Sen. Harry Reid has gone ahead with the so-called "nuclear option" to attempt to change Senate filibuster rules on some executive branch nominations, passing the rule change with a 52-48 vote. In their Vital Statistics on Congress report, Brookings Senior Fellow Thomas Mann and AEI Resident Scholar Norman Ornstein provide data on the number of attempted Senate cloture votes taken from 1979 to 2012, the 96th to 112th Congresses. The chart below demonstrates the average attempted cloture vote taken by party when that party was in the minority.

For more data on both attempted and successful cloture votes sine 1919, look up table 6-7 in Vital Stats (PDF).

Senior Fellow Sarah Binder, a leading expert on Congress and congressional history who called, in 2010, the Senate filibuster a "mistake," offered a recent analysis of Senate cloture votes, writing that "Counting cloture votes remains an imperfect — but still valid — method of capturing minority efforts to block the Senate."

More recently, Binder wondered whether "Democrats have the guts to go there and, if so, whether that compels any Republicans to stand down."

HHS Secretary Kathleen Sebelius may lose the most from the Senate’s rule change on the filibuster—and the Affordable Care Act may be healthier for it. I wrote last month on the FixGov blog that “Republicans are the Reason Secretary Sebelius Won’t Resign” (or be fired). That argument is no longer valid. My claim—the president’s inability to get her successor confirmed because of filibustering Republicans—is nullified by the Senate’s rule change, and the benefits may reach far beyond Obamacare.

The Implications of Filibuster Reform for Healthcare

Problems exist in HHS. No one denies it. However, for many appointees in the Department, the Senate rules served as a life preserver in a torrent of poor implementation, managerial failures, and bad PR. So long as the president faced the prospect of long-term vacancies among appointees overseeing ACA, the HHS leadership would be spared.

Today, that all changed. Moving forward, President Obama needs the support of only 51 Senate Democrats to replace top-level political appointees throughout the executive branch. This offers the president substantial breathing room. Nominees no longer need the support of every Democrat and a scarcely identifiable five Republicans. Instead, nominees can draw the ire of as many as four Democrats and still be confirmed.

Maybe Kathleen Sebelius is not to blame for the botched healthcare marketplace roll out. Maybe her Office did not give the thumbs up for the President to repeat “if you like your plan you can keep it.” Maybe she did not contribute to the poor salesmanship of the legislation from the start. However, if she was to blame (and perhaps if she wasn’t), her days in the president’s cabinet may well be numbered. The same may be true for deputies and other administrators in the Department who oversaw the weaker areas of the roll out of this law.

By repositioning HHS personnel or breathing new life into a Department facing continued struggles, the president may well ensure the administration of his signature legislation accomplishment improves. The right appointees can coordinate and communicate policy needs and goals up and down the bureaucratic hierarchy. Rather than settling for a program that meets or falls short of expectations, there is an opportunity to build an effective ACA.

Good Governance beyond Obamacare

The first half of October showed us that political actors in Congress contributed to a broken legislative branch. The second half of October showed us that political actors in the Administration contributed to a broken executive branch. Now is the time for the president to start anew and fix one branch, in the shadow of a Senate trying to fix itself.

In my piece from last month, I also argued that the filibuster rules in the Senate allow for the continuation of poor management and governance. If weak appointed personnel are causing policy problems, communication miscues, and other headaches for the president, the ability to replace them with something other than the word “ACTING” was limited by the 60-vote threshold.

President Obama, who has faced a string of personnel and management issues over the past year, now has greater freedom not simply to oust problematic appointees, but to install talented, effective leaders. With this ability comes a tremendous opportunity to jumpstart an administration that is sputtering.

The July 4th congressional recess’s pause in 2014’s record pace of judicial confirmations is a good time to explore the reason for the upsurge.

The 54 confirmations at 2014’s half-way point compare to 43 in all of 2013. What’s behind the increase? Some have said that the Senate’s November 2013 rules change—to allow a simple majority to end filibusters on most nominees—“has resulted in [the] sharp increase.” There is a lot of appeal (and even a little truth) to the claim, but beware the “post hoc ergo propter hoc” fallacy that if “B” follows “A”, “A” necessarily caused “B”.

There have been 61 confirmations since November 21. The rules change clearly enabled three of them. Late October and mid-November filibusters of three D.C. circuit appellate nominees were the immediate cause of the change, which in turn allowed their post-November confirmations.

Saying how many of the other post-November confirmations would have failed without the rules change is an exercise in informed speculation. Here’s one way to look at it: how many of those confirmations had enough negative votes to have sustained a filibuster under the old rule?

Invoking cloture—i.e., cutting off debate—under the old rule required 60 votes. Filibuster proponents were often able to prevent that by peeling off, if not 41 Nay votes, at least votes in the 30s, assuming not all 100 senators were present to vote. For this analysis, let’s set the bar at 34—the fewest number of votes that prevented a 60 vote cloture-invocation against any Obama nominee (most filibuster-sustaining votes were in the high 30’s and low 40’s).

Forty five of the 51 post-November district confirmations quite probably would have happened without the rules change. They had fewer than 34 Nays. And it’s hardly automatic that the six with at least 34 Nays would have been filibustered under the old rule. Senators can and do oppose a nominee but oppose filibustering her as well. Prior to the rules change, 12 district judges were confirmed even though they had at least 34 Nays. Only one of those needed a cloture vote to move to confirmation—33 voted against cloture and 44 voted against confirmation. (Cloture votes, a rarity before the rules change, have been routine since then, and they generally get around 30-40 negative notes. But these appear to be protest votes against the rules change, inasmuch as 27 of the 51 district confirmation had no Nays and another 14 had 20 or fewer Nays.)

So it’s reasonable speculation, but still speculation, that the rules change had no direct effect on district confirmations.

Circuit confirmations are a different story. The three D.C. nominees clearly owe their confirmations to the rules change. Three of the seven other circuit confirmations since November had well over 34 Nays (40, 43, and 45, in fact). One nominee had represented challengers to California’s since-overturned same-sex marriage ban; another, also a Californian, was nominated to a long-vacant seat that Republican senators claimed belonged in Idaho. The third, with 45 Nays, had authored Justice Department memos providing legal justifications for drone strikes against U.S. citizens. Successful filibusters against all three, under the old rule, seem quite plausible. (The other four post-rules-change nominees were confirmed with either no, or in one case, three negative votes.)

