The Senate Banking Subcommittee Hearing on Commodity Activities of Financial Holding Companies (July 23, 2013)

In my previous post, I discussed the problems with a New York Times article on aluminum that seemed timed to precede by a couple of days a hearing held by a subcommittee of the Senate Banking Committee on the permissible activities of financial holding companies. The hearing focused on whether these companies should be permitted to own affiliates involved in such activities as storing physical commodities or generating electricity. The hearing itself did not produce any insights into the aluminum issue but it did usefully shed light on the legal and regulatory developments that resulted in some financial holding companies, notably J.P. Morgan Chase and Goldman Sachs, being in these businesses.

Three witnesses at the hearing argued that financial holding companies involvement in these types of activities should either be prohibited or sharply curtailed: Tim Weiner of MillerCoors, Joshua Rosner of Graham Fisher & Co., and Saule Omarova, an associate law professor at the University of North Carolina at Chapel Hill. Joshua Rosner is the coauthor of Reckless Endangerment, a book I criticized in this blog post. I know Saule Omarova slightly. She was a senior adviser to Randall Quarles when he was Treasury Under Secretary for Domestic Finance in the George W. Bush Administration. I do not know her party affiliation, if any, but many Republicans who follow these issues likely disagree with her forcefully presented and strong opinions on the issues discussed at the hearing.

One witness, Randall D. Guynn, a partner and head of the Financial Institutions Group at the law firm, Davis Polk & Wardwell, argued that no changes needed to be made to curtail financial holding companies activities with respect to physical commodities or electric power generation. Interestingly, both Randall Quarles and Saule Omarova have also worked at Davis Polk. Quarles was at one point the co-head of the Financial Institutions Group.

In his testimony, Mr. Weiner implies that MillerCoors purchases and obtains aluminum through the LME market. However, he does not say that MillerCoors obtains the bulk of the aluminum it uses in this manner. Given the delays he claims, up to 18 months for “aluminum users like MillerCoors,” this is doubtful. There does not appear to be any shortage of beverages in aluminum cans available for purchase by American beverage drinkers. What is most likely is that companies needing aluminum obtain it directly from the companies that produce it. What MillerCoors is apparently upset about, as mentioned in my previous post, is the increase in the “premium” they have to pay. The reason for that remains unclear. Unfortunately, none of the Senators at the hearing questioned Weiner on these issues.

Whether Goldman was deliberately manipulating the aluminum market by its warehouse practices, though, is a separate issue from whether financial holding companies should be in this business at all. Saule Omarova in her testimony and a draft law article she cites in her written statement provides interesting background to the legal development resulting in permitting financial holding companies into the physical commodity business. I also agree with her that financial holding companies should not be permitted to do this. They have conflicts of interest and financial advantages provided by the federal government that argue strongly for limiting what lines of business are permissible for these companies.

“Shuffle of Aluminum” – A Disappointing Investigative Article in the New York Times

On July 20, the New York Times posted an article on its website, “A Shuffle of Aluminum, but to Banks, Pure Gold,” which appeared on the front page of the Sunday edition the next day. The article’s thesis is that Goldman Sachs, through a subsidiary, Metro International, has been keeping the price of aluminum artificially high and collecting unjustified storage fees. The article alleges that they do this by being excessively slow in delivering aluminum out of warehouses designated as good delivery points for aluminum futures trading on the London Metal Exchange (“LME”). Also, the article maintains that Metro shuffles aluminum among around different warehouses in Detroit in order to satisfy LME rule requirement regarding minimum deliveries of aluminum out of approved warehouses.

The article attracted a good deal of attention, especially among those who distrust or have a professional interest in disparaging Wall Street. It was timed to precede by a couple of days a hearing before a subcommittee of the Senate Committee on Banking, Housing, and Urban Affairs focusing on whether financial holding companies, such as Goldman, should be in the physical commodity business at all. There is also now a private lawsuit against Goldman and the LME charging them with antitrust violations by limiting the amount of aluminum available and keeping the price artificially high.

I am not an expert on the aluminum market and do not know whether the allegations against Goldman and the LME have any merit. However, while the Daily Show made fun of those who found the New York Times article confusing, the New York Times article was badly written and, in my view, not ready to print. While the reporter, David Kocieniewski, is on to something, he did not fully explore the issue.

One problem with the article is that the story of a “merry-go-round of metal” appears to be based on interviews with forklift drivers. They are certainly worth talking to, but the reporter did not apparently see or ask for the documentation behind the movements, nor did he obtain an explanation from either Metro or Goldman. In its reply to the article, Goldman states that “it is the owners of the metal who direct warehouse operators to dispose of stored metal or transport metal from LME-approved warehouses to warehouses outside the LME system to meet their own needs or objectives.” Kocieniewski should have explored this issue.  

