Sunday, March 28, 2010

Financial Reform

More than a year after the 2008 financial collapse Senate Banking Chair Christopher Dodd of Connecticut made a formal release of a proposed financial reform bill. Senator Dodd directed his Banking Committee staff to up load an Acrobat summary of the bill, which is 12 pages and titled “Restoring American Financial Stability.”

The bill intends to create three new independent agencies: the Consumer Financial Protection Agency, the Agency for Financial Stability, the Financial Institutions Regulatory Administration.

It intends to create a new Office of National Insurance at the Department of the Treasury and a new Office of Credit Rating and an Office of Investor Advocate at the Securities and Exchange Commission.

Many of the duties and authorities of the agencies are combined from other existing offices and agencies, especially the Federal Reserve Bank. Under the new bill the Federal Reserve Bank would continue to manage monetary policy and be the lender of last resort, but it would lose many of its consumer and bank regulatory duties.

New duties for the new agencies include authority for the Securities and Exchange Commission (SEC) to regulate derivatives and hedge funds. New SEC duties give authority to examine credit rating agencies, disclose their methodologies and track record and deregister an agency. There are new proposals to regulate municipal securities advisors and dealers with enforcement through the SEC.

The bill provides for an annual assessment of the Securities and Exchange Commission, an apparent attempt to regulate the regulators, where an Investment Advisory Committee will watch over SEC practices and priorities along with a new Office of Investor Advocate.

There are more changes in corporate governance and shareholder rights and a page with the caption “Ending Too Big to Fail” describing new requirements for “limiting large, complex companies and preventing future bailouts.”

Back in 1998 the director of the Commodities Futures Trading Commission, a women named Brooksley Born, argued derivatives should be regulated because banks were taking risks lending money to hedge funds to buy derivatives. To shut her off Congress passed legislation prohibiting the Commodity Futures Trading Commission from writing new rules to regulate derivatives.

A review article [“What went Wrong” Washington Post, 10/15/2008] from last fall quotes former Federal Reserve Chair Alan Greenspan: “Regulation of derivative transactions that are privately negotiated by professionals is unnecessary.”

Apparently Congress agreed with Alan Greenspan that professionals are infallible, but that was in 1998. Now they think they are greedy and irrational and need to be controlled with new agencies and regulations.

Truth is that nothing has changed from the 1990’s or the 1930’s. Financial crises occur because banks only hold a fraction of deposit liabilities in reserve to pay for checks. If banks make enough risky loans for things like derivatives that default they will not be able to clear checks for account holders who need to make payments. Unless there is a bailout, business transactions will halt and the economy will collapse.

Back in the 1930’s there were many gamblers who took risks and bought stocks with borrowed money. After many banks failed Congress passed the National Banking Act of 1933 and the Securities and Exchange Act of 1934, which included Federal Reserve authority to set Margin Requirements: requirements that limit the percentage of borrowed funds to buy financial assets.

Margin requirements are still available for use as they have been since the 1930’s. If Congress thinks derivatives are not covered by Margin Requirements a sentence or two of revision in the regulations would take care of it.

Perhaps a 1,100 page bill reflects a Congressional mania for grandiose solutions, but I have to wonder about their motivation. Do they really want to regulate their friends on Wall Street? We will see.

Saturday, March 13, 2010

Jobs and Surplus

The caption in the Washington Post reads “Obama calls for White House summit on job creation.” [WP 11/13/09] The article reports the summit will be an attempt to signal his concern about the growing ranks of the unemployed and to focus on longer term strategies to improve the job market.

It is a worthy goal but reducing the unemployment rate and the number of unemployed is not the same as creating more jobs. That is because a majority of Americans live in families that make job decisions that depend on their spouse and the circumstance of other family members.

Economists often act as though individuals make independent decisions when it is time to enter the labor force and become part of the labor supply. Instead one person losing their job will often mean that two people start looking for work.

To see why suppose the mister in the Smith family has a job as a tool and die maker working in manufacturing. Tool and die maker is one of America’s better paid production occupations with a median wage reported at $22.32 an hour or $46,430 a year for 2008, and a 90th percentile wage of $34.76 an hour or $72,300 a year. As a family they might earn $60 to $80 thousand dollars.

