Bailouts and Destruction: Your Risk, Our Reward

31 Sunday May 2015

Posted by Nuetzel in Big Government, Regulation

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Bailout Barometer, Dodd-Frank, Federal Reserve Bank of Richmond, Financial Risk Taking, Holman Jenkins, Housing Bubble, John Ligon, Too big to fail

The federal government creates some artificial incentives for financial risk taking. These are mostly guarantees against losses, either explicit or implied by similar, past acts of loss indemnification, i.e, bailouts. Under this regime, successes accrue to private risk takers while failures are borne by taxpayers and others from whom resources are diverted by artificially low user costs. This is a huge source of waste, pure and simple.

The financial crisis that began in 2007 featured bailouts of a variety of privately-owned institutions such as banks and insurers, as well as government-sponsored enterprises (GSEs: Fannie Mae and Freddie Mac). So-called financial reforms enacted in the wake of the crisis, especially those embodied in the Dodd-Frank Act, did nothing to eliminate the expectation that losses, should they occur, would be met by a rescue package.

“This approach to financial regulation, while a natural response to a market failure narrative, only increases the vulnerability of financial system to regulatory failure. Regulatory failure played an important role in the last crisis by concentrating resources in the housing sector, encouraging reliance on credit-rating agencies, and driving financial institutions to concentrate their holdings in mortgage-backed securities. Dodd-Frank gives regulators more authority and broad discretion to shape the financial sector and the firms operating within it.“

The Federal Reserve Bank of Richmond’s so-called “bailout barometer” shows the share of implicit and explicit federal guarantees on a large class of financial liabilities. It reached a total of 60% at the end of 2013. When losses are covered, who cares about risk? Did any of this change, as a lesson learned, after the last financial crisis? No. Instead, we have this:

“The 2010 Dodd-Frank law has certified various large institutions as “systemically important,” as prelude to burying them in costly regulation ostensibly for safety purposes but partly to divert lending to politically favored sectors. This hasn’t helped the economy. It probably hasn’t done much to make the financial system safer.“

That quote is from Holman Jenkins in “Bank Bashing: the Modern Nero’s Fiddle“. Jenkins accepts “too big to fail” (TBTF) and government guarantees as a reality, blaming the financial crisis on other aspects of government regulatory policy. And there is plenty of evidence that the government contributed in a number of ways, contrary to the usual media narrative. I don’t disagree, but federal guarantees have, and still do, distort risk-reward tradeoffs faced in the financial sector. And the guarantees don’t stop there: federal bailouts of large or politically-connected firms in other industries are now more commonplace and they will continue. Today, the expectation of federal bailouts even extends to other levels of government saddled with insolvent pension funds and other debts that can’t be paid.

Even now, the federal government is creating conditions that may lead to another financial crisis: in addition to the high bailout barometer, bank reserves are plentiful thanks to Federal Reserve policy, and the government seems eager to have those reserves invested in new mortgage lending. Here is John Ligon on this point:

“Two recent examples: Fannie Mae recently started a program guaranteeing loans with as little as 3 percent down payments, and, earlier this year, the Federal Housing Administration reduced by 50 basis points the annual mortgage insurance premiums it charges borrowers. …

A great irony, though, is that these affordable housing initiatives have had the exact opposite of their intended impact: These programs encourage higher levels of debt, increased housing prices (and lower affordability) in many markets, and greater risk within the overall housing finance system.”

There is no doubt that taxpayers will be called upon to cover losses should another financial bubble pop, whether that is in housing or other assets. The one-sided risk this creates represents a transfer of wealth to the financial sector. What’s worse is the contribution of government policy to the sort of economic instability this creates.

Federal Strings and Executive Puppeteers

28 Thursday May 2015

Posted by Nuetzel in Big Government, Federalism, Regulation

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Administrative State, Cooperative federalism, Executive federalism, Federalism, Michael S. Greve, Nullification, Tenth Amendment

We often think of government bureaucracy as a force of stasis, but it is unlikely to promote stability. At all levels, government administrative organs have a way of growing, absorbing increasing levels of resources and constricting private activity by imposing increasingly complex rules. A large administrative apparatus tends to calcify the economy, undermining growth or even a sustained level of economic activity. The negative consequences of the administrative state were treated twice on this blog last year.

