The Trump and Clinton Foundations Are Character Tests that Hillary Clinton Passes and Donald Trump Fails 

The Trump and Clinton Foundations Are Character Tests that Hillary Clinton Passes and Donald Trump Fails 

September 14, 2016

Donald Trump’s charge that Hillary Clinton used her office as Secretary of State to service donors of the Clinton Foundation exemplifies a regular Trump tactic: Preemptively charge your opponent with what you know you’ve done.

So, fully aware that his own family foundation is a shoe-string operation that breached IRS regulations, or worse; Trump and his surrogates charged for months that the Clinton Foundation’s funding and works are proof of corruption. No disinterested party found any such proof.

Instead, a review of the dimensions and operations of the two foundations suggest that the Clintons built a serious and effective philanthropic enterprise while Trump’s foundation is a sham.

To start, the creation and funding of a private foundation can provide a measure of its founder’s generosity, because virtually all family foundations involve substantial gifts from their founders. Public records do show that the Clintons have contributed $5 million to $10 million, or roughly five to ten percent of their personal assets, since establishing their foundation 15 years ago.

According to a far-reaching  new investigation by David Fahrenthold of The Washington Post, Trump also contributed some $5.5 million to his foundation from 1987 to 2008. What does this say about their relative generosity? Trump says he’s worth $10 billion, so he has contributed .00055 percent of his personal assets — that’s 55 one-thousandths of one percent — to the Trump Foundation.

By contrast, the Clintons have contributed roughly five to ten percent of their personal assets to the Clinton Foundation. So, the Clintons have been 90 times more generous than Trump in funding their respective family foundations.

The Clintons’ charitable ambitions also are orders of magnitude greater than Trump’s. In 2013, the Trump Foundation provided grants totaling $913,000 for good works, while the Clinton Foundation spent $196 million on its good works. Do the math: The Clinton Foundation spent 215 times as much as the Trump Foundation on charitable works. This huge difference has import beyond their respective founders’ benevolent aspirations, because private foundations are major sources of public goods and welfare.

In 2008, a colleague and I published the first broad analysis of the benefits generated by private foundations, and found that each dollar in grants and support by those foundations produced welfare benefits valued at $8.58. On this basis, the Clinton Foundation grants and operations in 2013 helped generate benefits totaling nearly $1.7 billion, compared to $7.8 million in benefits generated by the Trump Foundation.

Another meaningful measure of a foundation’s value is the nature of its activities. The Clinton Foundation is known best for its Health Access initiative,  which, according to the World Health Organization and others, has dramatically cut the cost of HIV and anti-malarial treatments for tens of millions of sufferers in low- and middle-income countries.

The Clinton Foundation also sponsors programs to reduce the risks of climate change, including partnerships with businesses to retrofit their building for green energy; a joint initiative with the Scottish Hunter Foundation to target the roots of poverty in Africa; an alliance with the American Heart Association and the Robert Woods Johnson Foundation to reduce childhood obesity; disaster relief efforts following the 2004 Indian Ocean earthquake, Hurricane Katrina in 2005, and the 2010 earthquake in Haiti; and a partnership with the Bill and Melinda Gates Foundation to collect and compile information from around the world on the status of women. The head of the independent watchdog group Charity Watch, Daniel Borochoff, recently called the Clinton Foundation “one of America’s great humanitarian charities.”

The Trump Foundation reports no joint initiatives with other charitable organizations and few good works of any kind.  Instead, Trump’s foundation appears to be mainly a personal platform for its founder.

Fahrenthold’s investigation  found repeated instances of Trump soliciting funds from other foundations, a common charitable fundraising tactic. But Trump then used the funds donated to the Trump Foundation to make a donation in the name of the Trump Foundation, without adding any funds or operations of its own. In fact, all Trump Foundation grants since 2008 have been funded by others, because Trump himself has contributed nothing to his own foundation for the plast eight years.

Trump also appears to use his novel approach to philanthropy for his own personal profit: He solicited a $150,000 donation from the Charles Evans Foundation to benefit the Palm Beach Police Foundation, packaged it as a $150,000 grant from the Trump Foundation, arranged for the police foundation to receive the grant at a gala held at his Mar-A-Lago Club in Palm Beach, and then charged the police foundation $276,463 to rent Mar-A-Lago for the event.

Similarly, after Trump offered to personally donate $500,000 to charities highlighted on his “Celebrity Apprentice” television show, NBC/Universal which airs the program, donated $500,000 to the Trump Foundation to cover Trump’s “personal” pledges. Trump also appears to violate federal regulation of foundation by using foundation funds for personal benefit: The Trump Foundation paid $20,000 for a six-foot portrait of Trump that now hangs at one of his gold resorts; after Melania Trump bid on and won the painting at a charity auction held, of course, at Mar-A-Lago.

There is also the much-reported case of Trump’s foundation contributing $25,000 to the campaign of Florida Attorney General Pamela Bondi while Bondi’s office was investigating consumer complaints about Trump University.  Shortly there]after, A.G. Bondi declined to join other state attorneys general in a suit against the now-defunct Trump University.  Beyond the Trump Foundation’s direct breach of IRS regulations, for which it paid a nominal fine, the conduct fairly smacks of the pay-for-play corruption that Trump charges his opponent has committed.

Finally, Fahrenthold found five cases where the Trump Foundation claims it made donations, totaling $51,000, which the purported beneficiaries say they never received. The subjects of this trick included a veterans’ charity in Vermont, a pro-life nonprofit in Kansas, a Latino AIDs charity in New York, a children’s medical center in Omaha, and an umbrella organization for small charities in Los Angeles.

