Update Archive

Tax Extenders Time is Here (December 11)

Update 318 — Tax Extenders Time is Here;
Perennial Policy Debate is Itself Debated

No holiday season on the Hill is complete without a tax extenders bill to re-up the temporary tax breaks expiring that given year.  A policy perennial, the annual debate can be seen as a natural way to review and renew breaks not ready to be codified.

But the argument is vitiated when these same breaks come up year after year and when the breaks become an occasion to fill the campaign coffers of members on the tax committees.  

More on the ecology of the extenders and an effort to end them below.  

Best,

Dana

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When Temporary Becomes, Well, Permanent

The set of tax breaks known as “extenders” is the temporary tax reductions, deferrals, and exemptions for individuals and businesses expiring in a given calendar year. They are used to achieve policy objectives or to promote or benefit certain investments. Their temporary status comes into question upon expiration.

In February this year, the Bipartisan Budget Act retroactively extended 32 provisions for tax year 2017. 28 of these 32 provisions are due to expire at the end of this year and Congress will likely vote to extend them yet again.

The Price of Permanent Indecision

The tax extenders saga has persisted for decades, as the number and scope of the tax extenders become narrower and narrower. Most valuable provisions have already been made permanent. What remains is a hodgepodge of provisions that fit into three buckets:

  • Special-interest provisions: These extenders give unfair tax advantages to disparate special interests, ranging from mortgage insurance premium deductions to tax credits for business activity in American Samoa. They are by far the largest category of provisions. 
  • Duplicative cost of capital provisions: Seven of the remaining extenders provide more amenable depreciation schedules for various industries. Provisions in the Tax Cuts and Jobs Act (TCJA) render some of these efforts redundant and inherently unfair, as they distort investment decisions to favor particular industries over another. 
  • Provisions that could be made permanent: Two of the remaining extenders offer an incentive for railroad maintenance and a credit toward mine rescue training costs. They are not as noxious as the rest and could be made permanent, either through law or through the appropriations process rather than by this perennial cycle of extension.

The nominal amount of the tax extenders is relatively small — around $90 billion if they were all continued permanently. However, the extenders set a bad policy precedent and fuel an annual breeding ground on K Street for quid pro quo negotiations between lobbyists and lawmakers.

There are other reasons why implementing tax policy by way of extenders is bad practice:

  • Retroactively authorizing tax provisions creates uncertainty and undermines any incentives that may be behind the provisions. Many tax extenders are provisions designed to create an incentive for a particular behavior by an individual or a business. The process of retroactively applying these tax breaks creates unnecessary uncertainty and undermines the original intent of some tax policy meant to incentivize behaviors. 
  • Many tax extenders are pure giveaways to special interests. Examples of these niche provisions that give a break to special interests include tax write-offs for racehorses and special depreciation schedules for “motorsports entertainment complexes.” These extenders clearly give special favors to certain industries. 
  • Tax extenders distort budget projections. Budget baselines assume that tax extenders expire at the end of their current extension. Their perennial renewal means that these supposedly temporary provisions are not adequately projected in budget forecasts, making their impact under-the-radar and not fully accounted for in the budget process.

Eliminating Extenders: A Signal Reform

There is a growing consensus across the political spectrum that tax extenders are not good policy. Organizations have individually expressed opposition in the past, but recently, a broad coalition released a letter rejecting tax extenders. This coalition includes a number of groups that don’t often agree on the correct course of action:

  • Committee for a Responsible Federal Budget
  • Economic Policy Institute
  • Freedom Partners
  • U.S. PIRG
  • Heritage Action for America
  • Institute on Taxation and Economic Policy (ITEP)
  • Americans for Prosperity

The reasoning behind the coalition’s opposition to tax extenders is simple: tax policy should not be changed from year to year. The use of tax extenders often results in retroactive policy and special interest tax giveaways, as opposed to long-term, meaningful tax reform. Although current Senate Finance Chair Orrin Hatch promised to end the practice by 2015, it has continued to be a widely used policy option in Congress.

Congressional Support

Senator Ron Wyden, Ranking Member of the Senate Finance Committee, is another vocal opponent of the year-by-year tax extenders process.  Wyden was a supporter of the PATH Act of 2015, a bill intended to curtail the repeated tax extenders exercise by permanently renewing some of the extenders. The bill was an important first step, but did not end the practice in its entirety.

On the House side, the incoming Ways and Means Committee Chair Richard Neal has expressed frustration about the consistent lapsing of tax provisions, but has not taken a position on tax extenders as a whole, instead focusing on specific extenders as they lapse.

Last Hurrah

In the dog days of this lame-duck, outgoing House Ways and Means Chair Kevin Brady is pushing for a sweeping tax bill that is unlikely to get to the Senate for a full vote, even if it were to pass the House. The original package contained provisions that would renew the tax extenders, but these provisions were not included in the latest version. Extenders may therefore move separately through Congress, making them more likely to pass before the end of the year.

There is a swath of bipartisan support in Congress for perpetuating the tax extenders, but calls for their removal from both the left and the right are growing. There may be some benefit in trialing certain incentives on a small scale for a temporary period, but the tax extenders process essentially turns what are meant to be temporary measures into de facto permanent provisions. Tax extenders ultimately lead to undesirable outcomes, and their practice should be ended.

