Big Think

Bank Bonuses and the Reform Agenda in the Balance

Health care reform hangs in the balance at the same time we learn from the Cuomo Report (http://www.oag.state.ny.us) that nine banks, all recipients of federal bailout support, paid an astounding $33 billion in bonuses in 2008, including more than 4,700 bonuses of at least $1 million. Though seemingly unrelated, health care reform and the bank bonus scandal are interconnected. When Washington politics seems merely to be a scam, even worthy policy initiatives like health care reform are likely to go down in flames. On the other hand, if Washington would now move aggressively to claw back these ill-gotten bonuses, the public would also place increased trust in Washington to tackle reforms such as health care. Consider just two of the banks involved in the bonus scandal: Citigroup and Merrill. Together they lost $54 billion in 2008, and received $55 billion in TARP bailout funds. Yet this did not stop them from paying $9 billion in bonuses for a job well done. Merrill's top four bonus recipients pocketed $121 million, and the next 4 took home $62 million. Citigroup, propped up from collapse by the US Government, paid a shocking 738 employees more than $1 million each. Everything is wrong with this picture. Even in a good year much of the Wall Street bonus package is merely banking on special privileges from the US Government that allow the big banks to gamble to the hilt. In a bad year like 2007, the Wall Street bonuses are brazen. In 2008, the year that the banks nearly brought the global financial system to a halt, the $33 billion are without a shred of legitimacy. Perhaps $3.7 billion explains why all too many in Washington seem ready to allow the abuses to stand. According to http://www.opensecrets.org, that's the amount that the financial sector paid in lobbying during 1999-2008. This was the largest lobbying outlay of any sector of the economy. Perhaps $474 million adds to the explanation. That's the amount of campaign contributions by the financial sector (both individuals and PACs) during the 2008 electoral cycle, again the most by any sector. This largesse produced the deregulation of the late 1990s that allowed the bonuses to soar on the mirage of unregulated credit default swaps. That's the same deregulation that eventually led to the trillions of dollars of asset losses now being picked up by Americans and other taxpayers around the world. And of course that's the deregulation that has made possible the soaring compensation in the financial sector, a point demonstrated convincingly in a recent scholarly paper by Philippon and Reshef (http://www.nber.org). What is needed now? First, we need government action to claw back the ill-gotten 2008 bonuses. All nine of the banks covered in the Cuomo Report received TARP funding. All have depended on government largesse in other ways as well, including transfers from AIG, itself bailed out by the government, and cheap loans from the Fed. A recent Financial Times story explained that this year's Wall Street profits are also padded by what is essentially insider trading with the Fed in the market for US Treasuries. As Paul Krugman has rightly emphasized in his recent New York Times columns, the banks' wins have been our losses. Even if the banks are making profits again, they have polluted the world's financial system with trillions of dollars of losses incurred by the rest of society, and owe the renewed profits significantly to taxpayer largesse. Let's recall (if we need reminding!) that $33 billion is a rather meaningful sum to pay out to some thousands of people. After all, in a world of extraordinary hunger and suffering, all of the rich world combined recently promised a total of $20 billion over three years to relieve the plight of hundreds of millions of people in the world's hungriest farm households. Yet here is $33 billion in a single year for some thousands of bankers in nine banks during a catastrophic year. The $33 billion per year, or $330 billion over a decade, would also pay for roughly one third of the extension of health insurance to the 46 million or so uninsured Americans. In short, we will suffer a huge lost opportunity, as well as a blow to social justice, if Washington simply winks cynically at the "finality" of these unjustified bonuses. Second, let us reject the view that bank compensation is in any event a matter to be left solely to the banks' shareholders and management. As Prof. Lucian Bebchuk of Harvard Law School has rightly emphasized in the Financial Times and elsewhere, even if bank shareholders were to gain a better control over management compensation than they have now, the shareholders and managers actually would still share the incentive to gamble recklessly in view of the government guarantees and expected future bailouts. Bank shareholders will not adopt bonus schedules that protect the public from the excessive risk-taking of the banks. Only bank regulators can do that. President Obama promised real change in Washington so that our country can escape from the poison of insider interests and unprecedented inequalities in wealth and influence. His agenda for change has the public's support, enough to win the 2008 election and re-election in 2012 if the reforms are adopted and implemented. It would be tragic to squander this chance for change by Washington remaining passive as the banks flagrantly abuse the taxpayers' trust and hard-earned income.

