Noah Millman

Randy Barnett Pokes a Hole In My ACA Argument

[I]f they have a commerce power to mandate you buy things, then under existing law and financial law, they could put you in jail. Every time you give up a tax subsidy, all you lose is the $5,000 benefit you didn’t get. It can’t be enforced through imprisonment. And that’s a big difference.

That’s from this interview with Ezra Klein (h/t Andrew Sullivan, and thanks for the link, btw).

The core argument I was making was: there’s no difference between a tax-voucher-rebate scheme and a mandate. In each case, you pay money and get a service, whether you want it or not, but if you can prove you have already received the service by some other means (say, from your employer) you don’t have to pay. In each case, the government is regulating how much you pay and what you get, and in neither case do you get a choice of opting out. The only difference is whether the check goes directly to the private company or gets to the private company via the government.

Barnett points out a potential difference. In the case of the ACA, the penalty for non-compliance is a fine. But in theory, if the government has the right to order you to purchase insurance, and you refuse, the penalty could be non-monetary. The government could imprison you for refusing to purchase insurance. By contrast, in a tax-voucher-rebate scheme, if you fail to either claim the rebate or use the voucher, you’re just out the cost of the tax. There’s no way prison enters into it.

Does that distinction hold up? Let’s see.

Under the ACA, you could fail to purchase insurance, either because you already have insurance or because you don’t. If you already have insurance, the government should know about it, and therefore there should be no problem. If somehow the government doesn’t know, you have a problem, which should be able to be remedied by communicating the necessary information. If you don’t have insurance, you have a problem, and if you don’t remedy it you’ll be fined (or, potentially, imprisoned).

Under a tax-voucher-rebate scheme, you could fail on more dimensions. You could fail to pay the tax, or fail to use the voucher, or fail to claim the rebate. Let’s look at each in turn.

The rebate claim could be made automatic; if the government knows about your insurance, then you’ll automatically get a rebate; if the government doesn’t, you have a problem (and could be out money), but this should be easily remedied by communicating the necessary information to the necessary authorities. This is parallel to the situation under the ACA where you might already have insurance. There is a small asymmetry here in that in the hypothetical world where the ACA’s penalties include imprisonment, you could be arrested for failing to purchase insurance when you were not, in fact, obligated to because you already owned it (but somehow the government didn’t know), whereas in the tax-voucher-rebate scheme, all that would happen is that you wouldn’t get the rebate you’re owed. But, again, this is a circumstance where the government is acting on incorrect information, and there is a ready remedy in each case.

Suppose, on the other hand, you don’t use the voucher. There’s no clear equivalent in the ACA world; the closest equivalent is to not making claims under insurance you have purchased. Consider: you’ve paid the tax. You’ve got the voucher (because you don’t have insurance through your employer). You just don’t use it. That’s not equivalent to refusing to purchase insurance – because you’ve paid. So there’s another asymmetry, but I’m not sure what the significance of it is – because there’s no situation under the ACA or under a tax-voucher-rebate equivalent where I see a penalty of any kind clearly coming into play.

Finally: suppose you don’t pay the tax. Well, then, you’ll be subject to criminal penalties. This is clearly equivalent to refusing to purchase insurance under the ACA – and this is where penalties kick in under the ACA as well. Under the ACA, the penalty is a fine. Barnett argues that the precedent set by the ACA would make criminal penalties such as imprisonment possible. But that’s true if you don’t pay the tax in a tax-voucher-rebate scheme as well. It sounds to me like there’s more symmetry than asymmetry here.

Barnett says that under a tax-voucher-rebate scheme, the only penalty you could pay is if you don’t claim the rebate, in which case there appears to be an asymmetry versus the ACA. But that’s comparing apples and oranges. Not claiming the rebate is like purchasing insurance when you already own it through your employer. Not purchasing insurance is equivalent to refusing to pay the tax – or, alternatively, fraudulently claiming the rebate. Both would subject you to criminal penalties.

Barnett says, “just because the government does have the power to do x, doesn’t mean they have the power to do y, even if y has the same effect as x,” but the issue isn’t whether the effect is the same but whether the actions are functionally equivalent.

Nonetheless, I acknowledge that the Court seemed unsympathetic to the argument that the mandate is a tax. That means that the question comes down to the commerce power – whether the activity/inactivity distinction is meaningful at all and, if it is, whether, because everyone is part of the healthcare market, the government can legitimately claim that nobody is actually “inactive.” Because the plaintiffs accept that the government can make you pay for insurance, and the plaintiffs accept that the government can get private insurers to provide that insurance, and the plaintiffs accept that the government can make you transact directly with a private company when you are already engaged in commerce.


6-3 To Uphold

That’s still my prediction, even after a brutal first day of questioning.

Nobody disputes that the Federal government could set up a single-payer healthcare system, or that the government could levy taxes of whatever sort to fund it. (Currently, we have just such a system, called Medicare, funded by a tax on wages.) Nobody disputes that the government could, alternatively, set up a system of taxes to fund vouchers to be distributed to individuals to purchase health insurance from private providers. (We already have one of those as well: Medicare part D.) Moreover, nobody disputes that the government could provide for a tax credit for any individual who already owns health insurance (such as through their employer), such that nobody winds up paying for insurance twice.