Senate Banking and Finance in the Next Congress (December 7)

Update 317: Incumbent Ranking Members in the Next Congress
Sens. Brown of Banking and Wyden of Finance

Last week, we looked at the agenda for the House Financial Services Committee under new Chair, Maxine Waters. The midterms were less kind to Democrats in the Senate, as Republicans narrowly increased their majority. Gavels on Senate Banking and Senate Finance therefore stay with the GOP. But ranking members will play a critical role in fashioning legislation and holding regulators accountable for overreach in the 116th Congress.

This morning, Donald Trump signed the continuing resolution presented by Congress that now funds the government through December 21. On that date or prior, Congress must act or a government shutdown will begin.

Happy weekends all,

Dana

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Senate Banking Committee

In the next Congress, Sen. Crapo will continue to serve as Banking Committee chair. Sen. Brown, a critical center of gravity for progressive banking policy on Capitol Hill, will remain Ranking Member. Sens. Donnelly and Heitkamp, both moderate members of the Committee, lost their seats in the midterm election and therefore, the Committee. Their defeats change the complexion and reduce the number of moderate members on the Committee.

Senator-elect Kyrsten Sinema is the most frequently mentioned candidate to join as a new member on the Committee, but the full makeup and ratios are yet to be decided. Sinema, with experience serving on the House Financial Services Committee, would have a distinctly moderate voice among the Committee Democrats.

Sen. Crapo will continue to conduct oversight of the regulatory implementation of S. 2155 next year. Sens. Crapo and Brown have a good working relationship, which bodes well for potential areas of bipartisanship, such as GSE reform. Prior to the passage of S. 2155, Crapo launched a joint effort with Brown and publicly solicited for ideas to craft a bipartisan bill. Negotiations eventually broke down, but it shows a commitment by Crapo to work with Brown on this area going forward. Also watch for a new dynamic between the House and Senate, as Crapo’s agenda may conflict with Rep. Waters’ as Chair of House Financial Services.

Housing: Wait Till Next Year Again?

Outside of the contentious issues surrounding big bank deregulation, the following areas are where we see possible legislative agreement between Chair Crapo and Ranking Member Brown:

  • Housing reform: A bipartisan housing finance reform bill was crafted this past January by Sens. Corker and Warner, but Sen. Reed and Ranking Member Brown felt that the bill didn’t do enough to address affordable housing. This area becomes more promising now that Democrats control the House, as Chair Waters has put affordable housing high on her priorities list in HFSC. Sen. Brown wants a GSE reform package that addresses affordable housing, but that doesn’t preclude the House from looking at it separately and working in tandem with the Senate on workable proposals. 
  • Big data and privacy reform: Sen. Crapo has publicly stated his intention to push for major legislation to tackle big data and privacy issues heading into 2019. Proposals in this area would likely garner Democrat support and might be similar to the recent General Data Protection Regulation privacy protections that went into effect in the European Union earlier this year. 
  • BSA/AML reform: Changes to the Bank Secrecy Act to combat illicit financial transactions and reforms to anti-money laundering laws are also areas for both parties to come to the table. Sen. Brown has called this issue an important topic, reflecting his priorities of protecting consumers and holding big banks accountable.

Other areas of potential bipartisanship include flood insurance reform and issues surrounding proxy advisors and their duties to Main Street investors. The Export-Import Bank has allies on both sides of the aisle, as many on the committee see the agency as a job creator and a deficit reducer. Financial technology (or Fintech) is also ripe for bipartisanship as Congress continues to grapple with how to regulate this nascent sector.

JOBS 3.0 Redux

Rep. Hensarling, departing Chair of HFSC, has been pushing for a Senate vote during the lame-duck session on the JOBS 3.0 package that passed through the House in July. Despite his insistence, action before the end of the year is looking increasingly unlikely. The full package (see here) contains some dubious regulatory relief bills and would require reintroduction by another member of Congress should it not be voted through before 2019. It is possible that some of the bills in the package could be re-worked, including improving the Accredited Investor standard, to make the package more palatable in the 116th Congress.

Senate Finance Committee

Sen. Wyden remains Ranking Member of Senate Finance in the next Congress. He has been a healthcare champion in the past, pushing through critical expansions in Medicare, Medicaid, and the Children’s Health Insurance Program (CHIP) earlier this year. The horizon on tax reform in Congress is limited, though Ranking Member Wyden has a history of advocating for more progressive and fair tax policy. He will continue to be a vocal counterweight to Sen. Grassley’s agenda.

Sen. Grassley will replace Sen. Hatch as chair of Senate Finance, marking his return to the committee after serving as Chair from 2003 to 2006. Like Hatch, Grassley is a traditional, party-line, GOP voice. He is a staunch opponent to financial regulation and reasonable tax rates, and has voted in the past for generous exemptions for large corporations.

Legislative Agenda

Grassley can be expected to pursue technical fixes to the Tax Cuts and Jobs Act (TCJA) — the GOPs signature tax reform bill passed last year. Senate Finance Republicans met with Treasury Secretary Mnuchin this week to discuss potential revisions to the law. Though current House Ways and Means Chair Brady has tried to get a floor vote on corrections to the TCJA during this lame-duck session, action on the legislative front looks unlikely before the next Congress.

We can also expect to see oversight — but not in the way Democrats will like. Sen. Grassley has said he plans to prioritize “diligent oversight” of government bureaucracy, particularly with regards to healthcare, blaming “excessive regulation” for a dysfunctioning government.

Area of Agreement?