The article also does not address how the major purchasers of aluminum obtain the metal. It suggests that they buy it on the LME futures markets and stand for delivery. Futures markets, though, are usually used for hedging and speculation, not as marketplaces used to obtain a physical commodity. Some contracts, of course, culminate in delivery, but the amounts are usually not that significant. The reason for a delivery option is that the potential for or threat of delivery ensures that prices in the cash and futures markets converge at the time that the futures contract matures.

Another problem with the article is that it does not discuss the reason aluminum in storage has increased. On this point, Mr. Charles Li, the CEO of HKEx, the Hong Kong firm that now owns the LME, argues that aluminum producers did not cut production and that the global slowdown in the world economy led to reduced demand. The futures markets started pricing aluminum too high relative to the spot price; that is, the cost of aluminum in the cash market plus the cost of carry (storage, interest, and insurance) is lower than the futures market price. This occurred in a situation where the cost of carry had decrease because interest rates had fallen. In such a situation, the obvious arbitrage is to buy the physical aluminum, put it (or keep it) in storage, and sell an equal amount on the futures market. This effectively locks in a profit, though it is not entirely riskless. The risk to this position is that the short position on the futures market may require variation margin payments if the price of aluminum increases (the loss on the short position is offset by a gain in the market value of the physical aluminum, but that does not bring in cash until the position is sold).

Theoretically, this arbitrage should continue until the futures price equals the spot price plus the cost of carry by raising the spot price and lowering the futures price. The arbitrage also has the effect of locking up some aluminum in storage, and it is owned for a time by arbitrageurs who never intend to use the metal for any industrial purpose.

Goldman, in its rebuttal to the Times article claims, however, that “approximately 95 percent of the aluminum that is used in manufacturing is sourced from producers and dealers outside of the LME warehouse system,” and that “aluminum stored in Metro warehouses amounts to approximately 1.5 million tonnes, compared with global aluminum production in 2012 of about 48 million tonnes.” The Times article should have incorporated a discussion of the sources of aluminum to users and addressed the contention that there is no shortage of aluminum to those who want it.

A point on which both Mr. Li and the Times article agree is that there has been an increase in the “premiums” purchasers of physical aluminum have to pay over the spot price due to the warehouse delays. It is not clear why large companies, such as MillerCoors or Coca-Cola, do not have the ability to strike a more favorable deal on premiums with companies such as Alcoa. There is probably an explanation, but the Times article does not provide it.

Another omission from the Times article, particularly significant due to its timing preceding the Congressional hearing on permissible businesses for financial holding companies, is the apparent intent of Goldman and J.P. Morgan Chase to exit the metal warehouse business. The Financial Times reported on July 14, i.e., before the New York Times article appeared, that these two firms “are seeking to sell their metal warehousing units just three years after their controversial entry to the industry, even as a proposed rule change by the London Metal Exchange is likely to reduce the attractiveness of the business.” The New York Times could have usefully mentioned this.

While one can understand that the Times wanted to publish this article before the Congressional hearings, not all the necessary reporting had been done. The news editors should have insisted that the reporter develop more information. Somewhat surprisingly, the editors of the editorial pages wrote an editorial on this subject that was better than the news article. You can read it here.

Some Reactions to Edward Snowden’s NSA Disclosures

Current news stories about the National Security Agency reminded me of a book I read in the early 1980s: James Bamford’s first book on the NSA, The Puzzle Palace: America’s Most Secret Agency (Houghton Mifflin, 1982). At that time, the NSA was not well-known, and, for me, the book revealed capabilities of the U.S. Government and a history about their use of which I had been unaware. My reaction at the time was that the NSA could become a very powerful tool for nefarious purposes if unethical, power-hungry people were to become in charge of the Executive Branch.

Recently, I read an interesting book, Subversives: The FBI’s War on Student Radicals, and Reagan’s Rise toPower (Farrar, Straus and Giroux, 2012), which focuses on the FBI’s relationship with Ronald Reagan while he was in the movie industry as an actor and union leader and then as governor of California unhappy with and fighting developments at the University of California at Berkeley. Amazingly, it took the author, Seth Rosenfeld, a former San Francisco newspaper reporter, decades, beginning in the early 1980’s with multiple lawsuits using the Freedom of Information Act, to pry from the FBI the documents on which the book is based, even though J. Edgar Hoover has been long gone. The book’s title, of course, is ambiguous. Who were the real subversives?

