Topic: The Government and the Economy
Rivlin: I’m Alice Rivlin, and I’m a senior fellow at the Brooking’s Institution.
Question: How is government expanding opportunities for business?
Rivlin: There are some quite obvious things that, companies can do right now depending on what kind of companies they are if we are fixing our crumbling infrastructure then companies that specialize in doing that will benefit it we’re giving more people access to broadband that is certainly an opportunity if we’re making our healthcare system more efficient, there will be some people who will loose by that but there will also be both providers and the healthcare technology industry that will benefit.
Question: How will government stimulus affect small business?
Rivlin: The stimulus plan is I think widely misunderstood because think of it, is just infrastructure. It is partly that but the most important part of the stimulus I thought were the parts that got money to individuals so that they could keep paying their bills, that means the food stamp part or the unemployment benefits increase, the modest increase in social security benefits and the other part that seem to me very important were the benefits to states to keep them from cutting back on their services. So and I didn’t even mention the tax cuts which go to ordinary people. Those things will keep demand up. It will keep consumption of and it will benefit the businesses across the board. There is no special benefit here. It just means that people will not be cutting back on their consumption as much as they ordinarily would have.
Question: Will salary caps stifle innovation?
Rivlin: We were bringing a lot of talents to Wall Street that in my opinion would have been better employed doing something else the financial services industry got way out of kilter with the rest of the economy. Financial services are supposed to be serving the rest of the economy actually our financial our financial services industry got into a position where it was largely servicing itself we don’t need that many smart people inventing more and more complex derivatives and instruments to sell to each other. There is very little social benefit in that activity. Now, I don’t mean we can close down all derivatives, markets, or anything like that but if compensation in financial services is less astronomical and we attract less of our high skilled talent in the financial services and more of it into other parts of the economy, it will be all to the good.
Question: Do you foresee fundamental changes to the financial sector following the crisis?
Rivlin: This massive disaster has certainly expose weaknesses in the financial sector. Some we knew were there, many we didn’t and we need a drastic overhaul I think on 2 fronts. Partly it is a question of modernizing our regulatory system which simply did not keep up with the advances in financial innovation and globalization that were happening all around us. That means stricter regulation for major institutions that are very interlink with the rest of the economy and indeed with the global economy. It can’t be too strict. We need those major institutions. The 2nd front which I think is more important is we need to go over our economic structure or economic architecture and look for perverse incentives. Places where there are incentives that mean that people can make a lot of money doing something really risky. Now, we have a good example of that in mortgage lending the mortgage lending standards got very lax in part because we missed the perverse incentive. We missed the fact that the loan originator has no reason to worry about the credit worthiness of the borrower if he doesn’t keep any of that risk himself. If he is just selling this mortgage to somebody else as part of a package backing a bond issue then he has no reason to worry about whether the borrower can repay. That was a perverse incentive. It had been there for a while bit nobody noticed it. It was the big influx of capital into the mortgage back security market. A lot of it coming from overseas that exposed this weakness and we have to look for things like that and change them.
Question: Will President Obama be good for business?
Rivlin: I think that President Obama has to work right now on the thing that is most important namely getting out of this recession and getting the financial services industry functioning again. If he doesn’t accomplish that and I think he will, it will be a disaster for business. We need a functioning economy where people have jobs. We need to be a more sustainable economy than we were before. Both in an environmental sense and in the sense that we need to save more and finance more of our own investment out of domestic saving. I think that will happen because people who borrowed too much and consume too much got badly burned but we need an economy which is functioning well and in which people are saving more, borrowing less and doing more productive work.
Discuss
Michael Masnick on April 22, 2009, 4:55 AM
Alice Rivlin makes some really good points in this discussion on the economy and the regulatory environment surrounding it. I particularly like the point she raises about “perverse incentives,” because it’s a point that I’ve found myself talking about quite a bit. Lots of attention is being put on who to “blame” for all of this, but a bit part of the problem was that many participants were doing all of the “right” things — but in aggregate the results were really, really bad because of those “perverse incentives.”
The incentives made it so that people could get quite rich simply by passing the risk hot potato around. The more you passed it, the more you could make in the short term. But with so much money flowing, it became a situation where nobody could get out of the game — you had to stay in and make sure you got the next hot potato to go around.
