoff to the SEC and the SEC did nothing. So anything you recommend has to take into account the strange incentives of government officials also.

Charlie writes:

"But if that's your meaning of feasible, then tell me the specific regulations you would advocate that would have prevented the problem and that you think you can trust government officials to enforce and not undercut."

I think focusing on the "too big" part is feasible. I think we could take steps that moved more of the shadow banking sector into the banking sector. I think there would be efficiency losses, but that they are not as large as having explicit bailouts and not regulating.

What I mean by feasible is that I am modeling a two-player game, where the financial sector moves first and the gov't moves second. The financials have the choices "Act good" and "act bad" and the gov't has the choice "bail out" or "don't bail out."

If Financials choose act good, the payouts are "bail out" = (0,0), "don't bail out" =(5,10).

If financials choose, "act bad" the payouts are "bail out" = (10,-10), "don't bail out" = (-10,-20).

Or more clearly:
BO NBO
AG (0,0) (5,10)
AB (10,-10) (-10,-20)

So if we could somehow commit to no bailout we could push the equilibrium to AG,NBO, but we can't so the equilibrium will be AB, BO.

Obviously, this is vastly oversimplified, and the payoffs are made up just to illustrate the point.

So it is infeasible, because of time-inconsistency. The government can't precommit to no bail outs and so will end up in the bad bail out equilibrium. Also, one could think about this as an infinetely repeated game. Even if we could play no bail outs once or several times, the equilibrium is still the bad one.

John Jenkins writes:

The tax law in question would not be an ex post facto law.

The ex post facto clause applies only to criminal laws. See Calder v. Bull, 3 U.S. 386 (1798); Stogner v. California, 539 U.S. 607 (2003).

Retroactive application of tax laws is not barred. United States v. Carlton, 512 U.S. 26 (1994).

It is possible that the law would be considered a bill of attainder, however, and therefore unconstitutional.

David R. Henderson writes:

Dear John Jenkins,
If I'm not mistaken, ex post facto means "after the fact." The law taxes income after it is earned and the people receiving it faced a different law when they earned it. That makes it ex post facto. The part of the Constitution that forbids ex post facto law does not refer to criminal laws. It states, "No bill of attainder or ex post facto Law shall be passed."
You might be able to point to Supreme Court decisions that say that the limit applies only to criminal laws, but the Supreme Court can be wrong. I think you're talking more about whether the Congress can get away with ignoring the Constitution with the collusion of the Supreme Court, not whether the law is constitutional.
Best,
David

frankcross writes:

I enjoy your economic insights, but you might want to be a little more cautious about your constitutional law claims

Trieu writes:

FYI -- The toaster metaphor is often used by Elizabeth Warren to describe the plastic money industry. (Warren is a Harvard econ prof and was chosen to oversee TARP. I haven't watched the interview. Did Obama already cite this?)

El Presidente writes:

David,

Incidentally, the 90 percent tax is also imposed after the fact, which makes it an ex post facto law and, therefore, unconstitutional. Not that that typically matters in Washington.

As a matter of fact it does matter in Washington, and as a matter of law, I assure you that you are incorrect. If it is unconstitutional, this is not the basis on which it would be deemed so.

16th Amendment: The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.

An act of Congress authorized under this amendment satisfies the demand for due process of law required by the 5th and 14th amendments before the government may deprive a person of property. This is not an ex post facto law because such laws must define a particular act as criminal and then authorize the punishment of said act. This is a tax, not a fine. Nobody is being charged with a crime. Your point stands though, amongst the reasonable crowd, that this is not a good way to do things. I don't think you need the legal argument to persuade us. I think the President's approach was better. You may recall I disagree with you markedly about the effects of marginal rates.

Troy Camplin writes:

There is already a precedent for passing an ex post facto tax law: Clinton's tax increase, which he mad "retroactive." Nobody bothered with that, either.

scineram writes:

The bonuses were paid before the tax levied. How is the tax on paying bonuses not ex post facto?

El Presidente writes:

scineram,

The bonuses were paid before the tax levied. How is the tax on paying bonuses not ex post facto?

You might very well call it an ex post facto TAX. However, an ex post facto LAW (Article I, Section 9) has to make something illegal that has already occurred. A tax is not formally a punishment for criminal behavior (recent rhetoric aside), it's a levy for government revenue. If somebody wanted to make a case against it, they might argue that it is a "bill of attainder" (Article I, Section 9). Even so, this limitation on Congressional power was created to address punishment for crimes (esp. the death penalty), not taxes, which is why it is in the same sentence as the prohibition of ex post facto laws. You would have a challenge persuading the courts. The 16th Amendment allows the federal government to tax citizens directly whereas they used to have to tax the states, and it does not contain restrictions on the breadth or focus of such taxation of income, nor does it limit the taxation of property. So, you would have to make a claim of unconstitutionality based upon the law's focus and argue that this unfairly targets some people which would violate the equal protection clause of the 14th amendment with respect to the due process clause of the 5th amendment which forbids the government to take life, liberty, or PROPERTY without due process of law. This argument would not be accepted by the courts because they would find there was due process through Congress' power to tax (rational basis test), and the challenge would fail.

