January 28th, 2010
What should be done (Policy options)
Unemployment policies at the national and the state levels must be reviewed and revised to meet the challenge of increasing number of unemployed older workers. One of the significant and recent Federal policy tools that encouraged older workers to remain in the work force was The Age Discrimination in Employment Act of 1967 (ADEA). The intent of the law was to promote the employment of older persons based upon their ability rather than age. It explicitly prohibits age discrimination in hiring, employment, and firing (the Equal Employment Opportunity Commission (EEOC) enforces ADEA).
But the intersection between unemployment, employment, and retirement policies should also be reviewed and strategies developed for removing conflicting incentives. The following is a set of policy options based on my findings:
1. Stay the present course as the economy will recover.
This option basically means letting the employment market resolve the problem in the long term. In the short to medium term, this option includes counting on positive affects from the American Recovery and Reinvestment Act of 2009 (ARRA). The Act adds 120 million for additional grants to the Community Service Employment for Older Americans and 400 million to modernize state unemployment insurance operations. Other ARRA minor changes included for the Trade Adjustment Assistance Program (an additional UI program instituted in 2002 targeted specifically for older workers from industries which were negatively impacted by trade) attempting to lower certain barriers to participation. UI benefits have also been extended through the Emergency Unemployment Compensation Act of 2008 (which will expire in December of this year) and the Worker, Homeownership, and Business Assistance Act of 2009.
2. Change retirement policies
This option calls for changing national level retirement policies with a tax incentive for keeping older workers by reducing UI contributions companies pay on older workers and raising them for younger workers. In response to concerns that such a policy would crowd out younger workers, a recent NBER study should be referred to that shows increasing employment of older workers does not negatively impact the employment rate of younger workers.
3. Change the mission of the Washington State’s ESD to prepare for providing more services older workers.
Washington State ESD should revise their implementation of RCW 50.62 and plan now for adjusting for more unemployed older workers. It will need to determine what programs help unemployed older workers become re-employed. It needs to find ways to make UI benefits less a one-way bridge to full retirement benefits but rather a mix of financial, educational, and other support to help older workers continue to contribute to society.
Washington State
The extent of unemployed older workers in Washington State seems less severe in comparison to the national level and that of other states. Deseree Phair of the LMEA showed that the 45 to 54 and 55 and older category of workers in King County were generally gaining in proportion to those of others. Instead of unemployment, the worry is how to keep older workers in the labor force, depending on the sector, as there may not be enough younger ones taking their place. Additionally, it is thought that older workers have important knowledge and skills that may be irreplaceable; as this knowledge leaves, productivity and competitiveness could decline.
State policy in RCW 50.62 (“Special employment assistance”) defines older unemployed workers as those “unemployment insurance claimants who are at least fifty years of age”. The law also stated that older workers have “greater difficulty finding new employment at wages comparable to their prelayoff earnings relative to all unemployment insurance claimants who return to work”. Although enacted in 1987 , the current implementation of this policy is inadequate because the ESD does not appear to do anything specifically to mitigate the challenges of an unemployed older. Nor does it appear that state has a policy to deal with the increasing number of older unemployed workers now or in the future.
It is even difficult for the public to get unemployment and employment statistics broken down by age from state e-Government resources (such as the LMEA web site). Since state unemployment data by age is difficult to find proxy can be used to estimate the scale of this category of demographic unemployment. First, UI Claims by age group was obtained by personal correspondence with an ESD employee. The numbers of claims by older workers from January to September this year about 11% to 12% of unemployed older workers today collect UI and by implication likely consider themselves not retired. Secondly, Census Bureau Longitudinal Employer-Household Dynamics (LEHD) data for King County shows employment by the 55 to 64 aged cohort has grown upward since 1996 and the trend is increasing. These two data sources show that as Boomers age the number of older workers in the labor force will increase and so, too, the number of unemployed older workers will also rise, irrespective of economic conditions. Since Boomers are a significant part of the economy, accounting for about 45% of all consumer spending, perhaps getting as high as 50% by 2015, having them out of the workforce or living on limited incomes, could slow economic growth, productivity , reduce revenue, and strain UI trust funds, Social Security and Medicare.
