Category Archives: rent seeking

Anatomy of a Scam on Taxpayers: Biden Plumps Up IDRs

29 Monday Aug 2022

Posted by in Federal Budget, rent seeking, Student Loans

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In my last post I discussed the difficulty faced by potential challengers to President Biden’s student loan forgiveness program in establishing legal standing in court. I also mentioned an estimate of the cost of the plan to taxpayers of around $600 billion over ten years. That was from the Penn-Wharton Budget Model, but now the model’s estimate ranges to more than $1 trillion! The difference is a reassessment of the changes to increasingly popular income-driven repayment (IDR) plans and uncertainty around behavioral assumptions like plan uptake over the ten-year budget window. The changes to IDRs are separate from the $10,000 – $20,000 short-term loan forgiveness component of Biden’s plan, and they are a perfect basis for a legal scam on taxpayers.

IDRs are not new. Under these plans, a borrower pays 10% of their income toward the outstanding balance of their student loans for a period of 10 to 20 years, depending on the plan, after which any remaining balance is forgiven. This may or may not make sense for borrowers with high student loan payments relative to income. In fact, there are some who warn that IDRs are a ripoff. However, only income above 150% of the poverty line is subject to IDR payments. For some students borrowing heavily, IDRs can make tuition hikes irrelevant beyond a certain loan balance: just borrow it! Living expenses can be borrowed as well! These plans almost completely eliminate price sensitivity among consumers of college educations, and it may make sense for certain students to borrow as much as possible. It’s also a prescription for escalating tuition.

Law graduates who work in the public sector have long received favorable treatment via IDRs: they pay 10% of their discretionary income for only 10 years. The so-called Public Service Loan Forgiveness (PSLF) program is leveraged by law schools, which offer deals for students called Loan Repayment Assistance Programs (LRAP). For an explanation, I’ll defer to Matt Bruenig and his interesting post on the topic (with hat tip to Alex Tabarrok):

“The LRAP schemes work as follows:

  1. The school increases their tuition.
  2. The student takes out federal loans to cover the tuition increase.
  3. The school squirrels away the debt-financed tuition increase into an LRAP fund.
  4. The school disburses money from the LRAP fund to cover PSLF repayments.

Through this roundabout process, the law schools effectively use student debt to pay off student debt and make their schools free or nearly free, at least for these particular students.”

The school knows the student’s debt payments are limited by income. Tuition hikes can be paid with additional loans, and the LRAPs future obligations are limited by the student’s income after graduation. Not only is the tuition hike “free” to the student, but the school might be able to pocket a share of the new loan and invest the whole nut for returns in the interim. That’s the gist of Tabarrok’s simple example. Needless to say, IDRs and PSLF create some very bad incentives! Farewell to cost control!

Biden’s plan extends IDRs in ways that make them far more attractive to students, including undergraduates. Here are the changes, again from Bruenig:

“The IDR changes are four-fold:

  1. Increase the amount of income not subject to IDR from 150 percent of the federal poverty line to 225 percent of the federal poverty line.
  2. Eliminate any accrual of interest on IDR-enrolled loans.
  3. For undergraduate debt, reduce the IDR rate from 10 percent of income beyond the threshold in (1) to 5 percent of income beyond the threshold in (1).
  4. For IDR-enrolled debts with original loan balances below $12,000, reduce the repayment period from 20 years to 10 years.”

Smaller payments and zero interest! This is what led to Penn-Wharton’s revision in the high-side cost estimates of Biden’s student loan forgiveness plan:

“‘Depending on future details of the actual IDR program and concomitant behavioral changes, the IDR program could add another $450 billion or more,’ the analysis found. ‘Thereby raising total plan costs to over $1 trillion.’”

The incentives are for schools to offer LRAPs more broadly, and to abuse them. Rent-seeking vendors have lined up to design and manage these programs. Students and even parents are encouraged to borrow up to the maximum limits, which conceivably allows the loan proceeds to be used outside of the ostensible educational purpose of the loan, potentially for investment gains. See Tabarrok’s post for some links to creative schemes to which part of the loan proceeds might be put by borrowers.

This is a huge scam! It’s hard to square the Administration’s action with any effort to apply economic logic to program design. But that’s not really the point of the student loan forgiveness program. Instead, it’s designed to warm the hearts of Biden’s political base among students and young college graduates. And it will further enrich the heavily endowed universities that can be counted upon to inculcate students with leftist dogma. Apparently, the rest of us, who lack standing to formally challenge these schemes, can just suck it.