Federalism, on the other hand, is usually viewed as a check on federal power relative to state governments. That was the perspective of “Nullifying the Federal Blob” last year on SCC. However, in “The Rise of Executive Federalism“, Michael S. Greve discusses forms of federalism that can serve as adjuncts or even alternatives to the exercise of federal legislative power. First, he discusses “cooperative federalism”, whereby lower levels of government receive federal funds and in turn administer federal programs:

“With very few exceptions…, virtually all federal domestic programs are administered by state and local governments, often under one of over 1,100 federal funding statutes (such as Medicaid or NCLB). Since its inception under the New Deal, this ‘cooperative’ federalism has proven stupendously successful in doing what it was supposed to do: expand government at all levels.“

Greve draws a connection between political and economic developments over recent decades, the coincident decline of cooperative federalism and the rise of a more aggressive “executive federalism”. These developments include constraints on funding at both the federal and state levels, a decline in the willingness of states to cooperate on certain programs, and a divided Congress. No funding, no federal-state cooperation and no federal legislative direction leaves a vacuum to be filled by federal executive initiative:

“Thus, to make federal programs ‘work’ under current conditions, agencies rewrite statutes, issue expansive waivers, and negotiate deals with individual states on a one-off basis. That is how the ACA is being ‘administered.’ That is how Secretary of Health and Human Services Sylvia Burwell is trying to expand Medicaid. That is how No Child Left Behind is run. And that is how Environmental Protection Agency is trying to impose its Clean Power Plan: ‘stakeholder meetings’ and assurances of regulatory forbearance for cooperating states; unveiled threats against holdout states. This brand of federalism knows neither statutory compliance nor even administrative regularity. It is executive federalism.“

It does not bode well that this perverse form of federalism “is robust to partisan politics.” Greve notes that certain aspects of executive federalism were initiated by the Reagan Administration.

Greve’s advice on combating this trend is to make federalism “less cooperative, one program at a time.” While he’s a little short on specifics, he advises that initiatives such as block grants to states are likely to be counterproductive in restoring traditional federalism. One point on which I part company with Greve is his disparaging reference to “state’s rights” as a battle of “yesterday”. I suspect his underlying objection (which I do not share) is drug legalization at the state level, or any other measure that he might find morally objectionable. Otherwise, I have no issue with what I take to be his favored approach, which seems to involve any assault on the exercise of federal administrative power and rule-making, whether that is through the courts or the exercise of nullification by the states. It is promising that so many states are resisting the imposition of additional administrative and funding burdens attendant to expansive federal sweeteners and control.

Racism And Minimum Wage Fairy Tales

02 Saturday May 2015

Posted by Nuetzel in Markets, Price Mechanism, Regulation

≈ 2 Comments

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Carrie Sheffield, David Henderson, Davis Bacon Act, Eugenics, John F. Kennedy, Minimum Wage, Progressive Rhetoric, Racial Discrimination, racism, Thomas Leonard, Thomas Sowell, Walter Williams

The real history of the minimum wage is an unsavory tale unknown to most current observers. The myth that it had honorable origins is widespread, with special currency among the progressive Left. Their uncritical support for a higher wage floor reflects a failure to grasp its pernicious economic effects on low-skilled labor and an ignorance of its historical context as a mechanism enabling racial discrimination. In fact, minimum wage legislation was often motivated by racist economic concerns, as Carrie Sheffield explained a year ago in this commentary in Forbes. She quotes, among others, the great Thomas Sowell, an African-American economist, from this opinion piece:

“In an earlier era, when racial discrimination was both legally and socially accepted, minimum-wage laws were often used openly to price minorities out of the job market.“

Sowell cites historical examples of minimum wage legislation intended to harm the employment prospects of Japanese, Chinese and blacks, including the following:

“Some supporters of the first federal minimum-wage law in the United States — the Davis-Bacon Act of 1931 — used exactly the same rationale, citing the fact that Southern construction companies, using non-union black workers, were able to come north and underbid construction companies using unionized white labor.

These supporters of minimum-wage laws understood long ago something that today’s supporters of such laws seem not to have bothered to think through. People whose wages are raised by law do not necessarily benefit, because they are often less likely to be hired at the imposed minimum-wage rate.“

Walter Williams, another well-known African-American economist, provides more evidence of these origins of the wage floor in “Mandated Wages and Discrimination“:

“During the legislative debate over the Davis-Bacon Act, which sets minimum wages on federally financed or assisted construction projects, racist intents were obvious. Rep. John Cochran, D-Mo., supported the bill, saying he had ‘received numerous complaints in recent months about Southern contractors employing low-paid colored mechanics getting work and bringing the employees from the South.’ Rep. Miles Allgood, D-Ala., complained: ‘That contractor has cheap colored labor that he transports, and he puts them in cabins, and it is labor of that sort that is in competition with white labor throughout the country.’ Rep. William Upshaw, D-Ga., spoke of the ‘superabundance or large aggregation of Negro labor.’ American Federation of Labor President William Green said, ‘Colored labor is being sought to demoralize wage rates.’ The Davis-Bacon Act, still on the books today, virtually eliminated blacks from federally financed construction projects when it was passed.“

An article by Thomas C. Leonard in the Journal of Economic Perspectives, “Eugenics and Economics in the Progressive Era“, reinforces the point:

“The progressive economists believed that the job loss induced by minimum wages was a social benefit as it performed the eugenic service ridding the labour force of the unemployable.”