Bottom line: The rules change likely enabled at most twelve of the 61 post-rules change confirmations, and it more likely enabled only six.

The frenetic pace of 2014 confirmations is due mainly to Senate Democrats’ desire to secure as many as they can before the November elections and the possibility of losing control of the confirmation process.

For nearly fifteen hours between Wednesday morning and early Thursday, Senator Chris Murphy (D-CT), along with his Connecticut colleague Senator Richard Blumenthal (D) and Senator Cory Booker (D-NJ), led a filibuster on the floor of the Senate aimed at addressing gun control issues in the aftermath of last weekend’s mass shooting in Orlando. Other than learning that Wednesday is pizza night in the Murphy household, what else should we take away from this Mr. Smith Goes to Washington­-style exercise? Here are three lessons:

1. The real meaning of “I” in “I hold the floor until I yield the floor.”

Anyone who tuned into yesterday’s filibuster joined Senate procedure wonks (and faithful viewers of the West Wing) in the knowledge that a senator who holds the floor can yield to another senator for a question without yielding the floor. Indeed, 38 of Murphy’s 45 Democratic colleagues (as well as two Republicans, Senators Ben Sasse (R-NE) and Pat Toomey (R-PA)), came to the chamber yesterday to ask “questions.” In many cases, these were lengthy speeches—Senator Tammy Baldwin (D-WI), for example, read brief biographies of all 49 Orlando victims—in which the speaker satisfied the question requirement with a conclusion that asked Murphy for his reactions to their statement.

This kind of teamwork on extended speech-making is not unusual. When Senator Ted Cruz (R-TX) took the floor to talk for 21 hours about the Affordable Care Act in 2013, he took questions from nine fellow Republicans (as well as two Democrats). Last May, Senator Rand Paul (R-KY) got an assist from ten colleagues, including seven Democrats, during his filibuster of a bill extending the PATRIOT Act. The depth of Murphy’s bench not only reduced the energy he had to expend speaking, but also helped guarantee that the entire discussion was on-message and focused on the topic at hand; Murphy did not have to resort to reading the phone book to fill the hours.

2. In policy terms, it’s hard to know if the filibuster was a success…

When Murphy left the floor early Thursday morning, it was reported that Senate leaders had agreed to consider two gun control amendments: one that would address the ability of suspected terrorists to purchase guns and a second that would expand background checks for gun purchases. Details of the deal ensuring consideration are still emerging, but it is difficult to know if Murphy’s filibuster caused Senate leaders to agree to hold votes on them. It is possible that, had Democrats simply threatened to object to the motion to proceed to debate on the underlying spending bill, Republican leaders would have been forced to agree to consider the amendments for which Murphy and his allies were pushing. In the contemporary Senate, this is often how obstruction proceeds: without extended speeches and off the floor, with the two sides negotiating behind the scenes.

3. …but the political victory is perhaps more important

As my colleague Sarah Binder and her co-author Steve Smith wrote in their 1997 book on the filibuster, “encouragement from external groups…has given senators an incentive to exploit their procedural rights, sometimes leading them to block legislation with the filibuster or with holds and at other times leading them to use procedural prerogatives to force the Senate to consider issues of importance to parochial, partisan, or national constituencies.” On these grounds, Murphy’s filibuster was unequivocally a success in the eyes of its supporters. As the filibuster neared its end, Murphy reported that his office had received 10,000 phone calls supporting his efforts, and the hashtag #filibuster was trending on Twitter for much of the day. Even if the underlying amendments are not adopted—a real possibility that Murphy acknowledged in one of his final speeches of the evening—the visibility of the exercise is likely to pay political dividends for Democrats in the coming weeks.

Jennifer S. Vey, a fellow with the Centennial Scholar Initiative, discusses the current economic, social, and political situation in Baltimore a year after the riots.

“1/5 people in Baltimore lives in a neighborhood of extreme poverty, and yet these communities are located in a relatively affluent metro area, in a city with many vibrant and growing neighborhoods,” Vey says. In this podcast, Vey describes the current state of Baltimore and urges the start of discussions about the abject poverty facing many cities in the United States.

Also in this episode: stay tuned for our presidential election update with John Hudak. Also, Vanda Felbab-Brown discusses global drug policy and the upcoming United Nations General Assembly special session on drug policy.

Show Notes

"The Third Rail"

One year after: Observations on the rise of innovation districts

Confronting Suburban Poverty in America

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Event Information

Having emerged from the largest municipal bankruptcy in American history, Detroit is now on surer financial footing and experiencing an economic resurgence. Due much in part to an unprecedented collaboration among philanthropy, business, and government, Detroit is benefiting from private and public sector investments downtown and across its neighborhoods. Today, there are revived neighborhoods, new businesses, a downtown innovation district, the M-1 RAIL transit corridor, and a spirit of creativity and entrepreneurialism.

On Tuesday, April 26, the Metropolitan Policy Program at the Brookings Institution hosted an event about Detroit’s rebound. Brookings Vice President of Metropolitan Policy Amy Liu opened the program and introduced Kresge Foundation President Rip Rapson, who presented findings from The Detroit Reinvestment Index, forthcoming research on what national business leaders think about the city. Rapson then moderated a panel of experts who discussed accomplishments to date and the work yet to come in furthering Detroit’s revitalization.