When it comes to the current NSA revelations, defenders and apologists for what the NSA does and the legal framework it operates under can point to Hoover and say what matters are the people, not the technology. After all, Hoover was able to trample on civil liberties and retain power by gathering compromising information on key political players without today’s super computers and near limitless digital storage capacity. In a sense, they have a point; there is no evidence of which I am aware that the NSA has been used to attack domestic political opponents.

It is, though, a limited point. The defenders and apologists miss some reasons for the current concerns, including the innate conservatism of bureaucracies and the temptations of the surveillance apparatus which these bureaucracies will mightily defend. Does anyone doubt that, upon a new Administration entering office, the intelligence community, including the NSA, would be endeavoring to convince their new political masters of the vital role that they play and that their way of doing things, at least for the most part, is essential? They probably make an effective case.

What then are the concerns?

First, it is not difficult to imagine an Administration, faced with some difficult problem, bending the law, maybe just a little, in order to achieve something they believe to be crucial. The problem is that once one goes down that path, it is perhaps easier to justify the next venture going into an area colored by a deeper shade of grey. And, since it is all done in secrecy, there is no need to worry about the media or public comment (as long as leaks do not occur).

Second, the notion of a FISA court approving programs in secret, creating a classified body of law, and doing this without the traditional adversarial procedures that are a key element of our judicial tradition is both laughable and disturbing. Even granting the need to preserve operational secrecy, the development of secret judge-made law is contrary to what most of us thought the American political system stood for.

Third, American history is replete with examples of civil liberties being eroded, if not just completely obliterated, during times of fear. Examples include the Palmer Raids (1919-1920) during the Red Scare of the early 20^th century, the internment of Japanese-Americans on the west coast during World War II, and the excesses of the McCarthy period. Past excesses have eventually been corrected after doing substantial damage to people’s lives, but they have gone quite far before being pulled back. Now we have the rise of the surveillance state, currently justified by the specter of terrorism since 2001.    

Fourth, the collection of information for one purpose easily leads to other uses. Someone will think that information collected for a particular purpose, e.g., protecting against terrorism threats, should be used for some other purpose. Pick your favorite cause: combatting drug trafficking, fighting corporate crime, gathering information on “subversives,” etc.

Finally, it is worrying, not reassuring, that some other governments, such as those of the UK and France, have active surveillance programs. While one might argue, as some have, that French protestations about the NSA are hypocritical, that observation is not dispositive of the concerns.

While intelligence agencies of allies may not always cooperate, since national interests diverge, it seems likely that they also share surveillance information with one another. In some cases, the particular shared information may not be legal according to domestic law for the agency receiving it to collect itself. However, it may not be illegal for the agency to receive it from another government and to use it and store it. In fact, Mr. Bamford in his 1982 book writes about the 1978 FISA law in this regard that the NSA had “skillfully excluded from the coverage of the FISA statute as well as the surveillance court all interceptions received from the British GCHQ or any other non-NSA source. Thus it is possible for GCHQ to monitor the necessary domestic or foreign circuits of interest and pass them on to NSA through the UKUSA Agreement. Once they were received, NSA could process the communications through its own computers and analysts, targeting and watch-listing Americans with impunity, since the action would not be covered under the FIS statute or any other law” (pp. 372-373). (I have not researched any changes to the law since this was written. It may not even be possible to ascertain what the law on this is now, given the secrecy surrounding judicial interpretations.)

At the end of his book, Subversives, Seth Rosenfeld writes:

“On the morning of May 2, 1972, J. Edgar Hoover was found dead on the floor of his bedroom. Helen Gandy, his longtime secretary, quickly executed one of his final orders: to destroy his personal office files.

“Thirty-five file cabinet drawers full of records were removed from his office and shredded. Gandy would later testify that none of them involved bureau business, that they were all private. But some documents survived, having been transferred to other files. They concerned illegal black bag jobs and other highly sensitive matters…”

Of course, the collection of massive computer records cannot be managed nor destroyed by one secretary, nor is it reliant on one official answerable only to himself. Recent polling results suggest that public attitudes concerning the perceived tradeoff between civil liberties and security may be changing. There is both domestic and international pressure for governments to let their publics know more about what they are doing. Preserving civil liberties requires constant vigilance; unchecked, there are great temptations for governments to erode these liberties, even if this does not begin with malicious intent.

What Does John Makin Believe?