Therefore, the question at issue is not whether or not the government can compel everybody to purchase insurance from a private provider. The system I outlined above would do exactly that – but payment would pass through the government (people would pay taxes, the taxes would fund vouchers, the vouchers would be redeemed by insurance companies for cash from the government). The issue is whether the government can compel you to write the check directly to the insurance provider.

I understand why this seems like a huge leap in terms of the government’s power. They can order you to take an affirmative act! You must buy this product whether you want it or not! You can’t leave the market! But the affirmative act you are required to engage in is writing a check. And that is something we already know the government can force you to do.

Let’s compare to the famous broccoli example. The government wants to make sure everybody has access to broccoli. It seems obviously absurd that the government could order you to purchase broccoli once a month. But consider. The government could decide to make broccoli available from government-run grocers; no problem. The government could, instead, distribute broccoli vouchers, funded (let’s say) by a per-calorie food tax (which would capture the entire population – you can’t avoid it without eating), with a rebate of said tax if you can demonstrate that you purchased a requisite allotment of broccoli with cash. That looks, to me, like something clearly within the government’s power – tax to promote the general welfare and all that. But it’s also substantively identical to a broccoli mandate. In both cases, anybody who doesn’t purchase broccoli voluntarily is obliged to pay money, and receive broccoli in exchange.

Of course, nobody can make you eat the broccoli. And, similarly, nobody can make you avail yourself of the insurance you are provided. But the government can make you pay for all sorts of stuff you don’t want – bridges to nowhere, wars in the Middle East, etc. And they can tax you pretty much any way they like to pay for it, including directly, irrespective of your participation in commerce. Broccoli’s the least of it.

The principal contention of the plaintiffs in the ACA case is that regulating “inactivity” cannot be construed as regulation of interstate commerce – you can only regulate someone already participating in a market, not somebody who has chosen to stay out. The government’s response is that everybody is going to use healthcare at some point, and that the government, in fact, mandates that health care be provided universally in emergency circumstances, regardless of ability to pay. So everybody is already “insured” in some sense by the government (just not very efficiently). Therefore everybody has entered the market. Therefore everybody can be made to pay.

The tone of Roberts’s and Kennedy’s tough questioning was: we get that, but this still feels like an open-ended grant of power to the government. If the government can order you to buy health insurance, what can’t the government order you to do?

My own answer to that is: the government can’t order you to do things (except in the context of a military draft), only to pay for things, and that’s precisely because ordering you to buy something is substantively identical to taxing you and providing you with that thing (whether directly or through a private provider). In either case, you pay the money and you get the product or service, whether you want the thing or not. That distinction – between purchases and other acts – is not a specious distinction.

I don’t know that the Court will accept that; they probably want a stronger limitation on what the government can order you to buy. But that is what Roberts and Kennedy are groping for. They want some basis for saying: yes, Congress can make you pay for health insurance, but they can’t just make you enter into any transaction whatsoever. And once they find that basis, as narrow as they can make it, they’ll vote to uphold, because I don’t believe Roberts or Kennedy wants to strike down such a massive, substantive economic reform (this isn’t the Violence Against Women Act) for fear of what such an action would do to the Court’s credibility.

But I could be wrong. They might buy into the active/inactive distinction. In that case, all the government would have to do to salvage health-care reform is to do the workaround I described above: levy a tax, provide a voucher, and provide for a tax credit if you already own insurance and don’t need the voucher. There’s something to be said for clarity for such an alternative – a mandate is a tax, really, so why not call it that? – and there’s something to be said for clarity in the system as it is – if you pay the check directly to the insurer, there’s no intermediary who could confuse you about price signals, whereas if you are taxed and rebated and vouchered, you might have no idea what you’re actually paying. But nothing, in terms of a personal experience of freedom, would be different. (Alternatively, the Federal government could strongarm the states into adopting Massachusetts-style mandates of their own (by tying continued Federal support for medical care in the states – and there’s a lot of it – to the adoption of such mandates, similar to the way they strongarmed the states into adopting a national speed limit). Again, I don’t see a big difference in the individual experience of freedom between the Feds basically forcing the states to adopt a mandate and the Feds adopting a mandate directly.)

Of course, the votes aren’t there for such a re-worked ACA right now. And regardless of the outcome of the 2012 election (and how either striking down the law or upholding it will affect that contest is a whole ‘nother topic), the votes likely still won’t be there immediately after. But in a practical sense, that’s what this fight is about: is there enough genuine popular opposition to health-care reform along Obamacare lines (or lines further left) that even after another couple of elections, even in the wake of the collapse of the rest of Obamacare (which is pretty popular – the public likes the regulatory benefits from the law; they just don’t like paying for them), there still won’t be the votes to enact anything resembling a national guarantee of health insurance in the United States.

Personally, I don’t like that bet. But then again, I think the ACA is basically a good start, something the GOP should have been fighting to reform rather than to demonize. So I suppose I would say that.


Weekly Double Feature: Richard III and The King’s Speech

Last week I paired two films that appeared to be wildly divergent in style and that appear to be about wildly different classes, and pointed out how the two movies might talk to each other productively around the central concern of how a man – of any class – can lose his wife, and how he might win her back.

This week, I’m going to pair two films that tell two wildly divergent stories about the same person and period. Talking to each other they are unlikely to do, but argue with each other furiously they will do – and watching that argument could be the best entertainment of all.