  • Opportunity zones (OZs): OZs provide various tax incentives to businesses in economically distressed areas. Championed by Republican Sen. Tim Scott and originally supported by Sen. Cory Booker, opportunity zones offer temporary tax deferrals, tax liability reductions, and tax exemptions on capital gains.

Despite this initial glimmer of bipartisan hope, Sen. Wyden and other Democrats have vocalized concerns for the program, citing the potential for conflicts of interests by elected officials in the use of zoning for political or financial gain. Other concerns include potential gentrification and tax benefits going to parties who would have invested in OZs without the legislation. Another concern is larger established businesses crowding out local upstarts, the intended beneficiaries of the bill — a point exemplified by the recent decision from Amazon to locate its new headquarters in an opportunity zone in Long Island City.

Leading in Minority

Senate Democrats may not hold the gavels on these committees, but they will still be able to pursue positive agendas with the Democrat-controlled House on a limited and selective basis.

Fed Stability Report Incomplete (December 5)

Update 316 — Fed Stability Report: Incomplete
Missing: Systemic Risk and TBTF Analysis

Yesterday, the Dow lost over 800 points, its third worst point decline in history; the S&P 500 saw its steepest fall since February. Waves of selling are hitting Wall Street amid fear of slowing economic growth and trade tensions between the U.S. and China.  The VIX — Wall Street’s fear gauge — is on the rise again and hasn’t fallen below the 15 point benchmark for market stability since September.

Not the picture of financial stability. This of course was not reflected in the Federal Reserve’s Report on Financial Stability yesterday.  But neither was analysis conducted or even reference made to TBTF and systemic risk in the financial sector, oddly. There’s a curious Nothingburger here.  Details below…

Best,

Dana

———————-

Last week, the Federal Reserve released its first Financial Stability Report, a new semi-annual publication that will provide an overview of the health of the financial system.  Missing from this overview is a thorough discussion of regulatory rules and their impact on systemic risk — a curious oversight given that the Fed announced its plans to reduce capital and liquidity standards for banks between $100 and $700 billion in assets just last month.  These changes will increase systemic risk and instability in the financial system. The Fed’s report concludes that big bank capital and liquidity is adequate, but ignores the systemic risk implications of its current rulemaking proposals and market forces, such as debt levels and increasing consolidation in the sector.

The Fed’s First Financial Stability Report

The Fed’s new semi-annual report complements the existing annual report by the Financial Stability Oversight Council (FSOC) and is similar to others produced by central banks around the world. The Fed has lagged behind other countries in terms of transparency, so this report is a welcome step in aligning to global norms. Fed Governor Lael Brainard calls it “an important step in providing the public with more information about the board’s assessment of financial stability.”

The report was generally positive; the labor market is strong, inflation appears to be controlled, and wages are growing moderately. The report did, however, identify four broad categories of vulnerability in the financial system:

  • Elevated valuation pressures: Echoing Brainard’s warning in a speech earlier this year, the Fed is concerned that elevated asset prices are signalling an increased willingness of investors to take on risk. Greater appetite for risk implies a greater possibility of outsize drops in asset prices, or losses, that could shock the financial system. This risk has been made clear by the recent volatility in the U.S. stock market.

  • Excessive borrowing by businesses and households: Historically, heightened borrowing by businesses and households has resulted in major stress on consumers, as well as the financial system. After a steady rise at pace with nominal GDP, business and household borrowing is starting to grow at a faster rate. Business debt levels in particular are high, with signs of increased risky debt issuance and deteriorating credit standards. Although household debt is concentrated among low-credit-risk borrowers, households are still struggling with student, auto, and credit card loans.

  • Excessive leverage within the business sector: The leveraged loans market is worth just over $1 trillion, and in its report, the Fed highlighted this market as another cause for concern. Current regulators have rolled back the leveraged loan safeguards put in place by Obama-era regulators. Investors have flocked to this market, and leveraged loan prices will likely deteriorate rapidly in the event of a crisis. Leveraged loan funds have already seen heavy outflows in recent months.

  • Funding risk: Many firms have taken advantage of the period of record-low interest rates after the financial crisis by taking on mountains of debt. Both the Fed and the Office of the Comptroller of the Currency (OCC) have expressed concern about the high level of corporate debt. Per the report, corporate borrowing levels are “historically high” and debt at US nonfinancial companies is up nearly 70 percent since 2008. Ominously, debt levels at nonfinancial companies have typically risen sharply just before the past three downturns.

If It Ain’t Broke, Don’t Unfix It

The report concluded that “the nation’s largest banks are strongly capitalized” and “hold more liquid assets” than in the period leading up to the crisis, making them more resilient in case of another downturn. Despite the relatively rosy tone taken by the Fed on the state of the financial sector, it continues to plug away with the deregulatory agenda meant to roll back “burdensome” Dodd Frank-era rules.

Last week, the Fed released an official rule report outlining a number of changes that were first presented by Vice Chair Quarles about a month ago. The rule report is a detailed overview of how the Fed plans to implement S. 2155 and “tailor” regulatory processes. These proposed changes include:

  • raising the asset thresholds for banks to be subject to enhanced prudential standards

  • overhauling the Dodd-Frank stress testing framework

These changes are likely to increase systemic risk and harm the stability of the financial system. Find a more detailed explanation of our views on the proposed changes here.