I was interested to read recently at the Huffington Post that John Makin, an economist at the American Enterprise Institute (“AEI”), a conservative Washington, DC think tank, had recently written that the U.S. was already on a deficit reduction path and that there should not be more deficit reduction at the current time. Of course, liberals like this message coming from a conservative, but, if one reads Makin’s paper, there is much in it for liberals to dislike. The paper does not appear, though, to be aimed at convincing liberals. It is aimed at a different audience.

Before turning to this recent paper, I note that Paul Krugman once praised John Makin in a post about an article Makin had written in 2010. The title of Krugman’s post was “John Makin’s Hair Is On Fire.”  Krugman wrote that even though Makin is a political conservative at a “right-wing think tank,” he had written “something I or Jan Hatzius (Goldman’s chief economist — never mind the Blankfein stuff, the econ group is very good, and very pessimistic) might have written. Except Makin is even more gloomy, warning that we might enter deflation this year.” 

The article to which Krugman was referring is a July 2010 Economic Outlook piece called “The Rising Threat of Deflation.”  It is worth reading, and it certainly does not toe the line that austerity (“fiscal consolidation”) is a good idea.  At the end of the article, Makin writes:

“The G20's shift toward rapid, global fiscal consolidation--a halving of deficits by 2013--threatens a public sector, Keynesian ‘paradox of thrift’ whereby because all governments are simultaneously tightening fiscal policy, growth is cut so much that revenues collapse and budget deficits actually rise. The underlying hope or expectation that easier money, a weaker currency, and higher exports can somehow compensate for the negative impact on growth from rapid, global fiscal consolidation cannot be realized everywhere at once. The combination of tighter fiscal policy, easy money, and a weaker currency, which can work for a small open economy, cannot work for the global economy.

“The link between volatile financial conditions and the real economy has been powerfully underscored by the events since mid-2007. Growth has suffered and subsequently recovered given powerful monetary and fiscal stimulus. And yet, the damaged financial sector, unable to supply credit; a jump in the precautionary demand for cash; and a persistent overhang of global production capacity have combined to leave deflation pressure intact. The G20's newfound embrace of fiscal stringency only adds to the extant deflation pressure.

“No wonder no country wants a strong currency anymore, as attested to by Europe's easy acceptance of a weaker euro. The acute phase of the financial crisis is over, but the chronic trend toward deflation that has followed it is not.”

One can criticize Makin’s 2010 article for being overly pessimistic; deflation has not happened. It was, though, a solid piece of analysis of the risks. Unfortunately, one cannot say the same about the analysis in his new Economic Outlook piece, “Austerity Undone” or his shorter Guardian article on the same subject.

In “Austerity Undone,” he writes that the now-famous Carmen Reinhart and Kenneth Rogoff article implying that a 90 percent debt-to-GDP ratio represents a danger point “has been shown to be seriously flawed.”  He states that there are now doubts about both “fiscal austerity” and “a resumption of Federal Reserve tightening.” After all, “U.S. inflation is slowing and bond yields are falling…” 

So far, so good. Makin, though, then begins to generate some confusion when he turns his attention to a recent IMF report. He writes:

“Underscoring the widespread confusion about the use of fiscal austerity, the IMF's Fiscal Monitor, after charging the United States with tightening fiscal policy too rapidly, singled it out as among the 10 countries with ‘the most severe fiscal problems,’ suggesting that it still needs to agree on medium-term deficit reduction targets.

“The IMF Fiscal Monitor prescriptions for the United States are badly muddled and ignore significant changes in its fiscal stance. The decried sequester does cut annual spending next year by about $120 billion if it is not rescinded by a nervous and confused-no thanks to the IMF-Congress. Let us hope the sequester is left in place, providing as it does a modest $1.2 trillion worth of spending cuts (only about 2.5 percent of federal spending over the next decade).”

Makin appears to be criticizing the IMF for saying that, while the U.S. has implemented too much austerity in the here and now, it is not doing enough about the deficit in the “medium term.” This view can be criticized, but Makin’s does not make entirely clear his reasons for disagreeing with the IMF. He does say that the IMF ignores the progress that has been made in cutting the budget deficit in the next few years, though Makin just assumes, with no explanation, that this is good policy.  He then turns his attention to the sequester, which he claims to be a “modest” budget cut, but one which he approves. Why? He does not say, but there seems to be an implicit assumption that his audience shares his view that cutting budget spending is usually good idea, even if done in a thoughtless way. Note that he has not prepared the ground for this, because his earlier discussion said there was doubt that austerity is a good idea. He does not give a reason why “modest” austerity is then a good idea; he just assumes it. Perhaps that is a given in the lunchroom at AEI, but it is not elsewhere. And his earlier statements about austerity might not meet with AEI lunchroom approval.