In the end, the questions raised about the Trump and Clinton foundations go to the character of Hillary Clinton and Donald Trump. Hillary and Bill Clinton have built an esteemed charitable foundation that has improved and saved the lives of millions of people around the world. Donald Trump has created a con, inveigling others to finance him play-acting as a philanthropist, and turning a profit for himself in the bargain.



Why We Need the Hackers behind the Panama Papers

April 28, 2016

The outrage heard around the world on the release of the Panama Papers brings to mind Claude Rains’s turn as the Vichy prefect of police in Casablanca, “discovering” gambling going on at Rick’s Café. The fact that many of the world’s richest people and most corrupt politicians squirrel away hundreds of billions of dollars in secret offshore accounts has been common knowledge for years. Less well known is the dogged opposition of Congressional Republicans to reforms that would end much of the secrecy surrounding the untaxed offshore wealth of the very rich and very powerful, reforms that most other countries have embraced.

The ownership and assets of these offshore accounts are hidden by complex networks of trusts and shell companies, often distributed across multiple tax havens from the Cayman Islands and Bermuda to Luxembourg and Singapore.  Lawyers and bankers create and maintain these trusts, shell companies and accounts in ways that have kept them hidden; at least until hackers accessed 11.5 million pages of files on the networks held by the Panamanian law firm Mossack Fonseca, a leading fixer in this shady practice.

The outstanding question is why governments allow these networks to remain secret, when they shield trillions of dollars in investment gains and profits that escape normal taxation and the ill-gotten riches of criminal and terrorist organizations and crooked politicians. The United States has two major laws in this area. For 46 years, the Bank Secrecy Act of 1970 has directed that any U.S. citizen, resident or business with financial interests in offshore accounts must report any income earned on those accounts.

The Foreign Account Tax Compliance Act of 2010 goes further. It directs all American citizens and residents that file U.S. income tax to report all offshore financial assets valued at $50,000 or more, and mandates that all foreign financial institutions report to the U.S. Treasury all of their accounts with substantial U.S. owners that also receive payments from the U.S. Both laws carry big financial penalties for violation; but neither law has any enforcement provisions, so the laws have little effect.

As financial losses from cross-border tax evasion and corruption have mounted, the Organisation for Economic Co-operation and Development (OECD) stepped in to sponsor new international standards for financial transparency and, equally important, new protocols for the automatic exchange by governments of the information they collect. Under these OECD standards and protocols, each government agrees to collect information on all account balances, investment income and other proceeds from financial assets within its jurisdiction; and to automatically share that information with the tax administrators of the nations where the owners of those accounts, investments and assets reside.

The G-20 finance ministers endorsed these standards and protocols in 2014. Since then, 97 countries have signed on, including most tax havens.  Even Panama agreed to the new standards and protocols, although the OECD reports that Panama and 10 other countries have not yet implemented them.

But the whole system is on hold, because the United States has not signed on. The Obama administration endorsed the new transparency system and proposed legislation to require U.S. financial institutions to collect the information on foreign-owned accounts held here and to authorize the automatic exchanges. Citing their longtime “respect for privacy rights,” Congressional Republicans flat-out reject both proposals.

On top of the administration’s proposals, Senator Sheldon Whitehouse has offered new legislation to strengthen the proposed transparency regime. His proposal targets many of the stratagems used by U.S. multinationals to avoid U.S. taxes, including shifting profits to tax haven countries. He also would tighten the OECD’s transparency standards and beef up compliance in several ways.

Whitehouse’s bill states that any foreign trust or shell company with substantial assets in the U.S. and managed here will be deemed a U.S. taxpayer, that U.S. taxpayers who set up entities in tax havens will be considered to control those assets, and that funds transferred from the U.S. to those entities will be deemed taxable income not yet taxed.  Most important, the proposal would bar U.S. banks from dealing with any foreign financial institution that fails to disclose offshore accounts opened by Americans and holding non-U.S. investments. Unsurprisingly, the Senate GOP has blocked the bill.

Such a bar is the big stick required to pierce the global secrecy treasured by the very rich and the very corrupt, and ensure that the automatic exchanges of information happen. In 2017, Hillary Clinton and a Democratic or divided but chastened Congress should pass reforms directing that all U.S. financial institutions comply with the OECD standards and protocols. This step would not only create real transparency; it also should produce several tens of billions of dollars in new annual revenues for the Treasury.

These reforms also must bar U.S. financial institutions from conducting business with any foreign financial institution that fails to disclose the ownership and holdings of accounts, trusts and shell companies owned by U.S. citizens, residents and businesses, within their jurisdiction. That’s a threat that every financial institution in the world will have to take seriously.



Are Financial Crises the New Normal?

June 17, 2014

The policy-making committee of the Federal Reserve Board meets again tomorrow, and the news won’t be encouraging. The one-percent decline in GDP in the first quarter disposed of the Fed’s forecast for 2.9 percent growth this year, and they have to lower it to the range of 2.0 percent to 2.5 percent. That’s just what the IMF did yesterday, forecasting as well that the United States won’t reach full employment again until 2017. So the Fed will leave interest rates at rock-bottom levels through at least next year. But Fed chair Janet Yellen will also continue to wind-down the quantitative easing program, because doing otherwise would signal big troubles ahead for the U.S. economy and scare the daylights out of the markets. In short, happy days are still out of reach, and there’s little the Fed can do about it.

We know it could be a lot worse, since it was much worse not very long ago. And it is much worse in other places. Consider Argentina: On Monday, the Supreme Court refused to let the Argentine government arbitrarily void its contracts with selected American lenders. So, now Argentina — with admittedly the world’s most irrepressibly, irresponsible, freely-elected government — may face another sovereign debt default by the end of the month. And according to the ratings agencies, the place next in line for a debt default is Puerto Rico. If it happens, the Obama administration will have to swallow hard and bail out our island Commonwealth — or risk economic chaos there and new problems for important banks here and in Puerto Rico.