Monetarist Approach to Systemic Risk

When it comes to monetary policy, the Fed is on cruise control. The Board has raised the short term interest rate eight times since 2015, the last time in September from 2 to 2.25 percent, as part of the Fed’s dual-mandate to achieve full employment and sustainable inflation rates. Given those narrow objectives, the Fed has done a commendable job, but is it doing the right things to protect those gains in the future?

While mainstream media seems enamoured with last-minute changes to the interest rate, they fail to see what the Fed is doing when it comes to regulation and oversight, which may have more impact on the economy in the long-run. Vice Chair Quarles is pushing rule changes to capital regimes at a time when risk in the economy is low, but continued growth is uncertain.

Conclusion

The current Fed is on a mission, seeking to reduce capital and regulatory standards at precisely the most counter-cyclical time. Coming to the end of a long period of growth and stability, we need the safeguards implemented by Dodd-Frank. Reducing regulatory requirements at this juncture facilities risk-taking by financial institutions as the economy slows, setting up a repeat of 2008 as institutions chase returns that will be increasingly diminished.

In a speech at the Economic Club of New York on Wednesday, November 28, Powell said: “The question for financial stability is whether elevated business bankruptcies and outsized losses would risk undermining the ability of the financial system to perform its critical functions on behalf of households and businesses.” Powell contended, as his predecessors did in the run-up to 2008, that such losses would likely fall on investors rather than posing a threat to the financial institutions that are at the core of the system.

If history has taught us anything, it is that average Americans are always the ones who bear the brunt of financial crises, not wealthy investors.  During his speech last week, Fed Chair Powell asserted that monetary policy should not be used as a tool for stabilizing a financial crisis, yet he appears content in allowing the Fed to pursue destabilizing rule changes in financial policy.

 

Maxine Takes Helm at House Financial Svcs. (November 30)

Update 315:  Rough Waters Ahead for Banks?
Maxine Takes Helm at House Financial Svcs.  

The gavel passing from retiring Rep. Jeb Hensarling (R-TX) to Rep. Maxine Waters (CA) at the House Financial Services Committee augurs one of the clearest sea changes in policy and style a U.S. House Committee will see in the 116th Congress.  

Accordingly, we have a closer look today at what these changes under Waters imply regarding  particular policy priorities among the legislative agenda and issues before the Committee.

Good weekends, all…

Best,

Dana

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The Immovable Waters

Rep. Waters’ bedrock issues have long been housing, consumer protection, and big bank regulation. In the 115th Congress, Waters focused on protecting the Community Reinvestment Act, designed to prevent discriminatory credit practices, and guarantee fair housing protections.

A number of bills introduced by Waters during the current Congress (capping a six-year tenure as Ranking Member of HFSC) indicate her key priorities, including:

 

  • Public Housing Tenant Protection and Reinvestment Act of 2017 — H.R. 3160: The bill reforms the public housing demolition and disposition rules to require one-for-one replacement and tenant protections, and provides public housing agencies with additional resources and flexibility to preserve public housing.

 

 

  • Comprehensive Consumer Credit Reporting Reform Act of 2017 — H.R. 3755: The bill enhances requirements on consumer reporting agencies, like Equifax, TransUnion, and Experian, to better ensure that the information on credit reports is accurate and complete.

 

  • Megabank Accountability and Consequences Act — H.R.3937: The bill would give authority to federal banking regulators to break up banks that mistreat their customers.
  • Consumers First ActH.R.6972: The bill would reverse the harmful changes to the Consumer Financial Protection Bureau imposed by the Trump Administration and restore the agency’s supervisory and enforcement powers.

  • Restoring Fair Housing Protections Eliminated by HUD Act of 2018H.R.6220 The bill would restore several fair housing protections that HUD Sec. Ben Carson eliminated.

Blue-Moon Bipartisanship?

During her tenure as Ranking Member on the Committee, Rep. Waters supported bipartisan legislation, notably the third iteration of the JOBS and Investor Confidence Act (aka JOBS 3.0; see our take on that package here). The bill includes provisions aimed at “decreasing the regulatory burden” for some financial institutions, as well as others that aim to increase protections for consumers.

In a similar vein, she partnered with Sen. Sherrod Brown on S. 1491, the Community Lender Regulatory Relief and Consumer Protection Act of 2015. The bill would give banks and credit unions with under $10 billion in assets relief from the Consumer Financial Protection Bureau’s (CFPB) “Qualified Mortgage” rule.

Appealing to Waters’ passion for housing reform, the measure would make permanent expired provisions that protect tenants from eviction when their landlord or property owner has entered foreclosure. When it comes to her bedrock issues, Waters may be more willing to compromise to ensure she reaches her legislative goals.

She has also reached across the aisle to work with Republicans to reauthorize the Export-Import Bank, and used her political savvy to get Republicans on board with a reauthorization of the National Flood Insurance Program. While she will look to make some strides in these areas as Financial Services Chair, she has expressed firm and progressive stances regarding systemic risk and oversight.

Mitigating Systemic Risk

Importantly, Rep. Waters at the helm of the HFSC means two things for systemic risk:

  • the “tide” of financial sector deregulatory passing the Committee is “at an end”
  • regulators and agencies should be prepared to will have their feet held to the fire more often

Heading into the next Congress, a key item on Waters’ agenda will be monitoring systemic and other risks in big banks. The financial industry has enjoyed several months of continuous deregulatory activity under an HFSC headed by Rep. Hensarling and a Republican-controlled Congress. Under her leadership, the Committee will be limited in its ability to stall measures at the federal regulator level, but it will be able to increase oversight and change rhetoric to keep a check on agency overreach.