4. Private Unemployment Insurance.
Basically a variation of a forced savings account, Private unemployment insurance could benefit workers, capital markets, and state governments. Workers benefit from such a system because they can help prepare themselves for the financial impact of job loss. Worker’s could draw on private insurance benefits, supplementing those from the state without penalty. Governments benefit from such a system as it could help ease the pressure on UI benefit trust funds. And the self-employed could have an unemployment insurance coverage, too, which has been denied to them under current law. Companies which underwrite such insurance would collect valuable data on the labor market and create new sources of investment capital.
Sources:
Urban Institute. Retirement Policy Program. Rising Senior Unemployment and the Need to Work at Older Ages Richard W. Johnson. September 2009.
Johnson, R.W. (2009, November 09). Unemployment statistics on older Americans (updated 11/09).
Giegerich, S. Over 50 and jobless? Common – and scary Newly out-of-work job seekers must reinvent themselves, expert says. St. Louis Post-Dispatch. 25 September 2009.B1.
Washington State Employment Security Department. Labor Market and Economic Analysis. Washington State Employment Situation Report for October 2009. November 17, 2009
Creamer. A. Unemployment after 50; Older workers need new hustle to land jobs. The Sacramento Bee. 29 September 2009.B1.
Evans, K. U.S. News: Ranks of Older Workers Swell as Losses Shorten Retirement. Wall Street Journal. May 9, 2009. A.2.
Aversa, J. and Rugaber, C.S. Economic recovery ‘looks like roadkill’. AP. Deseret Morning News. 3 October 2009. A10.
An SOS on Social Security. Roanoke Times & World News. A18. 30 September 2009.
Whittaker, J.M. Congressional Research Service., (2007). Unemployment and older workers (RL32757). Washington, DC: Congressional Research Service.
Zagler, M. A New Look at Old Issues: Keynesian Unemployment Revisited. International Review of Applied Economics, Vol. 18, No. 2, 209–224, April 2004.
Fullerton, Howard N. “Labor Force Participation: 75 Years of Change, 1950-1998 and 1998-2025,” Monthly Labor Review (Dec. 1999), pp. 3-12.
Orszag, P.R. Why Are Older Workers Working Longer – Peter R. Orszag (OMB Press release). States News Service. 25 September 2009.
The Mature Market Institute (MMI) study, Boomer Bookends: Insights Into the Oldest and Youngest Boomers, compares the “leading edge”. February 2009.
Mittelman, E.B. The Displacement of Workers, 45-64 Years of Age. The American Economic Review, Vol. 26, No. 1 (Mar., 1936), pp. 81-83.Published by: American Economic Association
Greenwald, J. Age-bias bill would ease burden for plaintiffs. Business Insurance, 2009 October 19. Vol. 43, Issue 37. Factiva.
Lavagnino, J. Age is Different: Supreme Court Raises Bar for Age Discrimination Claims, Will Congress Strike Back? June 18, 2009. findlaw blog.
Greenwald, J. Age-bias bill would ease burden for plaintiffs. Business Insurance, 2009 October 19. Vol. 43, Issue 37. Factiva.
Congressional Research Service RL30629. Older Workers: Employment and Retirement Trends Patrick Purcell Specialist in Income Security September 16, 2009
United States General Accounting Office. November 2001 .OLDER WORKERS: Demographic Trends Pose Challenges for Employers and Workers.GAO-02-85.
Morrison, M. H. “The aging of the U.S . population human resource implications Older workers”
Congressional Research Service RL30629. Older Workers: Employment and Retirement Trends Patrick Purcell Specialist in Income Security September 16, 2009
RETIREMENT DECISIONS Federal Policies Offer Mixed Signals about When to Retire. July 2007. GAO-07-753.
United States General Accounting Office. November 2001 .OLDER WORKERS: Demographic Trends Pose Challenges for Employers and Workers.GAO-02-85.
Tergesen, A. Seniors Face Unemployment Issues. The Wall Street Journal Online. 27 September 2009.
Fullerton, Howard N. “Labor Force Participation: 75 Years of Change, 1950-1998 and 1998-2025,” Monthly Labor Review (Dec. 1999), pp. 3-12.
United States General Accounting Office. June 2004 HIGHLIGHTS OF A GAO FORUM. Workforce Challenges and Opportunities For the 21st Century: Changing Labor Force Dynamics and the Role of Government Policies. GAO-04-845SP.
