The CFPA’s Effects on Consumer Credit?

Does anyone want to open a consulting/lobbying firm with me where we just make up numbers? Like Mr. Ford does with polling statistics in Frisky Dingo, if you are fans, but with financial institutions? (Please avoid the obvious joke of “isn’t that what financial engineering is entirely?”)

There’s a new study, “The Effect of the Consumer Financial Protection Agency Act of 2009 on Consumer Credit” (Evans/Wright) where they try to figure out the adverse effects that the CFPA will have. I’m incredibly sympathetic to this argument, and was hoping to see a really sophisticated review of the potential numbers. Instead they lead with scare statistics (4.2% new job loss!) that are entirely hypotheticals (we assume (.05 x .867) = 4.2% new job loss). It’s a lot of noise when we need signal.

Anyway, Credit Slips demolished it on at their page (“The short answer: just make up the numbers. I kid you not.”). I came to a similar critique and forgot to link to it here, go and check it out over at the Business Channel.

The “Financial Autopsy” Perlmutter and Grayson Amendment

I’d really like to thank James Kwak, Kevin Drum, and Felix Salmon for follow-up comments on the CFPA Financial Autopsy amendment.

So looking at the Committee on Financial Services markup page for the CFPA, the original Financial Autopsy amendment (#13, pdf here) was not agreed to, and was reintroduced as the Perlmutter and Grayson Amendment (#35, pdf here). The new amendment is the old amendment, with a giant X through part C (click on the amendments – it really is the same amendments with some x’s and lines and new names written at the top. Legislation is cool). What were the parts again?

Part (a) required a study, a “Financial Autopsy”, of each state’s bankruptcies and foreclosures with an eye towards products that lead to larger numbers of foreclosures and bankruptcies. Part (b) required the CFPA to report annually on these studies and on the top financial products that lead to these bankruptcies. Part (c) requires the CFPA to take corrective action to eliminate these products.

The language of part (c) is what must have scared some people. There are two relevant problems with regulation that we have found in the buildup to the previous crisis worth mentioning here. One is that regulators don’t have the tools to do what they need to do. That was clear in terms of winding down large financial institutions, such as the large banks. It was also clear in terms of teams that were able to investigate financial problems on the ground. As we’ve seen before, when local areas started to experience problems with consumer financial protection, there wasn’t any apparatus like the National Transportation Safety Board who could come in and look critically. The Federal Reserve knows banks, so they just went ahead and asked banks.

But there’s another big problem, and that is of political will. You could have the best team in the world but, like Greenspan at the Fed, if the people in charge aren’t interested in enforcing the rules they aren’t worth anything. Will the reforms we are proposing survive whoever is President next? That’s where a mandate comes in – hopefully a similar purpose can work its way back in.

At the very least though, it’s good that the financial autopsy reports are made public to Congress. At least this way it can become a matter of public record, and consumer advocacy groups can take these reports and run with them.

CFPA Markup

The “Financial Autopsy” Amendment, which we discussed here, was introduced for committee markup by Congressman Grayson with quotes from this blog! (He mentions an Atlantic Business Channel contributor, not ‘rortybomb’, which is probably for the best.) That’s pretty damn awesome and completely humbling.

It honestly amazes me the power blogs can have. I’m just a random dude with a matlab license, and I get to interact with all kinds of brilliant people, both commenters and other bloggers. Tyler Cowen brought up a similar point when he said “Not many outsiders understand what a powerful learning mechanism the blogosphere has set in place.” I couldn’t agree more.

The “Financial Autopsy” CFPA Amendment

I’ve just been informed by people in Washington DC that there is a newly proposed amendment to the Consumer Financial Protection Agency, an amendment that I find promising. Here is a first draft:

Today we will offer the “Financial Autopsy” amendment. The Grayson/Clay/Miller amendment is essential to attacking the root problem of consumer bankruptcy and foreclosure because it requires the CFPA to do a financial audit of products that have caused the highest rates of bankruptcy and foreclosure annually. Not later than March 31st of each calendar year, the CFPA will list these anti-consumer products, submit their conclusions on why these products “fail” consumers, the companies and employees that underwrote these products, and authorizes the CFPA to take action to restrict these products.