And if that isn’t enough for you, David Henderson has this to say:

“Unions don’t support minimum wage increases because their own members are working at the minimum wage. Virtually all union employees–I’ve never heard of an exception–work at wages above the minimum. Northern unions and unionized firms, for example, have traditionally supported higher minimum wages to hobble their low-wage competition in the South…

… In a 1957 Senate hearing, minimum-wage advocate Senator John F. Kennedy of Massachusetts, who just four years later would be President of the United States, stated,

‘Of course, having on the market a rather large source of cheap labor depresses wages outside of that group, too – the wages of the white worker who has to compete. And when an employer can substitute a colored worker at a lower wage – and there are, as you pointed out, these hundreds of thousands looking for decent work – it affects the whole wage structure of an area, doesn’t it?’“

One can claim that JFK was advocating for a higher wage floor to benefit all workers, but it’s hard to avoid the conclusion that “protecting” white workers was his priority. And it strains credulity to deny that JFK was aware of the other side of the coin: there would be negative repercussions for low-skilled black workers. What is painfully obvious about minimum wage legislation is that the real beneficiaries are generally not those competing for minimum wage jobs, but more entrenched labor interests.

It is an unfortunate reality that blacks make up a disproportionately large share of the unskilled labor force. According to another commentary by Walter Williams, unemployment among blacks was not a chronic problem in the first half of the 20th century, even among teens, and male labor force participation among blacks was higher than for whites. Over the past 50 years, however, black unemployment has averaged twice the rate for whites. Minimum wage legislation has encouraged this disparity.

Today’s advocates of a higher minimum wage are inadvertently rooting for a policy that compounds the disadvantages faced by the least skilled workers. The minimum wage contributes to a negative disparate impact on black labor market outcomes and prevents blacks from gaining valuable job experience. It is impossible to regulate wages without impinging on hiring decisions, and it is impossible to regulate both wages and hiring without impinging on the survival of employers. To help the unskilled, the best thing policymakers can do is allow them to trade their labor freely.

Precaution Forbids Your Rewards

19 Thursday Feb 2015

Posted by Nuetzel in Regulation

≈ 2 Comments

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Carbon forcing, Climate models, Climate Warming, Coyote Blog, GMOs, Precautionary Principle, psuedoscience, regulation, Risk Management, Warren Meyer

The precautionary principle (PP) is often used to justify actions that radically infringe on liberty, but it is an unreliable guide to managing risk, both for society and for individuals. Warren Meyer makes this point forcefully in a recent post entitled “A Unified Theory of Poor Risk Management“. The whole post is worth reading, but PP is the focus of second section. Meyer offers the following definition of the PP from Wikipedia:

“The precautionary principle or precautionary approach to risk management states that if an action or policy has a suspected risk of causing harm to the public or to the environment, in the absence of scientific consensus that the action or policy is not harmful, the burden of proof that it is not harmful falls on those taking an action.”

He goes on to explain several problems with PP, the most important of which is its one-sided emphasis on the risks of an activity while dismissing prospective benefits of any kind. Enough said! That shortcoming immediately disqualifies PP as a guide to action. Rather, it justifies compulsion to not act, which is usually the desired outcome when PP is invoked. We are told to stop burning fossil fuels because CO2 emissions might lead to catastrophic global warming. Yet burning fossil fuels brings enormous benefits to humanity, including real environmental benefits. We are told to stop the cultivation of GMOs because of perceived risks, yet the potential benefits of GMOs are routinely ignored, such as higher yields, improved nutrition, drought resistance and reduced environmental damage. Meyer asks whether there is an irony in ignoring these potential gains, as it entails an acceptance of certain risks. Forced energy shortages would bring widespread economic decline. Less-developed countries face risks of continuing poverty and malnutrition that could otherwise be mitigated.

The terrifying risks cited by PP adherents are generally not well-founded. For example, climate models based on CO2 forcings have extremely poor track records. And whether such hypothetical warming would be costly or beneficial, on balance, is open to debate. The supposed risks of GMOs are largely based on pseudoscience and ignore a vast body of evidence of their safety. As Meyer says:

“… the principle is inherently anti-progress. The proposition requires that folks who want to introduce new innovations must prove a negative, and it is very hard to prove a negative — how do I prove there are no invisible aliens in my closet who may come out and eat me someday, and how can I possibly get a scientific consensus to this fact? As a result, by merely expressing that one ‘suspects’ a risk (note there is no need listed for proof or justification of this suspicion), any advance may be stopped cold. Had we followed such a principle consistently, we would still all be subsistence farmers, vassals to our feudal lord.”