US Senate Special Commission on Aging.
Blackburn, P. Understanding Unemployment; the need for a Social Perspective. International Journal of Sociology and Social Policy. 1988. 8:1, 1-22.
Phair, D. Aging Workforce in King County, January 2009.
SUBSTITUTE SENATE BILL NO. 5393, AS AMENDED BY THE HOUSE, C 284 L 87.
US Census Labor Employment Dynamics.
Epstein, G. Boomer Consumer. 5 October 2009. Barron’s. B 22.
Whittaker, J.M., Shelton, A.M. CRS Report RS22915. Temporary Extension of Unemployment Benefits: Emergency Unemployment Compensation (EUC08). November 17, 2009
Gruber, J. , K. Milligan and D.A. Wise. Social Security Programs and Retirement Around the World: The Relationship to Youth Employment. Working Paper 14647. National Bureau of Economic Research. January 2009
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Categories: Aging, Public Policy, Social Security, Workplace
January 28th, 2010
Recent Federal Policies
The trend of increasing unemployment among older workers was anticipated by some as a consequence of the aging of the Boomers (people born between 1946 and 1964). One Census Bureau estimate projects that the number of people aged 65 and older should grow to 31.7 million between 2010 and 2030 (79%) nearly twice that as 25 to 64 year olds. The first of the Boomers turn 65 in 2011 while the last in 2029. Because of projections of the slowing growth of the labor force of younger workers over the last decade, a trend that is expected to continue, older workers are needed to remain in the work force. The American labor force has been transforming greatly since 1950. From then until 1990, the working adults under age 55 grew at an average of 1.9%. From 1990 to 2000, this rate fell to 1.0% and by 2000 BLS projected it to fall further an annual rate of 0.3% from 2000 to 2025 labor.
Given the demographic transition over the next 30 years, older workers will make up a substantial portion of the employed and unemployed. The BLS Monthly Labor Review published articles about the employment issues of older worker in the US as far back as 1983. It was predicated then that older workers would be pressured to continue working into their early retirement ages due to demographic and retirement policy changes at the federal level. Demographic changes alone were predicted to complicate retirement policies. The 55 and older age group was expected reach about 70 million (1 in 4 people) with about half of them being 65 years old. Concurrently, life expectancy was also predicted to increase. As the wave of Boomers aged, the imbalance of the working to the nonworking (leading to a reduction in the ratio of workers per Social Security beneficiary) compelled Congress to make radical changes retirement policy. Part of the mix of solutions back then was the expectation that older workers in this century would require and be expected to continue working at older ages to alleviate fiscal pressures on Social Security and Medicare.
Older workers have incentives to keep working or retire early.
The most significant Federal policy change in the recent past that inadvertently affected caused greater unemployment among older workers today were the Social Security Amendments of 1983 (P.L. 98-21). This changed full retirement age from 65 to 67 over a 22-year period from 1998 to 2020. Retirement benefits are currently available at age 62 but they are permanently reduced (a penalty for retiring early). For example, if you took Social Security at 62 your benefits are reduced by 25% below the amount that would be payable at the full retirement age. As full retirement age goes to 67 by 2020, the payable benefits will decrease to 30% less than the full paid if you retired at age 67.
Federal policies have conflicting incentives to both retire earlier or later than Social Security’s full retirement age. Currently, a person can draw reduced benefits at age 62, an incentive to retire early. As policy goals shifted toward preserving the longevity of the Social Security trust funds there now exists a stepped increase from age 65 to 67 for full retirement, encouraging delaying early retirement. Further, removing the earnings test in 2000 (increasing the amount a person could earn in before a reduction in their Social Security benefits.) created an additional incentive to continue working. GAO found evidence that the elimination of the earnings test encouraged workforce participation at and above full retirement age.
Medicare’s eligibility age of 65 creates an incentive to wait until then to retire, especially if lacking an employee provided health insurance. (GAO found a correlation between retiree health insurance and pension plans and early retirement choices ). Meanwhile, Federal tax policy on pension funds encourage early retirement depending on the pension. While most pension plans encourage workers to retire at or before age 65 (for example, some defined benefit plans subsidize early retirement, discouraging employment after becoming eligible for these benefits). Further complicating an older worker’s options during unemployment are the rules governing UI benefits. Depending on what state in which an unemployed older adult resides, UI benefits can be cut or delayed due to rules governing receipt of pensions, severance pay, or other factors because states are legally obligated to do so (especially in the case of pensions). This is the result of policies Congress instituted years ago to prevent workers getting a pension from the same employer contributing unemployment benefits.