The Bureau of Labor Statistics reports jobs as tool and die maker in decline every year since the late 1990’s. With a broad base of manufacturing also in decline it is easy to imagine a layoff for Mr. Smith. Economists argue and predict people will work less at lower wages and work more at higher wages so unless Mr. Smith can find work at his tool and die maker wage economists expect him to work less after a layoff than before.

Economists do not base their predictions on interviews, observation or data. Instead they rely on conjecture about preferences. Leisure they argue is valuable and will be traded for work in the personal preferences of individuals. Therefore, at higher wages leisure time is more expensive because it means giving up those higher wages, and people with standard preferences want less of what is more expensive. Conversely, at lower wages leisure time is less expensive because it means giving up lower wages, and people will devote more to leisure when it’s less expensive.

Those less devoted to the economist’s way think the Smith’s will do whatever they can to pay the bills and maintain their economic status. Mr. Smith will take a job in maintenance or construction or whatever he can find at lower wages if necessary, and a second job working evenings or weekends, but we can expect that Mrs. Smith will also enter the workforce looking for work. Together the Smith’s work more hours at lower wages to keep up, just as they might work less if their wage was higher. People like the Smiths assure that lower wages add to the surplus of labor.

Business owners and economists will be invited to the above mentioned summit. Too often job summits end up sounding the great cry: get some training. We will hope they recognize that low pay helps create a surplus of labor that makes more jobs a necessary but not sufficient condition to ease America’s employment problems. Recognizing something new is a lot to hope, but it’s a start.

Monday, March 1, 2010

Skills and Wages

I have heard people say that the director, the general manager, the CEO, or the boss should make more money, have a higher salary, than the people he or she manages. It may not be a universal thought but in America high wages carry prestige, which many agree brings authority.

Economists commonly reject any idea that a wage depends on prestige or confers authority. In the economists tool chest wages depend on productivity. High productivity means high wages and vice versa.

Take doctors where productivity equals important skills that can only be learned over a long period of time: typically 10 years. The years of medical training are a personal investment, not only because Americans pay their medical school tuition and finance their own education, but because the skills belong to the individual and can be transferred between employers.

A personnel investment is different than a personal investment. Personnel investment is training paid for by an employer. Training typically runs for weeks or months with orientation to specific employer needs. Employers are reluctant to pay for long term, general training because the skills and benefits belong to the individual that can be moved to other employers.

In a society where individuals pay for their own post-secondary education wages must reflect the time and money for investment if we expect people to have skills. We don’t want doctors to be paid low wages because they would not have the ability or willingness to make the investment to learn what we want them to learn.

Late last spring I clipped an article where wages do not reflect the skills Americans expect. The caption was “Panel on Fatal Crash Looks at Pilots’ Pay, Commutes.” [Washington Post, May 14, 2009]

The article detailed the efforts of executives at Colgan Air to defend the low pay of their pilots following the worst airline accident in 7 years. The co-pilot, aged 24, earned “about $16,200” and commuted by air from Seattle to Newark, New Jersey to go to work.

Colgan officials justified the low salary and long commute by saying “Pilots are told what the pay scales are. Our pay scales are within the industry standard.”

The Bureau of Labor Statistics reports a median national wage of $111,680 for an occupation titled Airline Pilots, Co-pilots, and Flight Engineers.

There was a time, not too long ago, when airline pilots were almost universally trained by the military at public expense. When pilots left military service to find commercial jobs as pilots, the airlines knew they were hiring thoroughly trained pilots.

The time has passed when airlines can rely on finding applicants trained by the military, but if airlines pay for military style pilot training they know their pilots can leave and go elsewhere. The weak financial incentive for airlines to pay for pilot training puts the burden on individuals who now find it necessary to pay for their own training.

Much of the incentive for individuals depends on the wage they can earn. Going beyond the minimum to be a well trained pilot requires an early investment of time, money and lost wages. A salary of $16,200 will not pay for that investment.

We want pilots to make more the $16,200, but not because we want them to have prestige. We want them to make more because our safety depends on it.