Congressional Testimony, October 28, 2009
By Russ Roberts
What follows is my testimony before the House Committee on Oversight and Government Reform, delivered October 28, 2009. The topic was executive compensation and the Special Master for TARP Compensation, Kenneth Feinberg, who was determining compensation at the firms who had not repaid their TARP funds.
Chairman Towns, Ranking Member Issa, and Distinguished Members of the Committee:
Americans are angry about executive compensation.
Rightfully so.
The executives at General Motors and Chrysler don’t deserve to make a lot of money. They made bad products that people didn’t want to buy.
The executives on Wall Street don’t deserve to make a lot of money. They were reckless. They borrowed huge sums to make bets that didn’t pay off. And they wasted trillions of dollars of precious capital, funneling it into housing instead of health innovation or high mileage cars or a thousand investments more productive than more and bigger houses.
Everyday folks who are out of work through no fault of their own want to know why people who made bad decisions not only have a job but a big salary to go with it.
No wonder they’re angry at Wall Street,
But if we keep getting angry at Wall Street, we’ll miss the real source of the problem. It’s right here. In Washington.
We are what we do. Not what we wish to be. Not what we say we are. But what we do. And what we do here in Washington is rescue big companies and rich people from the consequences of their mistakes. When mistakes don’t cost you anything, you do more of them.
When your teenager drives drunk and wrecks the car, and you keep give him a do-over—repairing the car and handing him back the keys—he’s going to keep driving drunk. Washington keeps giving bad banks and Wall Street firms a do-over. Here are the keys. Keep driving. The story always ends with a crash.
Capitalism is a profit and loss system. The profits encourage risk-taking. The losses encourage prudence. Is it a surprise that when the government takes the losses, instead of the investors, that investing gets less prudent? If you always bail out lenders, is it surprising that firms can borrow enormous amounts of money living on the edge of insolvency?
I’m mad at Wall Street. But I’m a lot madder at the people who gave them the keys to drive our economy off a cliff. I’m mad at the people who have taken hundreds of billions of taxpayer money and given it to some of the richest people in human history.
I’m mad at President Bush and President Obama and Secretary Paulson and Secretary Geithner and Chairman Bernanake. And I’m mad at Congress. You helped risk-takers continue to expect that the rules that apply to the rest of us don’t apply to people with the right connections.
You have saved the system, but it’s not a system worth saving. It’s not capitalism but crony capitalism.
Using a Special Master for Compensation to get our money back is too little, too late.
Many people argue that because the government handed out the money, the government has a right to dictate how it is spent. It’s a reasonable thought in personal relations. If I offer you money, I have a right to attach strings to my generosity. But in a constitutional democracy like ours, it is not the government that has rights. We, the people, have rights. The Constitution exists to restrain government, not to empower it.
Whether government has the right to limit pay isn’t the question. The question is whether it’s a good idea for the government to have the power to set compensation. Despite our anger, the answer is no.
F. A. Hayek, the Nobel Laureate economist, said: “The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”
The Special Master imagines he can design compensation packages that “align incentives” while “retaining key talent.”
But it is impossible for any one person—no matter how wise—to anticipate the consequences of such decisions. Certainly the Special Master does not possess that knowledge.
The Special Master doesn’t even know who is key and who is not. Some of that talent should leave and some of those firms need to disappear. But he does not know enough to decide correctly.
Nor does he have any incentive to acquire that knowledge. He has no skin in the game.
A single individual has been given enormous arbitrary power with insufficient accountability or transparency. This is not good for the rule of law, democracy or capitalism.
By focusing on those who owe the government TARP money, the Special Master distracts us from other firms that benefited from government rescue such as Goldman Sachs and JP Morgan Chase.
The comfort we receive from seeing compensation reduced distracts us from the policies that created the problem in the first place—the rescue of Wall Street from its own recklessness.
It is a charade of political window dressing to make crony capitalism look respectable.
I want my country back.
Let’s get the government out of the auto business, out of the banking business and out of the compensation design business. We need explicit timetables to disengage from government ownership including a plan for how the Federal Reserve will draw down its balance sheet. Most of all, we need to stop trying to imagine we can design housing markets and mortgage markets and financial markets and compensation.
I want my country back.
I want a country where responsibility still means something. Where rich and poor, Main Street and Wall Street live by the same rules. We don’t need a Special Master to level the playing field. We just need to take the crony out of crony capitalism so we can get back to the real thing.
How Little We Know
By Russ Roberts
Here is my take on financial reform from the latest issue of The Economists' Voice.
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Will Time Prove Ben Bernanke Wrong?