The King’s Speech” is, basically, “Rocky” story. The protagonist, at the start, isn’t even an underdog; he’s not even in the competition. His elder brother is destined to be the next King. He has no aspirations to replace him. And even if he did, nobody would seriously consider him for the role, because of his disability (particularly not his father, who seems especially disdainful of any impairment). He would like, if truth be told, simply to get through life without causing undue embarrassment to himself or his family. But, circumstances conspire to give him a shot at the title, for which he must be trained. Which he is – successfully – by an eccentric but wise old trainer. And then, when he finally earns the crown, he discovers that this was not the real contest. The championship bout will be with Adolph Hitler, a naturally gifted leader, and he will need to bring all his training to bear, and all the strength of character developed in relative obscurity, to prevail.

Richard III” as adapted by the star, Ian McKellen, and the director, Richard Loncraine, is the opposite. It’s the story of a man who, sentenced to playing second-fiddle (and often hatchet-man) for his elder brother, the King, and held in contempt or worse by everyone because of his disability (particularly his mother, whose rejection is pointedly cruel), decides to do the only thing he can do, and win the crown by treachery and outright murder. Which he does, only to discover that this was not the real contest. To be safely and permanently king, he must triumph over Richmond, a naturally gifted leader. But, having no inner reserves to fall back on in the moment of truth, he is thrown down in utter defeat.

And, of course, the fun part is that are both about the same fellow, George V. [Um, or, rather, George VI. I can never keep the extra-Shakespearean monarchs straight] And they are both about the same question: the relationship of the House of Windsor to the fascist tide of the 1930s.

“The King’s Speech” tells a story about the monarchy as a focal point of national identity, the institution that rallied in the people the necessary fortitude to stand against Hitler in the dark early years of the war. Bertie’s elder brother, Edward, is portrayed (accurately) as a fascist sympathizer, but the film portrays him as an outlier, not as an extreme representative of his family. His younger, more capable (if stuttering) brother, who becomes George VI, is portrayed as anything but sanguine about the German threat. This, as Christopher Hitchens pointed out with his usual verve, is a considerable distortion of the facts. The royals were implicated more generally with efforts to support – including through constitutionally questionable means – Chamberlain and a policy of appeasement, a policy which certainly had substantial support but was hardly lacking for opposition. It is, in other words, something of a patriotic fairy tale.

If “The King’s Speech” is a fairy tale brief for the British monarchy, “Richard III” is a fairy tale brief for republicanism. If the British royal family are basically gangsters, who would happily have taken the country fascist if they could have done, then there’s really no point in discussing what their proper role is in modern Britain; they should simply have been tossed over the side long ago. The fact is that, unlike virtually the entirety of Europe, Britain didn’t go fascist in the 1930s. It is an interesting question as to why. It’s not adequate to say, well, they weren’t conquered by Hitler – many countries that weren’t conquered went fascist of their own accord (e.g., Hungary, Croatia, Spain, Italy) and in many of the conquered lands fascism was a potent force prior to conquest, to a far greater extent than was ever true in Britain.

The traditionalist conservative explanation for Britain’s relative reprieve is encapsulated best, I think, by Peter Hitchens’s quip, that the role of the king in the British constitution is akin to the role of the king in the game of chess. He doesn’t do much at all, but by occupying his square he prevents any other piece from occupying it. This explanation is, in fact, what is implicitly questioned by both movies. By “Richard III,” because if the monarchy was actively pro-fascist then Britain’s reprieve must be owed to other forces than this aspect of its constitution. “The King’s Speech” wields a subtler knife, and perhaps unknowingly, by suggesting that the fate of the Empire really did depend, at this moment, on the king’s ability, and not merely on his status. Because any ability he had cannot, in the terms the movie itself set out, be attributed to his lineage, which is the basis of his constitutional position. Britain’s reprieve, in other words, was a happy accident. Better not to count on accidents to save a constitution.

(Personally, I suspect that a well-timed and well-delivered speech has more often been the saving of the monarchy than of the nation. That’s the perspective of “The Queen“, another excellent film if you’ve got time for three – and one that subtly supports Hitchens’s contention, by suggesting that the alternative to the shabby sycophancy toward the royals is shabby sycophancy toward celebrities.)

In any event, regardless of whether you are exercised by these kinds of historical-political debates, both films are great  entertainments. Both feature marvelous period costumes and interiors. Both are led and supported by wonderful actors. And one thing both the House of Windsor and the fascists know how to do is put on a spectacular show.

(By the way, if you’re interested in thoughts of mine on Richard III, the play, see here and here.


Your Mother, Drunk Or Sober

“It’s a narcissistic book, and the narcissism of privileged and haughty people is never particularly attractive,” Martin Peretz, the former owner of the New Republic and Beinart’s earliest patron, told me. “I always knew he was a very vain man, but a lot of us are vain, and if you had his mother, or if I had his mother, I’d be even more vain than I am.” Peretz put on a mocking falsetto—“this is the most brilliant boy, he’s so smart, he’s so touching”—before going on: “It’s a Jewish mother situation. You can use that—even if it makes me sound a little bitchy.”

It does.

The quote’s from an article in Tablet about the firestorm of criticism of Peter Beinart’s new book. But it seems to me, given the close emotional and intellectual identification between the two men during the period of Beinart’s editorship, and the consequent depth of the feelings of betrayal, that the real Jewish mother in the situation is . . . Marty Peretz. And what’s a Jewish mother to do when guilt doesn’t work anymore?

