The Unaccountability of Peter Orszag

Office of Management and Budget Director, Peter Orszag is one of the first major players of the Obama administration to call it quits. Orszag was touted as one of the most brilliant minds in number-crunching, especially by Ezra Klein, who deemed Orszag as the most influencial bureaucrat:

In the coming years, no bureaucrat will be as decisive as Peter Orszag — the former director of the Congressional Budget Office who is now the head of Barack Obama’s Office of Management and Budget — and few bureaucracies will be as important as the CBO and the OMB. For every major policy and legislative fight, those organizations will decide the Number: the official price tag of a government program. And you can’t do anything without the Number.

But while everyone was so enamoured with the heartbreaker, stud, and hottie Orszag and his economic brilliance and wisdom to sound alarms of repeated financial unsustainability as the CBO director, what did the USA really get? Patterico has a quick outline on Orszag which touches on some key points, but with Orszag’s background, people should wonder how he ever got to hold the keys to the budget.

If you look a bit closer at his education, background, and experience, Orszag was everything that the Keynesians/progressives/Democrats could have dreamed of in a budget director. Let’s explore. Aside from being the former CBO director, Orszag was a senior fellow and Deputy Director of Economic Studies at the Brookings Institution, where he directed The Hamilton Project. His education is impressive having studied and receiving two degrees from the London School of Economics (LSE). While all Orszag’s education and experience appears impressive, it should have been more alarming than comforting to Americans.

Orszag’s policies are heavily influenced by his days at the LSE, and Obama has placed others from the LSE in his administration. As prestigous as the LSE may be, it is concerning because of the school’s founding and history, and continual ideological path it has taken since its inception. But how does all of this translate into effective economic policy specific to the capitalistic US economy? It doesn’t. Although it may not have been apparent, but Orszag’s ideology shaped the US economic policy into exactly what the Obama administration had planned.

While effectively sounding the healthcare alarms as CBO director, Orszag missed a big issue–the credit markets in September 2007:

Mr. Orszag spoke briefly about the risk to the economy from the slowdown in housing and the upheaval in credit markets. “The risk of a recession is clearly elevated but the most likely scenario appears to be one in which economic growth continues,” he said.

Couple that with the fact that Orszag had previously completed a report in 2002 for Fannie Mae and Freddie Mac (in PDF) entitled “Implications of the New Fannie Mae and Freddie Mac Risk-based Capital Standard” which stated in the foreword:

In 1997, former Federal Reserve Chairman Paul Volcker wrote that the possibility of default if Fannie Mae met the test was “remote.” To update that analysis, we commissioned Joseph Stiglitz (2001 Nobel Prize winner in economics), Jonathan Orszag (Peter’s brother), and Peter Orszag to examine the likelihood of the risk-based capital scenario. Their econometric analysis found that the probability of the stress test scenario is conservatively one in 500,000 and may be smaller than one in three million. As a result, they find that the risk of a default by these companies, if they hold sufficient capital to meet the stress test, is “effectively zero.”

Zero. Orszag got that way wrong. In fact, this is what the conclusion actually stated:

This analysis shows that, based on historical data, the probability of a shock as severe as embodied in the risk-based capital standard is substantially less than one in 500,000 – and may be smaller than one in three million. Given the low probability of the stress test shock occurring, and assuming that Fannie Mae and Freddie Mac hold sufficient capital to withstand that shock, the exposure of the government to the risk that the GSEs will become insolvent appears quite low.

Given the extremely small probability of default by the GSEs, the expected monetary costs of exposure to GSE insolvency are relatively small — even given very large levels of outstanding GSE debt and assuming that the government would bear the costs of all GSE debt in the case of insolvency. For example, if the probability of the case of insolvency. For example, if the probability of the stress test conditions occurring is less than one in 500,000, and if the GSEs hold sufficient capital to withstand the stress test, the implication is that the expected cost to the government of providing an explicit government guarantee on $1 trillion in GSE debt is just $2 million.

Two other points are worth noting. First, analysis of the risks posed by Fannie Mae and Freddie Mac must carefully consider the alternatives. In the absence of Fannie Mae and Freddie Mac, mortgage risk would likely be held by large banks and other types of financial institutions, which themselves benefit from the perception that they are “too big to fail.” Fannie Mae and Freddie Mac are among the largest financial institutions in the country. Even in the absence of a GSE charter it is likely that they would continue to benefit from their size, since the government has intervened on behalf of other large institutions in the past.

Secondly, and more broadly, Fannie Mae and Freddie Mac would likely require government assistance only in a severe housing market downturn. Such a severe housing downturn would, in turn, likely occur only in the presence of a substantial economic shock. Regardless of the structure of the mortgage market, the government would almost surely be forced to intervene in a variety of markets –including the mortgage market –in such a scenario. Fundamentally, given the public’s aspirations to homeownership and the myriad ways in which government subsidies are channeled to homeownership, the government is indirectly exposed to risks from the mortgage market regardless of the existence of the GSEs.

Hmmm…too big to fail and an economic crisis. Those two should sound very familiar and they have both played out as crises to be resolved by nationalization and centralization.

Additionally, Orszag’s consulting firm with Stiglitz and his brother was Sebago Associates, whose client list included the World Bank, the Nordic Council of Ministers, and most alarming, the Central Bank of Iceland. I always wondered why there was no inquiry to Orszag’s work prior to Iceland’s crash as the country accumulated very large amounts of debt under the direction of Orszag and his pals.

Moreover, Orszag’s confirmation hearing was more like a lunch date and none of these issues were ever discussed.

So, what we and generations to come are left with is a debt ceiling that has been increased twice, a “deemed” budget, a healthcare bill that will cost $115 billion more than projected (if we are lucky), and a national debt that overtakes the GDP.

Only after all of these legislative pieces were passed, budgets exploded, and the overall mission was accomplished did Orszag swing into full fiscal discipline mode.

Orszag will move on to another think tank (probably to watch how his bankrupting the country unfolds), completely unaccountable for the financial damage he has done to America–it took years to play itself out– but it does sound like the perfect crime doesn’t it?