By Russ Roberts
(This piece appeared on NPR.org on 8/25/09)
President Obama has reappointed Federal Reserve Chairman Ben Bernanke, praising his creativity in preventing another Great Depression.
Talk about damning with faint praise.
It's true that we appear to have avoided the worst-case scenarios of the last year, but at what price?
Back in March of 2008, Bernanke and Treasury Secretary Henry Paulson engineered a rescue of Bear Stearns. A single suitor, JP Morgan Chase, was chosen to receive a sweetheart deal in the name of avoiding a credit freeze. The freeze came anyway. The Bear Stearns rescue was the beginning of an unprecedented expansion of power in the hands of the Fed and the Treasury with a level of opaque decision-making that is not appropriate for a democracy.
Even today we have heard little justification for the expansion of the Fed's power and the Fed's balance sheet.
Yes, we have avoided a depression. But let us count the costs.
Financial firms that made irresponsible and imprudent decisions have been rescued, propped up and bailed out.
AIG has received about $180 billion. That is almost $2,000 for every American household. That money has gone to sustain the bonuses of AIG and the financial health of its counterparties, such as Goldman Sachs. This is an obscene travesty.
The Fed currently holds $600 billion worth of Fannie, Freddie and Ginnie mortgage-backed securities. I am not optimistic about how that will turn out.
The Fed has injected hundreds of billions of reserves into member banks. This will fuel future inflation unless Bernanke is willing to raise interest rates when the recovery begins. There will be tremendous political pressure on him not to do so. So inflation is likely to come along with any recovery.
Worst of all, Bernanke, Paulson and Timothy Geithner have continued the disastrous policy of sustaining bondholders and creditors of reckless financial institutions. Capitalism is a profit-and-loss system. The profits encourage risk-taking. The losses encourage prudence. The bondholders and creditors are the single most important check on imprudence. They care only about one thing: solvency. By making them whole, their incentive to restrain recklessness has been greatly weakened. This sows the seeds of the next financial crisis.
I feel sorry for Bernanke. In one sense, as the world's greatest living authority on the Great Depression, he is the best man for the job. But because he is the world's greatest living authority on the Great Depression, another catastrophic economic debacle of a similar magnitude would be particularly embarrassing were it to occur on his watch. I believe he has gone too far in the other direction.
The Great Depression was caused, or at least greatly worsened, by too little liquidity. Bernanke has avoided that mistake. He has instead committed the opposite mistake of too much liquidity and too few failures. Obama has praised him. How history judges him will be the real test.
Halve The Deficit? Good Luck, Obama
By Russ Roberts
(This piece appeared on NPR.org on 2/25/09)
In his first address to a joint session of Congress, President Obama pledged to cut the federal budget deficit in half in four years.
Keeping that pledge won't be easy.
The Congressional Budget Office is forecasting a deficit for this year of $1.2 trillion.
That forecast does not include the spending package Congress just passed and Obama signed that will add hundreds of billions of dollars to the deficit over the next four years. And that doesn't include unforeseen spending increases in further bailouts for Fannie and Freddie or AIG or Bank of America or GM or the state of California or whoever else shows up in Washington with a hand out.
So Obama probably needs to cut spending or raise taxes by at least $700 billion a year. To give you an idea of how much money that is, that's about the amount the payroll tax currently collects. The payroll tax is about 15 percent, shared between employer and employee. Doubling that rate to 30 percent would add an extra $700 billion if — and it's an impossible if — if a tax rate of 30 percent didn't lead employers to reduce their number of employees or force workers to reduce their hours.
Besides, Obama also promised Tuesday night that 98 percent of American families, those earning less than $250,000, would not pay an extra dime in taxes. So to cut the deficit in half, he needs to raise taxes on the richest Americans and look for spending cuts.
He claims to have found $200 billion per year in spending we can do without. Assuming those spending cuts actually materialize, that still leaves $500 billion in higher taxes for the richest Americans.
In 2006, the latest year we have data for, the top 2 percent of tax returns yielded around $500 billion in revenue. So to cut the deficit in half, Obama will have to roughly double the tax rates on the top 2 percent. I don't think that strategy will be politically viable or economically productive.
What I think will happen instead, is that he will simply settle for running larger deficits for a while, continuing to borrow money from our fellow citizens and from foreigners, and hoping that the interest rates we offer on those loans don't start to rise because people start to realize that no asset, even treasuries, is risk-free.
The cheery scenario is the economy grows like gangbusters and tax revenues surge without increases in rates. Could happen, but I am not optimistic. Too many unknowns lie ahead.