Join the conversation on Twitter at #DetroitResurgence

Photos

Amy Liu opens the program

Rip Rapson gives remarks

Sandy Baruah, President and Chief Executive Officer, Detroit Regional Chamber; Stephen Henderson, Editorial Page Editor, The Detroit Free Press; Quintin E. Primo III, Co-Founder, Chairman and Chief Executive Officer, Capri Investment Group, LLC ; Jennifer Vey, Fellow & Co-Director, Robert and Anne Bass Initiative on Innovation and Placemaking, The Brookings Institution

Video

• Welcome and Presentation
• Panel

Audio

• How philanthropy, business, and government sparked Detroit’s resurgence

Stephen was still a teenager on the north side of St. Louis when his dad, a police officer, was killed during a robbery in their neighborhood. Despite the trauma, Stephen later joined the police force to continue his dad’s legacy and commitment to safe and inclusive neighborhoods. But even before the fatal shooting of Michael Brown in Ferguson in 2014, Stephen (not his real name) yearned to right local wrongs through broader approaches. “The darkest forces weren’t necessarily the ones getting arrested,” he observed. “So I retired from the police force after 22 years, essentially to chase after a different type of perpetrator.” Wanting to focus on policies at multiple levels of government that “were causing the disparities that fueled increasing crime and violence in St. Louis,” Stephen pivoted to civil rights enforcement, tracking policy violations and innovations at a government agency in the St. Louis region.

I met Stephen in February while in St. Louis for a conference his agency organized on HUD’s recently strengthened Affirmatively Furthering Fair Housing (AFFH ) rule, which increases local accountability in promoting residential integration. He wasn’t a speaker at the event, but hearing his story reinforced the importance of combating the deeply entrenched and often invisible causes of segregation.

Recent events and new academic research, including landmark findings by Raj Chetty and colleagues testifying to the benefits of low-poverty neighborhoods for low-income kids, the updated AFFH rule, and the Supreme Court’s disparate impact decision upholding other tools to fight segregation have brought renewed attention to these challenges. Meanwhile, underlying these developments, poverty has failed to decline since the recession and, as recent Brookings research shows, has become more concentrated in neighborhoods of extreme poverty.

How can regional leaders and practitioners respond to these challenges? I was in St. Louis to discuss one part of the solution—advancing more mixed-income neighborhoods. In the Chicago region, our housing and community development-focused firm, BRicK Partners, is collaborating with the Chicago Metropolitan Agency for Planning (CMAP), the Illinois Housing Development Authority (IHDA), and 10 metropolitan Chicago public housing authorities, with support and leadership from HUD, to develop and operate the Regional Housing Initiative (RHI)

RHI is a small, systemic, and potentially scalable “work around” of a very specific set of programs and policies that contribute inadvertently to regional inequities. A flexible and regional pool of resources working across the many traditional public housing authority (PHA) and municipal jurisdictions in the Chicago region, RHI increases quality rental housing in neighborhoods with good jobs, schools, and transit access and provides more housing options to households on Housing Choice Voucher (HCV) waiting lists. Recognizing that the federal formulas allocating HCVs to each individual PHA are not responsive to population, employment, or poverty trends, RHI partners convert and pool a small portion of their HCVs to provide place-based operating subsidies in support of development activity that advances local and regional priorities. RHI supports both opportunity areas with strong markets and quality amenities as well as revitalization areas where public and private sector partners are planning and investing toward that end. In both cases, the bulk of RHI investments are in the suburbs, where the PHAs are smaller and the rental stock more limited. 

RHI has committed over 550 RHI subsidies to nearly 40 mixed-income and supportive housing developments across Chicagoland, supporting more than 2,200 total apartments, over half of which are in opportunity areas. The pooling and transferring of subsidies has allowed RHI to support proposals that local jurisdictions wouldn’t be able to undertake otherwise.

Although a number of innovative programs around the country provide assistance to households moving to opportunity areas, RHI is unique its focus on increasing the supply of housing in opportunity areas regionwide. Its approach is consistent with lessons learned from Brookings’ work on Confronting Suburban Poverty in America: With CMAP as a strong quarterback, RHI has addressed the shortage of rental housing in the suburbs by working across jurisdictions, developing shared priorities, metrics and selection criteria, and by working with IHDA and other stakeholders to leverage greater private sector investment.

This recipe for success is now being deployed in communities beyond Chicago. Baltimore is preparing to advertise for its first round of developer applicants under the leadership of the Baltimore Metropolitan Council, with regionwide PHAs, the State Housing Finance Agency, and a regional housing counselor lined up as supportive partners. In St. Louis, the regional planning and housing finance organizations both attended the February conference where I met Stephen, signaling the potential for greater collaboration for both these entities and the PHAs.

Like many housing advocates and professionals, my colleagues and I at BRicK Partners derive a lot of satisfaction from supporting communities like Baltimore and St. Louis and individuals like Stephen and his peers with replicable best practices. Given today’s political realities, we don’t expect major changes in the federal formulas and statutes behind some of the regional inequities, but “work arounds” such as RHI can still scale up. Nationwide, just a small percentage of HCVs have been converted for such flexible supply-side solutions, but there is reason to be hopeful that this will change. The Regional Mobility Demonstration proposed in the 2017 budget as well as federal public housing voucher legislation passed by the House of Representatives earlier this year are signs that there is real momentum to advance regional strategies that increase access to opportunity for low income residents and families. 

Baltimore police officer Edward Nero, one of six being tried separately in relation to the arrest and death of Freddie Gray, has been acquitted on all counts. The outcome for officer Nero was widely expected, but officials are nonetheless aware of the level of frustration and anger that remains in the city. Mayor Stephanie Rawlings Blake said: "We once again ask the citizens to be patient and to allow the entire process to come to a conclusion."

Since Baltimore came to national attention, Brookings scholars have probed the city’s challenges and opportunities, as well addressing broader questions of place, race and opportunity.

• In this podcast, Jennifer Vey describes how, for parts of Baltimore, economic growth has been largely a spectator sport: "1/5 people in Baltimore lives in a neighborhood of extreme poverty, and yet these communities are located in a relatively affluent metro area, in a city with many vibrant and growing neighborhoods."
• Vey and her colleague Alan Berube, in this piece on the "Two Baltimores," reinforce the point about the distribution of economic opportunity and resources in the city:
  

  In 2013, 40,000 Baltimore households earned at least $100,000. Compare that to Milwaukee, a similar-sized city where only half as many households have such high incomes. As our analysis uncovered, jobs in Baltimore pay about $7,000 more on average than those nationally. The increasing presence of high-earning households and good jobs in Baltimore City helps explain why, as the piece itself notes, the city’s bond rating has improved and property values are rising at a healthy clip."