August 6, 2009, 3:02 PM

No Need to Oversimplify Poverty

Bill Easterly takes a complex problem, African poverty, and tries to reduce it to a single factor: "the consensus among most academic economists is that destructive governments rather than destructive geography explain the poverty of nations." This is a strange assertion. Geography and government policies both matter. The idea that geography affects economic performance is an old one. Easterly and some other economists have taken a particular position about the relationship between geography and development. They too have recognized the high correlation of a country's poverty with being in a malaria-transmission region, or being landlocked, or being in an ecological zone leading to low food productivity. Those correlations after all are powerful, as recently shown again by Prof. William Nordhaus of Yale , in the Proceedings of the National Academy of Sciences. Easterly and the others, however, have made a very unusual argument: yes, the correlations are there, but only for historical reasons. Bad geography two centuries ago led colonial powers to adopt exploitative political and economic institutions in the adversely affected regions. The adverse geography itself is no longer important, Easterly and his colleagues have claimed, but the adverse political and economic institutions live on nonetheless. Specialists in many fields, inside economics and beyond, disagree strongly with this way of thinking. They believe that various dimensions of geography were important in the past, and are still important directly today. A region that suffers from malaria today, whether because of its tropical climate or the species of its mosquitoes, is hindered in development not only because it has poor institutions inherited from 1820, but because it has malaria, which kills and disables children, discourages public and private investments, and hinders economies in many other ways. A recent academic study by Kai Carstensen and Erich Gundlach, published in the World Bank Economic Review in 2006, made this point powerfully and directly: "After controlling for institutional quality, malaria prevalence is found to cause quantitatively negative effects on income." Adam Smith, the pioneer of market economics, knew about the direct role of geography in affecting transport and trade all the way back in 1776. Even though the main purpose of the Wealth of Nations was to discuss the implications of economic policy and the division of labor on economic wealth, Smith also emphasized the role of geography in affecting national wealth. He cited Africa as a region suffering from especially high transport costs and therefore poor economic development: "There are in Africa none of those great inlets, such as the Baltic and Adriatic seas in Europe, the Mediterranean and Euxine [Black] seas in both Europe and Asia, and the gulfs of Arabia, Persia, India, Bengal, and Siam, in Asia, to carry maritime commerce into the interior parts of that great continent: and the great rivers of Africa are at too great a distance from one another to give occasion to any considerable inland navigation." More recently, Paul Collier in The Bottom Billion, as well as my colleagues and I in several studies, have shown that being landlocked and far from the coast continues to be a major hindrance to participating in certain kinds of international trade, especially for manufacturing exports. This is seen powerfully in sectors like apparel and other assembly exports, where semi-processed goods are imported from abroad, further processed, and then re-exported. It is very disadvantageous in general to set up such export operations in landlocked countries or far from ports or major markets. Collier emphasizes the special difficulty for a poor landlocked country that is surrounded by poor neighbors. The nearby markets are insufficient to generate much trade, and participation in globe trade is very hard. As Collier puts it, landlocked countries are "hostages to their neighbors." When it comes to agriculture, the geography-based problems of water are often paramount. The Green Revolution in Asia, which helped to trigger long-term economic growth in India and other countries, depended heavily on irrigation from the massive rivers systems of the region. In dry land areas with much higher costs of irrigation, the Green Revolution has been much harder to achieve. It may not be impossible, but the costs of entry for poor dry land countries are very high. The result can be low farm productivity, chronic rural poverty, and often no escape from extreme deprivation. Bill Easterly seems not to want to be bothered by the details of irrigation-based versus rain-fed agriculture, or the types of mosquito species in Africa, or the implications of being landlocked for international trade, or the effects of a dry climate and high costs of irrigation on food production in poor rural areas. He seems to prefer a one-factor solution. He is not alone among economists in ignoring these "details," but this is nonetheless an odd approach scientifically, especially when dealing with a complex system like an economy. When biologists deal with a complex system like the human body, they know that thousands of particular causes - even one single change of base pair in the genetic code - can cause crippling diseases or deaths. They are attentive to the large number of possible causes and their interactions, rather than claiming as the ancients once did that disease is the result of an imbalance of the four bodily humours. The key is to use a "differential diagnosis" to ascertain the causes underlying a specific situation, rather than assuming that a problem like poverty has a single cause. Sub-Saharan Africa faces a constellation of special challenges, with greater or lesser impact in different parts of the region, including: a climate and ecology especially burdened by infectious diseases such as p. falciparum malaria and other vector-borne diseases; a rain-fed agriculture, much of it in sub-humid or arid zones that are prone to drought; high overland transport costs, including the greatest number of landlocked countries of any continent and a relative paucity of ocean-navigable rivers; low population densities in rural areas, characteristic of many rainforest and dry ecosystems, which make rural infrastructure relatively expensive; a historical legacy of colonial rule in which the colonial powers left behind relatively little infrastructure; and of course challenges of bad governance like Mr. Mugabe of Zimbabwe. These challenges should be addressed forthrightly and in an integrated manner. It's just bad science, and offensive, to read in Easterly's blog that I offer "a bizarre geographic theory of Africa's poverty and [am] oblivious to the bad governments that many courageous dissenters have fought at great sacrifice." The geographic factors are not "bizarre," and I have never been oblivious to the tremendous costs that can be caused by bad governments. In the End of Poverty (p. 194) I wrote "I visited Zimbabwe several times, and saw Robert Mugabe's depredations firsthand. Zimbabwe is a case where the traditional explanation of miserable rule is a sufficient explanation for a country's ills (although the nation no doubt suffers from other serious problems as well)." I have always pointed to geography and good governance as complementary factors, not a choice of one or the other. Complex systems, in summary, require explanations that acknowledge complexity. An economy is affected by many factors: its proximity to trade, resource base, climate, history, social divisions, as well as government policies. A true economic science treats the economy with the care and sophistication that biologists treat an organism or that ecologists treat an ecosystem. Single-factor explanations for poverty take us back to pre-scientific realms and ways of thinking that are counterproductive for solving real problems.