Across the pond, Yellen’s counterpart at the European Central Bank (ECB), Mario Draghi, continues to work overtime to stave off a European financial crisis. Two years ago, Greece, Spain, Portugal and Italy were all teetering towards sovereign debt crises, until Draghi stepped in and pledged that the ECB would purchase as many of their bonds as it took to support their debt markets. Two years later, those debts continue to rise, though not as fast as before. But their economies are still not productive enough to attract the foreign investors they need to support their large public debt burdens. And the large European banks which hold more of those bonds than anyone except the ECB are still unprepared to weather a serious crisis. Yet, you wouldn’t know it from official pronouncements: Wolfgang Münchau reported this week in the Financial Times that the “adverse scenario” designed by the ECB to stress-test those banks’ ability to weather a big shock is, in certain respects, more optimistic than the ECB’s own forecast.

Finally, while China blusters that its renminbi should be an exchangeable, global currency on par with the dollar, the flood of credit it unleashed to maintain high growth in recent years has left much of its banking system technically insolvent. And its “shadow banking system” — the network of arrangements that many Chinese municipalities and businesses use to borrow funds outside the regular banking system — is in equally precarious shape. The only things protecting China from its own financial crisis are strict credit controls and the fact that the renminbi is not an exchangeable currency, which insulate it from the judgments of global capital markets.

The fact is, financial crises have become as common as they were in the 19th century before the rise of central banking. This new cycle started in Latin America in 1985–1986, followed by Spain, Japan and Sweden in 1990–1991, moved on to Mexico in 1995 and East Asia in 1997–1998, and then to the United States in 2008–2009. The European Union has barely skirted its own crisis for the last three years, and the strains are intensifying in China. In ways that no one understands, the ultimate source of these cascading crises almost certainly lies in the globalization of capital markets. Until we figure out how and why this is happening, everyone’s prosperity will be hostage to upheavals that governments cannot control and can only barely manage.



Why Corporate Tax Reform Is So Desirable–and So Hard to Achieve

November 14, 2013

In a political environment most notable today for its partisan trench warfare, serious conversations across party lines are nonetheless taking place over a major reform of corporate taxes. This unusual instance of comity comes from a genuine consensus that lowering the corporate tax rate — the favored goal would move it from 35 percent to 28 percent — would be good for the economy. As an economic matter, a revenue-neutral cut in the corporate tax rate has something for almost everyone: It should lead directly to more investment and higher profits, which in turn should produce stronger growth and, with any luck, raise the wages of some workers. Yet, serious corporate tax reform will always be a long shot unless the parties can agree on how to pay for it and what to do about all the businesses that aren’t subject to it.

The hardest piece of this puzzle involves where to find the money for a lower rate. If, as expected, profits, growth and some wages go up, part of the cost should be relatively painless; but those additional revenues would amount to more of a free appetizer than a whole lunch. And one popular target for additional revenues, the special tax deductions for certain investments by oil and gas companies, would provide no more than a palate cleanser. In the end, there are only a few pieces of the corporate code large enough to finance meaningful rate reductions — and all of them are fiercely defended by the companies that benefit most from them.

The biggest target is accelerated depreciation — some $550 billion over 10 years to provide in special tax deductions that offset the cost of large corporate investments, and at a rate faster than the equipment or structure actually depreciates. For the biggest beneficiaries, think of the communications equipment industry, aircraft makers, mining and industrial equipment producers, and other heavy manufacturing. Pushing the corporate rate down to 28 percent rate would offset their economic costs, while helping other industries even more. But the revenues from ending accelerated depreciation for corporations would only be enough to lower the rate to a little less than 31 percent.

Another costly provision is “deferral” — the ability of American multinationals to delay paying any U.S. corporate taxes on their foreign profits until they transfer those profits from their foreign subsidiaries to the parent corporation back in America. While experts argue over how much revenues would actually result from ending deferral, it would spread the pain: That’s because the industries affected most by an end to deferral make relatively modest use of accelerated depreciation – think of our leading software, Internet and pharmaceutical firms. The catch lies in the indirect costs. American multinationals earn foreign profits by out-competing their German, British and Japanese rivals in foreign markets. But unlike the United States, Germany, Britain, Japan and nearly every other country taxes corporations only on the income they earn in their home markets. So, ending deferral would force only U.S. companies to pay taxes both abroad and at home, leaving them at a competitive disadvantage. Holding them harmless while ending deferral would require a corporate rate even lower than 28 percent — and the revenues gained by ending deferral, along with accelerated depreciation, wouldn’t be enough to get the rate down to even 28 percent.

Moreover, corporate tax reform is not the same as business tax reform, not by a long shot. More than half of all business profits in America are earned by companies that don’t pay the corporate tax, including most investment and legal practices, hedge funds, private equity funds, and privately held companies. They are all organized as partnerships, LLCs or S-corps, not subject to the corporate tax, and taxed as “pass-throughs”:  The income of such firms is distributed among their owners and then taxed at the owners’ personal tax rate, sometimes as ordinary income and more often as capital income.