What is it Alex Portnoy overhears his mother say to her friends, apropos of the lengths she has to go to to get him to eat? “I have to stand over him with a knife!”

To be a bit more serious for a moment, though, Chesterton famously quipped: “My country, right or wrong is a thing that no patriot would think of saying except in a desperate case. It is like saying: My mother, drunk or sober.” Well, yes, but she is your mother, drunk or sober, right? Similarly, it is your country, whether your country is right or wrong. The question is what that entails. If your mother is a drunk, and begs for another drink, are you obliged to give it to her? Presumably not.

But are you obliged to devote yourself to getting her to dry out? That, it seems to me is the real heart of the question. I think many of Beinart’s critics – like Jeffrey Goldberg – would say: that’s exactly how they think about Israel and the settlements. They are against them. They think they were and are a grave and historic mistake, have caused criminal suffering to the Palestinians, and are, to some degree, a crime in and of themselves. Goldberg praised Gershom Gorenberg’s recent book, for instance, which makes precisely the point that Zionists should in the forefront of opposition to the settlement enterprise because the settlement enterprise is undoing the historic achievements of Zionism.

So they are doing what they can to convince their mother to check herself in, and dry out. But she’s their mother. If it takes her a long time to convince, they’ll keep trying. If she slips a drink on the sly, they’ll try to hide the liquor better, but they’ll forgive her. And, whatever she does, they certainly aren’t going to call the cops on her, and give the neighbors (who never liked her, even have tried to get her evicted) the satisfaction of seeing her humiliated by her own son in public. After all, she’s their mother.

Well, talk to a few children of alcoholics, and you’ll discover that “my mother, drunk or sober” is not always a tenable proposition. Sometimes, for some people, the sense of obligation to one’s mother is trumped by a sense of obligation to oneself, and to protect oneself from her disease. And that, in a nutshell, is what Beinart is saying. She may be my mother, yes, but if she keeps carrying on, I don’t care what the neighbors say, and I don’t care if she never speaks to me again afterward: I’m going to call the cops on her.

So how would you react if you were the son who was standing by your mother through another bout with the bottle, and if your brother – who, unlike you, never sat up nights with her when she had d.t., never moved back home for months to keep watch on her, indeed, for years never even really acknowledged she had a problem – said that, and said that all your support was just enabling her illness.


But so what? Say you’re right about him. Maybe he is a shallow, self-regarding, cold-hearted son-of-a . . . well, I won’t say because I’m not going to insult our mother. Say all that’s true.

He might still be right about her. And he still might be right about you.



This week and next, I’m going to be guest-blogging over at Megan McArdle’s place. In my first post (after a brief personal introduction), I get back on my hobby-horse about whether the Fed can solve our economic problems. As shouldn’t surprise long-time readers, my answer is no – in this case, because there’s a real possibility that our long-term real growth potential has slowed, and arguments that the Fed can engineer a return to the pre-crisis nominal growth trend implicitly assume that this hasn’t happened (that is to say, that the pre-crisis growth trend was “normal” in spite of the bubble).

Anyway, come visit me there this week and next, though I’ll still try to post in this space as much as I can.


Towards A Productive Conversation About Low Total Fertility Rates

Matt Yglesias comes to the defense of David Brooks’s hand-wringing column about declining global birth rates and the burgeoning elderly population (and, by the way, someone should send Brooks’s column to Pat Buchanan – I’d be curious to see how his “legal abortion and birth control” explanation for Japan’s very low birthrate explains collapsing total fertility rates in Iran, Turkey, Saudi Arabia, etc.):

I think it’s worth emphasizing that the problems exist independently of the organization of public retirement programs. Let’s think about Singapore, which has both low birthrates and a semi-privatized retirement system organized around forced savings. How is it that today’s Singaporeans are able to stockpile resources for the future when tomorrow’s Singapore may be a shrinking society? Well the answer is that Singapore is small, and the Central Provident Fund is able to invest in foreign resources. This is one reason why countries like Japan and Germany run such large persistent budget surpluses. Normally people save for the future by (indirectly) channeling present income into the construction of big long-lasting physical structures that will be usable in the future. But the projected decline in Japanese population implies extremely low returns in making investments in Japanese structures. So you want to invest outside of Japan, which means that Japan needs to export more goods and services than it imports. This is all fine as far as it goes but if we talk about an entire world of declining population then you run up against the old adding-up constraint. No matter how many times Angela Merkel implies otherwise, we can’t all be net exporters. The same problem impacting Social Security impacts a private system.

But I’m not sure you need to look at trade surpluses in this light, exactly. If Japan runs a trade surplus, that means the current labor force is forgoing consumption in favor of producing goods for foreigners, so that it can invest the surplus abroad to get higher returns in foreign currencies. If Japan didn’t want to run a trade surplus, its currency would appreciate steadily, which would make the low return of domestic savings more attractive in terms of the ability to buy foreign-produced goods.

This just brings us back to Karl Smith’s point that if the population is static or shrinking, then investment returns go very low – and, in a crisis, real interest rates go negative. (Real interest rates are driven by expectations of future real growth; real growth is basically growth in the labor force plus growth in productivity.) But I think all this implies is that a world of declining populations requires a cashless economy. If you had an all-electronic economy, then nominal rates could go as low as you like, and if nominal rates can go as low as you like then you don’t have to worry about negative real rates trapping a country at well below full employment. And a cashless economy – at least in the developed world – is very much within reach.