Another Makin opinion that may not sit well in some Republican circles is his statement that “fiscal austerity has been moderate and probably, at the current pace of deficit reduction of about $300 billion per year over the next half decade, has proceeded far enough for now.” In fact, some liberals disagree with this too, believing that the current priority should be growth and that requires increased government spending in a time of lagging private sector demand. In this paper, Makin does not provide a rationale for his position. Why is some austerity called for now, but just the current amount? The reader has no way of knowing what type of economic model Makin is relying on for his judgments.

Makin does take pain, though, to burnish his conservative credibility by criticizing the President’s budget proposal. He claims “it does not advance the fiscal debate.” Really? One may agree or disagree with the Administration’s proposals – and plenty of liberals disagree with some parts of the Administration’s budget – but to say there is no debate to be had here makes no sense. Reading on, it becomes clear what Makin really means. According to his analysis, the Administration’s budget does not reduce the deficit – in his words, advance us on “the road to sustainable fiscal policy.” In other words, the Administration does not advance the fiscal debate because Makin does not agree with what the Administration has proposed. And, he still has not explained why deficit reduction right now is more important than growth-oriented policy. Unlike some fiscal hawks, Makin is not one who argues that deficit reduction is pro-growth. He writes:

“… It is necessary to remember that placing the United States on a sustainable fiscal path after four years of trillion-dollar deficits will have consequences in the short term. Coupled with a ‘tax’ of about $90 billion from higher oil prices, the total of fiscal and oil drag prior to sequester is about $270 billion, and $45 billion in 2013 sequester raised that to $315 billion, or nearly 2 percent of GDP. That drag needs to be contrasted with average fiscal thrust of nearly 3 percentage points of GDP over 2009-12.

“The ‘fiscal swing’ of 5 percentage points of average 2009-12 fiscal thrust of 3 percent of GDP to 2013's 2 percent of GDP drag means that a sharp US slowdown may occur in mid-2013, notwithstanding the heartening signs of growth in the housing sector and a strong push from rising stock prices, all occurring while interest rates remain remarkably low. Still, Congress should not try to reverse deficit reduction progress as the president's budget has in effect suggested. Sequestration will be blamed for any slowdown, but really the cause will be a swing from steady previous stimulus to about $225 billion of fiscal drag along with some bad luck supplied by about $90 billion in higher energy costs.”

This leaves the reader still puzzling why this “fiscal drag” is a good idea, even if factors other than the sequester contribute more to the drag. Why should the government (Congress and the Administration) not pursue in a slowing economy policies generating “fiscal thrust”? Makin assumes we know the answer to that, but readers who do not instinctively share this belief are left puzzled. One wonders how Makin would articulate his position on this if challenged, which I assume is not likely to happen at AEI’s offices in Washington, DC.

Finally, when it comes to deficit reduction, it is clear that Makin prefers spending cuts to tax increases. That is a defensible ideological position, especially if one’s political philosophy leads one to the conclusion that the government’s role is currently too large. But if you are going to contend that one is preferable to the other in terms of the impact on the economy, then one should have an economic argument to back up this assertion. Here is what Makin says:

“Republicans will decry the January 2013 tax increases as crippling the economy and vow to allow no more. Democrats will decry the sequester spending cuts and vow to allow no more spending cuts without tax increases. The president has already proposed rescinding the sequester. The reality the current weak economy is demonstrating is that further tax increases to replace the deficit reduction by the sequester as proposed by the president would weaken the economy even further.”

Makin gives no reason for the contention in the last sentence. Why is that? My guess is that this paper is not really meant as an objective view of the fiscal situation and economic outlook. The evidence is that Makin is perfectly capable of good economic analysis if that is what he wanted to do. Rather, the purpose of this article is to convince Republicans that budget austerity has gone far enough for now. The political reality is that Makin has no hope in convincing them to reverse course, and he knows that. He is worried, though, that additional austerity would be devastating and is trying to convince Republicans in Congress of that while making statements that preserve his conservative credibility. He does not have to justify these statements to his intended target audience.

We are left, though, wondering what Makin actually believes. He may well believe that the current amount of austerity is correct and that increasing taxes and cutting the amount of the sequester by equal amounts is bad policy. Since he gives no reasons, we are left to wonder.

Personal Note:   Early in my career I met John Makin, though I doubt he remembers me. He did some consulting work for the Treasury when I was working on U.S. balance of payment issues. He was trying to use a statistical methodology (Box-Jenkins) to predict the large statistical discrepancy that is put on the capital account side to make the capital and current account balances offset each other exactly, as they must from an accounting perspective. I also ran across him, I believe, in earlier jobs I had in international monetary research at Treasury and at the Federal Reserve Bank of San Francisco.

