Monthly Archives: February 2012

The Amazing Vanishing Act: Accounting Control Fraud Disappears from the Regulatory Lexicon

Criminologists know that accounting control fraud causes greater financial losses than all other forms of property crime – combined.  Some of the world’s best economists, George Akerlof and Paul Romer, praised the S&L regulators’ early recognition of these frauds and set out a formal economic theory of accounting control fraud (“Looting: the Economic Underworld of Bankruptcy for Profit”).  They ended their 1993 article with this paragraph, in order to emphasize its importance.

“Neither the public nor economists foresaw that [S&L deregulation was] bound to produce looting.  Nor, unaware of the concept, could they have known how serious it would be.  Thus the regulators in the field who understood what was happening from the beginning found lukewarm support, at best, for their cause. Now we know better.  If we learn from experience, history need not repeat itself.”

The primary reasons that accounting control fraud can produce catastrophic losses are the seeming legitimacy of the firm, the supreme status and respectability of the CEO leading the fraud, the fact that accounting control fraud is a “sure thing” (Akerlof & Romer 1993), the ability of control fraud to hyper-inflate bubbles, allowing the fraud to persist for years and magnify losses, and the paradox that the optimal means for a fraudulent CEO to loot “his” bank is to cause the bank to make exceptionally bad loans. 

The last element is so counter-intuitive that despite the accounting control frauds’ dominant role in driving the S&L debacle and the Enron-era accounting control frauds many people cannot really believe that elite CEOs would loot “their” banks despite the many felony convictions of the elite CEOs that drove the two predecessor crises.  

“Benjamin Wagner, a U.S. Attorney who is actively prosecuting mortgage fraud cases in Sacramento, Calif., points out that banks lose money when a loan turns out to be fraudulent. “It doesn’t make any sense to me that they would be deliberately defrauding themselves,” Wagner said.”

Wagner is so befuddled that he thinks that he cannot keep his pronouns straight in the same sentence.  “They” is the fraudulent CEO.  The fraudulent CEO loots “his” bank.  The bank is “themselves” in Wagner’s bewildered sentence.  The CEO is not looting himself when he loots the bank.  Wagner is so confused that he assumes away the existence of insider fraud.  Sacramento is one of the epicenters of mortgage fraud by some of the largest accounting control frauds, and it is no surprise that they have been able to commit their frauds with impunity.

The national commission that investigated the causes of the S&L debacle found:

“The typical large failure [grew] at an extremely rapid rate, achieving high concentrations of assets in risky ventures…. [E]very accounting trick available was used…. Evidence of fraud was invariably present as was the ability of the operators to “milk” the organization” (NCFIRRE 1993).

The fraud “recipe” for a lender engaged in accounting control fraud has four ingredients:
  1. Grow like crazy by
  2. Making bad loans at a premium yield while
  3. Employing extreme leverage, and
  4. Providing grossly inadequate allowances for loan and lease losses (ALLL)
Understanding the second element is essential to effective financial regulation and prosecution.  Requiring sound underwriting is the best, no cost means of preventing the worst bank frauds.   Making enormous numbers of bad loans requires fraudulent banks to suborn internal controls and underwriting.  The bank operates in a manner that makes no sense for an honest lender.  (See my earlier writings on “adverse selection” and the resultant “negative expected value.”)  Understanding why the recipe is a “sure thing” (the bank will report superb, albeit fictional, income and the controlling officers will, promptly, be made wealthy) is essential to effective regulation because the regulator must treat the fiction as real.  

If there was one agency that should have understood the fraud recipe, it was the Office of Thrift Supervision (OTS).  The Federal Home Loan Bank Board (OTS’ predecessor) first identified it, wrote about it, trained its staff, trained the FBI and the Justice Department, and used our understanding of the recipe to identify, close, sue, sanction, and convict the frauds. 
By August 1983, the Bank Board had detailed written examination manuals that explained much of the accounting control fraud dynamic.

Regulatory Concerns
In summary, incentives to report higher earnings, the nature of assumptions used in certain transactions, like securitizations, and improper reporting in general may affect reported earnings.  Examiners should be alert to the regulatory concerns cited throughout this section, and to the following additional regulatory concerns as well:

• Management may use gains to further leverage the balance sheet. You should consider the quality of capital supporting asset growth to the extent that management based gains on optimistic assumptions or that the value of the retained interest is highly sensitive to accelerating prepayments or declining asset quality.

• Management compensation or dividend payouts may be excessive, and dependent on earnings.  Associations often tie compensation and dividends to reported profits. To the extent that reported profits are overstated, these payouts can dissipate assets and capital.

• Management may ignore credit quality. The incentive for profits can override attention to quality of earnings. The potentially significant profit that management can generate by gain-on sale accounting creates a strong incentive to produce originations, often with little attention to credit quality.

Remember, this was written nearly 30 years ago.  We have known for a very long time that modern executive compensation plus deregulation created an intensely criminogenic environment that could lead bank CEOs leading accounting control frauds to make epic amounts of bad loans in order to optimize fictional reported income and the CEO’s compensation. 

Unfortunately, OTS retreated to the dark ages as it came under the sway of anti-regulators influenced by theoclassical economists who were ignorant of the criminology, regulatory, and economics literature about control fraud.  These economists were unaware of how central underwriting is to lenders’ success.

Clinton administration economists “knew” that a lender would never deliberately make a bad loan.  They knew that accounting control fraud did not exist – even though it had so recently devastated the S&L industry.  The June 20, 2000 HUD/Treasury report on lending abuses made explicit this claim, which ignored Akerlof & Romer, criminologists, and OTS’s (a bureau of Treasury) contrary findings,.

“In most respects, lending in the subprime mortgage market follows the same principles as lending in other markets.  Basic economic theory, not to mention common sense, tells us that a lender will only lend money to a borrower if the lender expects to be repaid. That repayment has two components: the return of the original amount lent (the principal), and compensation for the opportunity cost of lending the money and for taking the risk that the loan is not repaid as promised (the interest rate charged).  While a lender will not make a loan unless he or she expects to be repaid, clearly not all borrowers present a lender with the same risk of default.”

On January 17, 1996, OTS’ Notice of Proposed Rulemaking proposed to eliminate its rule requiring effective underwriting on the grounds that such rules were peripheral to bank safety.

“The OTS believes that regulations should be reserved for core safety and soundness requirements.  Details on prudent operating practices should be relegated to guidance.
Otherwise, regulated entities can find themselves unable to respond to market innovations because they are trapped in a rigid regulatory framework developed in accordance with conditions prevailing at an earlier time.”

This passage is delusional.  Underwriting is the core function of a mortgage lender.  Not underwriting mortgage loans is not an “innovation” – it is a “marker” of accounting control fraud.  The OTS press release dismissed the agency’s most important and useful rule as an archaic relic of a failed philosophy.

“By getting away from ‘cookie cutter’ and ‘one size fits all’ regulations, we’re giving thrifts more flexibility to tailor their operations to better meet the needs of their customers,” said John Downey, executive director, Supervision. “Enhancing flexibility and reducing paperwork will hopefully make the lending process easier for both savings institutions and their customers,” he noted.