In the words of Waters, “as we saw in the last crisis, it is the average hard-working Americans that will suffer the consequences if Washington deregulates Wall Street megabanks again.”

Oversight in Her Sights

A robust oversight agenda will accompany the legislative priorities of the Committee under Waters. This agenda will likely focus on four distinct areas: firms, rulemaking, agencies, and the presidency.

On the firms, Waters has expressed indignation about the slap-on-the-wrist treatment of Wells Fargo in light of the improper and unfair foreclosures on its customers. Many were erroneously denied loan modifications to lower their mortgage payments.

A Democrat-controlled House cannot do much in the way of affirmative rulemaking, but it will no longer have to play defense against further attempts at deregulation. Much of Waters’ oversight in this area will be over agencies, ensuring that the Trump appointee-controlled CFPB, FSOC, and OFR are operating according to their original statutory purposes and with the resources they need. This will likely take the form of hearings, subpoenas, and investigations.

Waters has been steadfast in her position that investigation into the president’s alleged illegal financial dealings is on her agenda, but it’s not her top priority. In a Bloomberg interview earlier this month, Rep. Waters was clear that she would use her authority to get more information, using subpoenas if necessary, but was far more eager to discuss Wells Fargo and the CFPB.

An Able Veteran who Came to Legislate

Waters is a skilled and seasoned legislator. Her turn with the gavel at HFSC is very welcome news and signals the end of the tide of deregulation. It also signals an end to a period of free-reign for regulators (or should we say deregulators) dogmatically pursuing an agenda that puts Wall Street megabanks ahead of ordinary Americans. Her agenda will be limited by the Republican-controlled Senate, but it will set the tone and pave the way for future legislation that will curb the rollbacks of Dodd-Frank that have occured in recent years.

 

What do Amazon and the GM Layoffs Portend? (November 27)

Update 314 — An Economy Shifting Gears:
What do Amazon and the GM Layoffs Portend?

Major tidal shifts and cross-currents underlying the changing American industrial landscape have been on full display in recent weeks.  Last month, Amazon announced it was going to base its second headquarters out of both New York and Virginia, promising to bring 25,000 jobs to each.

In an equally important but opposite development yesterday, General Motors announced its plan to eliminate up to 14,000 jobs. This surprise decision has rattled the Trump Administration and Republican leadership, challenging the belief that the economy is running fine on high octane fuel and should continue unfettered.  

We take a closer look at these developments for economic harbingers and cautionary notes below.  

Best,

Dana

———

GM Stalled

GM’s decision, which comes less than two years after it announced it would add or keep 7,000 jobs in the United States, translates to an expected loss of 14,700 jobs. The decision comes only a month after GM offered buyouts to as many as 18,000 long-time employees, only 4,000 of whom accepted the offer by the November 19 deadline — 3,000 employees short of its 7,000 target.

With the buyout program behind schedule, the decision to idle five facilities did not come as a surprise to many. The Lordstown assembly plant in Warren, Ohio, for example, had gone from three shifts per day in January 2017 to one shift this past April. The United Auto Workers said it would challenge GM’s decision. If GM still hasn’t reached its 7,000 buyout goal by January, further involuntary cuts are likely.

Tax Cuts and Jalopy Act

While the Tax Cuts and Jobs Act (TCJA) of 2017 purported to create record tax windfall for corporations to reinvest, the picture with GM is more complicated.

In GM’s case, the TCJA did not account for “deferred tax assets” which the company was able to accumulate due to poor performance predating the Great Recession. These assets allow companies to reduce taxable income, meaning GM had already been afforded a low tax bill for over a decade. The newly reduced corporate tax rate therefore rendered these assets less valuable, forcing GM to take a $7 billion charge against earnings during the fourth-quarter of FY 2017. Executives expected to see an eventual benefit from the new tax law, but not for years to come.

It’s hard to claim that in absence of sizable deferred tax assets, GM would have even used their $157 million in federal savings to support American plants and employees. An October survey published by the National Association for Business Economics reported 81 percent of 116 companies surveyed had not changed plans for investment or hiring as a result of the TCJA.

Trade Wars Are Easy To Win

The tariffs put forward by the Trump administration are another possible contributing factor to GM’s financial troubles. The timeline of the trade war is highlighted below:

  • June 1, 2018: The Trump Administration ended the exemption of Mexico, Canada and the EU from aluminium and steel tariffs. GM representatives warned the White House that these tariffs would drastically hurt the firm, saying that “this could still lead to less investment, fewer jobs, and lower wages for our employees.”

  • July 25, 2018: GM was forced to reduce its profits forecast for 2018, tanking stock by 4.6 percent. GM’s CFO predicted the original tariffs in March and the ending of exemptions to the US’s most trusted partners in June could add “as much as 700 million to GM’s costs” for FY 2018.

  • September 24, 2018: The White House compounded the problem by unveiling a new, stringent set of tariffs on Chinese automotive exports, putting in place a 10 percent levy on brakes, car batteries, tires, etc. Analysts predict these new tariffs will lead to higher sticker prices for cars and lower car sales.

GM, like all other US car manufacturers, relies on foreign-based subsidiary plants and goods to create finished products, making broad tariffs doubly damaging to an already wounded industry. With GM historically leading the way in moving jobs to Mexico and a less favorable domestic/international tax rate differential introduced in the TCJA, the Trump administration’s tariffs have only produced escalated offshoring.