• Groundbreaking work by Raj Chetty, which we summarized here, shows that Baltimore City is the worst place for a boy to grow up in the U.S. in terms of their likely adult earnings:

• Here Amy Liu offered some advice to the new mayor of the city: "I commend the much-needed focus on equity but…the mayoral candidates should not lose sight of another critical piece of the equity equation: economic growth."
• Following an event focused on race, place and opportunity, in this piece I drew out "Six policies to improve social mobility," including better targeting of housing vouchers, more incentives to build affordable homes in better-off neighborhoods, and looser zoning restrictions.
• Frederick C. Harris assessed President Obama’s initiative to help young men of color, "My Brother’s Keeper," praising many policy shifts and calling for a renewed focus on social capital and educational access. But Harris also warned that rhetoric counts and that a priority for policymakers is to "challenge some misconceptions about the shortcomings of black men, which have become a part of the negative public discourse."
• Malcolm Sparrow has a Brookings book on policing reform, "Handcuffed: What Holds Policing Back, and the Keys to Reform" (there is a selection here on Medium). Sparrow writes:
  

  Citizens of any mature democracy can expect and should demand police services that are responsive to their needs, tolerant of diversity, and skillful in unraveling and tackling crime and other community problems. They should expect and demand that police officers are decent, courteous, humane, sparing and skillful in the use of force, respectful of citizens’ rights, disciplined, and professional. These are ordinary, reasonable expectations."

Five more police officers await their verdicts. But the city of Baltimore should not have to wait much longer for stronger governance, and more inclusive growth.

Ranking U.S. metro areas, or counties, or even countries, by some fixed metric is a straightforward and often useful way to start a deeper dive into a larger body of research. For example, the top 10 counties by share of taxpayers claiming EITC, or the top 10 metro areas by change in prosperity. But what if the phenomenon being measured is more complex, has interacting characteristics that make a top 10 list less useful?

In new research, Brookings Senior Fellow Alan Berube, along with his colleagues at the Metropolitan Policy Program, and John Irons of the Rockefeller Foundation, ask “What makes an economy inclusive?” Inclusive economies, they say, “expand opportunities for more broadly shared prosperity, especially for those facing the greatest barriers to advancing their well-being.” A new Rockefeller Foundation framework identifies five characteristics of inclusive economies: equity, participation, stability, sustainability, and growth.

A typical ranking approach would list the top 10 inclusive economies (or the bottom 10) based on some score derived from data. It turns out, however, that understanding the “trends and relationships that might reveal the ‘big picture’ of what makes an economy inclusive” doesn’t lend itself to typical ranking techniques, and instead requires looking at relationships among the characteristics to ascertain that “big picture.”

Take, for example, equity, defined as: “More opportunities are available to enable upward mobility for more people.” For this analysis, Brookings researchers used 16 discrete indicators—such as the Gini coefficient, median income of less-educated workers as a share of overall median income, and transportation costs as a share of income—to come up with an equity score for each of the 100 largest U.S. metro areas. (Likewise, each of the other four inclusive economy indicators are composites of many discrete indicators, for a total of about 100 across the five.) Looking at equity alone, the top 10 metro areas are:

1. Allentown, PA-NJ
2. Harrisburg, PA
3. Ogden, UT
4. Scranton, PA
5. Des Moines, IA
6. Salt Lake City, UT
7. Wichita, KS
8. Grand Rapids, MI
9. Pittsburgh, PA
10. Worcester, MA-CT

Top 10 lists can also be fashioned for the other four dimensions in the inclusive economies research, each showing a different mix of U.S. metro areas. For example, the top three metro areas in the growth characteristic are San Jose, CA; Houston, TX; and Austin, TX. For participation: Madison, WI; Harrisburg, PA; and Des Moines. Stability: Madison; Minneapolis, MN-WI; and Provo, UT. And, sustainability: Seattle; Boston; and Portland, OR-WA. In fact, 30 different metropolitan areas are present in the combination of the five inclusive top 10 lists, spanning the country from Oxnard, to Omaha, to Raleigh. The individual top 10 lists for each inclusive economy characteristic look like this:

Because these rankings each impart useful and distinctive information about metro economies, Brookings researchers next combined the data into an overall ranking of the 100 metro areas “based on their average rankings on individual indicators for each of the five inclusive economy characteristics.” Instead of generating a ranking from 1 to 100, the analysis produces a grid-like chart that shows how metro areas fare not only in terms of inclusiveness (top to bottom), but also along a left-to-right spectrum that demonstrates the trade-offs between growth and equity. Here’s a sample from the chart (visit and study the chart here; note that wealth is depicted but by itself is not part of the inclusive economy score):

One thing that stands out when considering this colorful chart against the disaggregated top 10 lists is how unrelated they seem to be. San Jose sits at the upper right position of the chart, suggesting that it ranks as one of the most inclusive metro economies, and yet it ranks only 51st on equity. By contrast, Allentown, PA—on the left of the second row—ranked first in equity, but lower on other measures. However, taken as a whole, both Allentown and San Jose are in the top 20 metro areas overall for inclusiveness. Detroit sits along the bottom row of the inclusiveness chart. Among the five characteristics, it posts its highest rank in growth (37th overall), with much lower ranks in the other categories, even though it ranks 29th for wealth. Las Vegas, NV, is one of the least wealthy metro areas (91st), but ranks 19th in terms of equity.

Berube and Irons point to what they call “a few important insights” about the chart and these data:

• Judged across all five characteristics, the “most” and “least” inclusive metro economies are geographically and economically diverse.
• More equitable metropolitan economies also exhibit higher levels of participation and stability. 
• Growth and equity vary independently across metropolitan areas. 
• Metro areas with similar performance across the five characteristics may not possess the same capacity to improve their performance.

For more detailed discussion, and the complete inclusive economies chart, see “Measuring ‘inclusive economies’ in metropolitan America,’ by John Irons and Alan Berube.

See also “A metro map of inclusive economies,” showing metro areas that are similar to others in these outcomes.