“We believe we can simplify our rules and give thrift management more flexibility without jeopardizing the safety and soundness of thrifts’ lending and investing operations,” said Carolyn Buck, OTS chief counsel. “We are eliminating numerous picky details from the regulations, while leaving fundamental safety and soundness constraints in place,” she said.

The OTS underwriting rules imposed the minimum, not the optimal, underwriting processes that a prudent lender would follow.  It imposed no costs on honest lenders.  Any prudent lender should have done considerably more than was required under the rules. 

OTS was not unique.  The Clinton administration was in thrall to the “Reinventing Government” movement, which asserted that government was largely a failure and needed to be radically altered to embrace purportedly superior private sector practices.  Vice President Gore’s passion was pushing the reinvention of government.  (Then Texas Governor Bush was shared Gore’s passion.)  The scholars pushing reinvention claimed that their approach would invigorate regulation.  Their assumption was that CEOs were good people who wanted to do the right thing but were driven to despair and rebellion against bureaucratic restrictions that prevented them from doing the right thing and demonized them as bad guys.  The scholars wanted dramatically reduced regulation, regulations devised with the active participation of industry partners, greatly increased privatization, far less enforcement and fewer sanctions (which were said to only build a climate of business resistance), and a service mentality for the regulators (we were ordered to refer to the S&L as our “clients” and directed to always think of them as clients).   

The Clinton administration thought so little of the OTS that he left an economist in charge of it on an “acting” basis for many years.  The economist was not evil, but he inherited an industry that had been scoured of its control frauds and an economy that had swung into recession.  The Clinton administration wanted vastly less regulation of lenders and OTS Acting Director Fiechter was happy to deliver an anti-regulatory policy that he substantively supported.

“In summary, after the lifting of statutory requirements for mortgage loans in 1982, regulatory requirements were lifted as well.  The federal regulators relied on bank management to ensure sound operations, and on consumers to protect themselves against abusive loan practices [p. 161].

Regulators expected that market-­based decisions would lead to innovative loan products, which would maximize availability of credit and which practices.  Lender self-­interest, bounded by the legal mandate of “safety and soundness,” was relied upon to ensure safe offerings.  Consumer self-­interest was also relied upon to weed out unsafe products and practices [p. 163, footnotes omitted].”  

Di Lorenzo, Vincent, “Unsafe Loans in a Deregulated U.S. Mortgage Market” (2009). Pace Law Review. Paper 633.

Di Lorenzo misses the period in which OTS and its predecessor agency the Federal Home Loan Bank Board, rejection of this theoclassical dogma allowed us to prevent the debacle from becoming a national financial crisis and allowed us to prosecute the elite frauds.  He is, however, certainly correct about the overall triumph of theoclassical dogma (and the Reinventing Government movement, which he does not discuss). 

The single most destructive deregulatory act, ironically, was contemporaneous with Akerlof and Romer’s hopeful conclusion in 1993:  “now we know better” – and can use that knowledge to prevent future crises.  The 1993 deregulation was “bound to produce looting,” which demonstrated that economists never “knew better” and our successors as regulatory leaders no longer “knew better.”  In 1993, the federal financial regulatory agencies adopted an interagency rule junking their loan underwriting rules and substituting deliberately unenforceable guidelines.  This is the rule change that allowed fraudulent liar’s loans.  It was adopted only two years after we (OTS West Region) forced the end of S&Ls making liar’s loans.  I do not want to overstate the impact of the rule change.  Liar’s loans were overwhelmingly made by uninsured lenders.  OTS, however, was supposed to regulate several of the largest originators of liar’s loans – Countrywide, WaMu, and IndyMac.  The Federal Reserve’s anti-regulatory dogma was far more destructive because only the Fed had statutory authority under the Home Ownership and Equity Protection Act of 1994 (HOEPA) to stop all lenders from making liar’s loans.

OTS was the last of the federal regulators to fully drink the anti-regulatory Kool-aid in October 2006.  It junked its underwriting rules, claiming that it was doing so to comply with the Reinventing Government initiatives and laws.  OTS explained how its policy process relied on input that came exclusively from the industry, without even feeling the need to defend it.

“OTS also sought industry input regarding staff’s initial recommendations through an industry focus group meeting among seven thrift representatives, an industry trade association and OTS staff.”

When the S&Ls, rather than the people, are your “client”, it makes sense to meet only with the industry so that one can fulfill their desires. 

“OTS’s objective in removing the detail from some regulations and relying on a more general set of regulations and safety and soundness standards is to allow institutions greater flexibility in their lending and investment operations.” 

Banks gain exceptional “flexibility” when a regulator junks enforceable rules and replaces them with unenforceable guidelines. The industry, however, had a practical concern. OTS still had many examiners who knew that the guidelines were “bound to produce looting.” The danger was that the examiners would try to make the guidelines effective. The OTS, therefore, assured the industry that it would make sure it would not allow such an act. 

“OTS is also sensitive to commenters’ concerns regarding the potential for examiners to treat guidelines as binding regulations. OTS will emphasize the proper interpretation of supervisory guidance in its examiner training programs to ensure that guidance is not treated in the same manner as binding regulations.” 

The industry demanded even greater protection from regulation, raising the fear that the states might fill the regulatory gap left by the OTS and regulate federally chartered S&Ls. The OTS was happy to allay that fear, by making explicit its intent to preempt any protective state rule: “the agency still intends to occupy the entire field of lending regulation for federal savings associations.”

As late as 2004, the OTS examination guide provided this warning and mandate about inadequate records. Of course, the agency’s leadership no longer supported the guidance. Given what we know about the endemic nature of record deficiencies in the loan origination and foreclosure contexts, consider how harmful anti-regulatory leaders are.

Incomplete or Inaccurate Records
Regions should immediately take enforcement action if an association’s books and records are incomplete to make an examination impossible or if they do not provide complete and accurate details on all business transactions. The caseload manager (or equivalent) should promptly meet with the association’s board of directors, discuss the problem, and require prompt corrective action. If the association does not correct the deficiency, the caseload manager should refer the matter to OTS’s Regional Counsel for initiation of cease-and-desist proceedings.

You should be particularly alert to violations of Part 562 and § 563.170(c), as the presence of incomplete and inaccurate records historically is evidence of severely deficient operating standards and a resultant deteriorating financial condition. 

The federal banking agencies’ anti-regulatory leaders and economists drummed into their staff the fictional claim that “basic economic theory” and “common sense” proved that the CEO would never lead an accounting control fraud. The regulatory agencies, therefore, made zero criminal referrals against the massive frauds that specialized in making liar’s loans – loans that the lenders’ CEOs did not expect to be repaid. We are left with the myth of the Virgin Crisis, conceived without sin.

Bill Black is the author of The Best Way to Rob a Bank is to Own One (now translated into French as Une fraude presque parfaite : Le pillage des caisses d’épargne américaines par leurs dirigeants with a new preface from the French Jurist Jean de Maillard and a new chapter on the ongoing financial crisis. Paris, France: Charles Léopold Mayer. (January 2012)). Bill is an associate professor of economics and law at the University of Missouri-Kansas City. 