Politico Hypes Story about Congress and the Affordable Care Act

Politico has a story posted late yesterday with the headline, “Lawmakers, aides may get Obamacare exemption.” There is some real news in the story; leaders in Congress are looking for ways to change the provision of the Affordable Care Act (“ACA”) which denies members of Congress and their staff health insurance under the Federal Employees Health Benefit (“FEHB”) Program once the insurance exchanges mandated by the ACA become operational. Therefore, members and their staff under this provision will be denied employer-provided health insurance and will need to find coverage through the exchanges. (On the MSNBC cable show, Morning Joe, Mike Allen of Politico hyped this story and did not receive any questions that would have forced him to explain what this is really about. Mike Allen’s appearance can be viewed at the end of this clip.)

Politico’s presentation of this story is misleading and will provide fuel to the anger many feel about the ACA without really understanding it. In fact, the provision in question is in fact an exemption from the requirement that employers over a certain size provide health insurance to their employees. The provision, which was introduced by Senator Chuck Grassley (R., IA), reads as follows:

“(D) MEMBERS OF CONGRESS IN THE EXCHANGE.—

(i) REQUIREMENT.—Notwithstanding any other provision of law, after the effective date of this subtitle, the only health plans that the Federal Government may make available to Members of Congress and congressional staff with respect to their service as a Member of Congress or congressional staff shall be health plans that are—

(I) created under this Act (or an amendment made by this Act); or

(II) offered through an Exchange established under this Act (or an amendment made by this Act).

(ii) DEFINITIONS.—In this section:

(I) MEMBER OF CONGRESS.—The term ‘‘Member of Congress’’ means any member of the House of Representatives or the Senate.

(II) CONGRESSIONAL STAFF.—The term ‘‘congressional staff’’ means all full-time and part-time employees employed by the official office of a Member of Congress, whether in Washington, DC or outside of Washington, DC.”

The ACA (or “Obamacare”) is, of course, more than the exchanges, and U.S. residents are subject to and affected by provisions of the ACA whether or not they obtain health insurance through the ACA exchanges. Employers, such as corporations or the federal government, are supposed to offer their employees health insurance. The reason the ACA contains this provision removing most members and their staffs from the FEHBP was political. Now Congress realizes that this causes a problem for recruiting and retaining staff, since the rest of the federal government will continue to use the FEHBP. The FEHBP insurance plans are likely to be more attractive than what it is offered on the exchanges. It is a political problem for them to fix this, but to say that they are seeking an Obamacare exemption is misleading.

There is some confusion about the meaning of the Congressional provision. It appears generally accepted, as the Politico article states, that the provision does not cover the staff of Congressional committees. More subject to debate is whether the provision extends to the staffs of the Congressional leadership. The Politico article also says that it does not extend to members of Congress currently receiving Medicare benefits. I cannot find any support elsewhere for this contention and cannot say whether Politico is correct about this.

With regard to Medicare, it seems as if the provision could be read to deny some members and their staff Medicare benefits. It could be construed that their eligibility for Medicare is based on their service in Congress, if they had no significant employment elsewhere, and that Medicare is a health care plan offered by the federal government. That obviously was not the intent of the law, and I doubt that it will be interpreted that way. This may need to be clarified at some point. However, unless Politico is relying on some provision of the ACA that I am unable to locate, it would appear that under current law members of Congress and their staff eligible for Medicare will need to look elsewhere than the FEHB to supplement Medicare coverage.

It also appears that this provision will remove one benefit of federal employment, to continue to receive FEHB insurance as an annuitant. Congressional staff members who were planning on that for retirement will likely seek employment elsewhere in the federal government if the provision is not amended or repealed.

Politico is obviously trying to gain readers by hyping this story. It is a legitimate story; Congress has a political problem in amending or repealing this provision though there are persuasive arguments to do this. But in presenting the story in this misleading way, Politico is doing more than reporting; it is becoming a political actor inflaming opponents of the ACA with a false story line. That is not what one should expect from a news outlet founded by former Washington Post journalists that wants to be taken seriously.

More on the Chained CPI (April 18 House Ways and Means Subcommittee Hearing)

On April 18, the Subcommittee on Social Security of the House Ways and Means Committee held a hearing on the proposal to use the chained CPI-U to index Social Security payments. This index increases at a somewhat slower pace than the CPI-W, the index to which payments are currently indexed. 