Finally, download detailed information on the composition of the 100 indicators used to measure the five inclusive economies indicators.

Arne Duncan, former U.S. secretary of education during the Obama administration and now a nonresident senior fellow with the Brown Center on Education Policy, discusses the crisis of youth violence in Chicago and solutions that strengthen schools and encourage more opportunities for those who are marginalized to make a living in the legal economy.

“The best thing we can do is create hope, opportunity and jobs particularly on the South and West side for young and black men who have been disenfranchised, who have been on the streets. If we can give them some chances to earn a living in a legal economy not selling drugs and not on street corners, I think we have a chance to do something pretty significant here,” Duncan says. “My fundamental belief is that the police cannot solve this on their own we have to create opportunities for young people in communities who have been marginalized for far too long.”

Also in this episode, Bruce Katz, the Centennial Scholar, who discusses how European cities are addressing the refugee crisis in a new segment from our Refugee Series.

Thanks to audio engineer and producer Zack Kulzer, with editing help from Mark Hoelscher, plus thanks to Carisa Nietsche, Bill Finan, Jessica Pavone, Eric Abalahin, Rebecca Viser, and our intern Sara Abdel-Rahim.

Subscribe to the Brookings Cafeteria on iTunes, listen in all the usual places, and send feedback email to BCP@Brookings.edu 

Event Information

Puerto Rico is the latest, but probably not the last, case of a local government confronting financial strains that call into question its ability to meet its obligations to bondholders while providing services to its taxpaying constituents. Puerto Rico is, of course, a special case because it is a territory, not a state or municipality. Will Puerto Rico’s problems have ripple effects for the $3.7 trillion U.S. municipal bond market? What about the resolution of Detroit's bankruptcy? How will state and local governments and the courts weigh the interests of pensioners, employees, taxpayers and bondholders when there isn't enough money to go around?

On Tuesday, July 12, the Hutchins Center on Fiscal and Monetary Policy at Brookings webcasted the keynote address from the 5th annual Municipal Finance Conference, delivered by the sitting governor of Puerto Rico, Hon. Alejandro García Padilla. After Governor Padilla’s remarks on Puerto Rico’s future, Hutchins Center Director David Wessel moderated a panel on the politics and practice of municipal finance in the post-Detroit and post-Puerto Rico era.

Join the conversation and tweet questions for the panelists at #MuniFinance.

Video

• Keynote address by Alejandro García Padilla
• Panel: The muni market in the post-Detroit and post-Puerto Rico era
• Changing patterns in household ownership of municipal debt
• Municipal borrowing costs and state policies for distressed municipalities
• Municipal finance structure and Chapter 9 creditor priorities
• Term limits and municipal borrowing costs
• Why has regional income convergence in the U.S. declined?
• State strategies for detecting fiscal distress in local governments
• Pensions and other post-employment benefits

Transcript

• Download the uncorrected transcript (.pdf)

Event Materials

• Garcia Padilla Slides
• 20160712_munifinance_puertorico_detroit_transcript

Executive Summary

If the main purpose of the Emergency Economic Stabilization Act of 2008 is to give banks confidence in each other, then enabling Treasury directly to bolster the capital positions of banks that need more capital may be an even more effective way to restoring confidence to the inter-bank market than the purchased of troubled assets. Whatever Congress may have intended about the pricing of the distressed assets, it also authorized a much more direct way to recapitalize the financial system and weak banks in particular: direct purchases by Treasury of securities that individual institutions may wish to issue to bolster their capital. At this writing, Treasury reportedly is considering ways do this. In this essay, we outline a specific bank recapitalization plan for Treasury to consider.

In particular, Treasury could announce its willingness to entertain applications for capital injections, using a set pricing formula. For publicly traded banks, Treasury could buy at the price as of a given date, such as the price one or more days before its plan was announced. For privately-owned banks, Treasury could use a price based on the average price-to-book value for publicly traded banks as of that date. To prevent government intrusion into the affairs of the banks, the stock should be non-voting. Treasury would make clear that it only would take minority positions. There should be no takeovers of more companies—AIG, Fannie and Freddie are quite enough. Treasury also should announce that it will dispose (or sell back to the bank) any stock acquired through these actions as soon as the financial system has stabilized and the bank is in sound financial condition (perhaps a time limit, such as three years, should be a working presumption).

We believe Treasury can accommodate a systematic recapitalization plan within the funding it has been given – initially $350 billion and another $350 billion later upon request to Congress (unless it disapproves) – by using the required disclosures about its asset purchases as a way of jump starting private sector pricing and trading of these securities. This should conserve Treasury’s resources it might otherwise use for asset purchases, and thus free up funds to recapitalize weak banks directly, but in an orderly fashion.

Treasury will have to be careful when it buys distressed assets to guard against the possibility that banks will just dump their worst stuff on taxpayers. The Department will also have to be careful when buying equity in banks. There cannot be an open invitation for bank owners to move assets out of the bank and then, in effect, say: “We don’t want this bank, you buy it.” To avoid this problem, Treasury should work closely with the FDIC and other regulators to determine whether or not a particular bank is eligible for an equity injection. The Department also may need to limit the scope of the recapitalization program to larger national banks, if it becomes infeasible to allow smaller banks to participate.

Making the Rescue Package Work: Asset and Equity Purchases [1]

The unprecedented financial rescue plan – technically the Emergency Economic Stabilization Act of 2008 (“EESA,” the “Act”, or the “plan”) -- has now been enacted by the Congress. One of the goals of the plan is to end the immediate panic in inter-bank lending markets, and on this basis several omens are not encouraging.

The Dow Jones stock index has been dropping daily, by large amounts, since EESA was enacted. The TED spread measures the difference between the interest rate on short term Treasury bills and the interest rate banks pay to borrow from each other (the LIBOR) and is a widely accepted measure of perceived risk in the financial sector. For several years this spread had hovered around 50 basis points or half a percentage point, reflecting the fact that lending to other financial institutions was considered almost as safe as buying Treasury bills. However, the spread shot up to 2.4 percentage points in July 2007 as the financial crisis hit, and it fluctuated widely in subsequent months. Following passage of the plan it remains even more elevated than it was last July—it was 3.8 percentage points as of October 7 and broke 4 percent on October 8. Financial institutions simply do not trust each other’s credit worthiness. Some of the market worries, of course, reflect the fragile state of the U.S. and global economies, but clearly the passage of the rescue plan itself has not calmed markets.