The PP has obvious appeal to statists and fits comfortably into the philosophy of the regulatory state. But it’s a reasonable conjecture that widespread application of the PP exposes the world to greater natural and economic risks than without the PP. Under laissez-faire capitalism, human action is guided by the rational balancing of benefits against costs and risks, which has brought prosperity everywhere it’s been practiced.

Obamacare’s Medical Road To Serfdom

03 Tuesday Feb 2015

Posted by Nuetzel in Government, Obamacare, Regulation, The Road To Serfdom

≈ 1 Comment

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ACA, central planning, health care law, Kristen Held MD, Obamacare, Price Controls, regulation, Relative Value Units, The Road To Serfdom

The arrogance and shortsightedness of regulators and central planners is often astonishing and sometimes worthy of disgust. Here is a case of the latter, and it is one of the most damning things I have read about Obamacare, and that takes some doing.

Dr. Kristin Held is a physician who gained some notoriety last year when she live-tweeted a professional conference as ophthalmologists walked-out on a presentation about implementing and complying with Obamacare. More recently, she has written about the health care law’s perverse incentives for physicians. It is an excellent piece about a sickening effort at medical central planning by the government. Please read it!

What good can be said of a law that discourages physicians from performing procedures that would be of great benefit to most patients with a particular health issue; discourages physicians from tackling the more complex cases; encourages them to prolong an operation, having made the decision to operate. The standards by which outcomes are judged successful under Obamacare, and other rules governing remuneration to providers (Relative Value Units), represent crippling impediments to effective care and innovation in many areas of specialization. Here is part of Dr. Held’s summary:

“Consider again the perverse incentives created by government medicine. If I take a really long time operating — even though it subjects the patient to greater risk — and if I pick and choose who I will operate on, refusing the sickest, neediest patients, I am rated more highly by the government’s published “physician feedback” reports and hospital “performance scores” — and paid commensurately. If, on the other hand, I am skilled and quick and tackle the sickest, most challenging cases, subjecting me and my family to great risk, I am paid less or nothing and potentially punished. ”

HT: Dr. John Probst

Statists Make a Mess of Markets

20 Tuesday Jan 2015

Posted by Nuetzel in Markets, Regulation

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Foundation for Economic Education, Government Interference, Howard Baejter, Mark Perry, Markets, Mises Daily, Over-regulation, Patrick Barron, regulation, Self-Regulation, statism

Government is not well suited to regulate markets in many respects. In the first place, regulation is never absent from free markets: consumers, competitors, technology and all factors of production such as labor ultimately represent a network of forces that regulate market outcomes. The power of market self-regulation, and the often destructive results of government regulation, are discussed by Howard Baejter in “There is No Such Thing as an Unregulated Market“. Beyond the efficiency with which markets direct resources, Baejter notes that markets regulate the quality and pricing of goods and services. Mark Perry reviews Baejter’s post approvingly and adds some thoughts of his own:

“… the ruthless consumer-regulators also waste no time praising, endorsing and recommending the products, restaurants, movies, services, sellers, contractors and businesses they like, both by supporting them with plenty of their regulatory certificates of approval (dollars), and by giving them positive, sometimes even glowing reviews on Amazon, Yelp, Rotten Tomatoes, eBay, Angie’s List, Uber, etc….”

Baejter’s concluding section covers some ways in which government regulation short-circuits healthy market regulation. Regulatory actions not only impose significant compliance costs, but they often have the effect of suspending market price signals and hampering voluntary adjustments to change that would otherwise lead to improved welfare. Furthermore, regulated firms are often successful in “capturing” regulators, enabling the most powerful players in an industry to manipulate and obtain regulatory treatment that blunts competition. As Baetjer says:

“… government regulation often “crowds out” regulation by market forces and consumer-regulators, and markets therefore operate less efficiently because the interests of the producers take priority over the interests of consumers…”

The Mises Daily ran a post in early January by Patrick Barron in which he elaborates on the truism that peaceful, voluntary exchange necessarily improves well-being relative to third-party interference. Such interference may take the form of forced exchanges, rules, mandates, price controls, or distortions from taxation. A recent post on Sacred Cow Chips, “The State and the Invisible Future Lost“, emphasized the sacrifice of human well-being brought on by over-regulation. From that post:

“Our society routinely destroys economic opportunities as a matter of policy. This includes immediate discouragement of economic activity via tax disincentives and regulatory obstacles as well as lost capital investment and innovation. And it includes actions that grant protected status for monopolists, a steady by-product of the regulatory state.“