You (Don’t) Get What You Vote For

Starting on the campaign trail, President Trump made a series of promises to the American people about jobs, specifically jobs in manufacturing. During a speech in Michigan in October 2016, Trump promised to “bring back…jobs” and said “the long nightmare of jobs leaving Michigan will be coming to an end.” He blamed past factory closures on Democratic failures and promised not to let that happen again.

The GM decision reflects the fecklessness of Trump’s approach. Many voted for him because of his pledge to save the manufacturing industry. Instead, he has put forth policies that undermine that goal and expose fears that become self-fulfilling trade prophesies, aka, retaliation.  

Plants will be closing in two states that helped propel trump to victory — Michigan and Ohio. The GM closures thwart his guarantees to protect manufacturing and undermine his portrayal of a healthy economy that is growing with no end in sight and equitable for minority groups.  

Juxtaposition to Amazon

Almost simultaneously, Amazon announced its locations for its new HQ2. After a country-wide tax benefit bidding war, it has pledged to bring 25,000 jobs to both New York and Virginia, as well as an estimated 67,000 and 22,000 indirect jobs to each respectively. In return, Virginia agreed to give Amazon $819 million and New York agreed to $1.85 billion. Both states believe the benefits accrued from Amazon will far outweigh these costs. Gov. Ralph Northam of Virginia expects “Amazon to invest $2.5 billion in the commonwealth and create $3.2 billion in tax revenue.” Will this model work?

Amazon is encouraged to fulfill its jobs promise through “performance-based direct incentives,” meaning that for each pledged job that comes to fruition, they get a certain amount of tax breaks. This kind of city and state tax break is by no means an uncommon way of driving business to invest in a given area, and has been utilized in the past by other tech company giants, such as Google.

Although the model has proven very effective at creating jobs, there are some accompanying flaws. In Seattle, Amazon’s first HQ brought an economic boom and more than 40,000 jobs to the city; it also cost taxpayers hundreds of millions of dollars in ongoing infrastructure and transportation upgrades around the site, while neglecting other areas of the city. Affordable housing underwent a serious crisis.

Amazon has worked with Virginia and New York governments to try and get in front of some of these issues, pledging money for additional schools and low-income housing. Moreover, Arlington and Long Island are not Seattle. Bringing 100,000 jobs to these areas is a boon even to these booming coastal metropolises.

Trump v. Bezos

Trump has criticized Amazon repeatedly in the past and again following the announcement of HQ2.  The economic tide seems to be working against him — 44 cents to every dollar spent online goes to Amazon. As much as Trump wants new jobs in the manufacturing sector, the evidence shows that the tech sector is the one to watch. States are quite literally fighting over these Amazon jobs, whereas auto manufacturing jobs in the rust belt have become more burdensome than beneficial. Although tech jobs differ slightly from traditional manufacturing jobs in terms of benefits — i.e. GM offers pensions and Amazon offers 401ks — they still provide similar stability for their workers.

Even GM will be using its hefty savings to further bulk up its electric and autonomous vehicle development through R&D programs that already see more than $1 billion a year in company investment. Trump can no longer keep up the facade of a booming economy fueled by the manufacturing industry, and his supporters, especially in Michigan and Ohio, will soon come to realize the false hope and broken promises.

Fed Undertakes Implementation of S. 2155 (November 16)

Update 313 — Quarles Tailoring Too Swiftly?
Fed Undertakes Implementation of S. 2155

The current Congressional interregnum known as the Lame Duck session affords a chance to consider how the Fed plans to implement S. 2155, the broadest rollback of Dodd-Frank to date.  So far, evidence suggests that the implementation process be watched closely.

It invokes serious issues ranging from the limits of regulatory discretion to systemic risk policy on the merits.  We commend, as a sensible alternative to the proposal Fed Governor Quarles is concocting, the perspective of Governor Lael Brainard.  See below.

Good weekends all,

Best,

Dana

——————————————————

Yesterday, Michelle “Miki” Bowman was confirmed as Fed Governor by the Senate on a 64 to 34 vote. She adds another deregulation supporter to the Fed Board.

This week, the Fed’s Vice Chairman Randal Quarles testified in front of the House Financial Services and Senate Banking Committees to give an overview of the supervision and regulation of the financial system. His testimonies come after a speech last Friday at Brookings, where he detailed a list of changes to the current stress testing regime. It also comes in the wake of a Fed proposal last month to ease regulation for banks under $700 billion in assets.  

Will Fed Eviscerate Stress Tests?

On November 9, Randal Quarles gave a speech at Brookings detailing plans to overhaul the Dodd-Frank stress testing framework for the largest financial institutions. In the name of efficiency, “recalibration,” and “tailoring,” the Fed is proposing to reduce standards that were designed to ensure the resiliency of banks to weather any crises and are the basis for capital requirements.

The changes under consideration by the Fed are:

  • exempting banks with assets less than $250 billion from CCAR quantitative assessment and supervisory testing in 2019

  • disclosing stress test outcomes to firms before they execute their capital distributions

  • exempting leverage ratio requirements from future stress testing models

  • decreasing capital buffers for most banks by 2020 at the earliest

Capital and Liquidity Rules in Fed’s Sights

Late last month, the Federal Reserve Board voted 3-to-1 to reduce oversight and capital requirements for the 16 largest regional banks in the country. The Fed “tailoring” (deregulating by another name) implementation is now in full force.