He spent years working on regulatory policy and fraud prevention as Executive Director of the Institute for Fraud Prevention, Litigation Director of the Federal Home Loan Bank Board and Deputy Director of the National Commission on Financial Institution Reform, Recovery and Enforcement, among other positions.

Bill writes a column for Benzinga every Monday. His other academic articles, congressional testimony, and musings about the financial crisis can be found at his Social Science Research Network author page and at the blog New Economic Perspectives.

Follow him on Twitter: @WilliamKBlack

MMT Had a Banner Day

By Mitch Green

Via Animals Explain Economics

MMT received some love from the mainstream press today.  WashPo ran a story titled, “You know the deficit hawks.  Now meet the deficit owls.” via Ezra Klein’s Wonkblog.  Jared Bernstein, Dean Baker and Kevin Drum have each responded with a few words regarding their take on MMT.  For the initiated, this comes as a welcome surprise:  First they ignore you, then they ridicule you, then they run a story about you in the Washington Post.

Every now and again the planets align, and we are presented with an opportunity to do what just moments earlier seemed out of grasp.  There is now space for MMT to influence policy debates beyond the fringes of the blogosphere.  The time is ripe to clarify and strengthen MMT, especially given that as it spreads through new channels we are bound to encounter misinterpretations of our central positions.

It is also important to bear in mind that as MMT spreads beyond the confines of its corner of the blogosphere, we are likely to encounter hostile or opposing views.  Remember to be patient:  you’ve studied this stuff for awhile now; stay classy and offer resources where appropriate.  It’s easy to lose our sense of civility when we forget that at the end of a long chain of cables, routers and wireless cards are two human beings trying to have a conversation.


Via WaPo

MMP Blog #37: The Public Purpose

By L. Randall Wray

The households and business firms in a modern capitalist economy make many of the important economic decisions that contribute to determination of the level of employment and output, the composition of that output, the distribution of income, and the prices at which output is sold.

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Indiviglio’s Dogmatic Embrace of Failed Dogma in a Column Denouncing Dogma

By William K. Black

Daniel Indiviglio, a columnist for Reuters, wrote a column(“Dogma show”) denouncing the agreement to extend the payroll tax reduction. He was distressed by what he considered faux fiscal restraint. Indiviglio, writing at the same time that the Eurozone fell back into recession because of its austerity program, denounces both parties for being in the grip of dogmas that cause them to fail to impose greater austerity.

Why does Indiviglio want the U.S. to follow the worst possible response to a severe recession – austerity?  Because he is driven by a failed economic dogma, he has neither the capability nor any felt need to explain why he believes we should copy the Eurozone’s failed policies and join them in falling back into recession. He is so trapped by his dogma that he knows that austerity is the only rational economic policy and cannot conceive that his views are ideological because they are so self-evidently true. He has unintentionally proved his point about how destructive discredited economic dogma is.

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Reply to Comments on MMP Blog #36 What Governments Ought to Do

You might want to see my NEP front page piece: Mine’s BiggerThan Yours, which deals with various misunderstandings on size of government.It isn’t size that matters (beyond some minimum size—probably 15-20% of GDP),rather it’s what you do with it that counts. It is all about what governmentought to do, in other words. Ok so here are comments and my responses.
Neil: Is it worth mentioning that economic policy is aboutbeing largely right rather than precisely wrong?
A: I like it. But of course even “right” depends on “ought”.
Philip: Yes, the exchange rate is a bit of a mysteryalright. Any advice on a good book that tries to deal with these issues from aPK perspective. Preferably one that looks at the empirical evidence to somedegree. I seem to remember that John Harvey did something on this…
A: Truthfully, no one knows. No one has much of a clue,really. I like Harvey’s two JPKE papers and they might be as good as anythingout there. Add in Keynes’s interest rate parity theorem and Sraffa’s commoditypricing and I don’t think economists have much else to say. Since daily tradein financial assets exceeds annual trade in goods and services, it is clearthat whatever theory you have it must treat exchange rates in the context of atheory of asset pricing.
Dario: I am confused. Are you moving toward an Austrianapproach? May I ask you why? What’s your purpose?
A: Yes you are. Confused. My purpose is to talk about what government ought to do. What is yours? To make unfounded accusations?
Golfer: Why Crony capitalism? Because government is so bigthat the profits to be had by controlling it are irresistible. in former times,when government in the US was les than 10% of GDP, there were more profitsto be made in private enterprise. 
A: Oh really. And who is the richest man in the world? Hint:Mexican. Government much smaller relative to GDP than the US government; andthe US government is (next to Japan’s) the smallest of the big economies. Lookslike more ideology than content to me. And if you really believe the USgovernment in the time of the robber barons was less crony than today’s, youlive in la-la land.
Neil: No matter how small the government gets the profits tobe had by controlling it are always irresistible. It’s the flipping currencyissuer!
A: Yep. Give me a printing press and I can move the world.
Hewer: it may be worth adding that the impetus to controlgovernment is not entirely down to the notion that profits from being acurrency issuer are irresistible.  Of course that is true, but it is notsomething that those who seek to control the political process necessarilyunderstand, nor necessarily their first concern if they do.  The mainbenefit to controlling government does not come from the “profits”that can be made, but rather from the control over real resources thatpolitical dominance provides. 
A: Mr. Slim has got a real resource (phone monopoly) but USbanksters do OK, too.

Mine’s Bigger than Yours: Notes on Optimal Size of Govt.

By L. Randall Wray

For most of my career—going on 30 years–I’ve been accused of advocating Big Government. That is mostly because I adopted Hyman Minsky’s views—which I won’t go through here. Of course, those claims came from the right. I’ve always been proud of it, to some extent, even if I’ve always been critical of what my government actually does with its spending. And if I don’t piss-off at least one person every day, I’ve failed.

For the past 20 years as we developed the MMT approach and the JG/ELR proposal, we’ve faced all manner of ridiculous accusations: we advocate slavery (offering a job to someone who wants to work is no different from chaining him and whipping him and forcing him to pick cotton in the hot sun from sunrise to sunset) or communism (proposing full employment as a policy goal is the same thing as forcing everyone to share their undergarments) or fascism (noting that taxes-drive-money is equated to herding Jews into gas chambers).

Of course, those claims came mostly from the left—indeed, all three were proclaimed in the same sentence by a prominent Post Keynesian, and repeated at every opportunity by him and all his followers.

And now there is a whole website devoted to an “alternative” modern money view (called MMR—which I’ve not been able to decipher; it either stands for Measles, Mumps, and Rubella, or Monetarily Mentally Retarded—neither is very PC as an identity, I must say) insisting that the MMT approach embraces Nazi authoritarianism, since as we all know, no democratic government would ever impose taxes, much less use them to drive money (nay, according to MMR everyone would sit around leaderless campfires and barter with seashells whilst singing Kumbaya).

Oh and then there is the guilt by association: some financial markets people as well as Austrians agree with some of MMT, thus, MMT has to be an evil plan developed by Goldman Sachs to take over the world. This is the view of both right and left critics.