June 1, 2009, 10:32 AM

Moyo's Confused Attack on Aid for Africa

Ms. Dambisa Moyo's recent Huffington Post article exposes the confusions that underlie her slashing attacks on aid. Most importantly, she seems to believe that sub-Saharan Africa was economically prosperous and then was pushed into poverty by aid. She makes the following ludicrous statement: "No surprise, then, that Africa is on the whole worse off today than it was 40 years ago. For example in the 1970's less than 10 percent of Africa's population lived in dire poverty -- today over 70 percent of sub-Saharan Africa lives on less than US$2 a day." Let's parse that statement for a moment. World Bank researchers Shaohua Chen and Martin Ravallion prepare the benchmark under-$2-a-day historical headcount data going back to 1981. According to their figures, headcount poverty under $2 a day was 74 percent of the population in sub-Saharan Africa in 1981 and 73 percent in 2005. Other prominent estimates that go back to 1950 or 1970 also contradict Moyo's statement, by showing high and persistent poverty. All of the macroeconomic time series by Maddison, Summers and Heston, and others tell the same story: the majority of Africa's population started out impoverished at the time of national independence in the 1960s and 1970s, and a majority remains impoverished till today. If we move beyond the GNP and income measures, the enormity of Africa's long-term poverty challenges become even more apparent. As we have documented elsewhere, Africa's literacy, agricultural productivity and urbanization rates were very low in 1970. Rural poverty was pervasive. Africa's road coverage, electrification, rail network, and other infrastructure were sparse at best and typically non-existent in rural areas. Aid did not kill Africa. Despite the persistence of poverty, many conditions in Africa have in fact improved in recent decades. Child mortality has declined from 229 per 1,000 births in 1970 to 146 per 1,000 births in 2007. Adult literacy has increased from around 27 percent in 1970 to around 62 percent in 2007. Primary school net enrolments have increased from around 53 percent in 1991 to around 70 percent in 2007. Aid has played a helpful role in this. Yet aid was very limited, averaging around $35 per African per year since 1960. Aid has never been properly resourced or targeted for a focused period to end the poverty trap and thereby to break the dependency on aid. Africa's differences with other regions lie not in aid, but in circumstances and history. Unlike South Asia, for example, Africa has not yet had a Green Revolution of higher food yields, the formative event of India's economic takeoff from the late 1960s. India is a civilization of great river systems and large-scale irrigation, thanks to the Himalayan snowmelt and glacier melt and the annual monsoon rains. Africa is a continent of rain-fed (non-irrigation) agriculture. The original Green Revolution, in which India's food output per land area rose markedly, came in the irrigated systems of Asia, not the rain-fed systems of Africa. US aid heavily subsidized India's Green Revolution while World Bank opposition to aid for African agriculture from the 1980s until recently played an opposite and adverse role, holding back a similar breakthrough for Africa. It was the absence of aid for African agriculture rather than its presence that cost Africa mightily. And one can go on. Africa's tropical disease burden, heavy concentration of landlocked countries, decline of aid for infrastructure during the 1980s and 1990s, and misguided attempts by Africa's creditors to collect debt servicing under "structural adjustment programs" during the 1980s and 1990s all played their part. Moyo now campaigns against the kinds of aid that can keep millions of African children from dying or being maimed for a lifetime through the