The Fed’s proposal would create four new categories for how bank holding and savings and loan companies are treated:

  • Category I: Global Systemically Important Banks (GSIBs)

  • Category II: Banks with more than $700 billion in assets or $75 billion or more in cross-jurisdictional activity

  • Category III: Banks with between $250 billion and $750 billion in assets

  • Category IV: Banks with between $100 and $250 billion in assets

The proposal would be a huge let-off for banks in the $100 to $250 billion asset range, such as BB&T and Suntrust. These banks will be exempted from the liquidity coverage ratio, substantially reducing their requirement to be able to turn assets into cash in the event of a crisis. Fed Governor Lael Brainard estimates that these changes would reduce high quality liquid assets by around $70 billion and reduce their liquidity buffers by around 15 percent.

The changes also reduce oversight by eliminating the annual stress test requirement for these institutions, moving it to a bi-annual basis. Large “mega-regional” banks with assets between $250 and $700 billion such as US Bancorp, Capital One, and PNC Financial would also face much lighter liquidity requirements, equivalent to 70 to 85 percent percent of their current liquidity coverage ratio.

Signed into law in May, S. 2155 was touted as a regulatory relief bill for smaller banks and credit unions ostensibly stifled by excessive regulation, but the Fed’s new rule loosens restriction for mega-regional banks between $250-700 billion in assets. These mega-regionals are as or more likely to be both culprit and victim in a meltdown as any firms in other financial subsectors, given their increasing interconnectedness with each other, as well as with their Wall Street counterparts.

Per Sen. Brown: The “Fed’s proposed rule loosens protections for banks with more than $250 billion in assets – not small community banks – we’re talking about the nation’s biggest financial institutions.”  Ten years after the financial crisis, the nation’s most important regulators are eroding the fundamental protections offered under Dodd-Frank, increasing systemic risk, and leaving taxpayers at risk of a future bailout.

Consternation in Congress

On November 14, Democrats on the House Financial Services Committee (HFSC) raised their concerns with the Fed’s new proposals. Rep. Maloney questioned the provision to reduce the liquidity requirement for banks in the new Category III tier. Quarles argued that the language of S. 2155 now requires the Board to tailor policies to institutions between $100 and $250 billion in assets, but did not fully justify the decision to lower liquidity standards for such large banks. Moreover, the statement was inconsistent with his remarks against supervisory complacency in boom times.

The next day, Quarles recanted this testimony before the Senate Banking Committee. Sen. Brown highlighted his concern over the proposed reduction in capital requirements and argued that the proposed stress test “transparency” measures were akin to giving “students the answers to a quiz ahead of time.” Sen. Warren questioned the reduced enforcement of leverage lending ratio guidelines, forcing Quarles to admit that they would not hold banks to the standards set by the Fed, OCC, and FDIC in 2013.

Tailoring Too Swiftly?

In recent months, the Fed has proposed other significant rule changes, like adjusting the the enhanced supplementary leverage ratio (eSLR) — a change predicted to reduce GSIB capital requirements by $121 billion. The Fed is also on the verge of proposing changes to living wills requirements, releasing banks in the $100 to $250 billion asset range from filing resolution plans, thereby increasing systemic risk.

A Toxic Brew of Deregulation

The Fed is pushing ahead with rulemaking that threatens to increase systemic risk and harm the stability of the financial system. Fed Governor Lael Brainard explains, “I see little benefit to the institutions or the system from the proposed reduction in core resilience that could justify the increased risk to financial stability and the taxpayer.”

This deregulatory agenda will soon have a powerful challenger in Congress. The likely next HFSC Chair, Maxine Waters, told the public during the Nov. 14th hearing: “Make no mistake, come January, the days of this committee weakening regulations and putting our economy once again at risk of another financial crisis will come to an end.”

Economic Policy Implications of the Midterms (November 13)

Update 312:  Economic Policy Implications
of the Midterms and the 116th Congress

The result of last week’s midterms will have important ramifications for economic policy during the 116th Congress.  Democrats have taken the majority in the House and will take majority control of key committees setting the legislative agenda.

More than 100 women were projected to win seats in the House of Representatives, easily shattering the record of 84.  Overwhelmingly, they were Democrats, including 30 candidates endorsed by 20/20 Vision (out of 40).

Below, a look at the economic policy implications of last week’s midterms.  

Best,

Dana

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Financial Regulation and Oversight

The Democrats’ winning the House gives Rep. Maxine Waters the gavel of the House Financial Services Committee (HFSC).  Depending on the final seat tally, between 10 and 12 new Democratic members will be added to the Committee. Waters’ vote against S. 2155 and continued opposition to deregulatory overreach will change the tone and direction of the Committee, making it unlikely that any new deregulatory bills get through the House.

Oversight is likely to be a central theme of Waters’ regime. Recent actions by the Financial Stability Oversight Council (FSOC) to de-designate the last remaining nonbank systemically important financial institution (SIFI), as well as staffing and budget cuts at the Office of Financial Research (OFR) are likely to be scrutinized. The HFSC under Waters will also be a bulwark against rulemakings and practices that increase systemic risk; regulators will likely be called in to testify, which will increase public accountability, and perhaps slow down the deregulatory agenda. Kathy Kraninger, a Mick Mulvaney acolyte, looks set to be confirmed as CFPB director by the Republican-controlled Senate, so a Waters-controlled HFSC will be a welcome check on the direction of the Bureau under Kraninger’s tenure.

