Chairman Volcker testified in front of Congress. He was on a panel that including Mark Zandi from Moody's Economy.com and Jeffry Miron from Harvard, though it's Volcker that's getting most of the media buzz.
Surprisingly, Volcker gave a sober assessment of the Obama administration's actions thus far, while supporting most of the future policy agenda the administration is pushing. Most negatively, Volcker critiques the current situation by asserting that the "Too Big to Fail" (TBTF) problem continues to exist and will continue into the future. "The danger is that the spread of … moral hazard will make the next crisis bigger,”
Volcker seems resigned to the fact that we will continue to have TBTF and bailouts will occur, but says that best way to deal with this is problem is to split up commercial and investment banks, with commercial banks (by which I assume he means depository institutions) subject to a government safety net but also tighter regulation (trading securities, derivatives), and investment banks exempt from the tighter regulations but not entitled to a government bailout. "The safety net has been extended outside the banking system.... That's what I want to change"
Volcker thinks that the administration should make it more clear that the safety net from the government will only apply to traditional banking institutions.
This sounds an awful lot like a call for bringing Glass-Steagall back, among other things.
On other issues like Consumer Financial Protection Agency, he supports the Administration's plan. Interestingly, he thinks too much is made of issue around executive compensation and was worried about too much "political involvement". My optimistic guess is that Volcker thinks that too much attention is paid to the high levels of compensation, whereas the more critical issue should be around the risks and incentive systems, such as the "deferred blowup" strategies that many traders have implemented.
All in all, lucid testimony from one of the most "blue chip" economic thinkers / leaders. It will be interesting to see how Volcker is able to influence the debate. On the one hand, he is officially the Chair of the President's Economic Recovery Advisory Board (ERAB), but on the other hand, the "inside baseball" story is that he is not involved on a day-to-day basis like Geithner, Summers, Romer, Goolsbee. He has an office but is rarely there. In fact, The ERAB is largely council of outsiders that includes executives, academics, union heads , and other leaders from a cross-section of society, with Austan Goolsbee as the lead staff economist. Most of the board itself is just a part-time group that meet’s periodically. In that sense, Volcker is in many ways an “outsider”, with merely nominal insider status.
Thursday, September 24, 2009
Wednesday, September 9, 2009
Optional Public Option might be path to a viable compromise on Health Care Reform
Optional Public Option
The “Public Option” is the most contentious single item in the entire health-care reform debate. The debates touch not only the implications and effects of the public option, but on the very definition of what it is. A possible compromise on this most contentious item in the heath-care reform debate might be creating an “optional public option”. What is this is “double option”?
In short, the federal government would create and fund the infrastructure for a public insurance plan similar to Medicare, or allow the public to directly buy-in to Medicare for some X-amount in premium cost. However - and this is key to the compromise - states would get to decide if they wanted to opt-in (or Opt-out) of the public option program. In short, states would get an option to allow their residents the option to buy into this medicare like program.
To be clear, this will not be a “state based” program or co-op. This will be a federal program which will involve the federal government setting reimbursement policy and prices (either through negotiation or agreed to set rates such as medicare +5% ) with the health care provider community. States will get the option of “plugging in” to the system.
While purists on either side will not be completely satisfied with this approach, there are still plenty of advantages that both sides can cheer.
States with a significant fear of a "federal takeover of the health care system can opt-out.
At the same time, the Program will benefit from the economies of scale and (possible) negotiating power the a large buying entity like the federal government will have. Additionally, States may be able to customize the implementation of the program to meet specific state needs.
Perhaps most importantly, this partial roll-out of the program to only certain states will provide a great source of data and comparison to see what a public option looks like, and what the effects of it are. For those on both sides of the public option debate, the partial roll-out will provide an opportunity to say “prove it”. Will private insurance be driven out of business followed by rationed public care? Ok, prove it! Will insurance cost drop while care quality increase? Ok, prove it! With so many unknowns and unanswered questions regarding the public option, a partial rollout to states who choose the public option (or choose not to) will enable many of these questions to be answered, or to “Prove It”. Furthermore, as states may differ in implementation, this will also allow everyone to see how the public option works in various different states.
Specific details around the structure, especially with regards to the federal funding, will need to be worked out. In (accounting and microeconomics) theory, the federal government would fund all “fixed costs” and the states and individuals would fund all variable costs. Obviously, where one draws the line between “fixed” and “variable” costs would be tricky, but still easier than getting agreement among the current set of proposals.
In short, the Optional Public Option is both pro-market and federalism at its best, combining the potential benefits of centralized efficiency with decentralized diversity.
The “Public Option” is the most contentious single item in the entire health-care reform debate. The debates touch not only the implications and effects of the public option, but on the very definition of what it is. A possible compromise on this most contentious item in the heath-care reform debate might be creating an “optional public option”. What is this is “double option”?
In short, the federal government would create and fund the infrastructure for a public insurance plan similar to Medicare, or allow the public to directly buy-in to Medicare for some X-amount in premium cost. However - and this is key to the compromise - states would get to decide if they wanted to opt-in (or Opt-out) of the public option program. In short, states would get an option to allow their residents the option to buy into this medicare like program.