Like I told David, you don't need a legal argument here, and if you need one you probably won't be able to muster it. People can see clearly enough that increasing taxation on employees who got $5k bonuses is kind of absurd. However, the 73 folks in the list released today who got $1M or more, and the 5 who got $4M or more will have a hard time explaining their value to the company and the taxpayers who are footing the bill. I can't see why they ought to be allowed to keep the bulk of that money and their jobs. I think they need to make a choice. I don't think you'd say they "earned" it, and if you did I'd want to know how.

John C. Randolph writes:

"The people being bailed out are people that are AIG's counterparties. "

This makes not one bit of difference. If you lose money by making a bad bet, you are not entitled to rob your neighbor to cover your losses. It doesn't matter if you made that bet at the craps table, in the stock market, or in entering into an insurance contract without doing your due diligence regarding the solvency of the insurer.

The moral position doesn't change if you hire goons to rob your neighbor for you. It also doesn't change if you let the government provide the goons.

Taxpayer bailouts are unconstitutional, immoral, and they don't even win on any utilitarian grounds.

-jcr

alanstorm writes:

El Presidente,

You are missing the point.

"People can see clearly enough that increasing taxation on employees who got $5k bonuses is kind of absurd. However, the 73 folks in the list released today who got $1M or more, and the 5 who got $4M or more will have a hard time explaining their value to the company and the taxpayers who are footing the bill."

The question is, were the "bonuses" (that's in quotes, because from my reading, they are not bonuses in the sense that most people would think of them, e.g. something "extra". Apparently, these were amounts agreed upon by contract to be paid upon some conditions being met.) agreed to when the bailout occurred? If they were, Congress has no business interfering with them. None. Zero. Zip. Arguing that the amount matters is so much populist, mob-stirring horse pucky.

Of course, in this case, Congress and the President explicitly AUTHORIZED these bonuses, thanks to Chris "I didn't do it!" Dodd. Trying to deflect the blame by claiming they didn't know what was in the bill they voted for is a rare example of almost 100% pure bullshit.

Gandalf writes:

BS, this action by Congress is a punitive action against a small, select group of individuals to deprive them of their lawfully gained property. As the facts become more clearly known the public will understand that this makes it possible for Congress to come for their property. Expect revolution when that happens.

Bill writes:

Intersting point about the 98% loss by investors...

However, if I recall correctly, I read a year or two ago that the inverters (in some large Wall Street firms) where getting, very roughly, 1/3 of the income of the company, and "employees" where getting 2/3'rds of the returns (in bonuses and other performance based pay)...

First, does any one have the real ratios of investor/employee payouts (I may be wrong in my memory)...

And second, if the "employees" (including high bonused officers and others) get ~2/3rds of the return, than it could be said that the people who took the risk are being rewarded with continuing employment (or at least, a slash and burn mentality of the people running the companies).

In the end--the investors do have the responsibility to vote out board members and such (just like the voters do too).

-Bill

Joe C. writes:

Charlie writes: "Also, consider the assumption being made that companies knew the government would bailout these companies that were 'too big to fail' shouldn't this whole thing have been predictable ex ante then? How ridiculous does it sound to say that 1 year, 2 years or 5 years from now the current policy environment was completely predicatble [sic] or at least conditionally predicatble [sic]."

This was predicted 1, 2, 5 years ago, but warnings were ignored, and then action blocked: http://www.youtube.com/watch?v=cMnSp4qEXNM&feature=player_embedded .

The bailouts may not have been predicted because it wasn't contemplated that anyone would be dumb enough to do them. Obviously, we were wrong.

Mickey1776 writes:

Thank you!

Too big to fail? Isn't America too big to fail?

Listening to Obama has how he "inherited" record deficits makes me wonder if he has forgotten where and how a spending hog bill becomes law. What he "inherited" was exactly the create a crisis agenda that Congress (both houses) caused FOR THE SAKE OF AN ELECTION.

Did he forget that he was a U.S. Senator? I know he didn't spend much time on the job but surely he must remember that he and many, many of these hacks were up to their ears in the sub prime mortgage deal(Franks, Obama, Clinton, Dodd, Waters...ACORN, Black Caucus). Has he forgotten the bribes (donations) given to him by the very companies that were bailed out?