And now we find ourselves accused of advocating Small Government. The ultimate insult!
In a bizarre twist, the critics have been able to combine the guilt-by-association (some MMTers actually are willing to discuss Austrians views! Oh my, what has the world come to?), ad hominem attacks (a hedge fund manager must be against government!), and faulty logic (explaining how a JG is an automatic stabilizer must mean you are against discretionary fiscal stimulus!) to come up with yet another attack—and, again by Progressives (obviously—since Austerians want smaller government, so presumably they welcome us to the Small Government fold!).

I don’t think either our Austerian friends or our Progressives have the foggiest notion how big the federal government now is, what it spends on, and how much greater spending would need to be to fund all the programs Progressives want (and that Austrians fear).

I don’t know if this is going to make me more of a Big Government type or enhance my newly found Small Government reputation. But let’s see what the Federal government actually spends, using 2010 data (latest more-or-less actual data from the 2012 Economic Report of the President). The total is $3.5 Trillion, which is 24% of GDP that reached $14.66 Trillion.

Note that this is unusually high compared to trends due to the “big spending Democrats in the White House”.
No, actually it is big because GDP was depressed by the deep recession while government spending rose mostly automatically to deal with unemployment, poverty, and medical problems brought on by the crash.
But let’s take 24% of GDP as a rough approximation of the size of our “Big Government”. Note I am not including state and local governments—these are users, not issuers of the currency. Their spending is “paid for” by taxes, fees, fines, and some funding from Washington. I can see arguments either way for including them in our measure of the size of “Big Government” but I think that from the MMT perspective it makes more sense to leave them to the side.

I have added in parentheses the percent of GDP for the biggest items: defense (5%), Education and so on (1%), Health (2.5%), Medicare (3%), Income Security (4%), and Social Security (5%). Nothing else really matters much individually. Note there are well-known problems with the defense number—the reported figure significantly understates actual spending because a lot of “defense” activities are secret; some of the spending is hidden in other categories. Some is probably not reported anywhere.

Total: On-budget and off-budget …………………………………. 3,456,213    (24%)
National defense …………………………………………………………….. 693,586     (5%)
International affairs ……………………………………………………….. …45,195
General science, space and technology ………………………… ….31,047
Energy ………………………………………………………………………. ……..11,613
Natural resources and environment ……………………………… ….43,662
Agriculture ………………………………………………………………… …….21,356
Commerce and housing credit ……………………………………  ….–82,298
Transportation ………………………………………………………………… 91,972
Community and regional development …………………………. …23,804
Education, training, employment, and social services ……..127,710      (1%)
Health ………………………………………………………………………. ……369,054      (2.5%)
Medicare ………………………………………………………………….. ……451,636      (3%)
Income security ……………………………………………………………….622,210      (4%)
Social security …………………………………………………………… …..706,737      (5%)
Veterans benefits and services …………………………………….. .108,384
Administration of justice …………………………………………….. ….53,436
General government …………………………………………………… ……23,031
Net interest ………………………………………………………………….. ..196,194
Undistributed offsetting receipts ……………………………………–82,116
OK for our conservative and Austrian Austerians, a government that is almost 25% of our economy is far too big. For our progressive friends it is far too small. Let’s focus on the big things.
At least a fifth of all government spending goes to “defense”—and the actual figure is probably double that (say, 10% of GDP). Judging from libertarian support for Ron Paul and from the traditional progressive opposition to US imperialism abroad, I suspect we can agree that “defense” spending is far too big. Personally, I have opposed all US invasions of other nations with the exception of our participation in WWII. I’d bring all troops home, close all foreign bases, and prohibit further military adventures abroad; as our Republican friends say, “starve the beast” by cutting all military spending down to what is necessary to maintain a purely defensive force within our borders. The only foreign intervention I would support would be to air drop food and medical supplies wherever they are needed.
I know I won’t get my way. I would not call this a Big Government or Small Government preference—it is anti-war. But let us presume we scale back “defense” spending to a scale that makes it hard to mount sustained invasions abroad—to, say, 2% of GDP. (That should be sufficient to put a tank into the hands of every gun-loving and motherland-protecting patriot to ward-off attack.) We’ve thereby reduced the reported size of government by 3% of GDP (and perhaps actual size by 8% of GDP—but we will ignore that in calculations below). So, a 3% reduction of Big Government.
MMTers want a universal Job Guarantee program at a living wage. Various calculations have put that at about 1% of GDP, with net cost close to zero (due to savings on anti-poverty programs, unemployment compensation, and so on). Let’s say that is off by an order of a three hundred percent—true cost turns out to be 3% of GDP. That just replaces the reduction of defense spending, getting us back to 24% of GDP.
Now it is unreasonable to presume there is absolutely no reduction of “welfare” spending—in the form of “income security” that is 4% of GDP. We’ll offer a job to all who want to work, creating somewhere between 10 million and 30 million new jobs at a living wage (note that not all of the new jobs will be in the JG program—that depends on “multiplier” job creation in the private sector, but those jobs will also pay living wages or otherwise workers cannot be recruited out of the JG). Unemployment compensation, food stamps, and even some “tax expenditures” on the earned income tax credit will all decline.
Stephanie Kelton and I have replicated earlier work done by Hyman Minsky showing that a JG program will eliminate most poverty (defined as those below the official poverty line) just by providing one minimum wage job per household. At a higher wage, and by offering more than one job to households that want more work, the JG would raise most families well above the poverty line. Let us say that income security spending falls by a couple of percentage points (2% reduction). That offsets two-thirds of the JG program spending.
Note also there will be a bit of saving in the “education, training, employment, and social services” category that currently prepares workers for jobs that do not exist. But let’s keep the 1% devoted to that spending but instead prepare workers for jobs that will exist. So I won’t count any reduction here.
So we are down to 22% of GDP. Now let’s replace our failing US healthcare system with a universal and free, federally paid-for program that offers the range of services that are provided in the average rich nation. That will run about 7-8% of GDP. We already devote an amount equal to 5.5% of GDP to “health” and “Medicare”. Then there’s another 10% of GDP spent by consumers either out-of-pocket, through their state and local governments (“taxpayers”) and through private insurers. So we can cut total spending if we ramped up federal spending by a couple of percentage points. We’ll presume that extraordinary health spending (vanity nose jobs, anatomical augmentation, hair transplants from hairy backs to shiny scalps, etc) is taken care of by the private sector, while all the important stuff is covered by the federal government.
Let’s leave the savings to the nongovernment sector spending to the side and focus on the government’s portion: we go from 5.5% of GDP to, say, 8% of GDP for an increase of federal spending equal to 2.5% of GDP.
The remaining big category is Social Security—about three-quarters of which goes to retirees. That is the main income support for the majority of our seniors. Progressives believe benefits are too small—especially for retirees who had low earnings, and also for many who receive disabilities as well as for dependents and spouses of workers who die. Let’s ramp that up by 2% of GDP.
Note that with the JG program discussed above, that offers a living wage to all who want to work, seniors and their dependents will already have the option of earning more income from work. We should let them “double dip”—no reduction in work opportunity due to retirement onto Social Security benefits, nor in Social Security benefits should they choose to work. Living standards should be significantly higher with the boost to benefits plus the enhanced jobs prospects.
Our net impact on federal government spending so far: net increase of 2.5% of GDP. We’ve gone from a Big Government of 24% to 26.5%.
But we aren’t done yet. Let’s look to our progressive wish list for more. Public infrastructure is deficient—a point made by President Obama, and by our society of engineers that finds a deficit in our public infrastructure amounting to trillions of dollars. Yes we need bullet trains, cleaner water, better airports, bridges and hiways, and more dependable sewage treatment. And we need to join the developed world in getting our darned electrical wires safely underground so that power isn’t knocked out in every ice storm.
How much? Let’s look to the estimates provided by the progressive PERI report. They found that the rate of growth of public infrastructure spending fell by about half over the past decades; they project a needed “baseline” annual increase of $87 billion to make up for the shortfall, of which $54 billion would come from all levels of government.
Their “wish list” high end estimate would be for the public sector to spend even more, an additional $93 billion annually. However our state and local governments are broke—so let’s put the full burden on the federal government, and ramp up its spending by 1% of GDP (make it a nice round $150 billion per year). That is well above the PERI dreams—which will go beyond traditional projects and make a dent in our sustainability problems with insulation retrofitting and so on. (There is a nice synergy here as our JG workers will be doing these sorts of projects.)
So we add another percentage point to government spending.
Our Big Government is now 27.5% of GDP. We’ve got true full employment at a living wage. We’ve got universal and free healthcare. We’ve got a more generous retirement system, and better care for survivors and those with disabilities. We’ve got bullet trains and bridges that don’t fall into rivers. And we’re reducing our foreign entanglements.
All for 3.5% of GDP additional spending.
And we’ve avoided “dynamic budgeting”—we have not counted potential savings in terms of reduced incarceration for the young jobless males who turn to a life of crime. We haven’t counted health benefits; we didn’t reduce spending very significantly on income support that will face fewer demands. We didn’t count multiplier effects on private sector spending—that would reduce government spending in some areas. And so on.
All of us, progressives and Austrians alike, know we can “afford it” because a sovereign government cannot run out of its own currency. Three point five percent.
I do not know if that will comfort our Austerians, who think 24% is already far too big. Nor do I know if it will comfort our Progressives, who are now sure that MMTers have become advocates for Small Government.
To be sure, I can add some more items to the list above: more federal funding for education, federal support for sustainable agriculture (but less support for corporate farming—so that probably balances), more foreign aid, and good wine flowing from every water fountain in America.
All that might add one or two or three more percent—and get us to a 30% government. Will that horrify our Austrians, and still dissatisfy our Progressives?
Probably. Both.
What should government do?
I think reasonable people can disagree when it comes to what government ought to do. I think it is worth discussing. Lay it out on the table. Forget the silly arguments about deficits and hyperinflations and taxation by dictatorships and JG slavery and bankrupting our grandkids and associating with Austerians and Hedge Fundarians.
And about arbitrary government-to-GDP ratios. We don’t need to argue about whose is bigger. What matters is what you do with government.
What should government do? It’s a mostly political question. A 24% government (US) can do most of what most people seem to want government to do. And more than what others want. And so can a 50% government (France). The jury is still out on a 15% government (Mexico)—it would be hard to point to Mexico as either a case of a successful government doing what people want it to do, or as an Austrian Austerian utopian Small Government.
What do you want government to do? 