As an economic matter, the right answer is to tax all business income at the same rate, whether the business is a corporation or something else. It also would help with funding the lower rate:  For example, ending accelerated depreciation for all businesses, corporate or not, would raise an estimated $775 billion over 10 years instead of $550 billion. Moreover, a 28 percent rate on all business income mighty well raise substantial revenues, since so much of non-corporate business income today is taxed at the 20 percent rate for capital income. And that’s a political problem. To begin, ending the special “carried interest” tax break for hedge funds, private equity funds and real estate trusts might well ignite a Washington firestorm – which could explain why President Obama didn’t try to do it when he held healthy majorities in both house of Congress. That’s not all: To maintain a level playing field on personal taxes, the current 20 percent tax on the capital gains and dividends of ordinary investors also would have to go up to 28 percent up as well. But if that happened, the shareholders of public corporations would be at a costly disadvantage, since the same income would face a single 28 percent rate when earned by a non-corporate pass-through business, and a rate twice as high when generated by a corporation (28 percent at the corporate level and another 28 percent at the owners’ level).

This economic logic has led many conservative economists and Republicans to call for repealing all corporate taxes. Of course, there is no prospect of a bipartisan consensus for doing that. Rather, the Democratic side of the consensus for a lower corporate tax rate has always insisted that the same corporations make up for any and all revenues lost from cutting the rate. And that’s a problem which they haven’t yet solved.



As the Economy Improves, Give Some Credit to Globalization

June 3, 2013

The economic news and data have turned distinctly upbeat. With unemployment down, consumer confidence up, and personal debt back to normal levels, it was no surprise when last week’s revised report on first quarter GDP showed consumer spending rising at twice the rate of the preceding three quarters. Housing investment is now increasing at a 14 percent rate, following a 25 percent drop in home foreclosures compared to the first quarter of 2012 and many months of rising housing prices. Business investment is still sluggish, but corporate profits are strong, and the stock market is setting new records. These positive reports also explain why markets barely moved when Federal Reserve chairman Ben Bernanke noted recently that the Fed’s aggressive program to keep interest rates low might wind down sooner than expected.

The biggest drag on the economy, as usual, is government. If not for Washington’s misguided sequester cuts, tax increases and continuing layoffs by state and local governments, GDP would be growing at a healthy three to five percent annual rate.  Even so, conditions are improving enough to sharply drive down the deficits projected for the next two years. With Europe stuck in a double-dip recession, the United States once again finds itself a prime engine of global growth.

Credit for much of this turnaround goes to the Fed, and some of it is luck. But business attitudes and orientation count here, too. In particular, American policymakers and businesses have been committed to globalization for the last two decades, especially compared to their European counterparts.  And this deep engagement in global markets is a critical factor in the economy’s renewed strength. Not only are exports one of the brighter points in the current recovery.  In addition, years of sustained competition in global markets have made many U.S. industries markedly more efficient and innovative than their rivals in other advanced economies.

Bill Clinton deserves some thanks for all this.  He not only articulated the need for Americans to actively engage in world markets, clearly and convincingly. He also made that attitude concrete by corralling bipartisan majorities to enact NAFTA, create the World Trade Organization, and draw China and other large developing nations into a global trading system. American multinational companies may be best known today for their byzantine strategies to minimize their U.S. taxes. But their many years of investing in foreign markets at higher levels and rates than firms from other major economies count for a lot more.  Once there, they have had to compete with lower-cost producers in markets those producers know better than they do. This intense competition has forced U.S. multinationals to come up with new efficiencies and innovations, which they also have applied to their U.S. operations and markets.

The falling U.S. trade deficit provides clear evidence that all of this matters. In the first quarter of this year, for example, our trade imbalance was $22 billion less than it was a year earlier. This may seem remarkable, since stronger growth here than in Europe and Japan would suggest a rising U.S. trade deficit as imports rise and exports fall. It’s true that some imports are up — but so are most exports, including high tech goods that account for 19 percent of all U.S. exports.  The main reason, though, is globalization as U.S. companies that have spent years setting up shop around the world now tap into fast-growing markets across the developing world.

Consider whom we now trade with.  Our traditional major markets of Europe and Japan now account for just 25 percent of U.S. exports. They’re overshadowed today by the 32 percent share of our exports which go to our NAFTA partners, Canada (19 percent) and Mexico (13 percent). Another 12 percent of U.S. exports go to the rest of Latin America, seven percent to China, and 13 percent to the rest of non-Japan Asia. In fact, American firms export nearly half as much to Africa and the Middle East as they do to Europe.

President Obama is now doubling-down on the commitment to globalization. Last term, he got Congress to approve new free trade pacts with South Korea, Colombia and Panama. This term, he’s pressing for a major new trade deal with Pacific Rim countries and another with the European Union. The negotiations for the first deal, the Trans-Pacific Partnership Agreement (TPP) began in 2010. Now, the President is pressing all interested parties — Australia, Brunei, Chile, Canada, Malaysia, Mexico, New Zealand, Peru, Singapore and Vietnam, along with the United States — to complete the deal within one year. That’s an ambitious deadline, since TPP would lower or end many thorny domestic barriers to open trade. Among these are regulations and other impediments to competing in service-sector businesses, with state-owned enterprises, and in areas of government procurement, as well as health and safety regulations targeted at foreign competitors. And if we and the ten other Pacific Rim countries can strike the deal on TPP, Japan and South Korea would probably join too, and further expand its impact.

Completing a new free trade pact between the U.S. and the EU within the President’s two-year deadline will be equally daunting. Here, too, the issues include many of the toughest for trade in the 21st century, encompassing barriers rooted in the domestic regulation of services as well as health and safety, labor and environmental rules, agricultural subsidies, data privacy, and anti-trust policy. These are very difficult matters not only for the regulation-prone countries of continental Europe, but for the United States as well. Nevertheless, German Prime Minister Angela Merkel and the UK’s David Cameron are both on board with Mr. Obama. Alas, France’s President Francois Hollande is less enthusiastic, and the president of the European parliament, Martin Schulz, has warned that any deal must “put the European model at its core,” especially with regard to “labor unions and social rights.”