Financial Autopsy Amendment:

- Requires the CFPA conduct a “Financial Autopsy” of each state’s bankruptcies and foreclosures (a scientific sampling), and identify financial products that systematically led to a large number of bankruptcies and foreclosures.
- Requires the CFPA report to Congress annually on the top financial products (the companies and individuals that originated the products) that caused consumer bankruptcies and foreclosures.
- Requires the CFPA take corrective action to eliminate or restrict those deceptive products to prevent future bankruptcies and corrections
- The bottom line is to highlight destructive products based on if they are making people “broke”. Thank you for your consideration, we hope you will join us in supporting this amendment.

Sincerely,
Alan Grayson Wm. Lacy Clay Brad Miller

A few thoughts:

- The CDC has a response team for when it finds cancer clusters. I like the idea of the CFPA having a similar response team, that can be called in for expert opinion in the case of foreclosure and bankruptcy clusters. A team of forensic accountants and financial experts who can be called in by members of Congress, or as a result of their own statistical samplings, to give opinions on what is going on on the ground in a member’s district when it comes to the end result of financial innovations. Financial detectives, if you will, who can shift through all the noise one finds with dealing with consumer finances to see if there’s any signal that is the result of changing products and options available to consumers.

- Some readers may ask: Can’t the Federal Reserve do this? Let’s look at a previous time the Federal Reserve tried to do this. Here’s the transcript of “Morning Session of Public Hearing on Home Equity Lending, July 27, 2000.” There were worries among people in North Carolina that there was a problem with subprime loans and home equity lending causes bankruptcies and foreclosures. So what did the Federal Reserve do? They called up all the local subprime lenders and some community organizers who brought this problem public and asked the subprime lenders if they were doing anything wrong. You might be shocked to learn that, after some deep reflection, the subprime lenders found that they were not. Here’s a representative exchange between the Fed Chair and Martin Eakes, community financial lending organzier (later of the CRL):

GOVERNOR GRAMLICH: “…The last few years have seen enormous growth in subprime lending. …This is mainly, surely, a good thing in the sense that this growth in the subprime lending market has brought credit to low and moderate income households…But there are also seemingly some abuses.

There have been a series of anecdotes, a series of TV programs mentioning some of these abuses, there has been a rise in the foreclosure rate, and these adverse statistics have attracted our attention….We want to keep a relatively analytical focus and focus on specific things that the Fed might do, trying to make sure that, in technical talk, the benefits of what we do outweigh the costs….If predatory lending is as significant a problem as some people are alleging….”

MARTIN EAKES: “[later]…The first point I want to make is to say that predatory lending or loans that have abusive characteristics are not anecdotal as the Federal Reserve notice and your opening comments mentioned….”

Note the setup from the Fed Governor: “seemingly some”, “anecdotes”, “TV”, “as some people are alleging.” When Eakes replies that there were statistical efforts carried out, you can practically hear the crickets chirping in the silence. Now imagine if there was an independent congressional team, dedicated to investigating the consumer angle instead of bank safety and soundness, who could have testified here after doing ground work for some time, and could give expert opinion on the dynamics at play in this area. It would have changed the whole approach that could have been taken at this meeting.

- This is going to have, by nature, an adversial relationship with financial institutions. No detective has gotten anywhere in a murder mystery by yelling “Hey! Did anyone kill this guy? No? Must be natural causes.” The can be limited to some degree – smart banks who know they are not using tricks or traps on consumers would have incentives to co-operate with any autopsy investigations.

- This strikes a good balance on the the need we have for new financial innovation; it lets more in on the front end, with the idea of looking at the results at the back end. It’s a conceptual focus that is less focused on gatekeeping and more on detective results of what has happened as a result of the newest innovations.

All in all, a promising front for consumer financial reform. What do you think?

A little more on Geoengineering

Having spent a fair amount of brainpower and energy over the past month trying to convince right-leaning folks and libertarians that having three bureaucrats sit down and come up with a default ‘vanilla option’ checking account won’t be a first step on the road to serfdom, I’m somewhat confused by the wave of excitement among right-leaning folks and libertarians for having three bureaucrats sit down and come up with the optimal level of sulfur to be pumped into the stratosphere at the north and south poles.

I want to point out a comment from Will Wilkinson, in his “For More Responsible Climate Politics”:

Just suppose that some form of climate engineering could (1) do as much or more to slow or halt warming than could regulatory approaches (2) at a much lower cost while (3) posing no special problem of international coordination. Perhaps Avent has already made the case that some technology (or combination of technologies) meeting this description is less likely to emerge in the coming decades than an effective scheme of international carbon emission controls. If he has, I’ve missed it….