To be clear, this will not be a “state based” program or co-op. This will be a federal program which will involve the federal government setting reimbursement policy and prices (either through negotiation or agreed to set rates such as medicare +5% ) with the health care provider community. States will get the option of “plugging in” to the system.
While purists on either side will not be completely satisfied with this approach, there are still plenty of advantages that both sides can cheer.
States with a significant fear of a "federal takeover of the health care system can opt-out.
At the same time, the Program will benefit from the economies of scale and (possible) negotiating power the a large buying entity like the federal government will have. Additionally, States may be able to customize the implementation of the program to meet specific state needs.
Perhaps most importantly, this partial roll-out of the program to only certain states will provide a great source of data and comparison to see what a public option looks like, and what the effects of it are. For those on both sides of the public option debate, the partial roll-out will provide an opportunity to say “prove it”. Will private insurance be driven out of business followed by rationed public care? Ok, prove it! Will insurance cost drop while care quality increase? Ok, prove it! With so many unknowns and unanswered questions regarding the public option, a partial rollout to states who choose the public option (or choose not to) will enable many of these questions to be answered, or to “Prove It”. Furthermore, as states may differ in implementation, this will also allow everyone to see how the public option works in various different states.
Specific details around the structure, especially with regards to the federal funding, will need to be worked out. In (accounting and microeconomics) theory, the federal government would fund all “fixed costs” and the states and individuals would fund all variable costs. Obviously, where one draws the line between “fixed” and “variable” costs would be tricky, but still easier than getting agreement among the current set of proposals.
In short, the Optional Public Option is both pro-market and federalism at its best, combining the potential benefits of centralized efficiency with decentralized diversity.
Monday, September 7, 2009
Financial Sector Compensation and Governace Reform
I think this is an interesting issue that has to be framed correctly for those making the case for compensation reform. Here is my take on how to frame it:
This shouldn't be so much about "compensation caps" as it is about aligning compensation with risk, especially systemic risk. I think if one is able to frame it like that, the nature of the debate changes to one of risk management and away from charges of "government -interference in pay"
Taleb (author of the Black Swan) has alot to say about the problem of the "deferred blow up" strategy where traders can take outsized risks that have "low frequency, super high impact". An employee can take these outsized bets and make reap huge gains for several years until a big blowup occurs. The blow-up is so big it can bring the entire firm down or even the entire system down. In such an event, the employee is effectively getting a free Put option, as their upside is unlimited, but the down side is only limited to his/her job and perhaps the current year bonus, as their is no recourse for the past bonuses. Here we've got a problem of ill-gotten gains.
There is no mechanism to guard against systemic risk. One could argue that this is a corporate governance / shareholder issue, and in part it is. Here, there might be a case that shareholders need more governance and risk tools at their disposal. At this point, the administration is focusing on this as a shareholder rights issue, which politically is probably the best way to start, as it enlists institutional investors as allies in the cause.
However, I would eventually go even further, as even shareholders are not going to be guardians of systemic risk, as their obligations are to protecting common equity portion of the balance sheet, not systemic risk.For instance, shareholders themselves might be tempted to allow risks that are "very low frequency, very very high negative impact" where these negative impacts are several times the value of common equity but supposedly only occur once every 50 years. In such an instance, they too are being given a "free put option", as they reap the outsized gains from the outsized risks, but do not bear the full costs if a blowup were to occur.
This shouldn't be so much about "compensation caps" as it is about aligning compensation with risk, especially systemic risk. I think if one is able to frame it like that, the nature of the debate changes to one of risk management and away from charges of "government -interference in pay"
Taleb (author of the Black Swan) has alot to say about the problem of the "deferred blow up" strategy where traders can take outsized risks that have "low frequency, super high impact". An employee can take these outsized bets and make reap huge gains for several years until a big blowup occurs. The blow-up is so big it can bring the entire firm down or even the entire system down. In such an event, the employee is effectively getting a free Put option, as their upside is unlimited, but the down side is only limited to his/her job and perhaps the current year bonus, as their is no recourse for the past bonuses. Here we've got a problem of ill-gotten gains.
There is no mechanism to guard against systemic risk. One could argue that this is a corporate governance / shareholder issue, and in part it is. Here, there might be a case that shareholders need more governance and risk tools at their disposal. At this point, the administration is focusing on this as a shareholder rights issue, which politically is probably the best way to start, as it enlists institutional investors as allies in the cause.
However, I would eventually go even further, as even shareholders are not going to be guardians of systemic risk, as their obligations are to protecting common equity portion of the balance sheet, not systemic risk.For instance, shareholders themselves might be tempted to allow risks that are "very low frequency, very very high negative impact" where these negative impacts are several times the value of common equity but supposedly only occur once every 50 years. In such an instance, they too are being given a "free put option", as they reap the outsized gains from the outsized risks, but do not bear the full costs if a blowup were to occur.
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