Democratic Senators who supported S. 2155 didn’t fare well last week.  Sens. Joe Donnelly and Heidi Heitkamp both lost their reelection bids, leaving two vacancies to fill on the influential Senate Banking Committee. The loss of Donnelly and Heitkamp opens the possibility to get different Democratic voices on the Committee, which will hopefully provide some welcome dissent to the Committee’s deregulatory program during the last Congress.  Kyrsten Sinema, the recently-announced winner of the Senate race in Arizona, could wind up with a seat on the committee given her role on HFSC. With Republicans still at the helm, the Committee looks set to continue its confirmations agenda as well as push for a fast implementation of S. 2155.

Tax Policy

During the president’s post-midterm press conference on November 7, he highlighted some legislative areas where he may be willing to work with a Democratic House.  One of those areas was tax policy. In response to a question at Wednesday’s press conference about how he’d pay for his promised 10 percent tax cut on middle-income households, the President said, “if Democrats come up with an idea for tax cuts, which I am a big believer in tax cuts, I would absolutely pursue something, even if it means some adjustments.”

While the news cycle will focus mainly on the oversight that is sure to come, as well as the messaging bills that will be introduced, the main area in fiscal policy to watch will be the possible 10 percent tax break for middle class households. The main question now is how Democrats will propose to pay for the cut. Some have proposed bills to expand the Earned Income Tax Credit, financing an increase in the program with tax increases on corporations and big businesses.

The policy areas Democrats could mine here would be expanding tax breaks for retirement savings programs, healthcare, and tuition, but many seem to be skeptical of a major overhaul like we saw in the 115th Congress. We can expect several messaging bills and potentially some technical corrections to the Tax Cuts and Jobs Act (TCJA), but it is unlikely that much will pass the Senate, let alone the president’s veto.

Political Reform

Political reform and oversight will be at the top of the agenda for Democrats in Congress come January.  A large majority of Democratic challengers, several of whom will now move into junior roles in the House, made political reform a key platform item on the campaign trail, with almost 200 progressive candidates rejecting corporate PAC money this cycle.

In the 115th Congress, House and Senate Democrats developed a plan entitled “A Better Deal for Our Democracy” (BDD). They managed to tuck some BDD provisions into the spending bill in bipartisan areas like rural broadband access, child care assistance, and infrastructure improvement. In August, the week that Paul Manafort was convicted on eight counts of fraud, Sen. Warren introduced an anti-corruption bill that proposes toughening rules on conflict-of-interest, lobbying ethics, and campaign finance reform. In the Republican-controlled Senate, Warren’s bill has little-to-no-chance of passing. House Democrats, however, are making democracy reform their number one priority in January.

On Monday, Rep. Sarbanes (D-MD) announced that H.R. 1, the first vote in the House, will be a reform package removing obstacles to voting, closing loopholes in government ethics law, and reducing the influence of political money. H.R. 1 would establish automatic voter registration, shift redistricting power from states to independent commissions, overturn the Supreme Court’s Citizens United ruling, expand disclosure mandates, and establish public financing to match small contributions.  Rep. Sarbanes admits that though the bill is unlikely to pass the Senate, it will force political reform issues to the forefront of the legislative agenda for both chambers of Congress.

Other Policy Areas of Note

There are a few issues that emerged as major talking points during this election season that we should keep an eye on moving forward:

  • Infrastructure

Infrastructure spending appears to be the best hope for a bipartisan bill in the coming Congress.  Both parties and the president publicly seem to agree that fixing and modernizing America’s infrastructure is a high priority and point of cooperation. This issue has been ongoing for years because a key source of infrastructure funding, the federal gas tax, has not been raised or adjusted for inflation in the last 25 years. President Trump has voiced support for raising the tax, in addition to signing onto a comprehensive spending package, but it remains to be seen if any infrastructure bill will come to fruition. Many observers believe that the two parties are so far apart on key aspects of an infrastructure package that the likely outcome is no bill at all or only a modest one that falls well short of the nation’s infrastructure needs.

  • Education

Many Democratic candidates campaigned on improving education at the K-12 and university levels. For K-12 public education, the focus was mainly on increasing funding in general. At the university level, many candidates advocated for reducing the costs of a four-year degree and increasing options for job training programs. With Secretary Betsy DeVos at the head, national changes seem unlikely, but newly elected Dems can work within their districts to improve local public schools and universities.

  • Healthcare

Healthcare was a cornerstone of both Democratic and Republican platforms this cycle. Democratic victories in the House will, at the very minimum, mean that further attempts to repeal the ACA will be stopped. It is possible that we will see some proposals pass through the House, with select GOP support, calling for modest expansions in Medicare. There is also likely to be an emphasis on increased protections for the ACA, primarily through oversight rather than legislation. With the Senate firmly locked down by the GOP, it is unlikely that substantial overhauls will be adopted this term.

In the end, it is not clear whether the midterm elections this year saw a true “blue wave” or more of a harbinger of still greater things. The loss of seats in the Senate — all but inevitable given the map, which reverses and favors Democrats in 2020 and 2022 — somewhat obscures the fact that Democrats might end up with their biggest gain in the House since the post-Watergate election of 1974.  This resounding win will mean that Democrats have a strong mandate to press ahead with much needed reforms, forge a progressive agenda to challenge the current GOP status quo, and chart a path to 2020.