Both sets of negotiations will test everyone’s patience and political limits. But the process will recommit the United States to the path of liberal internationalism that has helped drive American prosperity for more than 65 years. And if they succeed, the result will not only reassert America’s global economic leadership.   The new agreements should also permanently raise the incomes of tens of millions of people here and abroad, along with the sales and profits of tens of thousands of U.S. and foreign companies.



Is This the Final Countdown to a Global Financial Calamity?

November 9, 2011

Ground zero of the European sovereign crisis has moved from Greece to Italy, and that’s very bad news for Europe, the United States, and most everywhere else. For a year, Angela Merkel and Nicholas Sarkozy have looked for some way to both prevent Greece from defaulting outright and reassure bond investors that Italy’s sovereign debt will remain sound. This week, the price that Italy pays to borrow money soared as global investors determined that holding Italian bonds is increasingly risky. The salacious Silvio Berlusconi is on his way out, but that won’t change the market’s judgment that Merkel and Sarkozy’s stratagems have failed. Europe now faces a real and present danger that major banks across Germany and France, along with Italy and Greece, could fail soon. Such a meltdown would take down the American expansion with it.

It’s still premature for a post mortem. But for the past year, domestic European politics, not international finance, has squeezed the acceptable options to solve the Eurozone’s metastasizing sovereign debt problems. Merkel and Sarkozy have long known that their countrymen and women would pick up pitchforks if their governments moved to bail out big banks a second time. If that wasn’t enough to inspire street demonstrations, the contemplated bailout this time would go to stabilize financial conditions in other countries. So Merkel and Sarkozy came up with a plan that appeared to spare French and German taxpayers. Unfortunately, it also couldn’t pass a laugh test by worldwide investors:  The plan has Eurozone financial stabilization board raising $1 trillion from those investors to back up Italy’s debt, with a pledge that Eurozone governments would guarantee the first 20 percent of any losses. Think about it: Italy, Greece, Ireland, and Portugal , all hanging by a thread or worse, would help the rest of the Eurozone cover the initial losses from bonds used to bail out Italy, Greece, Ireland and Portugal — and if things go south, probably Spain as well.

The $1 trillion commitment kept a meltdown at bay for a few days, much as the Bush Treasury’s commitment to spend $700 billion to bail out Wall Street staved off a market collapse after Lehman failed. The original Paulson plan also didn’t pass the laugh test, but no one doubted that the U.S. Government could raise the $700 billion. This time, the Eurozone’s $1 trillion commitment has bought them at most a few weeks of breathing space, as investors wait for Merkel and Sarkozy to come up with a real plan to raise it. But those investors already are eyeing the exits. Interbank lending to Europe’s biggest institutions dried up this week, just as it did here in the days before Lehman sank. And interest rates on Italian bonds are now so high that, according to the industry’s financial models, Rome will be unable to service its debt much longer.

All of this means that neither global investors nor European taxpayers are prepared to bail out the Eurozone. Even at this very late date, however, there are ways out of this mess:  Under the least bad of the options left, the European Central Bank (ECB) would become the Eurozone’s bond buyer of last resort.  The ECB could pay for them by printing enough Euros, for starters, to stabilize Italian bond markets. It wouldn’t be pretty. The Euro would weaken. European interest rates might edge up as Europe slowed. And the ECB would have to come up with another credible plan to withdraw the excess Euros once the crisis passed. But the alternative is much worse.

In a period of worst case scenarios, here’s what could well happen later this month. Start with the fact that Italy alone has $2 trillion in outstanding government debt. Most of those bonds are held by Italian, French and German banks, including the biggest banks in the world. Anything approaching an Italian default would wipe out the capital of those banks, leaving them insolvent; and most of the Eurozone economies would grind to a halt.

It gets worse, because a financial meltdown centered on sovereign debt is much more dangerous than one triggered by mortgage-backed securities. In effect, a sovereign debt crisis strips sovereigns of their ability to act to contain the crisis. With Italy and Greece in default, for example, who will believe those governments as they move to head off general bank runs by, say, guaranteeing money market balances as the United States did successfully in the days after Lehman?  And if the biggest banks in France and Germany go down, Sarkozy and Merkel wouldn’t have the credibility to do much about it either.

The bad news doesn’t end with Europe. Our own big financial institutions, along with those in Britain and Japan, have thousands of deals going that involve the major banks in Germany, France and Italy. Overnight, all of those deals become suspect, which could spread financial panic beyond the Eurozone. And remember the credit default swaps that destroyed AIG?  No one knows precisely how many of those “guarantees” are out today against Italian government bonds and the commercial paper of French, German and Italian banks. The fact that no one knows could be a big problem in itself, since that, too, could breed a broader financial panic. In any case, there’s little doubt that those credit default swaps involve, at a minimum, hundreds of billions of dollars, Euros and pounds. That would leave American, European and Japanese financial institutions on the hook for those losses. And if they can’t make good on them, they could go down as well. Their only hope would be another bailout — if Congress could approve one before the Tea Party and Occupy Wall Street folks pick up their pitchforks.

All this is not yet inevitable. But much of it might well unfold, and probably in a matter of weeks, unless the Eurozone’s leaders face the grim music and finally find their way to a real program to head it off.



The Cost of Playing Games with the Full Faith and Credit of the United States

June 2, 2011

I spent last week in Rio attending a meeting of the IMF’s advisory board for the Western Hemisphere — and returned this week to Washington for the latest round of threats and charges over raising the U.S. debt limit. The contrast was, at once, disturbing and farcical. At the IMF meeting, former finance ministers, prime ministers and other ex-economic policy officials tried to unravel the grim implications for all of us if (when) Greece, Portugal or, in the worst case, Spain is forced to default on their sovereign debts. Back in Washington, congressional Republicans laid out their terms for not driving the United States into a voluntary default on its sovereign debt. Perhaps holding onto a child-like faith that bad things don’t happen to the United States, under God, they spelled out terms which everyone knows will never be accepted by President Obama and a Democratic Senate. The irony is that the GOP gambit of holding out a potential debt default if they don’t get their way could, in itself, make long-term control over deficits much harder.