A second and related goal for the plan, according to media accounts, is to facilitate the recapitalization of the financial system, but the language of the bill is surprisingly coy about this. While the Act aims to “restore liquidity and stability to the financial system” it also directs the Treasury Secretary to prevent “unjust enrichment of financial institutions participating” in the asset purchase program. It is not yet clear whether Treasury will choose to recapitalize banks through its asset purchases – by buying them at prices above the values to which banks and other sellers have already written them down – or whether Treasury will simply use its purchases to stabilize prices for these securities and thus provide liquidity to the market, even if it may result in additional write-downs of their values (and thus additional reductions in capital).

Whatever Congress may have intended about the pricing of the distressed assets, it also authorized a much more direct way to recapitalize the financial system and weak banks in particular: direct purchases by Treasury of securities that individual institutions may wish to issue to bolster their capital. Of course, in normal times, such authority would be unnecessary because financial institutions would seek to tap private sources of capital first. But these are not normal times, to say the least.

If the main purpose of the plan is to give banks confidence in each other, then enabling Treasury directly to bolster the capital positions of banks that need more capital may be an even more effective way to restoring confidence to the inter-bank market. Accordingly, we outline here a possible supplementary bank recapitalization plan that we believe Treasury should pursue, at the same time it purchases distressed assets. As this paper is being completed on October 9, 2008, The New York Times reports that the Treasury is now considering such a move. We are encouraged by this and in this essay we provide both a rationale for doing so and some concrete suggestions for how such a direct recapitalization program might work. We do not support further nationalization of the banking system beyond what has already been done but we believe that the crisis has become so severe that the asset purchase plan on its own will not be enough to turn the current situation around. Additional capital is urgently needed and could be supplied by Treasury purchases of minority, non-voting equity stakes, or by warrants.

We believe Treasury can accommodate a systematic recapitalization plan within the funding it has been given – initially $350 billion and another $350 billion later upon request to Congress (unless it disapproves) – by using the required disclosures about its asset purchases as a way of jump starting private sector pricing and trading of these securities. This should conserve Treasury’s resources it might otherwise use for asset purchases, and thus free up funds to recapitalize weak banks directly, but in an orderly fashion, as we describe below.

Why Do Banks Need More Capital?

Financial institutions make money by borrowing money on favorable terms, that is, at low interest rates, and then lending it out at higher rates or by buying assets that yield higher returns. They may make money in other ways too, but the state of their balance sheets of assets and liabilities is crucial. In order to create a viable financial institution that can accommodate requests by depositors to take money out, someone has to put up capital and typically this comes from the equity in the company. The owners of the company have an incentive to keep this equity capital low and to build a large volume of borrowing and lending off a small base of capital—to increase leverage. This is because the profits earned are divided among the equity owners and the less capital there is, the higher the return on equity.

Governments for many years and in almost all countries have regulations in place setting capital requirements for banks in particular to stop them from taking too much risk in the pursuit of high returns and also protect any fund that insures their deposits against loss (the FDIC in this country). But some of our larger banks in recent years found a way around these rules by establishing “off-balance sheet” entities – Structured Investment Vehicles (“SIVs”) – to purchase mortgage-related and other asset-backed securities that the banks were issuing. In addition, large investment banks significantly increased their leverage in the years running up to the recent crisis, and were able to do so without mandated capital requirements. As a result, when the mortgage crisis hit, our financial system was weaker than was widely believed, and in the case of large banks in particular, than was officially reported.[2]

The mortgage crisis, which first surfaced in 2006 and has escalated rapidly since then, has hit bank balance sheets severely. As banks were forced to recognize losses on the mortgages they held in their portfolio, and especially to write down the values of their mortgage securities to their “market values” (even though the prices in those “markets” reflected relatively few “fire-sale” trades), they suffered reductions of their capital. Furthermore, the large banks that had created SIVs to escape such events found they could not hide from them when the SIVs could no longer roll over the commercial paper they had issued to finance their holdings of mortgage securities. To avoid dumping these securities on the market to satisfy their creditors, the banks took the SIVs back on their balance sheets, only to suffer further losses to their capital.

As we have seen, some of our largest banks – Washington Mutual and Wachovia, to name two – have not been able to survive all of this, and have been forced or are or being forced into the hands of stronger survivors. Other banks have been doing their best to shore up their capital bases by issuing new equity to replace the losses they have absorbed on delinquent loans and declining prices of their asset-backed securities. According to media reports, financial institutions (largely banks) worldwide have suffered over $700 billion in such losses to date, of which they replaced approximately $500 billion by issuing new equity.

But more losses are sure to come; indeed Secretary Paulson has said to expect further bank failures. Earlier this year, the International Monetary Fund projected that losses due to the credit crisis worldwide could hit $1 trillion. The IMF has recently upped that forecast to $1.4 trillion. If anything close to this latest forecast is realized, then many banks – here and abroad – will need to raise even more equity, but in a capital market that is now highly more risk averse than only a few months ago.

It is in this environment that banks have grown much less comfortable dealing with each other, even though they must to keep the financial system running. Every day, some banks have more cash on hand, or reserves, than they need to meet reserve requirements and ordinary demands for liquidity, while others are short of such funds. In the United States, banks thus trade with each other in the Federal Funds market while global banks borrow and lend to each other through the London Interbank market using the LIBOR rate of interest. The Federal Reserve’s main objective of monetary policy is to stabilize the “Fed funds” rate around a target, now just lowered to 1.5%, down from 2% where it has been for some months (and down from 5.25% before subprime mortgage crisis). To do so, the Fed has added a huge amount of liquidity to the financial system, even going so far this week as to buy up commercial paper issued by corporations, an unprecedented step. But the Fed does not and probably cannot control the longer term inter-bank market, in which banks lend to each other typically over a 3-month period.