Of course, the probabilities aren’t independent of public opinion, which isn’t independent of our attempts to persuade. I sense that Avent believes that an increased awareness of and interest in climate engineering would come at the cost of public support for domestic climate legislation and international regulatory coordination. That is, I sense that he believes he is combating a danger to the prospects of his favored policy.

This argument cuts both ways though. If the government credibly signals that, past a certain point of carbon levels, it will start pumping sulphur into the stratosphere above the North pole, where is the incentive to come up with other technologies that combat global warming? Why wouldn’t that be a massive moral hazard, akin to a government ‘bailout’ of the environment?

I assume Ryan likes his plan because it involves giving people incentives to come up with new technologies to reduce carbon outputs. If the government decides to go with the plan that it will simply alter the stratosphere sunlight short-term rate in accordance with its projections of the carbon cycle (Go Team Bernanke!), why would anyone pay to reduce carbon? It would just have them have their prices undercut by those relying on the government to up the sulphur emissions to take in their costs. The smart innovative money would be coming up with technology to deal with the new sulphur problems, like tech to fight ocean acidification or ozone depletion.

My background reading

I’d recommend Graeme Wood’s excellent article at The Atlantic, as well as this Real Climate review of a geoengineering conference. There are two levels we talk about with climate engineering. One is carbon capture and sequestration, which I’ll call “air capture.” This is the “Building a Better Tree” style geoengineering. We grab carbon out of the air through some technology – bioengineered plankton blooms with iron sprinkles in the oceans, special tower vents, etc. We take that carbon and store it somewhere – underground, at the bottom of the ocean, etc. This will actually reduce carbon out of the air, and as long as we store it correctly (a big if!) it will reduce carbon in the atmosphere, fighting global warming.

“Air capture” is not what most people, especially economists that you are likely to read, are talking about. A typical report (Real Climate link above) will say something like: “air capture technologies do not appear as promising as solar radiation management from a technical or a cost perspective.” So what’s solar radiation management? This is the plan to inject sulfate aerosol precursors into the stratosphere at the North and South poles using tech like jet fighters, balloons, a hose if we can design it to deliever it – this report (“The Benefits, Risks, and Costs of Stratospheric Geoengineering”) is a good overview. This will block out the sun, in effect engineering a massive volcanic eruption, which would cool the Earth. So that’s a plus.

Minuses are the trade-offs to weigh against. Here’s a list of some negatives. We’d have that ozone depletion problem back on the table. We’d also be effecting wind and precipitation patterns; initial models suggest severe droughts in Asia and Africa. From The Atlantic piece:

But, as with nearly every geo-engineering plan, there are substantial drawbacks to the gas-the-planet [sulfate aerosol] strategy. Opponents say it might produce acid rain and decimate plant and fish life. Perhaps more disturbing, it’s likely to trigger radical shifts in the climate that would hit the globe unevenly. “Plausibly, 6 billion people would benefit and 1 billion would be hurt,” says Martin Bunzl, a Rutgers climate-change policy expert. The billion negatively affected would include many in Africa, who would, perversely, live in a climate even hotter and drier than before. In India, rainfall levels might severely decline; the monsoons rely on temperature differences between the Asian landmass and the ocean, and sulfur aerosols could diminish those differences substantially.

Ah, that old 6 billion up, 1 billion down problem. Seems hard to get around it. Like most government interventions, it would pick winners and it would pick losers – perhaps it can be negotiated, but I’m not necessarily sure how.

What if we want to change course?

But the biggest problem, you may have notice, is that we aren’t removing any carbon from the air in this strategy. Thought exercise: the carbon could be at a point where global temperatures would rise 5 degrees, but we’ve engineered the stratosphere to be 5 degrees cooler by putting sulfur in the stratosphere. So we are net neutral temperature. Things that are related to carbon in the atmosphere that aren’t temperature related, like ocean acidification, would continue to go crazy.

But now let’s then assume that the sulfur is causing too many side effects, and we want to shut it down. Then what happens? The sulfur rains out over the course of a short time period, say a year, and then the Earth heats up 5 degrees very, very quickly. No gradual increase over this time period; we have the same carbon amount as we had before. We haven’t lost any weight, we were just wearing bigger pants. That would be a nightmare situation, and as such even if the side-effects were terrible it would be difficult to “turn off” such a plan.