Every president who inherits a deficit promises to cut it somewhere down the road. Only one president in recent years has kept that promise — Bill Clinton. But he was helped by six years of Republicans in the House and Senate. When the White House and the Congress are from the same party, it's very hard to say no to key constituencies that expect rewards for past support. If Obama is really serious about cutting the deficit down the road, he will almost certainly have to fight with his own party.
Russell Roberts is an economics professor at George Mason University, a distinguished scholar in the Mercatus Center and a research fellow at Stanford University's Hoover Institution. He is the host of the weekly podcast, EconTalk. His latest book is The Price of Everything: A Parable of Possibility and Prosperity.
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What Economists Know and Do Not Know
By Russ Roberts
(This piece appeared on the Boston Globe website on 2/2/09)
The House has passed an $819 billion spending package. Soon the Senate will vote. Will government spending get the economy going or slow it down? How long will it take to have an impact? How many jobs will it create? Can we afford it?
You would think economists could answer these questions. Since at least the Great Depression, economists have theorized about what causes the economy to slow down or speed up. We've theorized about unemployment and inflation and whether they're connected. We've theorized about monetary policy, tax policy, and the role of government spending. And economists have tried to find evidence to settle these fundamental questions.
And yet there is little or no consensus for what we should do right now to get the economy going and prevent it from getting worse. I wish it were otherwise. People expect us to know the answers. And plenty of economists claim to have the answers. Yet some of the finest economists in the country, including Nobel laureates, are on opposite sides of the current debate. And each side can cherry-pick data or historical anecdotes in support of its position.
I think the real divide between economists isn't over different macroeconomic theories but over underlying differences in philosophy and ideology. So where does that leave you, the curious, intelligent, non-economist citizen?
You could try to master the empirical evidence of each side. Perhaps one side is more persuasive than the other. Let me suggest a simpler strategy that gets at the underlying philosophic disagreement that I suspect is the heart of the matter.
Consider two different government programs for stimulating the economy. The first program borrows $819 billion and hires and pays groups of workers $819 billion to dig a bunch of holes and then fill them in. The second program spends $819 billion to repair a bunch of bridges on the verge of collapse, repair a bunch of sewers about to go bad, and revolutionize the energy and health sectors.
I think most economists would argue that the first program would be a bad use of federal money at a time when we're already running a growing budget deficit. Yes, it would put money in the hands of workers but the effect on the non-hole-digging part of the economy would be insufficient to justify increasing the future taxes necessary to repay the borrowing that financed the program. Most economists would also agree that the second program would be a bargain that would yield benefits well beyond the money put in the hands of those executing the project.
I think the disagreement among economists is really over which of these two scenarios is closest to reality. The federal budget is about $3 trillion. Is the next $500 billion or so money well spent or money squandered?
I think it will be mostly squandered, so I'm against the stimulus. Plenty of people think it would be money well spent. Many people want a role for government closer to that of Europe's. Most of us against increased government spending want to move in the other direction.
There is an underlying presumption in this debate that if the spending package doesn't stimulate the economy, then tax cuts or monetary policy are better. But maybe we simply don't have the knowledge to repair the economy from Washington. The economy is complex and the interaction between the financial sector and the real economy - between Wall Street and Main Street - is not well understood.
Rather than spending money we don't have, I wish Obama would use his political capital to change the parts of our political system that are dysfunctional - our entitlement programs that are demographically bankrupt, our broken budget system, our Byzantine tax system, our financial system that is in disarray. These changes would be more likely to create the confidence and trust in the future that our economy needs to get healthy again rather than borrowing and spending. Borrowing and spending is how we got into this mess. Let's look in a different direction.
Russell Roberts is professor of economics at George Mason University and a research fellow at Stanford's Hoover Institution. He is the host of the weekly podcast EconTalk.
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The Speech I Wish Obama Had Given
By Russ Roberts
(This piece appeared on Forbes.com on 1/23/09)
President Obama is eager to attack the economic crisis. Here is the speech I'd like to hear from him.
My fellow Americans, these are fearful times.
Through a set of public and private mistakes, our financial system is in disarray. The problems of Wall Street have spread to Main Street. Unemployment is on the rise.
Key sectors of our economy face unparalleled challenges. The auto industry is reeling. Housing and construction are in deep trouble. The financial sector has been hit with bankruptcy and layoffs. The retail sector is struggling.
Workers, investors, managers and entrepreneurs face a fog of doubt and uncertainty. When will the economy rebound? Will I lose my job? Will my products sell as they once did and at what price?