Even if we did that, of course, you’d still have the problem that you can’t support a larger percentage of dependents without either higher productivity, more working hours, or a lower standard of living.

But the problem isn’t aging per se; it’s a shrinking labor force as a percentage of the population. And it doesn’t matter why the percentage of the population that’s employed is dropping. Suppose, over a twenty-year period, the age structure and retirement practices of the population remain static, but the average person spends two more years in school at the end of the period than he or she did at the beginning. The labor force will shrink because of the two years “lost” to schooling – and the smaller labor force will need to be more productive to make up the difference. (Presumably, the point of being in school is to achieve just that increase in productivity – but perhaps the schools themselves have become less productive, or perhaps the rising student population has more deficits, such that the schools at the end of the twenty-year period need two more years to educate students to the same level that was achieved at the beginning.)

Even a baby boom initially diverts resources away from the labor force toward providing for the needs of children not yet in the labor force. This won’t lead to an economic boom as the kids grow up if the birth rate remains high because you are continually diverting resources downward. It does lead to an economic boom if the birth rate then declines – because when the demographic bulge moves into the prime working years, you’ve got a whole lot of productive activity relative to your population size. (This is what happened to South Korea in the 1980s, and it would probably be happening to Iran now but for the effect of economic sanctions and poor economic policies by the regime.)

On the assumption, then, that Japan remains resistant to immigration (pretty certain) and that even if its total fertility rate rises it won’t rise enough to make a dramatic difference (also pretty certain), Japan will solve the problem of its demographic imbalance in some combination of three ways. Either it will achieve dramatic improvements in the productivity of the labor force, probably through advances in robotics technology. Or it will accept a somewhat lower standard of living for retirees relative to their prior expectations. Or nominal retirees will make a greater contribution to Japan’s GDP, effectively rejoining the labor force to some degree. I suspect all three will happen to one degree or another – but, again, that “decline” in living standard would be relative to expectations, not an absolute decline. In any event, if there is any country on earth that I would expect to rise successfully to these particular economic challenges, it’s Japan.

Meanwhile, a declining population means more real resources per capita for the rising generation. Less crowded subways. More runs per day on the ski slopes. Japan is a very crowded country. It doesn’t need to get more crowded.

None of this is to suggest that there’s something inherently anti-feminist about worrying about fertility rates. I find Amanda Marcotte’s and Pat Buchanan’s arguments on this subject to be equally unconvincing mirror-images of each other. As I argued before, I think there are perfectly good arguments in favor of making childbearing and childrearing easier that have nothing to do with some putative social “need” for more workers or more innovators and do not depend on assumptions about the “proper” role of women. Most people – men and women – want children, and that want is very fundamental. If the social and economic system makes satisfying this profound desire more difficult than it needs to be, we can do something about it, and call that a gain for human welfare and for freedom, without getting into any conversation about demographics.

Wild demographic swings – in either direction – put big stresses on society, but I don’t see why an aging population is more to be feared than a too-rapidly growing one. Afghanistan and Yemen, Somalia and the Democratic Republic of Congo, all still have really high total fertility rates (and disastrous economies as well – which means labor force growth will badly lag population growth). I am far more worried about the consequences of that fact than I am about the consequences of low fertility rates across the developed (and much of the developing) world.



The Squid and the Elephant

I see that Kevin Drum and Felix Salmon have also been reading the Times this morning. They question Smith’s motives, pointing out that he only joined the firm in 2000, so he never experienced the “good old days” he pines for, and that the piece lacks “any sense of mea culpa, any sense that he was at all part of the problem.” Good points! I’ll take the opportunity of their comments to make a few more points of my own.

What changed since the mid-2000s is very simple: there isn’t as much money to go around.

Let’s think about the timeline of Smith’s career. He started right as the internet bubble had burst. Equity derivatives in the late-1990s, at least in the U.S., revolved around the dynamics of that bubble – getting tech companies to sell put options on their own stock (a way of betting that their stock would continue to go up – a very common trade before the bubble burst), hedging large blocks of founder shares in tech companies that had just gone public, etc. That business slowed down quite a bit from 2000 to 2002, but before very long, Wall Street found a new money machine. The biggest one in Wall Street history.

And the thing about Wall Street is: when there’s a lot of money being made, everybody gets paid. You don’t want all the high yield bond traders disgruntled because there wasn’t much going on in high yield in a given year. So you pay them something – not as much as in a good year, but something that makes them feel valued.

Well, since the financial crisis, there hasn’t been as much money going around. Oh, don’t get me wrong – there’s plenty of money. But not quite as much. And it’s harder to “earn.” And the people who “earned” that money want to keep it.

Salmon refers to Smith’s “final ill-gotten bonus check” but do we know what that check was? It wouldn’t be completely shocking to me if – relative to what Smith was “used” to getting, and thought he “earned” – it was very low. Indeed, if he were working for one of the money-center banks, it might well have been zero.

All of this is not to shed any tears for Greg Smith, but to explain what the world might look like to him, and why he might write that op-ed. If we take him at his word, for much of his career, doing his job in what, from his perspective, was a relatively ethical fashion meant that he got paid very well indeed. And he thought that he was getting paid for that work. But he wasn’t, not really. He was getting paid, in good part, for being a Goldman employee. The life-blood of the firm, what made the firm enough money to pay him, was business that on a fundamental level is difficult to justify. Some firms and some individuals were more ethical than others; when I worked in the business, I tried to acquit myself well. But the whole thing was rotten. And if Greg Smith was getting paid for leaving money on the table, it’s because there was so much money sloshing around the deck that nobody worried about it. Heck, they might even have believed that he was helping retain valuable clients that way.