So given that there’s a moral hazard to the problem – once government agents commit to doing it, we alter any subsequent decision by private agents to invest in carbon removing technologies – and there’s a series path dependency with turning it on – once we start doing this it is incredibly dangerous to stop doing this – I wouldn’t treat the decision for the government to add this to our intellectual and global warming portfolio of options as trivial.

Geoengineering

Also check out Ryan Avent on Geoengineering – Part I and II. Fantastic stuff, and better put than my quick thoughts here.

1) I understand a broad portfolio of research and technologies are the best means to combat global warming. But just a first pass at what I’m hearing makes me think that this will be the Missile Defense Shield of my generation. Amazing super-duper technology that won’t be able to pass a highly massaged beta test, and do nothing but piss off other countries in the process.

I mean, as an engineering feat, shooting a disc to block out the sun is by an order of magnitude (engineers, give me an estimate?) more difficult than getting one missile to hit another missile. And we can’t get one missile to hit a missile. If we were on track, shouldn’t we be able to shoot them down with orbital lazers by now? Luckily government military research doesn’t need to hit real deadlines.

2) Joe Weisenthal thinks liberals are uncomfortable with geoengineering because it will distract from our agenda of destroying meat eaters who drive SUVs in rural areas of Western nations.

Actually my first reaction is that we’ll give billions to Boeing, Lockheed Martin, and Raytheon to develop a sun disc that won’t launch without doing any type of responsible due-diligence in advance to see if the project has any chance of working, because we have a fantastic track record of that as a nation.

But implicit in Joe’s critique is that if tomorrow, a joint announcement was made by the UN Security Council and Ben Bernanke that we’ve found an optimal amount of 18.72% of the sun needs to be blocked out, and we’ll start working on that tomorrow, I think Red America would be more mad than Blue America. By a wide margin. I mean, just the idea of black UN helicopters flying over Iowa gives people a bad feeling; imagine a public announcement that black copters would instead fly up to the stratosphere to dump toxic sulphur in order to protect the people of Bangladesh 85 years from now. How would that poll in Peoria?

3) But my biggest problem with geoengineering is the nature of the debate; geoengineering is fantastical, when it really should be boring. It is, as Yglesias points out, something like giving people a $100 tax credit to paint their roofs white. It is planting more trees in parking lots. It is not going to be something cool and dramatic and make the issue solved immediately – like a giant lazer.

All the big massive solutions, as opposed to the little marginal ones, even theoretically proposed have massive side effects – no free lunches! – and are, effectively, the equivalent of a weight loss plan that is solely “buy bigger pants.”

Old Custer Freak Economist

Wow. I kind of had the feeling the new book Superfreakonomics was going to be weak, but I didn’t expect it to look as rough as the preview currently coming. I enjoyed Freakonomics – it was about doing research, finding results, questioning conclusions, and it had the feel of how research is conducted. The glaring problem with the organizing principle: “People responds to incentives, and you can tell what incentives are because they are what motivates people to do things” was usually glossed over, and you could look at the times when it is invoked with a sense of quirky amusement, like picturing a kid with a bucket on his head running in a circle thinking he is flying.

There’s a lot of internet discussion about the global cooling part of the book. As soon as I saw that on the title I knew that was going to be a disaster.

What I really want to point out is Ezra Klein’s takedown of the opening chapter. Ezra Klein is a health care wonk/reporter/blogger, and he swept-the-leg out of a shoddy econometrics argument by someone who won a Clark Medal for doing econometrics.

The next few pages purport to prove that drunk walking is eight times more dangerous than drunk driving. Here’s how they do it: Surveys show that one out of every 140 miles driven is driven drunk. “There are some 237 million Americans sixteen and older; all told, that’s 43 billion miles walked each year by people of driving age. If we assume that 1 out of every 140 of those miles are walked drunk — the same proportion of miles that are driven drunk — then 307 million miles are walked drunk each year.”

“If we assume.”

But why should we assume that? As the initial example demonstrates, a lot of people walk drunk when they would otherwise drive drunk. That substitution alone suggests that a higher proportion of walking miles are drunk miles. Other people walk, or take transit, when they know they’ll be drinking later. That’s why they’re walking and not driving. That skews the numbers and makes it impossible to simply “assume” parity.

I’m going to refer to this move economists make, where they make some provocative claim based on completely made-up data that doesn’t pass a critical first thought as “Old Custer.”

Why? Did you see the movie The Royal Tenenbaums? In it, Owen Wilson’s writer character Eli from the movie says “Well, everyone knows Custer died at Little Bighorn. What this book presupposes is…maybe he didn’t.”