Investors and employers, consumers and entrepreneurs are sitting on the sidelines. Such caution is understandable. Until people are confident of the future, our economy is going to struggle.
What can the federal government do to unleash the forces of recovery?
Many are urging a massive increase in government spending coupled with tax rebates as a way to jump start the economy. But the economy is not stagnant because of a lack of spending. The economy is stagnant because of a lack of confidence in the future. Government spending on bridges, roads and new schools will stimulate the construction industry. But without confidence, the benefits will not spread to the rest of the economy.
The argument for a massive spending increase presumes that spending is the source of our prosperity. But it is the combination of prudent spending and prudent investment that creates prosperity.
I would like to guarantee that we in Washington would spend an additional trillion dollars or so wisely. I would like to guarantee that such spending would be free of pork and the influence of the powerful. But those guarantees would be empty promises. As a former senator, I know the temptations of power and influence that are unleashed when a trillion dollars are slopping around in the government trough.
And would a trillion-dollar increase in the federal budget deficit enhance investor or consumer confidence? What costs will a spending increase of that magnitude impose on not just future generations but on this generation next year and the year after?
Trillions of dollars of annual red ink puts at risk the government's ability to keep its promises. That will discourage private investment and private spending, imperiling any recovery that might take place based on private initiative.
Finally, adding a trillion dollars to an already bloated federal budget is another sign that we in Washington are irresponsible and unable to live within our means. It is that failure of will and discipline that helped create the current situation--a belief that we could have cheap credit and ever-expanding home ownership without any consequences.
A massive increase in spending on hurried projects of uncertain value, financed by borrowing, is a promise to raise taxes in the future and to squander resources in the meanwhile. That is not the road to recovery. That is not the road to prosperity.
What is needed instead is a set of steps to stimulate the productive side of our economy. A tax rebate of either the payroll tax or the income does not stimulate investment. There is no evidence that rebates even stimulate spending. Rebates do not change the incentives of consumers to spend or savers to invest. Past rebates have consistently failed to encourage economic activity.
Instead, I'm proposing today a radical re-imagining of our tax system. I am recommending the elimination of the payroll tax. The payroll tax is a regressive tax that falls harshly on the poor. And it is deceptive, an unacceptable characteristic of a tax in a democracy.
Half of the payroll tax appears to be paid by employers. In fact, studies of the payroll tax show that the employer merely lowers worker compensation in response to the tax burden. So workers pay virtually the entire 15%.
Worse, the payroll tax gives the illusion that taxes are "contributions" toward future social security payments. In fact, the payroll tax is used to finance current recipients of Social Security and Medicare along with other government spending such as the war on Iraq and welfare for wealth farmers.
This fools workers into thinking such programs are cheaper than they actually are. This artificially encourages the demand for such programs.
Unlike a temporary rebate of payroll taxes, eliminating the payroll tax will change incentives facing firms and workers. The result will be job creation and increased worker compensation. The permanence of the change raises the effectiveness of that encouragement, again in contrast to a temporary rebate.
But eliminating the payroll tax without reforming the budget and entitlement programs would be irresponsible and would rob the tax cut of much of its kick.
The payroll tax currently generates about $700 billion. We will pay for that reduction with three other changes:
--Eliminating all corporate welfare. Corporate welfare rewards those corporations that excel at lobbying rather than serving their customers. Eliminating it will save $100 billion annually.
--Implementing spending reductions in all departments of 10%, saving over $250 billion. Such cuts in a federal budget heading toward $3 trillion are hardly draconian. They merely return spending to the level of a year or two ago.
--Making small across-the-board increases in the income tax rate, yielding $350 billion. The poorest workers will in fact see a significant improvement in their after-tax income because the elimination of the payroll tax will overwhelm the increase in income taxes. The richest Americans will see a slightly larger increase because their payroll tax contributions are currently capped.
At the same time, I will appoint two bipartisan commissions to reform the budget process itself and the Social Security and Medicare programs. The budget process is out of control. Signaling to the private sector that the public sector will live within its means and avoid the erratic behavior of the past year will go a long way toward rejuvenating the economy. So will reform of Social Security and Medicare.
Social Security and Medicare are not viable in their current form given our demographics. For 70 years we have pretended that they are insurance programs. In fact, they are welfare programs that also help the rich in the name of generating support for the system. It is absurd for wealthy Americans to be part of a retirement and health system when they have the wherewithal to take care of themselves without government help.