In 1999, the BLS Monthly Labor Review warned that the number of older workers would grow substantially over the next 20 years and then taper off. Participation in the labor force by people over age 55 was to increase from 30% in 2000 to 37% by 2015 according; meaning, that workers over the age of 55 would make up about 20% of the total labor force by 2015. BLS estimated that older workers would have greater impact in some industries over others. For examples, professions such as teaching and nursing would see increases at about 6% by 2008. This demographic of workers was thought to also enjoy higher real earnings over the same time period at 11% percent for workers age 55 to 74 in comparison with a 2% gain for those aged 40 to 54.
By 2019, some estimates show that nearly 29% of the total U.S. population will be 55 and older. In 2001, the GAO claimed that older workers would be a growing proportion of the labor force for the next twenty years; at that time when many of these policies were developed, unemployment among older workers was not as high as it is now. The demographic shift of aging boomers and slower labor growth led policy analysts to expect a tight labor market in the near-term and recommended policies to match this assumption. Keeping older workers in the labor force longer with flexible retirement options was thought to help reduce the risks of labor shortages of experienced workers and ease the financial burden on Social Security and Medicare.
Conclusion
Unemployed older workers can find themselves caught in the intersection of three Federal policy streams: Retirement Policies (the variety of ages in which to draw Social Security and Medicare and other retirement funds); Employment Policies (such as the ADEA or the goal of full employment, one of the responsibilities of the Federal Reserve); and, Unemployment Policies (such as the size, duration, and qualifications for UI benefits, training and re-employment assistance).
The US Senate Special Committee on Aging believes that many people intend on working longer because they desire the mental, physical, and financial benefits of work. . The committee sees current retirement policies as a one-size-fits-all and it is time to change those policies. In general, the committee cites current pension laws, inadequate job training programs, and the fact that many boomers find themselves sandwiched between commitments of caring for aging parents and their own adult children.
Older unemployed workers can face age job discrimination. At present, some companies are currently in a Competitive Unemployment trend: they layoff older more expensive workers, borrow cheap money in order to state higher earnings making the stock price appear high. Layoffs without a decrease in business in certain industries signal to the stock market that the company is able to operate more efficiently with less labor, creating a false signal of structural employment change (they will likely have to rehire less experienced and cheaper workers but later have to make up for the productivity loss).
Thus, current Employment, Unemployment and Retirement Policies at the Federal level (which affect all states) are not changing effectively to deal with the demographic shift of American workers. If 80% of Boomers were to work past the traditional retirement age of 65, the number of unemployed workers during recessions will be from that demographic group.
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Categories: Aging, Public Policy, Workplace
January 20th, 2010
Why it is happening
Higher numbers of unemployed older workers could be due to cyclical unemployment caused by the current recession. If that is the case, the unemployment among older workers should alleviate once consumer demand rises and the economy recovers sufficiently. Structural unemploymentcould explain some of it, too. Many of the lost jobs are not likely to return to pre-recession levels, especially for those from the auto and financial industries. Further, the population of workers over the age 65 has trended upwards in the past few years and it will be getting higher.
What is unusual about these higher numbers in this recession is that it is counter to economic and policy models of the 1980’s, 90’s and those of more recent times which predicted that older workers who lost their jobs would make a reasonably smooth transition to retirement, eventually exiting the work force. For example, the year 2000 Displaced Worker Survey showed that even when older workers were loosing jobs at a lower rate about than 57% would still transition to retirement (partial or full) once they were out of work. Also, prior to the current recession, older workers were considered less likely than younger ones to lose a job because they were assumed to be too valuable to let go of (being highly experienced and productive in their given industry).
Peter R. Orszag, OMB Director, observed that higher unemployment rates among older workers was higher in this recession than in earlier ones due to three factors. First, the trend of delaying retirement, beginning in the 1990s, simply added more older workers to the labor force. Secondly, retirement assets declined due to the recession. Lastly, due to statistical definitions: employment and unemployment rates for workers over 65 are higher since because if they draw unemployment compensation after loosing a job, instead of transitioning to retirement, they are counted as part of the labor force (perhaps in part explaining the higher unemployment numbers). Orszag expects higher unemployment to continue even as the economy recovers.