The hearing was stacked in favor of the change. There were two proponents of the change, Charles Blahous and Ed Lorenzen; two government witnesses – Jeffrey Kling (Assistant Director for Economic Analysis, Congressional Budget Office) and Erica Groshen (Commissioner of the Bureau of Labor Statistics – who, while assuming a neutral stance, clearly believe that the chained CPI-U is a better index to measure the change in the “cost of living”; and one witness, Nancy Altman, who opposed the change and any other changes to Social Security at this time.

Reading the prepared statements is dispiriting. This is a political fight that some pretend to be all about a technical fix. To the proponents of the chained CPI-U, the argument is that it is a better index, this is a technical fix, and using it helps shore up Social Security finances. Charles Blahous couches his recommendation by saying that the chained CPI should be used for all government programs if Congress is persuaded that it is a better index, though it is fairly clear that Mr. Blahous believes that Congress should be persuaded of that. He also says that if the chained CPI-U is adopted, there should be no exceptions. He does not mention that the Administration in its budget proposes that the chained CPI-U not be used for means-tested government programs. Also, he, like most everyone else, ignores the inflation indexation of some Treasury securities. For reasons mentioned in my previous post on this subject, it is not legal to use chained CPI-U for outstanding inflation-indexed securities and not practical to use it for forthcoming issues of these securities.

The proponents also brush aside the long delay (years, not months) in getting final numbers for the chained CPI-U. They just point out that CBO has come up with some ways to use initial numbers. This is still, though, a real problem, and would likely become more so in higher inflationary environments than we are currently experiencing.

For her part, Ms. Altman argues that using the chained CPI-U is a benefit cut which hits the most vulnerable and that it is a worse, not better, index for measuring the cost of living for seniors.  On the latter point, she points out that the CPI-E, the experimental inflation index for those 62 and over, generally shows more inflation than the CPI-W. Therefore, moving to an index that increases more slowly than the CPI-W is even less accurate.

The real disagreement between Ms. Altman, on one side, and Mr. Blahous and Mr. Lorenzen on the other, is on whether we need to cut Social Security benefits. Blahous and Lorenzen use graphs from the Social Security trustees to show that the Social Security trust funds will be running out of money. Lorenzen says using the chained CPI-U is an easy fix; Blahous argues that there is an urgent need for real reform of Social Security and he does not consider adopting the chained CPI-U reform of the system. Altman uses data from the Social Security trustees projecting that Social Security benefits will reach 6.1 percent of GDP and stay there in the future, a percentage she says we can easily afford.

The fight over the chained CPI is an opening skirmish in more fights about Social Security cuts.  The outcome of this opening skirmish on a highly technical subject will not be decided objectively, but politically. It is interesting, though, that Andrew Biggs, a former principal Deputy Commissioner of the Social Security Administration and currently a resident scholar at AEI, a conservative think tank, has recently written in opposition to the chained CPI:

“It's hard to see how chained CPI can be a win for conservatives. With congressional Democrats opposed, the narrative is already forming that President Obama only proposed using the chained CPI to appease congressional Republicans. But why should Republicans take the rap for a measure that weakens Social Security for the least well-off and institutes a large and regressive tax increase? Higher taxes and a less effective Social Security program - what's not to dislike?”

Some Comments on the Chained CPI Controversy

I have perhaps a unique perspective on the Administration’s proposal in its FY 2014 Budget to use the chained CPI-U (“C-CPI-U”) for “most” government programs indexed to an inflation measure, including Social Security, and for the indexation in the Internal Revenue Code (see last page of this link). As a Treasury official, I once had to decide what inflation measure would be used for a new security we were developing – inflation-indexed bonds and notes, which are now called Treasury Inflation-Protected Securities (“TIPS”). While various indices had been proposed, the choice was not all that difficult – the CPI-U (all urban consumers) was the most recognized measure of inflation, though Social Security is indexed to a somewhat narrower index, the CPI-W (urban wage earners and clerical workers.)  However, while the headline monthly inflation number uses the seasonally adjusted version of the CPI-U, TIPS use the non-seasonally adjusted number because it is not subject to revision.  In order for there to be a well-functioning market for these securities, there needs to be finality in the index numbers. On trade and settlement dates, the nominal values of the principal and accrued interest need to be known with certainty.