The reason lies in the powerful influence of worldwide investors on our interest rates. Thankfully, global capital markets still have confidence that our two political parties can settle this dispute on reasonable terms, and that in time the United States will regain control over its deficits and debt. We know that confidence is still there, because the interest rates and yields on U.S. Treasury bills, notes and bonds all remain near historic lows. If there were real doubts about our capacity to control long-term deficits, those interest rates would be rising as investors demanded higher returns to offset the risk that we’ll fail. This confidence makes sense, because we succeeded at the same task twice before, in the 1980s and again in the 1990s. It took several years of squabbling and compromise, but President Reagan and a Democratic House agreed to raise taxes, cut defense and reduce Medicare and Medicaid spending in the 1980s — and the same pattern played out again a decade later with President Clinton and, first, a Democratic House and then a GOP one. That combination of revenues, defense and health care was, and remains today, inevitable, since those are the only pieces of fiscal policy big enough for cuts and reforms that can make a significant difference for deficits.

But neither Reagan nor Clinton faced opponents prepared to hold the full faith and credit of the United States hostage to their own partisan approach to the deficit. To make this gambit appear respectable, House Majority Leader Cantor even claimed last week that major players on Wall Street had assured him that a U.S. default would be a matter of economic indifference. The only explanation is that Mr. Cantor, without realizing it, was talking to short-sellers getting ready to bet billions that U.S. stocks and bonds might crash — as they will if we actually do default.

Happily, worldwide investors are probably correct that the likelihood of a U.S. debt default is still very, very small. If it ever came close to that, the real players on Wall Street would face down the U.S. Congress. But cutting it close may turn out to be very expensive, too.

Let’s perform a small thought experiment. A Tea-Party infused GOP takes us to the edge of default and then pulls back. A really close call, however, would almost certainly make worldwide investors nervous. They would begin to question whether our politics truly are up to the task of dealing with our deficits, so they add a small risk premium to our interest rates. Let’s say — and this would be optimistic in this scenario — that short-term rates on Treasury bills go up one-half of a percentage-point; medium-term rates on Treasury notes rise three-quarters of a percentage-point, and long-term rates on U.S. bonds increase by 1.25 percentage-points.

Now, let’s be optimistic again and assume that Congress and the President eventually agree to cut the 2012 deficit by 10 percent — $108 billion off of the current projection of $1.081 trillion. That will leave a 2012 deficit of $973 billion to be financed. The small increases to interest rates would add about $7 billion just to the first-year interest costs of the 2012 deficit. And that’s just the beginning: All publicly-held Treasury bills also have to be refinanced in 2012 — nearly $2 trillion worth at last count. The tiny 0.50 percentage-point increase in those rates would add another $10 billion to next year’s interest costs. That comes to $17 billion in extra interest costs in just the first year, and just on publically-held debt. Those premiums would become embedded in those interest rates, adding much more to our interest costs, year after year, as additional deficits have to be financed and some $7 trillion in publicly-held Treasury notes and bonds come due for refinancing. A single refinancing of that current stock of publicly-held Treasury notes and bonds, with the new risk premiums, would add more than $50 billion, per-year, to interest costs. And the actual risk premiums demanded by global investors could be significantly higher than we assume here, and so that much more expensive.

These incremental increases in interest rates also wouldn’t be confined to U.S. Treasury rates; they would be transmitted immediately to other interest rates, from mortgages to credit cards. That means the expansion would further slow, American incomes and the government’s revenues would grow less, and, lo and behold, the deficits would be even bigger.

That’s the math. Even if congressional Republicans don’t mean it, the political games they’re playing today with a U.S. debt default, purportedly in the name of fiscal responsibility, could make U.S. deficits and debt even more unmanageable, and U.S. prosperity more problematic.



Why Big Banks Want Americans to Pay More for Everything

April 7, 2011

Once again, the nation’s big banks are working hard to have their own way with some of the most consequential issues before Congress. Tucked into the small print of Paul Ryan’s budget plan for 2012 and beyond are provisions to roll back the key regulatory steps taken to make another financial meltdown less likely, especially higher capital requirements tied to the riskiness of a bank’s investments. That’s not their only fight these days: They also are trying to roll back a critical debit-card reform enacted last year and just now about to go into effect. If they succeed — and the Washington airwaves are saturated with ominous ads calling for the rollback — it could cost many Americans nearly as much as what they have at stake in the ongoing squabbling over the 2011 budget.

The bipartisan debt and credit card reforms passed last year put the first real limits on how much the card networks and the large banks that issue nearly all cards can charge merchants when a consumer pays with a debit card. These charges are called “swipe fees,” and while they apply to all credit card as well as debit card transactions, the 2010 swipe-fee reforms apply only to debit card transactions. But if they save consumers as much as economists estimate, these reforms could well be extended to all credit card transactions too. And that could save the average American household some $230 per-year.

This is worth dwelling on, because it involves an ostensibly free market which, behind the curtain, a few huge companies actually manage to a significant degree — and now, behind the scenes, they’re also trying to manage the legislative process.

The facts, in a nutshell, are as follows. Merchants pay the three credit and debit card networks that account for some 80 percent of all charges a fee for every transaction using one of their cards that ranges from 1.5 percent to about 3.2 percent of the value of the transaction. A fee at some level makes perfect sense, since people buy more when they can charge or debit it, which benefits the merchants. But there’s no real economic basis for the actual levels of the fees. Less than 20 percent of the fees go to cover the actual costs of transaction for the banks and the credit card networks. Most of the rest goes to the four big banks that account for nearly 70 percent of all card transactions, with some going into higher profits and some for the advertising and rewards programs used to attract more customers.

