The S&P Ruckus and the Real Policy Challenge

The S&P downgrade was signaled well in advance, so it should not have come as a surprise. Paul Krugman takes a no-holds-barred position today that yes, the United States is a mess, but no, S&P is not the organization to rely on for this evaluation, since its laxity during the mortgage-finance bubble contributed to the meltdown and triggered the Great Recession. A neat summary of blogviews by economists is at Curious Capitalist. 

My Comment: Since U.S. Treasuries have been the global gold standard for risk-free debt, it is odd to think of them as rating less than AAA. For a rating agency to downgrade the debt in the way it did smacks of petulance over the way Congress conducted the debate. That should not be any business of S&P. The American voter will deal with that in 2012.

What strikes me as sad is that the unnecessary debt-ceiling debate precipitated the downgrade. The U.S. Government should remain focused on the 13.9 million unemployed Americans and the 9.1 percent unemployment rate. Demanding more cuts in spending now will not be helpful unless a package of job incentives is passed ASAP. What ought to have precipitated a rating-agency downgrade of U.S. debt, on technical grounds, was the exclusion of the Iraq and Afghanistan wars from the Federal budget, pushing this spending into the deficit and add to the U.S. debt. Or a downgrade for running up of deficits during the good years of 2004-2006 years unemployment was below 6 percent and falling. But that was when S&P was otherwise preoccupied, selling AAA ratings of evil baskets of CDOs. S&P is about six years late and a couple of trillion dollars off the mark.

NYC & LA | Counterfeit Goods

Counterfeit iPods etc. confiscated in Los Angeles

A November 2004 report by the New York City Comptroller's Office estimated that $23 billion was spent on counterfeit goods in NYC in 2003.

This was an estimate not just of counterfeit goods sold on NYC  streets, although such sales at the time were highly visible, for example up and down Broadway. The estimate also included:

• Counterfeit goods sold in stores. 
• Wholesale trade in NYC of counterfeit goods trans-shipped to places as far away as the Dominican Republic and Ohio. 
• Out-of-town shipments. A raid on a Chelsea warehouse found a huge volume of counterfeit goods being packaged for shipment out of town.
• Wholesale buying by out-of-town resellers. A Broadway warehouse was raided and found to be a major shopping center for wholesale buyers who brought their goods out in black plastic bags to load into waiting trucks.

It's not hard to hide in plain sight as a value-added counterfeiter in NYC. I was once included on a police raid targeting a small private house in Queens. A small group of people was making pirate CDs, packaging them in plastic "jewel cases" along with the usual inserts for delivery to retail CD sellers. The copying was done on up-to-date towers that could produce 20 copies from one master in a few minutes.

The cardboard boxes that the jewel cases came in were reused for shipment out, but the CD boxes remained, so it was easy to estimate the volume of CDs that were being shipped out. The empty boxes not yet trashed/recycled had contained hundreds of thousands of blank CDs.

An August 2011 "Nightline" story shows that Los Angeles has joined New York as a major trans-shipment and retail center for counterfeit goods. Counterfeit clothing and other branded goods are sold both on the street and in stores, to both retail and wholesale customers.

Counterfeiting may sound like a "victimless" crime, but it is not. When the goods are fake prescription drugs, fake sunglasses, fake auto parts or bootleg toys or food, they bypass certification or safety inspections. They also bypass sales taxes, which is a reason prices can be much lower than legitimate products. State and local governments are hard-pressed to pay for the services they provide and tax-evaders reduce revenues and force up the cost of collecting taxes.

The impact on brands is sometimes debated. Knockoffs can be described as promoting the products they try to duplicate. A parent may buy a knockoff for a young child. The extent of competition is determined by the cross-elasticity of demand, i.e., the extent to which the knockoff is a complement to the genuine item or is a substitute:

• If it is a substitute, sales of counterfeit goods harm sales of the genuine item. Example: Someone intending to buy a genuine Vuitton bag for a pre-teen daughter sees a vendor selling counterfeit bags and decides to save some money. This is a threat to the brands, because the availability ofthe counterfeit means that a sale of the genuine item was not made.
• If it is a complement, sales of counterfeit goods do not harm sales of the genuine item. Example: A woman who has just bought a genuine Rolex watch on Fifth Avenue for herself, sees a vendor selling fake Rolex watches and buys one for her pre-teen daughter (she would never have purchased a genuine one because her daughter is likely to lose it). This is less of a threat to the brands.

Brands that do not spend money to track and expose counterfeiters are in danger of seeing their reputation tarnished. Why should a consumer buy a high-status watch if counterfeits are available at huge discounts on the street? The stakes posed by counterfeiting are high.