That game ended with the financial crisis. Wall Street is way, way too big. It has to shrink. The first way it is going to shrink is by ruthlessly culling the herd, doubling down on winner-take-all economics. That’s what Greg Smith is observing: the only ones who are still getting paid are the ones who are still reeling it in.

I don’t think that’s a sustainable answer to Wall Street’s predicament, because there just aren’t that many elephants. And the de-financialization of the American economy hasn’t even really begun.

One comment

Where The Money Is

Thanks to Rod Dreher for pointing out this NY Times Op Ed by a Goldman Sachs executive publicly decrying the moral collapse of his firm, and resigning in consequence. It’s a heck of a statement.

And yet, it’s missing something. What it’s missing is a narrative: how did the culture change? Why did it change? How did Goldman go from being one of the more trusted firms on the Street, with an exceptionally strong culture, to being a vampire squid.

The simple answer – and the one that Michael Lewis goes with at the end of The Big Short – is that the corporate structure changed. Not just at Goldman, but across Wall Street, investment banks that were once private partnerships are now subsidiaries of money-center banks that are public corporations. So, where once the goal was partnership, which required playing a long game of loyalty to the firm (and hence a long game of cultivating client relationships), and which required prudent risk-taking with the partner’s capital, now the goal is a big bonus, which requires racking up big numbers in a single year.

That may be part of it. But on the other hand, one driver of the new Wall Street culture is competition for talent with hedge funds, which are private partnerships.

But let’s look at the three ways our ex-Goldmanite says you can make it big these days:

What are three quick ways to become a leader? a) Execute on the firm’s “axes,” which is Goldman-speak for persuading your clients to invest in the stocks or other products that we are trying to get rid of because they are not seen as having a lot of potential profit. b) “Hunt Elephants.” In English: get your clients — some of whom are sophisticated, and some of whom aren’t — to trade whatever will bring the biggest profit to Goldman. Call me old-fashioned, but I don’t like selling my clients a product that is wrong for them. c) Find yourself sitting in a seat where your job is to trade any illiquid, opaque product with a three-letter acronym.

The author of the piece, Greg Smith, worked in equity derivatives, which I worked in for the earlier part of my Wall Street career, and I think that’s significant. Because none of these three ways of making money make sense outside of the derivatives world.

A firm “axe” is a position the firm is trying to liquidate (sell if it’s a long position, buy back if it’s a short position). In a flow business – selling bonds or stocks, for example – you don’t deliberately try to hold inventory. Indeed, you’re usually sharply penalized by risk-management for holding inventory for any length of time. So your “axes” are, generally, fleeting. Good sales-traders can work out of axes efficiently, losing as little of the bid/offer spread as possible in a short time period. It’s a basic market-making skill.

But derivatives products are not liquidated; they are hedged. And there is considerable discretion for how to hedge them, because the “proper” hedge is the output of a theoretical model bearing only partial resemblance to the behavior of these products in the real world. In effect, every derivatives position is a proprietary trading position, and hedging it is the art of trading around that position to maximize profit. Some derivatives axes will look similar to axes in flow business – you’ve got too much long exposure to the market, say – but these will generally be the simplest axes to hedge, and therefore the least-likely to require working with a client in the first place. If you’ve gotten to the point where you’re structuring something for a client specifically to work out of an axe, you’re already in a profoundly adversarial relationship.

His second is “hunt elephants.” Now, if you’re in M&A, everything you do is hunt elephants – big deals with large profits that don’t come around terribly often. But while on one level these deals are complex, on another level they are very simple – your client is buying a business. And if you’re a municipal bond trader, elephants are few on the ground. But in the derivatives business, you can construct an elephant, by inventing a product that is sufficiently opaque that price-discovery is difficult. Sometimes elephants are constructed for a particular client, to suit that client’s needs. That sounds like customer-service, but it’s rather like custom cabinetry or bespoke tailoring: you’re paying for that service, and you can’t easily tell how much. But one of the extraordinary things about the decade of the CDO is that Wall Street managed to hit on a mass-produced product that was as opaque as these customized products usually are. And priced accordingly.

Which brings us to his third, “trade any illiquid, opaque product with a three-letter acronym.” Now, back in normal times, trading illiquid products was a hardship assignment. Nobody on the block desk wants to take down an order for a chunk of stock that never trades – because if it never trades, you can’t trade it. They want to take down enormous orders of liquid stocks – and then try to make money versus estimates of how much it will cost to trade out of it in an orderly fashion. But on the derivatives side of things, illiquidity is a function of product design. It means the customer can’t tell what the price ought to be, can’t properly compare like for like with competing products. Just as Apple has an incentive to make a product that you can’t hack into (because this locks you into their product line long-term), derivatives structurers have an incentive to put together products that are difficult to reverse-engineer.

But derivatives themselves have been around since the 1980s. They go through their own cycles. In the early 1990s, exotic interest-rate derivatives products were all the rage, and Bankers Trust was the lead firm in putting them together. Then Greenspan hiked rates sharply, a bunch of clients lost much more money than they thought they would, and the business shrank sharply as clients shied away from exotic products, focusing on the simplest, easiest-to-value solutions to their needs. So why should the most recent cycle have destroyed the culture of venerable Goldman Sachs?