We studied these fees last year. We found that in 2008, merchants paid swipe fees totaling some $48 billion. Those costs were tacked on to the price of everything they sold – clothing, computers, gasoline, restaurant meals, airline tickets, medications and so on. Moreover, the credit card networks forbid merchants from charging anyone using their cards a higher price to cover the fee, than those who pay cash. So, everyone pays for the swipe fees in higher prices every time they buy anything, whether or not they even use a credit or debit card.

We found that 56 percent of the swipe fees paid by merchants get passed along in higher prices, which in 2008 came to about $26 billion or $230 per-household. This year, it will be more, because we’re all charging more. And if the swipe fees were limited to the actual costs of processing debit and credit card transactions, plus normal profits, the lower prices for everything would expand real demand enough to create nearly 250,000 more American jobs.

In truth, the credit and debit card system operates more like a cartel than a genuine market. The fees are set by three companies that together account for 95 percent of consumer charges and two-thirds of business charges — Visa, MasterCard and American Express. Their actual customers are the banks that issue the cards, because the more cards are issued, the more swipe fees are generated. Moreover, four banks account for 70 percent of all cards and charges: JP Morgan Chase, Bank of America, Citigroup, and American Express (all of which, by the way, also collected taxpayer bailouts).

Since each of the networks and each of the banks account for a good slice of any merchant’s business, merchants have little option but to deal with them — again, much like a cartel. So, merchants can’t put normal market pressures on the networks and the banks to lower the fees by exiting the system. And since the networks forbid merchants from charging different prices based on whether a customer uses a card or cash, consumers have no incentive to pressure the networks and banks to lower their fees by using cash instead.

This not only produces higher prices, but higher prices that are applied in particularly unfair ways. More than half of all lower and moderate-income Americans don’t carry credit or debit cards at all. Yet they pay the higher prices along with everyone else. And most middle-class Americans with credit or debit cards pay higher prices to finance rewards programs largely restricted to more affluent card users.

So, last year, Congress gave the Federal Reserve authority to set rules for the swipe fees on debit card transactions. When Australia did much the same to cover both credit and debit cards, swipe fees there fell to 0.50 percent — and the system continued to work fine. The new rules are nearly ready to be issued here, and that’s what the banks and credit card networks are working so hard to stop. It will be another political test of whether big finance really can get anything it wants from Washington, regardless of the cost to everybody else.



The Quiet Role of Class in the Coming Budget Battle

December 2, 2010

The political struggle over how the federal budget will shape American government is now in full swing and likely to dominate Washington for the next two years. This week, the President joined the battle by proposing a two-year freeze on federal pay, his symbolic version of Bill Clinton’s maxim that “the era of big government is over.” In doing so, he aligns himself with growing public skepticism about the value of much of what Washington does. Yet, the anger driving the public debate isn’t really about federal spending much less federal pay. It’s about continuing high unemployment and stagnating incomes, because if Washington can’t get that right, what credibility does it have to manage everything else the public pays for? 

There’s another, more subliminal factor feeding the public’s anger about taxes and spending, and the only accurate term for it is economic class. Most Americans are fine with rich people getting richer, even when they get richer faster than everyone else — as long as the rest of us make progress too. But that’s clearly and painfully not the case today — the stock market and corporate profits are way up and multi-million-dollar Wall Street bonuses are back; while high unemployment won’t budge, wages are down, and the value of most people’s homes keep falling. On top of that, it was middle-class Americans who financed a recovery, through taxpayer bailouts and emergency spending, which so far seems to benefit only the wealthy. These factors alone should give Republicans pause as they prepare to block the extension of unemployment benefits and hold tax cuts for the middle-class hostage to preserving the tax cuts for the well-to-do.

The bigger political question is how most Americans would feel about the GOP’s hard-line positions, if they realized how much the economy in recent years has tilted to favor the wealthy. Recent data from the Federal Reserve document this tilt. In 2007, for example, the top one percent of Americans owned about 35 percent of all of this country’s assets or wealth — including houses, stocks, bonds, businesses, and so on — and the top 10 percent owned 70 percent of those assets.

The distribution of financial assets is even more skewed: In 2007, the top one percent owned 43 percent of the total value of all bank accounts, stocks and bonds, business equity, mutual funds, pensions, and retirement savings; and the top 20 percent of Americans owned an astonishing 93 percent. Ownership of only one type of asset is still spread around fairly broadly: With 70 percent of Americans being homeowners, the bottom 90 percent owned 40 percent of the total value of all residential real estate in 2007. But that fact is no longer evidence for the conservative trope that good times for the wealthy presage good news for everyone else: Since 2007, the housing bust has destroyed about 30 percent of the value of American homes, and it was triggered by Wall Street geniuses who took the taxpayer bailouts and now are pocketing multi-million dollar bonuses.

The tilt towards the wealthy is also much less steep in most other societies. While the top 10 percent of Americans own 70 percent of this country’s wealth and assets, the top 10 percent of Britons own only 56 percent of the wealth of their nation, the top 10 percent of Canadians own just 53 percent of their country’s assets, and the top 10 percent of Germans hold but 44 percent of the assets of their nation.  