consequences of serious episodes of disease. She advocates cutting the aid that has allowed more than 2 million Africans access to life-saving AIDS treatment, since governments are involved. Almost unimaginably, she opposes the distribution of anti-malaria bed nets for Africa's hundreds of millions of young people on the alleged grounds that it has put bed net producers in Africa out of business. In her own words: "Finally, with respect to Mr. Sachs' remark that I would see nothing wrong with denying US$10 in aid to an African child for an anti-malarial bed net -- even labeling me as cruel; I say, if working towards a sustainable solution where Africans can make their own anti-malaria bed-nets (thereby creating jobs for Africans and a real chance for continents economic prospects) rather than encouraging all and sundry to dump malaria nets across the continent (which incidentally, put Africans out of business), then I am guilty as charged. Don't forget that the over 60 percent of Africans that are under the age of 24 need jobs not sympathy." The confusion underlying this remark is staggering. There are hundreds of millions of Africans at risk of a killer disease, around two hundred million cases of the disease, and around 1 million preventable deaths per year, yet Moyo is opposed to urgent help if nets are not produced in Africa. She seems both unmoved by the massive suffering and unaware that Africa has gone from producing exactly zero long-lasting insecticidal nets (LLINs) a few years ago to several million per year now, with thousands of jobs in the local industry, as a result of the demand for nets created by aid for malaria control. She takes no note of the fact that global aid for malaria control is also training tens of thousands and soon hundred of thousands of rural Africans as community health workers; and seems to be unaware that unchecked malaria has long devastated Africa's economy while malaria control is finally emptying the hospitals, putting mothers and fathers back to work and children back to school, and contributing to the boost in Africa's productivity and economic growth of recent years. She says that if her position against aid for LLINs is deemed to be cruel, then yes, she is "guilty as charged." Moyo is not offering a reasoned or evidence-based position on aid. Everybody that deals with aid wants to promote financial transparency and market-led growth, not aid dependency. We and others have recommended many successful mechanisms to limit corruption and ensure that aid reaches the recipients, as is happening in the disease-control programs. The purpose of aid should indeed be to break the poverty trap through targeted investments in an African Green Revolution; disease control; children's education; core infrastructure of roads, power, safe drinking water and sanitation, and broadband; and business development, including microfinance and rural diversification among impoverished smallholder farmers. Moyo wants to cut aid off dramatically, even if that leaves millions to die. African leaders - like President Ellen Johnson Sirleaf of Liberia, Dr. Awa Coll-Seck of Roll Back Malaria, and Ministers Charity Ngilu and Beth Mugo of Kenya - have fought for Africa's poor and have used aid to save lives and help economies to prosper. These leaders disagree fundamentally and urgently with Moyo's attacks. They recommend more aid, fully accountable and properly targeted, to meet urgent needs. Since the record shows that Africa has long been struggling with rural poverty, tropical diseases, illiteracy, and lack of infrastructure, the right solution is to help address these critical needs through transparent and targeted public and private investments. This includes both more aid and more market financing. That combination will indeed ensure that private markets and African entrepreneurship can succeed.