OMB observations have merit. A MetLife research organization recently published a study based on two representative surveys of the Oldest Boomers (turning age 63 in 2009) and the Youngest Boomers (born in 1964). The first was done in 2007 and repeated (with most of the same respondents) two years later. The Youngest Boomer respondents in their study indicated they planned to take Social Security benefits at 64, two years after their eligibility, and believed they could retire fully by then. In comparison the Oldest planned on retiring at an average age of 66. However, half of the Oldest Boomer respondents were working full-time with barely 20% being fully retired. Those who described themselves as partially retired supplement their income with part-time or seasonal work. Several of the Oldest Boomers from the 2007 survey who planned to retire at 62 did not retire and actually remained in the work force.
The higher numbers may be due in part to frictional unemployment (the phenomenon of a mismatch in the labor market in which job vacancies exist but the preferred candidates are not found by the employer). Some of this may be attributable to an age bias in hiring and firing, which has existed for many years. The highest number of complaints ever filed with the EEOC occurred this year. Two recent Supreme Court decisions led to a policy change concerning age discrimination. In January, President Obama signed into law the Lilly Ledbetter Fair Pay Act of 2009, now easing time limits for ADEA suits, basically reversing the court’s 2007 Lilly Ledbetter vs. Goodyear Tire & Rubber Co. Inc. ruling. In June of this year, the Supreme Court overturned an appeals court decision in Gross v. FBL Financial Services, that age discrimination must meet a higher and different standard than that of other classes of discrimination. Because of this ruling, suing in Federal court for an ADEA case is more challenging for plaintiffs as they must show conclusively (with a “preponderance of evidence”) that an employer took negative action against an employee because of age. In response to that ruling, Democrats in Congress proposed two bills addressing the standard used in ADEA cases (H.R. 3721 and S.1756). (This will be a policy stream to watch).
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Categories: Aging, Public Policy, Social Security, eGovernment
January 9th, 2010
Part 1: What is happening
As unemployment reached 10.2% by October of this year, the rates for older workers (55 to 65) were reaching record levels. BLS data showed unemployment for men 55 and older went to 7.2% and women to 6.1% this October, compared to roughly 2.7% for both in same time last year. The number of unemployed workers over 55 has reached nearly 2 million, the highest on record with the BLS. According to our state’s Employment Security Department’s (ESD) Labor Market and Economic Analysis (LMEA), Washington State unemployment rate across all age groups was seasonally adjusted at 9.3% this month (up from 9.1% in September).
Unemployed older workers who are looking for work should expect to do so for a year or more. The financial costs of unemployment can be devastating for professional (and blue-collar union) older workers who had jobs with higher incomes. If they are not eligible for retirement or pension pay-outs, unemployment insurance often cannot meet all their financial obligations, leading to dramatic loss of wealth (loosing houses, savings, investments and more). Meanwhile, the rules of the game to finding a new job have also changed dramatically for this generation adding to the fear, anxiety and uncertainty they face once becoming unemployed. The message unemployed older workers get is that they simply must adjust to new market realities and retool and reinvent themselves, and expect intense competition for a new job.
Public policies relevant to unemployment among older Americans (people in the labor force of age 55 to 65) which this blog entry addresses, are tightly coupled those of retirement policy. For instance, some unemployed older workers who are not eligible for early retirement drop out of the labor force altogether. Meanwhile, those who can retire but believe they cannot afford to do so will try continue working to supplement their income. A recent Employment Benefits Research Institute (EBRI) survey reported that 20% of workers in their sample over 65 were planning on working into their 70s. Another study suggested that the average 55 year old had to work two more years to make up for retirement account losses from 2008. In non-recession and milder recession periods, older workers could make unemployment an opportunity to transition to retirement (especially for those aged 62 and older). During this recession, it appears that many older workers are remaining in the labor force searching for work after they lose their jobs for financial reasons.