Confederacy-lite: The Oklahoma’s AG’s Civil War against the United States of America

By William K. Black
(Cross-posted from

The fact that only 49 State Attorneys General (“AG”) entered into the mortgage fraud foreclosure fraud settlement focused attention briefly on Oklahoma’s AG, E. Scott Pruitt. The Oklahoma Republican Party bills Oklahoma as the reddest state, and Pruitt is beet red. He refused to enter into the settlement not because it was too weak, but because it provided any reduction in the principal amount of the debt of distressed Oklahoma homeowners.

The distinguishing characteristic about Pruitt is that he was elected on the promise to launch a litigation war against the federal government, particularly federal regulation. Pruitt and his counterparts in Virginia (Ken Cuccinelli) and Florida (Pam Bondi) claim that their principal function is protecting their citizens from the depredations of – the United States of America. Pruitt, ala South Carolina in 1860, expressly politicized the cause as opposition to the elected President of the United States. He asserts that regulation is inherently illegitimate because it is done by “unelected bureaucrats.” (So is policing and firefighting and service in the military.)

“Oklahomans deserve an Attorney General who will stand up to the Obama Administration that seeks greater and greater control your life. Oklahomans deserve and Attorney General who will stand unapologetically for the truths of the Constitution.


I will serve as Attorney General of the State of Oklahoma for one fundamental reason — to advance your freedom.

Washington DC tells us that we possess freedom, yet the federal government defines the extent of that freedom through the regulations of unelected bureaucrats.”

“What is your reason for running?

“I truly believe this election is unlike any other election that any of us have ever experienced. Right now, all across Oklahoma, our families and businesses are besieged by a Congress, an Administration and its federal agencies that are hostile to our most cherished values and ideals. Furthermore, I believe that what is at stake in this election is whether we are going to live consistent with what our Constitution stands for – whether we will live with the freedoms for which we were intended. I am seeking to serve as Attorney General of the State of Oklahoma to advance your freedom….”

It is no coincidence that the three AGs represent states (a territory in the case of Oklahoma) that supported the Confederacy and use phrases and arguments made famous by secessionists. They represent the resurgence of the old, sad embrace of the great lie. The United State of America, the greatest democracy in world history, is supposedly the great evil threatening Virginia, Florida, and Oklahoma. The Confederacy viewed the great evil as the threat to the “state right” to “our way of life” – enslaving black slaves. One hundred and fifty years ago the worst disaster in U.S. history was brought on by proponents of this monstrous system. It took 150 years of massive bailouts from the Northern and Western states to the states and territories that supported the Confederacy to make it possible for them to overcome the damage their racism did to their economies.

The new Confederacy-lite has no “noble cause” akin to slavery, but the cry is still the need to preserve “our way of life.” Pruitt, during his election campaign, highlighted what he described as the epitome of federal tyranny destroying the freedom of Oklahomans. Listen to the full horror of the federal regulatory assault on the cherished “way of life” of Oklahomans.

(Aug 27 [2010]) Republican candidate for attorney general, Scott Pruitt, said today the recent petition filed by the Center for Biological Diversity and several other groups with the US Environmental Protection Agency (EPA) to ban lead in ammunition and fishing tackle is a direct assault on the freedoms guaranteed Oklahomans under the Second Amendment.

While visiting the Lawton area today, Pruitt said, “The attempts to ban lead in ammunition and fishing tackle is a back-door attack on basic freedoms we enjoy as Oklahomans and our way of life. Should the Environmental Protection Agency pursue this ban, as attorney general, I will do all I can to stop Washington bureaucrats like the EPA.”