May 27, 2009, 4:16 PM

Aid Ironies

The debate about foreign aid has become farcical. The big opponents of aid today are Dambisa Moyo, an African-born economist who reportedly received scholarships so that she could go to Harvard and Oxford but sees nothing wrong with denying $10 in aid to an African child for an anti-malaria bed net. Her colleague in opposing aid, Bill Easterly, received large-scale government support from the National Science Foundation for his own graduate training. I certainly don't begrudge any of them the help that they got. Far from it. I believe in this kind of help. And I'd find Moyo's views cruel and mistaken even she did not get the scholarships that have been reported (Easterly mentioned his receipt of NSF support in the same book in which he denounces aid). I begrudge them trying to pull up the ladder for those still left behind. Before peddling their simplistic concoction of free markets and self-help, they and we should think about the realities of life, in which all of us need help at some time or other and in countless ways, and even more importantly we should think about the life-and-death consequences for impoverished people who are denied that help. Nine million children die each year of extreme poverty and disease conditions which are almost all preventable or treatable or both. Impoverished countries, with impoverished governments, can't solve these problems on their own. Yet with help they can. The Global Fund to Fight AIDS, TB, and Malaria, and the Global Alliance on Vaccines and Immunizations are both saving lives by the millions, and at remarkably low cost. Goldman Sachs, Ms. Moyo's former employer, gives out more in annual bonuses to its workers than the entire rich world gives to the Global Fund each year to help save the lives of poor children. And when Goldman Sachs got into financial trouble it got bailed-out by the US Government. Rich people have an uncanny ability to oppose aid for everybody but themselves. Recently Paul Kagame, President of Rwanda, wrote an op-ed for the Financial Times praising Moyo's fresh thinking. This is extraordinary. His government has depended on aid for more than a decade. Nearly half the budget revenues currently come from aid. Rwanda currently imports around $800 million of merchandise each year, but only earns $250 million or so in exports. So how does it do it? Aid, of course, helped to pay for around $450 million of the imports. Without foreign aid, Rwanda's pathbreaking public health successes and strong current economic growth would collapse. Kagame's op-ed did not help FT readers to understand this. Americans are predisposed to like the anti-aid message. They believe that the poor have only themselves (or perhaps their governments) to blame. They overestimate the actual aid from the US by around thirty times, so they imagine that vast sums are flowing to Africa that are then squandered. Many believe, typically in private, that by saving African children we would be creating a population explosion, so better to let the kids die now rather than grow up hungry. (I'm asked about this constantly, usually in whispers, after lectures). They don't understand the most basic point of worldwide experience: when children survive rather than die in large numbers, households choose to have many fewer children, in fact more than compensating for the decline in child mortality. Africa's high child mortality is ironically a core reason why Africa's population is continuing to soar rather than stabilize as in other parts of the world. Of course, most Americans know little about the many crucially successful aid efforts, because Moyo, Easterly, and others lump all kinds of programs - the good and the bad - into one big undifferentiated mass, rather than helping people to understand what is working and how it can be expanded, and what is not working, and should therefore be cut back. Nor do Americans hear that many poor countries graduate from the need for aid over time, precisely because aid programs help to spur economic growth and successfully prepare countries to tackle future priorities. US aid to India for increased food production in the 1960s paved the way for India's growth takeoff afterwards. There are countless other examples in which countries have benefited from aid and then graduated, including Korea, Malaysia, Taiwan, Israel, and others. Egypt is on that path today, and Rwanda, Tanzania, Ghana, and others will be as well if both donors and recipients carry forward with a sensible assistance strategies. Here are some of the most effective kinds of aid efforts: support for peasant farmers to help them grow more food, childhood vaccines, malaria control with bed nets and medicines, de-worming, mid-day school meals, training and salaries for community health workers, all-weather roads, electricity supplies, safe drinking water, treadle pumps for small-scale irrigation, directly observed therapy for tuberculosis, antiretroviral medicines for AIDS sufferers, clean low-cost cook stoves to prevent respiratory disease of young children. Shipment of food from the US is a kind of aid that should be cut back, with more attention on growing local food in Africa. Out of every $100 of US national income, our government currently provides the grand sum of 5 cents in aid to all of Africa. Out of that same $100, we have found around $10 for the stimulus package and bank bailouts and another $5 for the military. It is not wonderful that what has caught the public's eye are proposals to cut today's 5 cents to 4 or 3 cents or perhaps zero.