The point that I’m a lot less sure about, however, is the idea that we can somehow be “better” at “spotting these perverse incentives” and doing something about them from the regulatory side. History has shown that this rarely happens — for a variety of reasons. Part of it is regulatory capture, where the industries benefiting most from the perverse incentives have enough power and sway over regulators to make it next to impossible to change things.
Part of it is that it’s really, really difficult to recognize these perverse incentives as they’re happening. Sure, some people will claim they’ve got it figured out, and sometimes people are lucky and right — but often the’re wrong. Sometimes it’s difficult to tell the difference between a “perverse incentive” and a more efficient process.
Everyone claims they understood the perverse incentives in hindsight, but very few actually recognized them when it mattered.
So instead of simply trying to hunt down perverse incentives, I’d argue that the more effective solution is to promote better transparency. The reason the financial mess got so overheated was that it was a giant game of “find the next sucker” where you did everything possible to obfuscate the real risk, so that you could sell a risky proposition at a higher price than it deserved.
The real problem was the obfuscation. No one could adequately judge the risk, and thus they eventually made really bad bets — buying up incredibly risky bets, but paying a premium, believing they were safe.
The way to solve that is to push for much greater transparency. This is what some are calling radical transparency. It means publishing all of the underlying data clearly, and in standardized formats so that anyone can make use of them. Imagine if all of the mortgage-backed securities actually published the data on the underlying loans that made them up, and anyone could then write a program to make use of that data. Suddenly, you’d have much more compelling and detailed analyses of the real risk associated with the securities, rather than having it hidden beneath layers of fakery.
Seeking out perverse incentives is a noble goal, but difficult in practice. Pushing for radical transparency, on the other hand, is quite achievable, and would actually benefit the overall economy much more, by increasing confidence, and creating transactions that involve both parties being better off, rather than one party suckering the other into a deal.
Emma McNamara on May 7, 2009, 9:44 AM
I agree that perverse incentives are a real problem. But performance is also an issue. Apparently we don’t have in place accurate measures of true financial performance, since excellent performance (well, seemingly excellent) in one year, can lead to devastation the next, or some time later. It’s too late when we’ve rewarded the apparent yet baseless excellent results in one year, and then try to punish years later, when the culprits have walked away with many millions, or bilions. How can we spot these performance issues early? Regulation must be in place so that issues are confronted early.
Jack Sallay on May 12, 2009, 4:50 PM
Rivlin mentions that the current stimulus plan is misunderstood and I agree with her. I’m curious as to how the government could better communicate with those most in need – and also with media outlets – to ensure a clear understanding of benefits available. The state department uses online video (check it out: www.state.gov). Why couldn’t other departments help improve communication through such methods?
Chad Welch on June 11, 2009, 4:14 AM
The news about what Washington is doing to help revive the economy is dominated by reports on corporate bailouts and public works projects. But, Rivlin brings up an excellent point that is being ignored. The stimulus plan is also increasing funds for food stamps, unemployment benefits, and many programs which are helping those who are being hit hardest by this economic situation. These people are buying groceries, paying rent and paying their heating, telephone and electric bills. This spending is , in turn, also helping small businesses, landlords and utility companies to remain solvent. Where would all these people be without the help of the government at this point? Yes, taxes might have to raise a bit, but this is a better alternative to evictions, small businesses failing and bailouts of utility companies.
I think there are very few of us who don’t have a friend or relative that has had to start relying on government help in some form in order to make it through these tough times. The hard work of getting our economy back on track remains- and we are not letting people who have become educated and worked hard all their lives to become destitute. I believe helping others in times of need is the right way to go. To do otherwise would be immoral and inhumane- Ms. Rivlin made me realize this.
Eliot Spaulding on June 11, 2009, 8:25 PM
Ms. Rivlin is supportive of salary caps, but in my mind this seems to strongly go against free market principles. Wall St. has gone through a correction and it is unlike that employees there will see 2005-like bonuses any time soon – without salary caps. Why will salary caps solve the problem of too many smart people heading to Wall St.? There is still money to be made there!
Instead of caps, I think that the administration should focus on incentives. There should be more and higher incentives for young people to go into teaching, science, high tech innovation – what about more grant programs? All that caps do is create a larger rift between government and business.
Laura Gordon on June 12, 2009, 1:12 PM
In response to Emma’s comment about looking for early performance indicators – partly that falls to the board of directors. It is the role of the directors to keep an eye on the interests of shareholders through converations and review of management’s strategy. While management should have a very clear vision for the company going forward the board must act as a check and balance – and ask the tough questions. They are the early testers.
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