Often, older workers may find that early retirement, if financially possible, is the best (sometimes only) alternative. Filings for early Social Security benefits have risen: filings were up 23% from last year. The higher unemployment among older workers increases not only demand but supply pressure on Social Security as the millions of jobs lost means fewer dollars going into it. The CBO projected that for this recession Social Security will be paying out more than it collects, adding more to the federal deficit.
In the mean time, for those older workers who want (or need) to continue working, but are unemployed, they are beset with different challenges than those faced by younger workers (such as age discrimination in rehiring and a dramatic loss of income). The need and desire among older adults to stay in the workforce past early retirement ages calls for a review and revision of current policies addressing employment, unemployment, and retirement –as all three of these policy arenas overlap for older Americans. The higher numbers of the older unemployed in the current recession opens policy window for such a review.
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Categories: Aging, Social Security, Workplace, eGovernment
December 31st, 2009
The Department of Treasury’s Financial Regulatory Reform proposal is worth looking at now that a bill based on it is working through congress.
The need for financial regulatory reform comes directly from the 2008-09 crash of asset markets. But the proposals by Treasury are like an unwanted dinner guest bringing a vinegar pie for dessert. It is too much of the wrong thing, too late.
Trying to regulate the macroeconomy must be one of the premier follys humanity can enjoy. Economies are as complex as ecosystems, full of dynamic and self-regulating subsystems each interacting with other subsystems in a myriad of ways. Since they are so complex any theory as to how or why the Great Recession came about will be incomplete and potentially inaccurate. That said one place to start would be the GLBA of 1999 effectively reversing the Glass-Steagall Act’s separation of banking, securities and insurance companies. The new law allowed firms to consolidate diverse financial activities creating an environment for some financial firms to become ‘too big to fail’.
In 2001 the Fed lowered interest rates to stimulate a recovery from a mild recession that in part contributed to the new wide-open playground for financial companies to innovate new investment schemes. BHC’s, FHC’s and non-banking firms created, traded, and underwrote billions upon billions of dollars of highly leveraged capital products, many of which were coupled to investments in the real estate boom of the early decade. Speculative bubbles took over in both the real estate and the securities markets with executives, traders, and, perhaps, regulators underestimating (or ignoring) the risks. As in most financial bubbles there was overconfidence in the expertise, intelligence, and judgment of all parties to deal with rapidly evolving complexities involving counterparty relationships which were international in scope [see Labonte, M. Systemic Risk and the Federal Reserve, CRS Report R40877. October 28, 2009]. Big firms (Bear, Lehman) trading risky mortgage-backed securities were also either unwilling or unable to get accurate information about the nature of the securities and the risks they were taking. Bond rating agencies, whose information was considered reliable, were either incapable or negligent in their formal risk ratings. Additionally, pro-cyclical capital ratios, in accordance to Basel II practice, could have contributed to the bubble; and, such practices were likely not followed in every case (and were not necessarily applicable to the non-banking sector).
So it is unlikely that the root cause can be distilled into one of greed by bankers seeking creative ways of avoiding capital regulations as some as Acharya and Richardson suggest; further, it cannot be determined at present whether bond rating agencies were either conspiratorial or just guilty of garden-variety incompetence (as is likely the case) [see Viral V. Acharya and Matthew Richardson. CAUSES OF THE FINANCIAL CRISIS. (forthcoming, Critical Review)]. Instead, this crisis had more to do with the combination of an outdated statutory environment and an enabling monetary policy (at least initially) that helped inflate asset speculation that eventually overwhelmed risk management systems. The O-Ring event in this particular explosion was the unfortunate trend of consumers (and governments) going deeper into debt (over extended credit including substantial borrowing against mortgages). The bubble had fragile walls as evidenced by the price shock of gasoline rising unexpectedly (peaking over $4 a gallon in the summer of 2008). This destroyed the assumed stability of mortgage and debt-based investment products: people overextended their credit while incomes remained flat. As the collapse of Bear-Stearns occurred in early 2008, due to the firm’s untenable risk profile, a run gripped the credit markets in nearly every economy in the world. Credit markets collapsed and The Great Recession settled in.