Lead is highly toxic, so removing lead from ammunition would be exceptionally good for waterfowl (who feed in a way that can fatally concentrate lead pellets) and for hunters who eat waterfowl. Non-toxic ammunition is now readily available. I do not know why Pruitt thinks that preventing the poisoning of waterfowl “is a[n] attack on basic freedoms” and Oklahomans’ “way of life.” The Oklahoma “way of life” is to shoot waterfowl and eat them. You cannot shoot or eat waterfowl that die from poisoning themselves by ingesting lead shot in a marsh along the migratory flyway six hundred miles north of Oklahoma. Waterfowl are big believers in interstate commerce.

We adopted the U.S. constitution in great part because under the Articles of Confederation the States interfered with interstate commerce in ways that harmed the national interest and because the States could not protect their citizens’ interests when protecting those interests depended on actions taken in other states. [EPA denied the petitions asking it to regulate lead ammunition and sinkers.]

It isn’t fair, of course, to characterize Pruitt’s passion to defend the right to poison ducks as typical of his basis for making his assault on federal regulation his office’s top priority. Pruitt wants to sue to stop most federal regulations that protect Americans. Oklahoma is a huge energy producer, so Pruitt’s real hate is any rule that restricts pollution or increases energy efficiency. Under Pruitt’s ideology, it is tyrannical for the EPA to protect Americans from pollution or for Congress to require NHTSA to adopt rules requiring that vehicle manufacturers improve the fuel efficiency. Providing health care to Oklahomans who cannot afford health care is tyrannical.

“Limited Government:

The passage of President Obama’s healthcare legislation in Washington fundamentally alters the relationship of citizen to government in America. Rather than government serving the citizen, it seeks to become master, controlling, dictating and utilizing power it does not possess.

Our founding documents are legal documents, not suggestions. They exist to control the impulses of men, and counteract the temptation toward tyranny; where elected individuals think they know better than the people they serve, that they are somehow more enlightened. The Founders defeated a monarchy that believed such things. We must in our generation now do the same.

I will, on behalf of Oklahomans, initiate a constitutional challenge to the legislation in its entirety, with a goal of rendering the legislation null and void in the State of Oklahoma.”

Pruitt has a self-inflicted problem with candor when it comes to his openly partisan attack on what he repeatedly labeled “Obamacare.” He now repeatedly denies that he has made such references.

“Pruitt, who was elected attorney general last year, said his office has filed two lawsuits against the federal government’s Affordable Care Act, also known as Obamacare. However, Pruitt said he does not refer to the controversial health care legislation as Obamacare because the issue is not about politics for him.”

Pruitt gently chided those who refer to the law as “Obamacare,” saying, “You will never hear me say ‘Obamacare.’ This is too important of an issue to make it partisan. It’s not about health care. It’s about the Constitution.”

In the face of budget cuts that have greatly reduced the already grossly inadequate ability of State AGs to protect their citizens from elite white-collar criminals, Pruitt redirected the scarce resources of his office away from protecting the citizens from the elite criminals.

“As part of keeping one of my primary commitments during the campaign, I formed a special federalism unit dedicated to the purity of constitutional balance of power, enforcing the plain meaning of the founders’ directive that the federal government be one of specific and enumerated powers, and conversely preserving to Oklahoma and its citizens reserved powers, all with an aim of preserving individual liberty. The Office of Federalism is under the direction and leadership of my Solicitor General, who constantly monitors the actions of the federal government and works as my top appellant litigator.”

“Office of Federalism

Inside the Office of Federalism I will assign attorneys in the A.G.’s office whose primary responsibility is to determine how the office can and should push back against Washington. Whether it’s related to property rights, the right to keep and bear arms, the right to educate our children, or related to the first amendment, the attorney general must have resources and leaders internal to the office fighting those battles every day.

In addition to bringing suit against the Obama Administration’s newly passed health care mandates, the new Office of Federalism will defend Oklahomans against agencies such as the Environmental Protection Agency when its regulations seek to establish climate and energy policy absent congressional action, and the Nat’l Highway Traffic & Safety Administration in setting new fuel-economy standards.”

The federal government is a massive enterprise, yet Pruitt has prioritized his inadequate resources to “constantly monitor[] the actions of the federal government” in an effort to achieve “purity” of the constitutional balance of power. His office brings suits designed to allow elites to become even wealthier by maiming or killing others through their pollution.

“This week, we also saw the EPA delay the announcement of draconian ozone standards they seek to put in place to advance a leftist-environmental agenda until after the November elections. This is the politics of Washington bureaucrats trying to hide their intentions from the people of Oklahoma, and it’s got to be stopped.”Pruitt said as attorney general one of the first initiatives of his administration will be to prioritize resources in the AG’s office, and dedicate a team to defend against abuses of power by the federal government that impact Oklahomans, “I will assign attorneys in the AG’s office whose primary responsibility is to determine how the office can and should push back against Washington. Whether its related to property rights, the right to keep and bear arms, the right to educate our children, or related to the first amendment, the attorney general must have resources and leaders internal to the office fighting those battles every day,” said Pruitt.

“I will be a new type of Attorney General. I will be an activist Attorney General, but from the conservative side of the political spectrum. I will shift existing resources to create an ‘Office of Federalism’ whose task it will be to keep the federal government from unduly burdening Oklahomans and Oklahoma businesses.”

In his election campaign, Pruitt used “battle” metaphors to describe his “activist” role and that of his new federalism office.

Issue Position: Office of Federalism

“I will establish an Office of Federalism with the Attorney General’s office. I will assign attorneys in the A.G.’s office whose primary responsibility is to determine how the office can and should push back against Washington. Whether its [sic] related to property rights, the right to keep and bear arms, the right to educate our children, or related to the first amendment, the attorney general must have resources and leaders internal to the office fighting those battles every day.”

Pruitt campaigned on the basis that he would protect the freedom to exercise one’s religion in the public space. In office, he has made clear that there is only one exception to that rule – Muslims are not welcome to seek to exercise their religion in the public sphere. Pruitt has continued to defend the constitutionality of an Oklahoma law that blatantly singles out Muslim religious tenets for discrimination in a manner that is inescapably unconstitutional under the U.S. and Oklahoma constitutions.

Pruitt’s twin objections to the national foreclosure fraud settlement with five massive financial institutions were that it sought reforms to their foreclosure practices to prevent the resumption of the endemic fraud and modestly reduced the principal on some underwater loans to borrowers. He is the perfect embodiment of Confederacy-lite – he runs his office to protect his elite contributors at the expense of Oklahomans.

Of course, he claims that he is doing the opposite – protecting little banks by going after the largest banks that the Obama administration refuses to go after. Indeed, he asserts that the federal government intentionally destroys small banks through regulation in order to ensure systemically dangerous institutions’ (SDIs) dominance.

“Sixty-eight percent of all money in this country is deposited into seven banks,” Pruitt said. “The regulatory environment is strangling the life out of community banks and I will tell you it’s intentional because the (federal government) can better manage an economy when you have all your money in just seven banks.”

When push came to shove, Pruitt sought to weaken the reforms that the Obama administration (reluctantly) imposed on the gigantic and fraudulent financial institutions. He worked against the interests of small, honest banks. Pruitt stresses that he will sue to force federal government “accountability”but he gives the big banks a pass from criminal liability or even serious civil liability.