One concern those of us who worked on TIPS had was the possible perception that the U.S. government had a conflict of interest in indexing securities to an index the U.S. government produces. We hoped people would understand that the Bureau of Labor Statistics (“BLS”) was not under the influence of the Treasury and staffed by objective economists and statisticians not subject to political influence. It did not help matters, though, that the Federal Reserve was at the time trying to persuade the BLS that the CPI needed technical fixes. All the technical fixes the Federal Reserve was proposing would lower inflation as measured by the CPI. While at least some of the Fed's suggestions were likely justified and the BLS made some changes, I did find it peculiar that they all went in the same direction -- lowering reported inflation. Were there no arguably necessary technical fixes that went in the opposite direction? And didn't the Fed's lobbying of the BLS seem a little like a student complaining about his grade to his teacher?

This brings out two concerns about the Administration’s proposal. First, it is not clear how the Administration plans to handle revisions in the chained CPI. The revisions are necessary because the calculations are based on expenditure data which are only available with a lag. According to the BLS, the initial data for the current calendar year is subject to two revisions. The next calendar year, interim data will be published for the previous calendar year, and, the year after that, final values will be published. If Congress and the Administration decide to use the C-CPI-U, they will have to decide whether or not they will ignore revisions to the initial data.

While this first concern is a technical problem, the second concern is more political. The Administration and supporters can protest all they want that using the C-CPI-U is justified on the grounds that it is a more accurate measure of inflation. No one will believe it. Even the Administration seems to contradict this premise, because it has proposed “protections” from the effects of indexing Social Security to the C-CPI-U for the elderly (starting at age 76). Also, means-tested benefit programs would not be indexed to the C-CPI-U.

Patrick Brennan, who writes for the National Review, also argues that the real reason to use the C-CPI-U is not because it may be a more accurate measure of inflation. In a recent article, he states that those who argue over which index to use for Social Security, perhaps a chained CPI for older consumers, are “missing the point: Chained CPI has been proposed because it is expected to slow one of the ways in which Social Security benefits are scheduled to increase, though it also happens to reflect that those increases were probably more generous than intended. Debating the most accurate measure of inflation is merely the most politically palatable way of limiting how much we are willing to promise in retirement benefits to every American. That kind of limitation has to happen somehow, unless Americans would prefer significantly higher taxes, much less spending on other federal priorities, or permanently higher levels of debt.” (Of course, as many of pointed out, there are other ways to improve Social Security finances, such as raising or eliminating the ceiling on the amount of salaries or wages to which it is applied.)

A perhaps somewhat more objective observer, Peter Coy, the economics editor of Bloomberg Businessweek, writes in another recent article that the chained CPI proposal is “presented as a technical, politically neutral fix, but make no mistake: The Obama administration’s proposal to change the basis for Social Security raises to ‘chained CPI’ is all about saving money by slowing the growth rate of benefits. Whether you think that’s a good thing or a bad thing depends on whether you believe workers have been paying too much to support their elders.”

I would also point out that there are people who feel that the current CPI under reports inflation. Many of the people who think this are probably not liberals and generally distrust the government. It is true, though, as anyone who has been involved in creating or calculating economic indices knows, there is no perfect index, whether it be an inflation, foreign exchange, stock market, or other index. In producing a general inflation measure, there will always be an element of judgment about how to do it.

Also, choosing the right index is a judgment call. If the purpose of indexing Social Security benefits is  to protect those receiving them from increases in prices, an argument can be made that a chained CPI based on the basket of goods and services older people consume would be justified. This might, though, mean indexing different parts of Social Security differently, as the Administration already proposes to some extent, since not all who receive Social Security benefits are elderly.

While liberals’ problems with the chained CPI proposal are obvious, it also poses a dilemma for Republicans. Since tax brackets would be indexed to an inflation measure, this would serve to increase taxes over time. Contrary to some commentary I have seen, this would even apply to those in the top marginal bracket. While these high income taxpayers would not see an increase in their marginal tax rate over time because of the chained CPI proposal, their average tax rates would increase as the lower brackets moved up more slowly than they would under current law. It is not politically possible for Social Security to be indexed to the C-CPI-U without doing the same to tax brackets.

While a grand budget bargain seems unlikely, those who are concerned about the chained CPI proposal because of its effect on Social Security benefits, taxes, or both, should not be entirely complacent.  There could be a smaller budget bargain that includes this.

Finally, with respect to TIPS, the index for the existing securities cannot be changed, since this is part of the terms and conditions for these securities. Also, as I indicated above, there would be problems with indexing new securities to an index subject to revision. The Treasury Department, though, might have a bit of a public relations problem if the chained CPI proposal were to become law. It might have to justify indexing securities designed to “protect” investors from inflation to an index that indicates higher inflation than that used by the government to calculate Social Security benefits or tax brackets.