This Freakeconomics experiment Klein tears to shreds is the exact duplicate of saying “What my argument presupposes is….maybe Old Custer died from walking around drunk.” The argument move “Maybe Custer didn’t die at Little Bighorn” is what is being used for a cutesy, counterintuitive take on drunk driving. It’s really worth noting that if Levitt was giving this argument at a seminar, and Ezra raised his hand and said what he said, the seminar would be over. Killed.

Inequality Forum at Cato Unbound

Will Wilkinson is hosting a forum at Cato Unbound, which are always interesting, on economic inequality. Here’s Will’s lead essay, which is a recap of his previous white paper from the summer. Lane Kentworthy has the first response. Check it out!

I’ll throw in some additional thoughts here.

Consumption versus Income Inequality

Here is Will:

As far as I can tell, when most people are worried about economic inequality, they’re usually worried about inequalities in real standards of living — in the real material conditions of life. . . An individual’s or household’s standard of living is determined rather more directly by the level of consumption than by the level of income.

So a few things of note. One is that if there’s income inequality, and there is less consumption inequality, by definition there’s an increase in savings inequality. All savings is is future consumption. Given the miracle that is compounding interest, one could make an argument that savings actually reflects more consumption, since you can consume much more tomorrow with that savings than I’ll be able to do without it.

Another is that consumption inequality has been kept in check by a massive leveraging among the middle and lower classes. The data shows this out. We found here that leveraging among the middle-class has increased greatly, and among the lowest quantiles as well. Digging further into the Fed document presented there, the leverage
ratio increased across all age groups, so it is not just a matter of consumption smoothing.

Over in the Business College…

A lot of these inequality studies are carried out by economists, so it is natural to their theories to look at consumption. That’s all people are at bottom in the theory – Robinson Crusoe sitting alone on his island, waiting for some coconuts to grow so he can eat them.

I prefer to look at individuals less as eating machines and more as firms, firms engaged in the neoliberal entrepreneurial business of leading their lives. Here we can brings some additional techniques, ones that would never look just at the owners assets, since they need to be match by his liabilities. Alternatively, if we look at the rewards, we need to look at the risks. And by any measure, the risks and liabilities of running a middle-class family firm have skyrocketed.

As a quick measure, we used the Merton Model of credit risk back here to price a CDS contract on a middle-class family. All the measures we would use, from a current ratio of assets to the level of volatility face by families on their incomes, lead us to conclude that, as far as businesses go, you should start looking to see if you can take a short position in the middle class.

Autonomy

What good is money for? Well, in a liberal society, it’s good for two things: more things and more autonomy. The things part is down – as Will is quick to point, goods at the lower end of the consumption scale are cheaper and better working over the past few decades. So even if many consumers have not seen their incomes rise, they feel richer since the goods they are getting are cheaper. True dat!

What I’m more interested in is the autonomy end of it. What about the ability to leave an abusive partner or job without worrying about health care? Travel, spend more time with your family, feel a sense of financial security, etc? Here people less worried about income inequality would say that consumers are in better position to take advantage of this as well since they are richer.

So what they have a cheaper basket of certain goods. Now though autonomy isn’t commodified and sold on a market, the items that we associate with it, insurance, education, perhaps housing, have all seen skyrocketing prices, an effect that blocks out the first effect. This leaves consumers noticeably poorer than they would be otherwise. You’d need to construct a separate index and see the effects played out; I hope researchers are able to do that.

Priorities

Will says that we should deal with the mechanisms of what creates inequality rather than being worried about inequality per se. That’s completely fair. But the question can be flipped – how much should we use the idea that inequality will be generated by our actions to guide what we should do?

Let’s take a thought example from the past year. Let’s say that government can either (a) bail out the financial sector or (b) allow judges to cramdown mortgages in bankruptcy, forcing (let’s say) a haircut on the financial sector to help middle and lower class families.

We went with (a), and not with (b). We could (should!) have done both! Now experts are already starting to worry that a rebound in the stock market combined with a long decline in housing is going to aggravate inequality even further than it was.

Now should inequality have been a guide here? Here I’ll confess that I think many liberals, myself included, have a slippage between inequality and un-fairness. I think it is in the interest of fairness to allow judges to cramdowns bankrupt mortgages, and I see that not having this go through exacerbates inequality. The same with unequal educational access, ‘under-banked’ communities, etc. I would note that I think these things are unfair because they increase inequality. Will would want me to be able to justify that they are unfair a priori, independent of distributional effects.