Now, after being caught for signing the unread hog bills, we are hearing how outraged he and his fellow cons are about legal bonuses that were allowed in the very unread bill that HE signed!
The answer: Pass an unconstitutional tax law in spite of legal contracts?


Have these clowns ever read the Constitution? Was Obama present during courses in contract law? Seriously, they take an oath and I would bet money they have never read the Constitution.

David E. Young writes:

The AIG disaster seems to be a direct result of speculation or gambling using credit default swaps based on the possible failure of various businesses. The figures I have heard regarding the possible extent of such losses if a series of such failures should happen are astounding - between $15 trillion and $63 trillion.

Exactly where in the Constitution does it say that the Federal Government is responsible for making whole those who engage in gambling and pure speculation? Is there an FDIC for credit default swaps? This gambling may have been legal, since there was no law against it, but it was still gambling. Since when would any sane person guarantee any speculators' losses? Exactly when did the Federal Government start guaranteeing reimbursement of gambling losses? Was it back when AIG started giving its biggest campaign contributions to certain Senators from Illinois and Connecticut?

This problem would probably not have occurred right now if not for the failure of Fanny and Freddie. And to blame for that we ultimately have government officials who encouraged, and even forced, the banking industry to make unsound loans. These are the same government officials who intend to tax Americans to cover the losses of those gambling on the failure of businesses via credit default swaps. They are also the same officials who pontificate about the problems the most in from of the cameras.

Arguing about millions of dollars in bonuses is quite a dog and pony show when used to divert attention away from the hundreds of billions and multimples of trillions of dollar problems that exist.

El Presidente writes:

alanstorm,

You are missing the point . . . The question is, were the "bonuses" (that's in quotes, because from my reading, they are not bonuses in the sense that most people would think of them, e.g. something "extra". Apparently, these were amounts agreed upon by contract to be paid upon some conditions being met.) agreed to when the bailout occurred? If they were, Congress has no business interfering with them. . . . Arguing that the amount matters is so much populist, mob-stirring horse pucky.

That's colorful. :-)

The amount matters because it suggests some people should benefit because they got together with other people and colluded to take undisclosed risks with everybody else's wellbeing while those who were unknowingly imperiled by these actions ought to pay up, forgive, and forget. It is probably legal. It is certainly contractual. It is unmistakably wrong. It is their indulgence in and insistence on this special entitlement that sets them apart and calls them out for special scrutiny. It would be better to address it here and now than to let it build into greater resentment that plagues us for a great while to come.

If you realized a contractor remodeling your home was doing a piss-poor job after you had given him partial payment, you might still pay him the rest because you only have that one home, it's cheaper than fighting him in court, and it's more convenient than insisting the work be redone to your satisfaction and having him walk away and leave you with an uninhabitable home. But you wouldn't hire him again, and if you could get your money back you'd probably try. If you were bound by circumstance to deal with that particular contractor in order to avoid some incredible peril, it wouldn't make the actions of the contractor justified nor would it mean that they earned what you agreed to pay them. I think it's pretty plain, and there's not much I can do for you if you manage to miss _that_ point.

Whether or not these were agreed to, they are unjustifiable. You seem to be arguing that they need no justification because they were contractual and because they were not previously nixed. You have a point, but so do I. I say that we have options about what we do next. Taxing them is one LEGAL option. I don't think that this legislation was the best option, but neither do I think we ought to continue to employ these individuals if they require this amount of money. What do they need it for? What do we get for it? Will nobody do the job for less? If we had not bailed them out they would have gone into bankruptcy and all of these bonuses, contractual or not, would be open for revision. I think this is a little more complex than simply appealing to the sanctity of contracts. Perhaps the amounts should not matter, but there is no denying that they do unless we intend to be oblivious to reality.

The amounts matter because many of us are convicted that it is this particular sense of entitlement that facilitated the excess, the deceit, the blatant disregard for the wellbeing of others and the false sense of security that brought about our present crisis rather than a milder correction earlier on. I wouldn't buy insurance from somebody who confessed to being a greedy SOB that didn't give a damn about anybody but themselves and would screw me if given the opportunity, even though it is perfectly legal to take that exact posture. Would you? I guess we know why they never told us. Sounds like a bad business model to me. I don't think we ought to encourage it.

dsm writes:

I love the toaster-credit card analogy. Was the president suggesting that a private entity, something like the Underwriters Laboratories that guarantees the safe and reliable functioning of that toaster, should be established for financial oversight? Probably not, but I can dream....

Songwriter writes:

Never mind the bonuses and tell me what AIG did with the $173,000,000,000 in bailout funds?

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