To answer that question, you need to recognize just how much money we were talking about in the middle of the last decade. The numbers are difficult to comprehend in the aggregate, so I’ll give a tiny example. I remember a fellow, one of the best sales-traders on the listed options desk, who moved over to become a marketer of CDOs. His first trade, he placed ten million illiquid bonds – not a big trade in nominal terms, but a big trade for that kind of asset. He was pleased with himself: he could play this game. Then he learned the margin on the trade: nearly twenty percent on the face. He’d made the firm nearly two million dollars. From one trade. That’s two orders of magnitude more money than he could make for the firm on a typical listed options trade. At this point he wasn’t pleased – he began to wonder whether he hadn’t been played for a sucker for his whole career until this point. And whether he wasn’t being played for a sucker still – whether he was going to be paid adequately for the insane amounts of money he now understood he’d be making for the firm.

Why there was so much money to be made, why the game went on as long as it did, and the bubble got as big as it did, is the subject of another post. My point here is just this. It takes discipline to say, “let’s take care of the customer, and think of the long term” when you’re talking about normal amounts of money. When the amounts of money become as staggering as they were in the mid-2000s, the game – at best – becomes “how can we convince ourselves that we’re taking care of the customer.” Because what if the only way to take care of the customer is to get out of the game? Which was certainly the case with sub-prime-mortgage-backed-CDOs by the mid-2000s. How do you turn off the machine that is responsible for the lion’s share of your firm’s profits? And if you don’t, then what exactly do you mean when you say you’re taking care of your customers?

The financial crisis should have led to a dramatic, wrenching shrinkage in the size of Wall Street. The businesses that were at the center of the crisis – mostly derivatives and structured products businesses – should have shrunk to tiny fractions of their former size, both in response to greater regulation and in response to customer’s shunning the products. But finance as it had come to be practiced had become not only too big to fail, but possibly too big to shrink, in any meaningful way, and our political response was not merely to fend off collapse – that was necessary – but to nurse the industry back to something resembling its former health – which not only wasn’t necessary, but was actively dangerous to our political and economic future.

If you talk to people on Wall Street now, they talk about the job market still being tough, particularly for new entrants, but they have no idea what tough would really mean. The industry is still enormously too big, enormously too profitable. We can’t fix the culture of a firm like Goldman so long as it’s still doing the same kind of business. Long term, the only way to fix Wall Street is to finally break it.


Does Santorum Matter?

So it looks like the edifying spectacle of a Republican primary season is going to go on for months, yet. The calendar, more than anything, has seen to that.

Rick Santorum is (presumably) going to win the Missouri caucuses (he won the “beauty contest” primary already) and Louisiana, and even if he loses Illinois narrowly as he did Michigan and Ohio (which is what I expect), that won’t lead him to drop out. Nor will he take any note of Romney’s upcoming victory in Puerto Rico, any more than anyone cares that Romney won American Samoa and Hawaii last night (wins that, in delegate terms, more than made up for his narrow losses in Alabama and Mississippi), nor that he won the U.S. Virgin Islands, Guam and the Northern Marianas on the 10th (nearly compensating for his trouncing in Kansas).

Then comes Wisconsin, which Santorum should win, and Maryland and D.C., each of which he should lose to Romney. Once again, Romney will likely win the most delegates, but Santorum won’t drop out. Then, on April 24th, the great Mid-Atlantic primary: New York, Pennsylvania, Connecticut, Rhode Island, Delaware. Santorum will win Pennsylvania; presumably he’ll lose everything else. But he won’t drop out! Because Santorum country is right around the corner: North Carolina, Indiana, West Virginia, Nebraska, Kentucky, Arkansas – Texas! As long as he has enough money to keep going, why shouldn’t he?

The usual answer to that question is “you can’t win; you must drop out for the good of the party” and the usual rejoinder to that is “we have to stay in for the good of the cause.” But is the party actually being hurt? And, conversely, is there a cause? Santorum and Romney are attacking each other over who is the “real” conservative, but they don’t seem to disagree in any important way about what a “real” conservative is. Of course, there’s the negative advertizing – but most of that is coming from Romney, and most of the attacks being made on Romney are ones that are going to be aired anyway in the general election.

The more I think about it, the less I feel like this primary season actually matters at all. Santorum’s insurgency has been compared to Goldwater in 1964, Hart in 1984, Jackson in 1988 – but these campaigns all reflected real and substantial disagreements about where the party should go, substantively, with different factions lined up behind the alternative candidates. But the more I watch this race, the less I see that kind of dynamic. There are cultural, geographic and demographic divisions between the two candidates’ bases of support. And there are obviously a whole lot of people who just don’t particularly want to vote for Mitt Romney. But I don’t see a battle for the soul of the party. I see a battle between two guys who want to be President.

The contest may be more similar to Obama-Clinton than we thought: two candidates with very different demographic coalitions and very different personalities/personal stories, but with little ideological disagreement between them. In this case, the party is lukewarm at best about each candidate, rather than fairly enthusiastic about both, and the establishment candidate is much stronger than the insurgent. But in terms of what it will mean for the general election, I’m increasingly thinking: not much.

Which is one reason why the contest will keep going on: it’s just not that important to end it.