The system isn't financially bankrupt--yet. But it is intellectually bankrupt. Why should today's workers pay for today's retirees in the expectation that future workers will do the same for them? Why should a poor worker of today send money to a wealthy retiree? There is a name for such schemes and it is not a pretty one. It would be far better to let those who are capable of taking care of themselves do so, while putting aside money for those unable to take care of themselves.
In short, I propose that Social Security and Medicare become means-tested safety nets for the truly needy, rather than a fake pension and insurance program with a hidden welfare component. The commission I appoint will design a gradual transition over time to such a transparent system, allowing today's workers to plan honestly for the future.
One method of transforming Social Security and Medicare will be to make them means-tested and make the welfare components explicit rather than buried and opaque as they are now.
Ultimately, this will allow for lower tax rates. Those expected lower tax rates will help encourage current spending because consumers will not have to worry about future tax increases.
If we have the courage to implement this plan of fiscal responsibility and a more transparent tax system with improved incentives, it will let the private sector know that the grown-ups are in charge and that the government can be trusted to act responsibly.
This will in turn encourage the risk taking and investment that must take place before our economy can recover. And most importantly, we will set the stage for future prosperity.
Thank you and God bless America.
Russ Roberts is a research fellow at the Hoover Institution, a professor of economics at George Mason University, and the host of a weekly podcast, EconTalk. His latest book is The Price of Everything: A Parable of Possibility and Prosperity.
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How to Move the Economy Forward?
By Russ Roberts
(This piece appeared on Forbes.com on 11/20/08)
President-elect Obama announced the other day that the government would do "whatever it takes" to revive the economy.
I suppose that made some people feel good. After all, who wouldn't want tireless effort in the face of a crucial problem?
Unfortunately, the problem with the economy isn't insufficient effort or focus. The problem is that no one knows what to do next. Hank Paulson already looks like a man who's not sleeping enough. His problem isn't insufficient effort. It's too much effort.
If reviving the economy were like reviving a patient whose heart has stopped, then relentless effort would be the key. Get out those paddles and keep stimulating the guy until he comes back to life. Never give up. Whatever it takes.
But reviving an economy is more like parenting. There's no manual. If there were a parenting manual, every hospital would hand one out with every newborn. But there isn't a manual because each kid is different. And parents come to learn that they aren't really in charge. There's too much of the process they can't control. So great parenting isn't about doing whatever it takes. It's an art. It's about a set of principles and knowing which principle to apply in which situation. When to be tough. When to be soft. When to give a kid a do-over.
Even the most skilled parents make mistakes. Not because they don't understand what it takes to be a good parent. Not because they aren't committed to doing the job as well as it can humanly be done. But simply because there's no way of knowing what to do next.
Often what's called for in parenting is the exact opposite of whatever it takes--what's called for is doing nothing.
Welcome to the world of macroeconomics. Even the wisest president and most skilled secretary of the Treasury doing whatever it takes isn't enough if you don't know what it takes. And there's no way of knowing.
Look at poor Henry Paulson. He can't figure out what to do. But you think it's easy? To revive financial markets, he just has to create confidence and a desire to invest. Piece of cake. Alas, no one knows how to do it. And it isn't from lack of trying. Or desire. Paulson's successor will have one advantage Paulson doesn't have. He'll know something about what not to do. But unfortunately, that isn't enough.
After all the changes in policy and the uses of the TARP that have been announced in the last six weeks, I suspect that confidence and a desire to invest are no longer under the control of the Treasury secretary or the president. If anything, many of Paulson's relentless efforts to move markets forward have made the situation worse.
Obama may promise whatever it takes, but the unfortunate reality is that he faces the same situation that Bush and Paulson have been facing. We need confidence and optimism, but there's no way of knowing how to get there from here.
Obama's only practical suggestion has been to support the idea floating around Congress for a stimulus package of $100 billion or more.
That doesn't exactly meet expectations of doing whatever it takes. That's doing what we've already done.
We tried a $160 billion stimulus package last spring. That accomplished very little. What's the argument for spending $100 billion to revive a $14 trillion economy? A $14 trillion economy where the government has just spent a few hundred billion and counting on financial bailouts and capital injections. To no avail. Does anyone really think that we haven't spent enough?
Somehow, I don't think an extra $100 billion or even $300 billion is going to get the job done, even if it goes toward infrastructure as some are suggesting.
What if markets are spooked by the specter of government spending without any constraints? What if doing whatever it takes means doing less, rather than more?
That is the conundrum for Obama and the successor to Paulson. The more options there are, the harder it is to know which one is the right one. The more options you try, the more uncertainty is injected into the economy, and the more cautious are investors and employers and consumers.
Nobody knows what it takes to move the economy forward right now.
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