The steep jump in the 3-month inter-bank lending rate – well over 4 percent – reflects two fundamental facts that EESA is designed to address. One is that banks don’t trust each others’ valuations of the mortgage and possibly other asset-backed securities they are all holding, precisely because the “markets” in those securities are so thin and thus not generating reliable prices. The second problem is that banks either are short of capital themselves, or fear that their counterparties are. No wonder that banks are so unwilling to lend to each other for a period even as short as three months – which in this environment, can seem like an eternity.

The capital shortage in the banking system, in particular, has severe implications for the rest of the economy. An institution that is short of capital is forced to cut back on its lending and this shows up in denials of lines of credit to companies and reductions in credit limits for consumers. Households cut back on spending; it is difficult to get a mortgage or a car loan; and companies reduce investment and curtail operations. And as we learn in any college course on banking, the impact of a loss of capital on bank lending can be multiplied. Each dollar of bank capital supports roughly ten dollars of overall lending in the economy. Each dollar of lost capital thus can result in ten dollars of lending contraction. The impact of an economy-wide bank contraction can be devastating for Main Street. The Great Depression was greatly exacerbated by the collapse of banks. The long stagnation in Japan was in large part the result of a failure to recapitalize the banks.

How bad is the current problem? We do not know how many banks, insurance companies or other financial institutions are in a weakened state, or perhaps even more important, may become weakened as the overall economy deteriorates. The official data published so far don’t really help on this score. The FDIC compiles information on the number and collective assets held by “problem banks,” or those in danger in failing. As of the second quarter of 2008, there were 117 such banks with assets of $78 billion up from 90 in the second quarter with assets of $28 billion., These figures did not include Washington Mutual, which would have failed had it not been bought by J.P. Morgan, or Wachovia, which at this writing, looks like it will be acquired by Wells Fargo (but also was in danger of failing without being acquired by someone). Together these banks hold more than $500 billion in customer deposits. Furthermore, according to recent media reports, even some large insurance companies (beyond AIG) may be having capital problems, having suffered large losses on the securities they hold in reserve to meet future claims.

Can the Asset Purchase Plan Succeed in Recapitalizing the Banks?

In principle, there are two ways in which the original Treasury asset purchase plan would recapitalize the banks. The first method is premised on the view that private markets are unwilling to supply capital to the banks because investors do not know how much their assets are worth. The Treasury, it is argued, would use its asset purchase plan as a way of revealing the prices of the assets and once that information is known, the banks will be able to raise new capital again from private markets. But better pricing will only attract capital if there are investors out there who are willing to supply it. Given the dramatic downturn in equities markets, finding such willing investors will be difficult, to say the least. Those investors that provided capital to banks early on in the crisis have been hit hard by the subsequent decline in equity prices and are reluctant to get burned again. When Bank of America said it would raise $10 billion from the markets, for example, its stock price fell sharply, suggesting there is a lot of market resistance to be overcome before private investors are willing to recapitalize the banking system.

Second, in principle, Treasury could recapitalize the banks by buying distressed assets at prices above those at which the securities are currently carried on the books of the institutions that sell them (original book or purchase value minus any write-offs).[3] In this case, the bank would be able to report a capital gain from its sale to the Treasury, a gain that would reverse, at least in part, the capital losses it had taken in the past and thereby add to its capital.

Treasury has said it will use reverse auctions[4] when it buys assets, and it is possible that the Department will be able to construct some auctions that will enable some holders of troubled assets to sell them to the Treasury at prices that earn a capital gain. But we are somewhat skeptical how many securities will fall into this category. For one thing, asset-backed securities are not homogenous, like traditional equity or bonds. In addition, it would be surprising in the current environment if reverse auctions would reveal prices that are above the written-down values of many of these securities. After all, an auction does not necessarily produce valuations that reflect the “hold to maturity” price rather than the “liquidation” price for the securities, as Fed Chairman Ben Bernanke suggested the purchase plan would accomplish.

Accordingly, we strongly suspect that Treasury will have to purchase many securities in one-on-one deals rather than through auctions. But in doing this, it may be both legally and politically difficult for the Treasury to pay prices in negotiations that are above the valuations banks or other sellers already have given them. Section 101 (e) of EESA specifically requires the Treasury Secretary “to take such steps as may be necessary to prevent unjust enrichment” of participating financial institutions, and Congress could construe such language to preclude such sales.[5] Furthermore, even if there were not a specific prohibition in the EESA, Treasury may wish to avoid the public criticism it would face if it purchased assets at prices that would allow participating institutions to book gains. And, in the case of sales at prices below the explicit or implicit price of the securities carried on an institution’s books, the sales will trigger further accounting losses and thus additional deductions from reported capital.

In short, we are not at all confident that the Treasury’s planned purchases of troubled securities, by themselves, will do much to recapitalize the banking system. This does not mean that the planned asset purchases will not deliver some needed help. Although at this writing the inter-bank lending market remains frozen even though EESA has been enacted and signed into law, one reason why banks and others may not yet have confidence that it will lead to a thaw in credit markets is that the guidelines for the asset purchases have not yet been issued. Once these guidelines are announced and the purchases begin, and the markets start to see real results, it is possible that some of the missing trust in the banking system will come back.[6]

However, Treasury may not need to spend, and for reasons elaborated below we do not believe it should spend, anywhere near the full $700 billion, or perhaps even most of the initial $350 billion tranche in borrowing authority, to liquefy the markets for mortgage and other asset-backed securities. EESA requires Treasury to publish (within two days) information about each of these purchases. We urge the Department to include in such publications (presumably on its website) regular data on the defaults and delinquencies to date of the loans underlying each batch of securities it purchases. Such information should enable financial institutions that are still holding similar securities not only to price them more accurately, but also to give market participants enough confidence to begin trading these securities without further Treasury purchases.