Weekly Double-Feature: The Philadelphia Story and Blue Valentine

Been thinking about adding this for a while, but a couple of weeks passed without an opportunity to do so. In any event, I hope to turn this into a weekly feature; not sure if I’ll stick to a particular day (probably not) or wander around the week.

The idea is to pair two movies, each (in my opinion) very worth seeing on its own, and that you wouldn’t necessarily think make a good double-feature, but that I think have interesting things to say to one another.

This week’s selection: “The Philadelphia Story” and “Blue Valentine”.

On the surface, these two movies have nothing in common except an eastern Pennsylvania setting (and the Main Line has precious little in common with King of Prussia). One is a classic comedy from Hollywood’s golden age, the other is a modern dark drama. The sexual mores of the two times could not be more different, Katherine Hepburn’s character being scandalized at the notion that she might have strayed with Jimmy Stewart (though of course her feelings are actually a bit more complicated than that), while Michelle Williams comes to Ryan Gosling already pregnant by another man. “The Philadelphia Story” is shot in lush black-and-white, and filled with witty characters tossing off quotable lines; “Blue Valentine” uses color – harshly blue-tinted video alternating with butter-yellow film stock – as an important means of conveying mood in a story about two characters who can barely communicate. And, of course, one is about the upper reaches of the upper crust, while the other is about a very ordinary working-class couple.

But: for all their differences of class and character, both Ryan Gosling and Cary Grant have something essential in common. They are both playing relatively aimless men who drink too much and have too little ambition, and whose wives come to hold them in contempt, and finally leave them, because of that. “Blue Valentine” tells the story of how the boy won, and then lost, the girl, while “The Philadelphia Story” opens on the losing and, after a gap of time, tells the story of how he wins her back.

Both should also be tough films for feminists to like – and, for that very reason, are important films for them to grapple with. “The Philadelphia Story” is quite cruel to Katherine Hepburn – the various men in the story basically blame her for all of their failings, because she is too harsh and judgmental, and so far as I can tell the movie sides with the men. The worst exchange is with her father, who blames her for his recent affair:

Mr. Lord: What most wives fail to realize is that their husband’s philandering has nothing whatever to do with them.
Tracy: Oh? Then, what has it to do with?
Mr. Lord: A reluctance to grow old, I think. I suppose the best mainstay a man can have as he gets along in years is a daughter – the right kind of daughter.
Tracy: How sweet!
Mr. Lord: No, no. I’m talking seriously about something I’ve thought over thoroughly. I’ve had to. I think a devoted young girl gives a man the illusion that youth is still his.
Tracy: Very important, I suppose.
Mr. Lord: Oh, very, very. Because without her, he might be inclined to go out in search of his youth. And that’s just as important to him as it is to any woman. But with a girl of his own full of warmth for him, full of foolish, unquestioning, uncritical affection –
Tracy: None of which I’ve got –
Mr. Lord: None.
You have a good mind, a pretty face, a disciplined body that does what you tell it to. You have everything it takes to make a lovely woman except the one essential – an understanding heart. And without that, you might just as well be made of bronze.
Tracy (deeply hurt): That’s an awful thing to say to anyone.
Mr. Lord: Yes, it is indeed.

I’m not sure, in the real world, that a daughter’s relationship with her father could survive such an exchange. I’m not sure it should. But while that makes Mr. Lord unconscionably cruel, it doesn’t make him wrong. But his are not insights that are at all congenial from a feminist perspective.

While from one perspective, “Blue Valentine” is clearly about class, and from another perspective (warning: click that link at your own risk; it is . . . not polite) it’s about the eternal and unpleasant verities of the battle of the sexes. Various reviewers have tried to make the Michelle Williams character into a heroine – she’s blossoming while her husband is stagnating, she’s got the strength to get out of a marriage that isn’t working, etc., etc. – but their efforts were never terribly convincing, because the bottom line is the Ryan Gosling character is a nice guy. He took her as she was, even though she was carrying another man’s child. Her loathing and contempt for him is just plain ugly – and entirely disproportionate to his misdemeanors, whatever they are. If there’s a truth here – and there is – it’s an ugly one for a woman to confront.

(Apropos of cruel fathers, it’s worth comparing the fathers of the Hepburn and Williams characters in the two movies. Their cruelties are of different kinds, but there is a common cruelty there – and I don’t think that’s unrelated to the intolerance of weakness both women display toward the men in their lives.)

But what about their men, Gosling and Grant? Here there’s an enormous asymmetry – in “Blue Valentine” we wind up sharing Williams’s feelings of contempt towards Gosling, and we feel dirty because of it, while in “The Philadelphia Story” we are firmly in Grant’s camp, even if we are a bit uncomfortable at the emotional wringer Hepburn is put through. But the Grant we see briefly in the opening scene is not the Grant we see for the rest of the movie. He has undergone a change – a change of character that begins, but doesn’t end, with the mastering of his “terrible thirst.” I wrote an extensive piece on “Blue Valentine” when I first saw it, most of which was a dissection of the Gosling character, showing the ways in which he is, while kind, basically immature, a boy-man looking to be mothered. I have a feeling that, when he married Tracy Lord, C. K. Dexter Haven, for all his class, had some similarities of character to Ryan Gosling’s Dean. Between losing her and winning her back, though, he did some growing up.

I that a class-bound achievement? I don’t think so. I don’t think emotional adulthood is a luxury good – not yet, anyway.

Which raises the question: what would it take for Ryan Gosling to become Cary Grant?

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