This is fine for how it goes, but there are many cases where the impact on distributional effects are part of the argumenting force for unfairness. Will points to unequal educational access. But why is that bad? Because it decreases opportunities for investment in, and deployment of, human capital. Why should we assume that? We should assume that because we can see the inequality in income and life chances after the fact.

I would love for Will, who is better with talking this through than I, to go further in this line. I would add this overlaps with one of my projects I’m thinking about, the financialization of the economy over the past 30 years – an event that has generated a large amount of inequality. I think Will thinks inequality is like the color blue, where I think inequality is like a tingling in your arm – a sign something terrible may happen, and that it should get check out immediately.

Arguments for Big Banks

I understand the arguments for not breaking up or nationalizing the largest banks, both in general and in the middle of a crisis. Those arguments are predicated on it being a bad idea, either too difficult or legally impossible. One talking point that I have not heard is that large banks are good for the economy. This is lobbyist talk, but let’s hear it anyway. From Simon Johnson:

Ms. FARRELL: We have created them [our biggest banks], and we’re sort of past that point, and I think that in some sense, the genie’s out of the bottle and what we need to do is to manage them and to oversee them, as opposed to hark back to a time that we’re unlikely to ever come back to or want to come back to.”

That’s not an argument. Under what circumstances would our biggest banks be the best arrangement of the banking sector? It’s important to realize how large the largest banks are. Here is a list of the Top 50 Bank Holding Companies from the Fed. I’m going to give you two charts. One is a histogram of those top 50:

Since this is in thousands, e^9 represents trillions above. Notice how fast the dropoff takes place. The other is the top 20, with an additional column for asset size as a multiple of the size of the 20th bank:

One potential argument is that something about the financial sector requires natural monopolies – clear leaders who can overcome informational and trust problems inherit in financial transactions, who can attract the top talent and thus allow the biggest players an extra level of certainty that they are dealing with the best. Natural monopolies is common thought for sectors with large fixed costs and low-to-zero marginal costs and increasing returns to scale, something not true of banking.

But take a look at that ratio column. We could take the top 4 banks, break them in half, and the halfs would clock in at….1st, 2nd, 3rd and 6th. See how far out the top players are in the histogram? Cutting the size of the largest banks would still likely leave them in the front of the pack, perhaps even by a distance. And it’s why I’m skeptical of marginal changes (higher capital requirements, for instance) as drivers of shrinking the size of the largest banks, since they would have so far to shrink down.

Another argument is that the scale at which the financial sector moves at these days requires large financial leaders. James Kwak grabs an obvious example, a large J&J bond issuance of $1.6bn, and shows that it splits up fine among several banks. The managerial responsibility of bond issuers is executed with no problem at mid-sized banks; I don’t hear complaints otherwise.

Another argument is that there is some sort of risk management scaling to size. The larger a bank gets, the better it is at diversifying, attracting risk-management talent, keeping losses down. Here’s a graph of expected loss, a measure of how poorly a bank has done, by asset size, taken from the Stress Test (so reported by the bank’s own models):

Notice the lack of variance among the big players there – they’ve all taken a big hit in this crisis. So I don’t think there’s a benefit to stability of the institutions themselves.

(Does anyone know how to get access to Bank Holding Documents in large data files? I want to aggregate and test this at a larger scale. Email or comment if you do.)

How about consumers? I’ve seen no evidence that larger banks help consumers, and indeed I’ve seen evidence that as bank consolidation happens, large banks ‘respond asymmetrically’ to interest rate changes, so they raise rates with the Fed faster, and lower rates when the Fed lowers them slowers, milking consumers. That’s exactly what you’d expect someone with market power to do.

In the next week I’ll see if I can get some historical data in here, but comparing the size, both absolute and relative, of the largest bank-holding companies now against the period from 1980-1999, it doesn’t strike me at all that the mergers and consolidation that has taken place has lead to better growth for the country.

Student Loans as the New Indentured Servitude

(Cross-posted at The Atlantic Business Channel. Picked up at Huffington Post, where, given I’m still figuring out what I think about the issue, it’s something to see 300+ comments personally and strongly reacting to the topic.)

From The Wall Street Journal, The ‘Democratization of Credit’ Is Over — Now It’s Payback Time. Check out the lead:

NEW YORK — Karen King owes nearly $36,000, more than she’s ever earned in a year.