Another contributor to the crisis which precipitates revisions to current regulatory schemes was the existence of a shadow banking sector (such as hedge funds, private equity firms, venture capital) that existed outside the reach of regulators [see Jickling, M and Edward V. Murphy. Who Regulates Whom? An Overview of U.S. Financial Supervision. Congressional Research Service. R40249. February 24, 2009]. In reaction to this the administration’s proposal distills the cause of the recession as one of regulatory inadequacy and a risk management failure. While the regulatory framework was overwhelmed due to the size, scope, and over-sophistication of the trading schemes, the risk management systems of the major firms in the market for tranches and CDOs were either inadequate or not taken seriously [see Blackhurst, C. The nun from Kensington who saw the great banking crash coming].
The solutions offered by Treasury was a potpourri of proposals. The proposals range from a revision of GLB for creating stricter capital ratio rules (unclear if this meant to supplement or substitute Basel II) to more dramatic changes such as greater power given to the Secretary of Treasury as the economy’s new Risk Czar or systemic risk regulator with the Federal Reserve as his implementer. It also addresses other policy variables such as consumer protection and macroeconomic crisis management. The stated intention of the plan is to increase transparency, simplicity, and access while upholding the values of fairness and accountability –while preserving market innovation (a remarkable feat if accomplished).
The administration’s proposal to create a systemic risk management regime led by the Secretary of Treasury and the FSOC intends to prevent or mitigate the effects of a similar crisis in the future. It shall do this by closing regulatory gaps, bring the shadow banking system under control and give the Fed new systemic risk regulatory tools. How the Secretary and the FSOC will approach the role of systemic risk regulator depends whether Congress grants them wide discretion or constrain their powers. Another facet will be their economic philosophy and the availability of information (in the present crisis, transparency in the markets was nearly impossible to achieve and the systemic risks were thus opaque to a great degree).
Analysis
A kind of punctuated equilibrium may be at play by this proposal with a clear challenge to current policy monopolies (a reform scope not attempted since the 1930’s.) Systemic regulation is accomplished by a new body (FSOC) with considerable power and an expansive role. The Sec of Treasury chairs the body and has final decision power over the Fed’s role concerning the regulation of Tier 1 HBCs and FBCs.
The proposals are generally backward-looking (like buying flood insurance after the levy breaks) with some exceptions. In reaction to abusive practices of certain mortgage and consumer loan firms, the proposal creates the CPFA. This is a laudable idea but it is unclear why such responsibility is not given to the FTC. A new agency could create jurisdictional conflicts between itself, the FTC and the SEC (and for a proposal trying to reduce the number of gaps between regulators, this seems to invite the possibility of more). It also includes a useless attempt to regulate compensation practices of firms, likely included for a populist affect. But key to systemic regulation is the ‘too big to fail’ problem. Identifying and regulating firms which pose systemic risks by “combination of size, leverage, and interconnectedness” necessitates more than just new legislation; it requires a paradigm shift in regulatory philosophy with concomitant market strategies in the private sector. The challenge of this change is not trivial.
Further, putting Tier 1 firms under FSOC/Treasury oversight the proposal could give the Sec. of Treasury power over nearly half (or more) of the GDP of the country. Can such responsibility be appropriate? Consider in all this the immaturity of mitigation plans for the financial Katrina just experienced. Though there were many warning signs of the impending disaster, once it happened regulators appeared as if they were surprised what with midnight emergency meetings of experts and lawmakers fearing a global financial meltdown. The mitigation plan seemed ad hoc with an overnight rush of liquidity to shore up banks and firms. This suggests that the government had no mitigation plans for such a scenario and perhaps expected or hoped the bubble would burst in an orderly, rational way. The same group think regulatory mindset and frameworks will still be in place even with this new proposal.
The proposal to deal with future systemic risk is inadequate. The best it offers is a solution addressing the ingredients of the recent crisis while making the unconvincing claim that it will enable regulators a priori identification of systemic risks that could lead to macroeconomic disasters. But systemic risks cannot be prevented; they can only be identified ex post in any system, especially economic ones. This proposal reinforces the idea that government should be the ultimate economic risk manager. By making itself into the systemic risk regulator, it can be legitimately (though not fairly) blamed for the next disaster (a great political risk for any administration). A more reasonable approach would be to make capital requirements more countercyclical, lobby the Basel committee to revise its clearly (now) procyclical standards ; and expand the scope of present regulatory agencies to include the shadow banking sector (SEC) and consumer financial protection (FTC); and consider making pension guarantees and protection a greater priority.
Categories: Finance, Public Policy