Husbanding its resources should be a prime objective for Treasury. In conducting its purchases of troubled assets, it should target first those asset categories that are the most illiquid. The main objective always should be jump-starting private sector activity or at least bringing greater clarity to the pricing of particular classes of securities. There is no need for Treasury, therefore, to make repeat purchases of similar securities (such as collateralized debt obligations issued within several months of each other, structured in roughly a similar way). Rather, the aim should be to make a market in as many different asset categories as are reasonably necessary to provide guidance to market participants, no more, no less.

Yet no one can be confident at this point that asset purchases alone will give banks sufficient confidence to begin dealing with each other at much lower interest rates. If the asset purchases do the trick, fine. But if they don’t, Treasury should make sure it has enough financial ammunition to pursue a second, more direct, strategy for restoring banks’ confidence – the direct bank recapitalization strategy to which we now turn.

Recapitalizing the Financial System Directly

Having the government put capital into financial institutions directly is not a new idea. It is the approach followed in this crisis for Fannie and Freddie and has been used in other countries. Sweden recapitalized its banks by adding capital to them during its crisis in the 1980s. Most recently, the British government has announced a sweeping bank recapitalization amidst the current crisis. And of more relevance to the U.S. situation, Congress specifically added authority in EESA for Treasury to make direct capital injections into banks.

In recent days, Treasury Secretary Paulson has acknowledged that the Department may take advantage of this authority and thus use some of its funds to buy equity in troubled banks. This is a welcome development. Even if Treasury’s asset purchase program restores confidence in the pricing of troubled securities, many banks still believe that many other banks lack sufficient capital, and thus can still be reluctant to lend to them. The fact that the FDIC stands ready (especially with its new unlimited line of credit at the Treasury) to assist acquiring banks in taking over failing banks is probably not sufficient, even with a successful Treasury asset purchase program, to provide this confidence. Bank lenders to failed banks can still lose money in such transactions, or at the very least may have difficulty accessing their funds for some period, at times when all banks seem to want or need as much liquidity as they can get.

How might such a capital injection program work? Treasury could announce its willingness to entertain applications for capital injections, using a set pricing formula. For publicly traded banks, Treasury could buy at the price as of a given date, such as the price one or more days before its plan was announced, as has been suggested by former St. Louis Federal Reserve Bank President William Poole.[7] For privately-owned banks, Treasury could use a price based on the average price-to-book value for publicly traded banks as of that date. To prevent government intrusion into the affairs of the banks, the stock should be non-voting. Treasury would make clear that it only would take minority positions. There should be no takeovers of more companies—AIG, Fannie and Freddie are quite enough. Treasury also should announce that it will dispose (or sell back to the bank) any stock acquired through these actions as soon as the financial system has stabilized and the bank is in sound financial condition (perhaps a time limit, such as three years, should be a working presumption).

The Treasury will have to be careful when it buys distressed assets to guard against the possibility that banks will just dump their worst stuff on the taxpayers. The Department also will have to be careful when buying equity in banks, especially if it decides to go for a broad, nationwide program. There cannot be an open invitation for owners to move assets out of the bank and then, in effect, say: “We don’t want this bank, you buy it.” This problem suggests that Treasury would need to work closely with the FDIC and other regulators to determine whether or not a particular bank is eligible for an equity injection. Treasury also may need to limit the scope of the program to larger banks, if it becomes infeasible to allow smaller banks to participate.

We presume that Treasury did not initially embrace the idea of a more systematic recapitalization of the banking system out of concern not to have any further government involvement in the banking system, especially on the heels of the Fannie/Freddie conservatorship and the Fed’s rescue of AIG. That Treasury is now considering direct capital injections indicates that this may no longer be a concern. In our view, limiting Treasury’s purchases to non-voting stock in any event would address this concern directly.

Conclusion

Ben Bernanke has compared the current financial crisis to a heart attack in the economy. For some heart attacks, it is enough to administer drugs and change diet and exercise habits. But in acute cases, major surgery is needed and the current crisis is in the acute phase. Direct surgery in the form of capital injected into financial institutions, along with direct asset purchases, should help calm the inter-banking lending market.

Based on recent monthly data it appears that GDP started to fall in mid-year and the economy is moving into recession so the proposals made here will not change that. Nor can the proposals compel banks to make loans to their traditional customers – consumers and businesses – in the current climate of fear. But Treasury can do something to mitigate that fear and thus, along with the recent further easing of monetary policy, likely additional fiscal stimulus and further homeowner relief, the Department will help reduce the severity of the current recession if it uses all the tools in its financial arsenal.

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EXECUTIVE SUMMARY

The ongoing financial crisis that began in 2007 has revealed a fundamental weakness in our financial regulatory system: the absence of a regulator charged with overseeing and preventing “systemic risk,” or the risks to the health of the entire financial system posed by the failure of one or more “systemically important financial institutions” (SIFIs).

On March 26, the Treasury Department released the first part of its plan to fix the financial system, which concentrates on reducing systemic risk. The Treasury’s suggestions, if enacted into law, would go a long a way toward achieving this objective. One of the central elements in the plan is to establish a systemic risk regulator. Treasury did not identify which agency or agencies should assume this job. I address this issue, among others, in this essay on systemic risk.

Ideally, all federal financial regulatory activities should be consolidated in two agencies, a financial solvency regulator and a federal consumer protection regulator, with systemic risk responsibilities being assigned to the solvency regulator. As a second-best option, clear systemic risk oversight authority should be assigned to the Fed. Either of these options is superior to creating a new agency or regulating systemic risk through a “college” of existing financial regulators.

The systemic risk regulator (SRR) should supervise all SIFIs, although the nature and details of this supervision should take account of the differences in types of such institutions (banks, large insurers, hedge funds, private equity funds, and financial conglomerates). The SRR should also regularly analyze and report to Congress on the systemic risks confronting the financial system.

There are legitimate concerns about vesting such large responsibilities with any financial regulator. But as long as there are financial institutions whose failure could lead to calamitous financial and economic consequences, and thus invite all-but-certain federal rescue efforts if the threat of failure is real, then some arm of the federal government must oversee systemic risk and do the best it can to make that oversight work.

While the United States should continue to cooperate with governments of other countries in reforming financial systems, notably through the G-20 process, policymakers here should not wait for international agreements to be in place before putting our own financial house in order.

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