For Green Jobs, Cut Fossil-Fuel Subsidies

Paul Krugman has a post on the green jobs issue. He wonders why wind energy investments and jobs have not been growing as fast as many have hoped. He argues that the "right incentives" have not been put in place and one reason is that progress on environmental issues is stymied by opponents of government intervention, i.e.,  believers in the markets. Krugman then makes the case that opponents of environmental intervention actually lack faith in the potential of markets. Markets would go to work to solve environmental problems if the right incentives were in place. For example, a price on carbon would be such an incentive.

I commented that in the context of the current debt-ceiling debate, the most promising path ahead in the Congress - especially for independent Republicans - is to push hard to end subsidies for fossil fuels. 

This is not a pipe dream. Last year I attended a press conference in Washington of the Green Scissors campaign, a 15-year-old group led by three organizations concerned about the environment. The campaign has identified $200 billion in wasteful and environmentally harmful subsidies, such as subsidies for petroleum and ethanol. The press  conference was bipartisan, including independently minded Republicans like Rep. Tom Petri of Wisconsin, who spoke in favor of reducing these subsidies.

The debate over the deficit and the debt ceiling is an opportunity for advancing alternative energy and energy efficiency by ending subsidies for the production of fossil fuels and ethanol.

The Great Debt Ceiling Countdown,15 Days to Go, A Missed Chance for GOP

President Obama offered a $4 trillion deficit reduction package to Speaker Boehner, but Boehner could not sell it the House GOP majority, even though it was tilted 4 to 1 towards spending cuts rather than revenue increases and a NY Times analysis shows even Republicans in a Gallup survey say they require only a 3 to 1 ratio.

George Packer, writing in the July 25 New Yorker, depicts the President as embodying responsibility without conviction – sane but not inspiring. The republicans represent conviction without responsibility, which is to say they are “raving mad.” Either way, the unemployed no longer have a place at the table. 

Comment: If you don’t have a seat at the table, you may be on the menu. Economists may not agree on details of solving debt issues, but the GOP emphasis on cutting spending now is preempting the potential for further fiscal action to revive the economy.  President Obama was acting on a utilitarian calculus, the GOP on deontological principles. But if politics is the art of the possible, rejecting Obama’s proposal was politically crazy. If S&P despairs of rational debate and lowers its rating on U.S. long-term debt, one outcome is that spending on debt service is likely to rise sharply.

MUNI BONDS | Rigged Markets

July 16, 2011–An outraged Republican friend sent me a link from Jesse's Café Américain, commenting on SEC and other actions announced on July 7. The related SEC actions, from their announcements, are summarized below. My friend was distressed at the inadequacy of the penalties.

SEC Actions and Related Other Government Actions

The SEC charged J.P. Morgan Securities LLC (JPMS) with fraudulently rigging at least 93 municipal bond reinvestment transactions in 31 states. JPMS agreed to settle SEC complaints of violations of Section 15(c)(1)(A) of the Securities Exchange Act of 1934 by paying approximately $51 million, to be passed on to municipalities that were cheated.

JPMS and its affiliates also agreed to pay $177 million to settle related claims by the IRS and other federal and state authorities.

JPMS improperly won bids by entering into secret arrangements with bidding agents to get an illegal 'last look' at competitors’ bids. Municipal issuers and investors didn't stand a chance against the fraudulent strategies JPMS and others used to guarantee profits.–Robert Khuzami, Director of the SEC's Division of Enforcement.

When municipalities sell securities, they usually invest the proceeds of the sales until the money is needed. As part of its oversight of the tax-exempt market, the IRS requires that such proceeds be invested at fair market value, which is commonly done by utilizing a competitive bidding process. But the SEC claims that during the period 1997-2005 JPMS's fraudulent practices undermined this process. Municipalities paid more for reinvestment products than they should have. JPMS thereby jeopardized the tax-exempt status of billions of dollars in municipal securities. 

When powerful financial institutions like JPMS conspire with each other to intentionally violate regulations designed to ensure fair investment prices, the integrity of the municipal marketplace becomes corrupted. Rather than playing by the rules, the rules got played. - Elaine C. Greenberg, Chief of the SEC's Municipal Securities and Public Pensions Unit.

The SEC complaint filed in U.S. District Court for New Jersey says that JPMS acted as agent for JPMorgan Chase Bank, N.A and on certain occasions:

• Won bids by obtaining information ("last looks") from bidding agents about competing bids. I
• Won bids that were wired in advance for JPMS to win (“set-ups”). The bidding agent deliberately set up non-winning bids from other providers, for whom other bids were wired for them to win. 