The gap in incomes also has grown substantially over the last generation, and that suggests that the wealth disparities will only continue to increase. From 1982 to 2006, for example, the share of all annual income claimed by the top one percent of Americans increased from 13 percent to more than 21 percent; and the top 20 percent of us took home more than 61 percent of all the income earned here in 2006. Put another way, 80 percent of Americans have to divvy up about 38 percent of all the income generated in our economy. To be sure, a modestly progressive tax system ensures that the top one percent and the top 20 percent both contribute slightly larger shares of all federal revenues than they collect as income. But their share of federal revenues is also much smaller than their fast-growing share of the nation’s wealth.

These disparities have grown not from our politics, but from the way the economy is evolving. For example, our economy is increasingly capital-intensive — just consider, for example, how much more technology-dense most offices and workplaces are today, compared to just 20 years ago. Since capital is the source of more wealth creation than before, the wealth of those who own most of it has been growing faster. Incomes also are linked closely to the ability to work with all of that capital, increasing the income share of the top 20 percent of Americans with the most advanced skills and education. It is certainly not the burden or responsibility of government to alter the economy’s natural course. But when that course precludes meaningful economic progress for most people and creates profoundly undemocratic disparities in wealth and incomes, it surely becomes the government’s responsibility to ensure that the majority can genuinely thrive in that economy.

That’s a budget battle that President Obama could champion with confidence. For example, a good handful of subsidies for various industries would pay for low-cost access to college and graduate training for any young American with the drive and ability to see it through — as Britain, Germany and other countries, all with much smaller disparities of wealth and incomes, do. A small tax on financial transactions could float a new program of low-cost loans for homeowners with troubled mortgages, and so help stabilize the housing values that comprise the only asset of most Americans. Even a modest reform of the “carried interest” tax preference for hedge funds and private equity funds could more than pay for grants to community colleges to provide free computer training for any working person who wants it. And surely it’s time for the new realities of wealth and incomes in the United States to provide part of the framework for reforming our taxes and entitlements.



The Troubling View from the IMF Meetings

October 12, 2010

The International Monetary Fund held its annual Washington meeting last weekend, so I spent a balmy Sunday discussing the potential pitfalls for the U.S. and world economies. I attended as an American representative on the IMF’s advisory board for the Western Hemisphere; and in that group and beyond, almost no one could see a clear path to worldwide prosperity. Yet, few delegates seemed open to their own countries accepting any costs to enhance the prospects of global growth or even to protect the world from another meltdown.

The weekend’s favorite topic was the slow growth unfolding in the United States, Europe and Japan — too slow, that is, for the large developing countries that depend on us to buy their exports and so support their employment. The upshot is new concerns about a “currency war” breaking out in the developing world, and perhaps beyond. Already, many countries are intervening to keep their currencies relatively cheap and so make their exports more price-competitive than their neighbors. Of course, the only certain way for a country to keep its exports competitive is to produce better goods and services than its rivals. But that can involve reforms in investment, education and business-formation policies, all much harder to pull off politically than temporarily managing an exchange rate. The catch is that when everyone tries to keep their currencies cheap at the same time, no one ends up better off — and the next step is protectionism. If that sounds far-fetched, consider that one of the first orders of business in the new Congress will be legislation to punish Beijing for its cheap currency by slapping new tariffs on Chinese imports.

Forgotten in all these machinations is the supporting role that artificially cheap currencies played in the financial crisis. The strong dollar, compared to almost everyone else’s currencies, made Americans outsized consumers of everyone else’s exports — in 2007, U.S. imports totaled $2.2 trillion, or more than the entire GDP of all but five countries. But most of the dollars we spent on imports came back here, since the United States is the only place where dollars are the legal currency to buy stocks or companies. Those dollars helped swell the liquidity that financed the reckless leveraging by mortgage lenders and Wall Street, which all came crashing down in 2008. And when economists today say we have to redress “global imbalances” to avoid another crisis, they’re talking about the same dynamics. Yet, today’s competitive currency devaluations put us right back on the same path.

The weekend’s next favorite topic was the current political fashion for tight budgets, especially in the advanced countries. Since those are the same countries with slow growth, the talk turned to technical moves by the Federal Reserve and perhaps other major central banks — so-called “quantitative easing” — to expand credit even as interest rates already are near zero. This cheap new credit, of course, could someday be the kindling for the next bubble.

Moreover, it was hard to find anyone at the meetings who believes that the financial reforms taken thus far, here and around the world, are enough to avoid another meltdown. The good news is that the Financial Stability Board — that’s a rule-setting body for the major central banks — is set to issue another set of requirements for big finance, which will go well beyond what anyone else has done so far.

Of course, it’s unlikely that the world’s big banks will accept significant restrictions from the FSB, following their success in watering down new limits everywhere else. And even if they did, those rules won’t help contain the current flash point in the global capital system, the sovereign debt problems of Greece, Spain, Portugal and Ireland. A default by Spain, for example, would leave major French and German banks insolvent. They also would be unable to meet their obligations to U.S. and British banks, setting the stage for another financial meltdown.  Now, even if Greece goes down, as most financial experts privately expect, Spain and the rest may still avoid the worst. But if the worst does happen, the EU-IMF contingency bailout program might well not stem the tide. At least, that’s the current judgment of global investors, who have bid down the prices for Greek, Spanish, Portuguese and Irish bonds to levels near those before the EU and IMF announced their program months ago.

Behind all of these problems, the core issue remains the persistent slow demand and growth across much of Europe, Japan and the United States. The unavoidable fact is that the financial crisis has left countless tens of millions of households in the advanced countries poorer, and therefore reluctant to spend like they used to. The only recourse is to help people rebuild their incomes and wealth through direct measures to stabilize housing prices (the source of most people’s wealth) and to induce employers to hire more people. As usual, the world’s dominant economy and its President will have to take the lead. And that, I suspect, was the main topic of discussion this past weekend at the White House, just a few blocks down the street from the IMF meetings.