“Pruitt has announced that he intends to establish an office to deal with federalism in the attorney general’s office with the intention of protecting Oklahoma’s rights against federal encroachment. The office would also deal with issues such as federal regulation of health care, financial business and immigration.

“I will look at options to make sure we take whatever steps necessary to hold the federal government accountable,” he said.

Pruitt previously announced that he plans on reviewing and taking some sort of action to hold the federal government responsible for securing the border. He said several states have considered such action as an alternative to enacting immigration laws such as those recently passed in Arizona.”

Bill Black is the author of ;The Best Way to Rob a Bank is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. He spent years working on regulatory policy and fraud prevention as Executive Director of the Institute for Fraud Prevention, Litigation Director of the Federal Home Loan Bank Board and Deputy Director of the National Commission on Financial Institution Reform, Recovery and Enforcement, among other positions.

Bill writes a column for Benzinga every Monday. His other academic articles, congressional testimony, and musings about the financial crisis can be found at his Social Science Research Network author page and at the blog New Economic Perspectives

Follow him on Twitter: @WilliamKBlack

Greece: A Default is a Better Outcome Than the Deal on Offer

By Marshall Auerback

Pick your poison. In the words of Greek Finance Minister Evangelos Venizelos, the choice facing Greece today in the wake of its deal with the so-called “Troika” (the ECB, IMF, and EU) is “to choose between difficult decisions and decisions even more difficult. We unfortunately have to choose between sacrifice and even greater sacrifices in incomparably more dearly.”  Of course, Venizelos implied that failure to accept the latest offer by the Troika is the lesser of two sacrifices.  And the markets appeared to agree, selling off on news that the deal struck between the two parties was coming unstuck after weeks of building up expectations of an imminent conclusion. 
In our view, the market’s judgment is wrong:   an outright default might ultimately prove the better tonic for both Greece and the euro zone. 

The only questions that remain to be resolved are these: have all of the parties begun preparations to mitigate the ultimate impact of an outright default by Athens?  And will the ECB be sufficiently aggressive in combating the inevitable speculative attacks on the other members of the euro zone periphery, which are almost certain to ensue, once Greece is “resolved” one way or the other.
Within the Troika, the Germans in particular have been the champions of taking the toughest line possible against the Greeks and other “Mediterranean profligates”. But however stubborn Berlin appears to be, the Merkel Administration is certainly not stupid. At this juncture, it seems more rational to view their  ongoing promotion of fiscal austerity as a political smokescreen: In reality, what Germany likely wants to do in the case of Greece is trigger is an involuntary default so that the other PIIGS don’t get the wrong idea and ask for a similarly large haircut on their debts.  They realize the consequences that might follow, as the others gear up for similar treatment.  Far easier were Greece to move toward involuntary default, in the eyes of Berlin.
Politically, of course, the Merkel government can’t actually come out and advocate a Greek default or, indeed, outright expulsion from the euro zone. Far more politically astute to promote fiscal austerity on top of yet more fiscal austerity, (even though that is certainly not winning Mrs. Merkel any popularity points in Greece), until the Greeks themselves scream “Uncle!” and default outright.
It helps domestically as well. According to polls Angela Merkel is now the most popular politician in Germany, which is why she persists with this pernicious narrative that the problems of Greece all stem from fiscal profligacy and laziness, in contrast to the responsible and hard-working German people.
Ultimately, though an involuntary default carries risks for the stability of the euro payments system, a deal, per the terms outlined in the press, is bad for Greece.  And probably even worse for global markets, especially the bond markets.
Either eventuality creates problems but default is probably the less bad option longer term. Let me elaborate:
Greece is a hopelessly uncompetitive economy that probably shouldn’t be in the euro zone. But can you surgically detach Greece if it defaults, without some sort of impact on the entire euro payments system?

And what will the impact be on Greece itself?  The country currently runs a primary budget deficit (excluding interest payments on debt) of around 5% of GDP. Were it to default, Athens would be forced to go cold turkey (“cold Greece”?) until the primary fiscal deficit (now around 5% of GDP) is balanced. Maybe the government could suspend all military expenditures as a first pass? At the very least, they can stop buying German military equipment!
No question, that under a default, a lot of public sector employees will be sacked, pensions will be at risk, and unemployment will almost certainly go higher.  But that is certainly going to occur under the deal now being struck.   Were the country to revert to the drachma, however, they would likely be left with a substantially weaker currency, which could ultimately provide the country with the wherewithal to compete in the global economy. With a super-cheap exchange rate, Greece could become a Mecca for retirement homes, research hospitals, trans-European liberal arts colleges, and maybe low-overhead software startups. Plus, a permanent home for the Olympics. It could live happily ever after, as Florida does, on the pension income of the elderly and the beer money of the young.
This would be the source of the foreign transfers that the private banking sector won’t make anymore. In Greece’s case that credit went to the public sector and a lot of it built useful infrastructure, so it’s not a waste, but the first step is surely to cancel the debts and stop the illusion that they can be paid. And it would end the “death by 1000 cuts” currently being imposed on the Troika, which will serve no useful economic, political or social purpose.
Of course, there will be a slew of defaults and an endless series of court cases, litigation, etc., much as there was when Argentina defaulted in 2001.  But it would force the issue of debt restructuring on the table in a meaningful way and at least provide Greece with light at the end of the tunnel.
To ensure some sort of viability of the drachma, the Greek government would have to find a more credible means of ensuring tax compliance. Most Greeks with money have presumably already moved it beyond the reach of the Greek banking system, so that savings would not be wiped out. As the tide of repossessions begins, many of these oligarchs would likely start to buy back the Greek assets on the cheap, as it is doubtful that the euro banks will want anything to with them.
Beyond that, it would be important for Athens to establish a new tax system that minimises tax evasion, so as to create demand for the new drachma immediately, and mitigate the formation of an extensive parallel transactions currency. After all, it is possible that many Greeks might prefer to use the existing stock of euros in the country and there is very little the EU authorities could do to stop this (much as the US government could not prevent Panama from dollarising its economy). But in order to establish a long-lasting demand for drachmas, two things would have to happen: 
  1. The Greek government would announce that it will begin taxing exclusively in the new currency.
  2. The Greek government would announce that it will make all payments in the new currency. 

Given the country’s history of tax evasion on income tax, a national real estate tax would likely work better than a new income tax.
(See here for more details:)

On the other hand, the challenge for the European Union authorities is to ensure that speculative capital is not unleashed on the next weakest link in the chain – say, Portugal – to ensure that there is an adequate firewall established and to minimise disruptions to the entire euro payments system. It’s unclear to me whether the euro zone authorities have truly thought this aspect through and considered the best means to prevent a major disruption of the EMU payments system. Then again, perhaps this is what the ECB’s new programs are really all about.