The employees involved are no longer with JPMS.

Comment

The SEC gets great credit for nailing this one. The penalties may be inadequate, but it's good to see the SEC taking action. The financial markets in the United States need to have their credibility restored and the SEC has a crucial role in making it happen.

DEBT CEILING | 8 Proposals

Michael D. Shear, online July 15, 2011 (in the Saturday, July 16 NY Times), provides a “cheat sheet” on the various proposals for meeting the August 2 deadline for raising the debt ceiling. Comment: Not mentioned is the fact that Both Moody’s and S&P have threatened to lower their triple-A ratings on long-term U.S. debt if the deadline is not met, with S&P going further and expressing hawkish views about the terms of any compromise. The threat of a downgrade at least partly offsets the argument that cuts in spending now might bring on a double-dip recession. Here is an abbreviated summary of eight overlapping and evolving proposals, with a few additional facts from a Washington newsletter (W&J Washington Update, July 15) and other sources, and my comments:

1. The Obama-Boehner $4 Trillion Grand Bargain.The “big deal” worked on between President Obama and House Speaker John Boehner (R-OH) would add up to more than $4 trillion in deficit reductions over ten years, with $1 trillion of it from new tax revenue. But the tax revenue portion of this bargain made it unpalatable to Republicans. Boehner backed off from this last weekend but the President still likes this idea. Comment: S&P also likes this approach, saying that there is a 50 percent chance it will downgrade U.S. debt within 90 days, and suggesting that anything less than a $4 trillion deficit-reduction plan over ten years could trigger a downgrade.

2. The Biden Half-Bargain. House Majority Leader Eric Cantor (R-VA) revealed some details of VP Joe Biden's plan to cut $2 trillion. Health care would lose about $340 billion. Reducing the debt would save $300 billlion. The Biden plan included several hundred billion dollars of new revenues from sources such as owners of private jets, hedge-fund managers and large oil companies. Cantor said the new tax revenues were a nonstarter. Comment: This would add up to about the $2.4 trillion of the debt-ceiling increase; it would not meet the S&P $4 trillion standard.

3. Cantor’s $2.4 Trillion Cuts.Cantor proposed $2.4 trillion worth of spending cuts without revenue increases. The President responded that these cuts are too deep, and would affect middle-class programs - student loans, Veterans’ benefits, Medicare and Medicaid – and that the cuts should be offset at least in part by higher taxes on wealthy individuals. Comment: Focusing only on the spending side does not meet the test of fairness.

4. White House: Proposed $1.5+ Trillion Cuts. President Obama has proposed cuts of $1.5-$1.7 trillion. Cantor says this would not be enough. Comment: Even if these cuts were matched by $700-$900 billion in new taxes to get to the $2.4 trillion of the debt increase, the total is below the S&P standard.

5. Cantor’s Stepwise Debt Increases. Rep. Cantor has suggested votes that would increase the debt ceiling in steps, with each step allowing Republicans to call again for more spending cuts. President Obama is opposed, saying that he wants to deal with the long-term deficit problem now. Comment: The President is operating on the sound principle that painful adjustments are best made as part of a package that shows fairness in the bearing of sacrifices.

6. The “Balanced Budget” Amendment.  In the background, House conservatives are seeking to tie an increase in the debt ceiling to the passage of a constitutional amendment requiring Congress to balance the budget. Another proposal is a cap on federal spending as a share of GDP. Comment: Would such an amendment be ratified by two-thirds of the states? Unlikely. It would make Keynesian counter-cyclical fiscal policies more difficult, limiting the ability of future fiscal policymakers to respond to a recession or depression. (But on the plus side it might end the practice of financing wars with new debt.)

7. The McConnell Three-Step Option. Senate Minority Leader Mitch McConnell (R-KY) proposes allowing President Obama to raise the debt ceiling in three steps ($700 billion, $900 billion and $900 billion) between now and the end of 2012. Even if the Senate joins the House in voting against the debt-ceiling hikes, the President could veto their opposing legislation and go ahead. Comment: This would put the onus on the President but would also get past the deadline – it’s a better alternative than defaulting on debt payments, but does not address the long-term deficit concerns of the rating agencies.

8. The Hybrid Obama-McConnell. President Obama would be given the authority to raise the debt ceiling in return for the President’s commitment to the level of cuts that he proposed as a starting point. Then a base-closing-type commission would come up with additional deficit-reduction plans by the end of 2011 for an up-or-down vote. Comment: A well-thought-through package like this might conceivably be enough for the rating agencies, at least for this year.