May 24, 2009, 1:23 PM

The Geithner-Summers Plan is Even Worse Than We Thought

Two weeks ago, I posted an article showing how the Geithner-Summers banking plan could potentially and unnecessarily transfer hundreds of billions of dollars of wealth from taxpayers to banks. The same basic arithmetic was later described by Joseph Stiglitz in the New York Times (April 1) and by Peyton Young in the Financial Times (April 1). In fact, the situation is even potentially more disastrous than we wrote. Insiders can easily game the system created by Geithner and Summers to cost up to a trillion dollars or more to the taxpayers. Here's how. Consider a toxic asset held by Citibank with a face value of $1 million, but with zero probability of any payout and therefore with a zero market value. An outside bidder would not pay anything for such an asset. All of the previous articles consider the case of true outside bidders. Suppose, however, that Citibank itself sets up a Citibank Public-Private Investment Fund (CPPIF) under the Geithner-Summers plan. The CPPIF will bid the full face value of $1 million for the worthless asset, because it can borrow $850K from the FDIC, and get $75K from the Treasury, to make the purchase! Citibank will only have to put in $75K of the total. Citibank thereby receives $1 million for the worthless asset, while the CPPIF ends up with an utterly worthless asset against $850K in debt to the FDIC. The CPPIF therefore quietly declares bankruptcy, while Citibank walks away with a cool $1 million. Citibank's net profit on the transaction is $925K (remember that the bank invested $75K in the CPPIF) and the taxpayers lose $925K. Since the total of toxic assets in the banking system exceeds $1 trillion, and perhaps reaches $2-3 trillion, the amount of potential rip-off in the Geithner-Summers plan is unconscionably large. The earlier criticisms of the Geithner-Summers plan showed that even outside bidders generally have the incentive to bid far too much for the toxic assets, since they too get a free ride from the government loans. But once we acknowledge the insider-bidding route, the potential to game the plan at the cost of the taxpayers becomes extraordinary. And the gaming of the system doesn't have to be as crude as Citibank setting up its own CPPIF. There are lots of ways that it can do this indirectly, for example, buying assets of other banks which in turn buy Citi's assets. Or other stakeholders in Citi, such as groups of bondholders and shareholders, could do the same. Several news stories suggest some grounding for these fears. Both Business Week and the Financial Times report that the banks themselves might be invited to bid for the toxic assets, which would seem to set up just the scam outline above. What is incredible is that lack of the most minimal transparency so far about the rules, risks, and procedures of this trillion-dollar plan. Also incredible is the apparent lack of any oversight by Congress, reinforcing the sense that the fix is in or that at best we are all sitting ducks. The sad part of all this is that there are now several much better ideas circulating among experts, but none of these seems to get the time of day from the Treasury. The best ideas are forms of corporate reorganization, in which a bank weighed down with toxic assets is divided into two banks -- a "good bank" and a "bad bank" -- with the bad bank left holding the toxic assets and the long-term debts, while owning the equity of the good bank. If the bad assets pay off better than is now feared, the bondholders get repaid and the current bank shares keep their value. If the bad assets in fact default heavily as is now expected, the bondholders and shareholders lose their investments. The key point of the good bank -- bad bank plans is an orderly process to restore healthy banking functions (in the good bank) while divvying up the losses in a fair way among the banks' existing claimants. The taxpayer is not needed for that, except to cover the insured part of the banks' existing liabilities, specifically the banks' deposits and perhaps other short-term liabilities that are key to financial market liquidity. Cynics believe that the Geithner-Summers Plan is exactly what it seems: a naked grab of taxpayer money for Wall Street interests. Geithner and Summers argue that it's the least bad approach to a messy situation, in which we need to restore banking functions but don't have any perfect ways to do that. If they are serious about their justification, let them come forward to confront their critics and to explain to the American people why the other proposals are not being pursued. Let them explain the hidden and not-so-hidden risks to the American taxpayer of the plan that they have put forward. Let them explain why they are so intent on saving the banks' bondholders, even the long-term unsecured creditors who clearly knew they were taking market risks in buying Citibank bonds. Let them work with their critics to fashion a less risky and less costly plan. So far Geithner and Summers tell us that their plan is the only option, but without a word of further explanation as to why.

April 6, 2009, 11:14 AM