On the other hand, I happen to think a rescue of the sort that is now being publicly mooted is worse for both sides. The imposition of yet more fiscal austerity on Greece will exacerbate the debt deflation dynamics which are destroying the country and will provide Greece with ZERO means of servicing even the reduced levels of debt. The country will still remain uncompetitive and depression like conditions will continue, with the ongoing burden of more euro denominated debt servicing.
More dangerous is the risk that comes if there is a “successful” deal: It come with the pending question- ‘if Greece doesn’t have to pay, why do I’- The Irish are asking that question already, and I’m sure the Portuguese and Spanish will soon be asking the same thing. As my friend Warren Mosler has noted: 

Possible immediate consequences of that discussion include a sharp spike in gold, silver, and other commodities in a flight from currency, falling equity and debt valuations, a banking crisis, and a tightening of ‘financial conditions’ in general from portfolio shifting, even as it’s fundamentally highly deflationary. And while it probably won’t last all that long, it will be long enough to seriously shake things up.

Longer term, a Greek default could well provoke the question, “What on earth do governments issue bonds for anyway?” That might well provoke a far more provocative debate on the nature of modern money and the self-imposed legal constraints with which sovereign governments bind themselves in their conduct of fiscal policy. But that’s probably best left to the pages of another blog post!

MMP Blog #36 What Government Ought to Do: An Introduction

By L. Randall Wray

In the nextseries of blogs we will turn to whatgovernment ought to do. This serieswill specifically treat only sovereign government—one that issues its owncurrency. From the earlier blogs, that will make it clear that we areaddressing only a government that does not face an affordability constraint.

In theseupcoming blogs we will examine alternative views about the proper role forgovernment—given that it can “afford” anything for sale in its own currency. Wefirst look at four reasons why government spending ought to be constrained. Wethen compare and contrast a typical “conservative” versus “liberal” view aboutthe scope of government. (These terms are used in the American sense—that are somewhatidiosyncratic. In America, conservative is closer to what is called “liberal”or “neoliberal” abroad. Liberal in America is closer to “social democratic” orto “labor party” abroad.)

We willwork toward developing an example of a government program that is consistentwith the MMT view of sovereign money—one that uses the principles we haveestablished in previous chapters to resolve the problem of unemployment in amanner that is consistent with both the liberal and the conservative views.That is the employer of last resort or job guarantee approach. I will concludethis series with my own view on whether MMT must include the ELR/JG proposal.

Warning:when we address views on whatgovernment ought to do, we have moved beyond description. My views of what government ought to do need not beaccepted by others, even those who fully understand MMT. I will be makingpolicy recommendations that are consistent with MMT. You do not have to likemine; you can come up with your own. I will devote a blog to an Austrianapproach to policy-making, and its goals will be different from my own.

Just Because Government Can Afford to Spend, Does Not MeanGovernment Ought to Spend. Understanding how government spends leads to the conclusion that affordability is not really theissue—government can always affordthe “keystrokes” necessary to make expenditures as desired. But that does notmean it should. We can list severallegitimate reasons for constraining government spending:
  • too much spending can causeinflation
  • too much spending couldpressure the exchange rate
  • too much spending by government might leave too few resources forprivate interests
  • government should not do everything—impactson incentives could be perverse
  • budgeting provides a lever to manage and evaluate government projects

Forexample, suppose government decides to newly hire 1000 rocket scientists for anexpedition to Pluto. Our first consideration is whether there are 1000 rocket scientists available forhire with the necessary skills. Even if government can afford its desired spending plan that does not mean it canaccomplish its mission if the resources are not available. In other words, thegovernment always faces a “real resource” constraint: do the resources exist,and are they for sale or hire? Related to this consideration: are the existinginfrastructure, technology, and knowledge up to the task of achieving programgoals. That, of course, is an important question. Let us presume that theseconditions are met.

The secondconsideration, then, concerns competition with alternative uses of theresources, what is called the “opportunity cost”. If those 1000 rocketscientists would otherwise be unemployed, then the opportunity cost of hiringthem for the Pluto mission is low or zero. (We might find, for example, that ifthey were not employed they would take care of their children at home so thenon-zero opportunity cost of employing them is the value of the foregonechildcare services. You get the picture—it is not likely that opportunity costsare zero, but for unemployed laborthey are probably low relative to benefits of employment in appropriate jobs.)

Moreimportantly, it is likely that many or most of them are already working, eitherin the private sector or on other government projects. Since sovereigngovernment does not face an affordability constraint, it can win a bidding waragainst the private sector if it chooses to do so. In that case, it will pushup the wages of rocket scientists so high that the private sector gives up andhires workers with other credentials. The impacts on the private sector couldbe complex—likely leading to higher wages, higher product costs, and even lessoutput in those sectors that use rocket scientists and other skilled workerswho can substitute to some degree for rocket scientists (perhaps for somepurposes, other types of engineers are almost as good, so firms bid up theirwages). At the very least, the Pluto mission could lead to“bottlenecks”—relative shortages of key resources—and some (perhaps limited)price hikes. In that case, public policy must consider the much greateropportunity cost of hiring rocket scientists away from other employment.

Inaddition, other wages and prices might be increased through spill-over effectsif a new government program is so big that it sets off a general bidding warfor labor and other resources. For example, during a major war like WWII,government not only conscripts workers into the military but it also redirectsresources to production for the war effort. Without rationing and wage andprice controls, it is relatively easy for this to lead to a general price andwage inflation. Note that it does not take a major war for this to happen. Ifgovernment spending pushes the economy to, and beyond, full employment it islikely that inflation will result even in the absence of a major war. At thesame time, high domestic employment and income can—under somecircumstances—lead to a trade deficit (as domestic demand for imports risesrelative to foreign demand for exports—discussed in the previous section). Thismight then pressure exchange rates (although the correlation between tradedeficits and exchange rate depreciation is far from certain).

Hence,while government can afford to spend more, it must weigh the consequences interms of withdrawing resources from other (perhaps more desirable) uses, aswell as possible impacts on prices and exchange rates.

There aremany other reasons to constrain government spending. For example, conservativesoften argue that spending on “welfare” affects incentives. A strong socialsafety net might send the signal that individuals do not really need to workbecause they can always live well enough on government hand-outs. Or,government bail-outs of business might encourage management to take excessiverisks on the belief that no matter what happens, government will cover thefirm’s losses.

Further, acorrupt government might spend on programs that help friends, but refuse to doanything to assist more deserving groups—what is often called “cronycapitalism”.  So, there could be complexand even unintended consequences of government programs.

All of thatmust be considered when undertaking government spending programs—and negativeconsequences raise legitimate concerns about the size of government spending,not due to the (im)possibility of insolvency but rather to undesired (andunknown) effects of government programs.

Finally,governments should, and do, use budgets, which are a form of self-imposedconstraint. Typically, the elected representatives will allocate a sum to bespent on a particular project. Program managers are then held accountable forfinishing the project within the budgeted amount. Over-running the budget canbe used as an indication of mismanagement. The budgeting process also helps toreduce the incentive for “mission creep”, expanding the project to enhance themanager’s power and prestige. In other words, budgeting by sovereign governmentprovides a useful mechanism for project control and evaluation.

We concludethis section by observing that absence of an “affordability” constraint doesnot imply that government ought tospend without constraint. As we discuss in the next blog, its spending ought tobe aimed toward achieving the “public purpose”.