All day long, bill collectors call. She hunts for a second job, sometimes skips meals, and stays with other family members at a grandfather’s crowded apartment, trying to get out of debt and turn her life around.

She largely holds herself at fault. “Years ago, I lived for now. It was so stupid,” the 28-year-old says. “It’s depressing, but I can’t live that life anymore.” Now, she says, “I basically want to live for the future.”

Now go about halfway through.

Her biggest chunk of debt, $26,000, stems from student loans to pay for her two-year associate’s degree from a community college — loans now in the hands of collectors. The remaining $10,000 or so includes old credit-card balances, debt to a store that rents furniture, utility bills and back taxes. Another obligation is $400 a month she contributes to the rent on her grandfather’s two-bedroom apartment, where her mother, uncle and sister also live.

Rolfe Winkler caught this too. In addition to pointing out how the current recession is focused in large part on men, it’s also worthwhile to note that the current recession is devastating the young. Here’s BusinessWeek on “The Lost Generation.”

But let’s go back to the person in question here: How should we judge this young person profiled in the Wall Street Journal? Is going into a large debt load to pay for college the post-Risk-Shift American Dream? Or is it a form of Living For Now, and being irresponsible and short-sited? According to FinAid.org, the average cumulative debt among graduating seniors is about $22,500. She’s ahead of that ($26K/2 years), but what is an acceptable amount of debt to carry to educate yourself? As as Krugman notes, education is a key to our country’s successes. Why should we think of her as irresponsible, instead of someone rationally going into debt peonage, like a 17th century indentured servant, in order to take a small shot at bettering oneself – the new middle class dream?

The New Indentured Servitude

Jeffrey Williams, in Dissent Magazine, wrote Student Debt and The Spirit of Indenture, in which he provocatively referred to student loans as the new form of indentured servitude.

Why is this the new form of indentured servitude? Williams gives some reasons: The prevalence of this debt, especially among the young and the poor/working classes, the transformation from a rounding error amount to a significant burden amount over the past 30 years, the length of term, the idea of mobility and “transport” to a job, debt secured not by property but by personhood, and limited legal recourse. All these characteristics are similar. The limited legal recourse is noteworthy here, since unlike most debt, it isn’t dischargeable under bankruptcy, thus it doesn’t have a natural protection for the consumer receiving credit (a protection, the original synthetic put option, that our Founders were aware of enough to make sure it was provisioned for in the Constitution).

This is not to soft-peddle indentured servitude. Indentured servitude was a violent contract, with physical torture used to coerce labor. As economist DW Galenson noted, “The Company clearly felt that [beaten workers running away] threatened the continued survival of their enterprise, for they reacted forcefully to this crime. In 1612, the colony’s governor dealt firmly with some recaptured laborers: ‘Some he apointed to be hanged. Some burned. Some to be broken upon wheles, others to be staked and some to be shott to death.’” But let’s put on our Galenson Economic Historian googles and think of it as an economic efficiency problem. Indentured servitude, like student loans, are a form of consumption smoothing. And one thing that is needed for consumptions smoothing is good information about the future.

Learning Your Earning

Here’s a graph from University of Minnesota macroeconomist Fatih Guvenen’s Learning Your Earnings:

Think of these two lines as a dial between perfect knowledge and no knowledge. In this model, a consumer who knows what he’ll make over his or her life will consumption smooth (perfect, or ‘full’, knowledge, flat consumption line); one who is uncertain about what will happen next will rationally not. So if you know exactly how much you’ll be making in the future, large loans aren’t really a problem.

Now we are currently asking children, 17, 18 or 19 years old, to try and assess how much of a student loan debt burden they can handle vis-a-vis their future income over their entire lives. But, especially compared to their grandparents, uncertainty is so much greater now. The consumption smoothing line invokes a world where everyone with a college degree will get a stable, solid job with certainty (and your employer will, of course, pick up the health care tab).

The person in the Wall Street Journal article almost certainly had no realistic idea for what would be awaiting her on the other side of the associate’s degree, and she misjudged this terribly. And, from an efficiency point of view, it’s what makes this more perverse than the indentured servitude contract – people under indentured servitude had the job waiting for them. The clock was ticking for the firms who had set up the contract, and they needed to get their value. With student loans, they can sit there for decades, never dischargeable, always getting paid regardless of recession or job market.