Who Are the Zero-Sum Winners?

09 Monday Sep 2019

Posted by in Big Government, rent seeking

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Productive effort seldom goes unrewarded, but all too often rewards are directed to nonproductive activities and secured in ways that are outright takings of resources and rights from others. These are zero-sum propositions at best, as the rewards come only at equivalent or greater costs to others. Gains from zero-sum activities are often purely consumptive in nature and tend to foster more destructive behavior. A clear-cut example is outright thievery, but there are many cases in which, by matters of degree, the perpetrators are not even dimly aware that their gains bring harm to others.

Sadly, our society has undergone a transition to a state in which everyone collects ongoing streams of zero-sum rewards, which are, by definition, at someone else’s (and often our own) expense. The turbulence caused by this unnecessary and avoidable mix of costs and rewards is all too real for consumers and businesses, but again, they don’t always fully grasp its dysfunctional nature.

The Way To Positive Sums

Of course, there are winners and losers in almost any area of economic life. Even when two individuals engage in mutually beneficial exchange, an otherwise win-win situation, other traders might regret missing out on the deal. Pleasing buyers more effectively than one’s competitors might force those rivals to turn to other pursuits. That’s all for the best from a social point of view, unless they can come up with an even better idea to win back customers. In this way, things can keep getting better and better for everyone, even for the one-time losers who are free to compete in trades to which they are better suited. Winners, then, are defined by their success in creating value for others. These are the productive winners. But again, material success doesn’t always come so honorably.

Bobbing For Booty?

Purely “consumptive” or zero-sum winners might be simple crooks who are able to avoid apprehension, or perhaps they are dishonest business-people who sell goods with hidden defects or inferior workmanship. There are many degrees here: a talented salesperson with shoddy merchandise might compromise on price. A clever product manager might reduce the size of a package slightly without reducing price.

A simple gamble is zero-sum in a purely monetary sense, but both gamblers do it for enjoyment, so there are psychic gains involved. A successful gambler might be a zero-sum winner in a monetary sense, but luck usually runs out on honest players. A cheater qualifies as a zero-sum winner. Conversely, it’s not correct to say that casinos are strictly zero-sum winners, though the odds are always stacked in favor of the house and everyone knows it. Casino patrons enjoy the experience, including other amusements available in casinos, so they are often happy customers despite their losses. They are engaging in mutually beneficial exchange.

Private Affairs Made Public

A short-hand description encompassing much of our zero-sum havoc is “the public trough”. Many zero-sum rewards have arisen out of legislative battles, court cases, and regulatory actions restricting private decision-making and encroaching on private property rights. The unremitting tendency is for expansion of these kinds of actions. Where there are zero-sum winners at the public trough, or an opportunity to expand the trough itself, there are always more covetous seekers of zero-sum winnings, otherwise known as rent seekers. They are reliable promoters of “do-something-ism” relative to the outrage du jour through more legislation, lawsuits, and regulatory filings. The tragic thing about rent seeking is that the process itself consumes resources and undermines private incentives, thereby transforming zero-sum outcomes into wasteful, negative-sum outcomes.

Winners At the Trough

There are many kinds of zero-sum winners at the public trough. The winning and losing often occur separately and asynchronously, connected only by an enabling authority who sets rules and funds winners from proceeds taken from losers. For this reason, it is easy for citizens to lose track of the “zero-sumness” of the many benefits they receive. After all, the government can deliver things for “free”, right? And the connection between one’s obligations, losses, and the gains reaped by others is not always obvious.

All of the following involve some degree of zero-sum activity, and all attract rent seekers:

  • Public aid in exchange for no contribution to output, funded by zero-sum losing taxpayers.
  • Subsidies for politically-favored technologies that are otherwise uneconomic, funded by zero-sum losing taxpayers.
  • Farm subsidies when too much is produced and the output is not highly valued, leading to an overallocation of resources to agricultural activity and rents for farmers funded by zero-sum losing taxpayers.
  • Complex regulatory and tax rules generate income for compliance advisors such as attorneys, accountants, and consultants. Those are rents, pure and simple, paid for by parties who must comply under penalty of law.
  • Regulatory advantage conferred upon firms sufficiently large or dominant to afford compliance. That penalizes smaller competitors and undermines their market position. The additional profit large firms may earn as a consequence is a rent, funded by zero-sum losing consumers and weaker competitors.
  • The award of government contracts is often as much political as it is economic. Such a process is not subject to the market discipline imposed on private contracts, so there is ample opportunity for rents via cost-padding and graft, again funded by zero-sum losing taxpayers.
  • More generally, government purchases of any kind are subject to weak market discipline, like any buyer spending someone else’s money. Thus, government has a tendency to pay prices not supported by economic value, offering rents to suppliers, funded by zero-sum losing taxpayers.
  • The tax deduction afforded to employer-provided health care is a targeted subsidy that leads employees to over-insure. More fundamentally, these employees and their employers are zero-sum winners. It also creates profits for health insurers and drives up health care costs. The zero-sum spoils are to the detriment of other taxpayers and participants in the individual insurance market.
  • Drug prohibition drives up black market profits, creating zero-sum winnings at the expense and safety of users.
  • Social Security creates zero-sum winnings for those who will not or cannot save. But this is a mixed bag to the extent that some people are unable to save privately: their ability to do so is largely usurped via payroll taxes, both on them and on their employer. The many zero-sum losers would otherwise have no difficulty earning better returns on private investments.

There are many other examples. And almost everyone ends up on one side or the other of many different zero-sum outcomes. Show me a government action and I’ll show you zero-sum winners and losers. This is not to say there are no welfare gains associated with government action. Public aid, for example, is intended as social insurance and surely has some value in mitigating the risks of personal economic calamity. Nonetheless, the overextension and poor incentives of aid programs create a significant zero-sum component. Likewise, government spending on public goods creates social benefits, but government is insufficiently incented to economize, creating a zero-sum win for contractors and losses for taxpayers.

Not Zero Sum

While zero-sum winners collect economic rents, the existence of economic rents does not imply a zero-sum winning. For example, members of the so-called rentier class collect passive investment income. Those investments represent a supply of current resources to other parties hoping to transform them into a greater supply of future resources. That’s productive, and so the gains enjoyed by rentiers are not zero-sum winnings, but payments for the use of transformational capital.

Economic profits are those exceeding the owner’s opportunity cost, and they too are called rents. They should not necessarily be classified as zero-sum gains, however. Only sometimes. Successful innovators and first movers often earn economic profits as a reward for their efforts, as do alert entrepreneurs deploying their resources where they are most demanded. This “positive-sumness” applies to monopolists with a hot product just as surely as it applies to a firm facing nascent competition. But economic profits gained through political connections, outright graft, and government-enabled monopoly are zero-sum, enabled by non-market, authoritarian forces. Members of the political class tend to share in these zero-sum gains, and there are many losers.

Zero-Sum Psyche

Unfortunately, zero-sum thinking is deeply ingrained in the human psyche, despite our transition to a higher plane of social cooperation via markets. Even in those markets, certain outcomes might seem zero-sum in the moment. Witness the widespread denigration of the profit motive, which produces efficient outcomes in the long-run. As noted above, over time, the biggest winners tend to be those capable of creating the most value.

If you ask school children today how to get rich, many will say “win the lottery” without hesitation. I know, I know, government-sponsored lotteries are a relatively new phenomenon, and some of the lottery proceeds may benefit schools or other public programs, but the idea that a game of chance is so indelibly ingrained in the minds of children is a manifestation of the psychology of zero-sum success.

The Tangled Mess

So we have the zero-sum winners: successful gamblers, thieves, and rent seekers. The latter root deeply for gains made possible by government intervention in private affairs, actions that always leave room for enduring rents. They always lobby fiercely for new public interventions that might confer private advantages. And then we have the hapless public, stumbling through a series of zero-sum gains and losses made possible by the Leviathan they know and obey. They should look in the mirror, because every law and every program they have allowed their political leaders to hatch, reliably sold as good and just, creates more zero-sum activity to the detriment of long-term economic welfare. Roll it back!

Corporate Lapdogs of the Left

04 Wednesday Apr 2018

Posted by in Central Planning, Identity Politics, Progressivism, rent seeking

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Now don’t get me wrong, I definitely prefer to see private goods and services produced privately, not publicly. Private ownership of the means of production makes the world a better place because ownership and self-interest drive performance and value, to put it all too briefly. But corporate America is now so thoroughly encumbered by ideological distractions that it compromises the mission of creating value, risking shareholder returns and invested capital as well. Having spent the past 31 years employed successively by three gigantic corporate hairballs (with a 2-year stint at the central bank), the following thesis about corporate CEOs, and corporate America by extension, strikes me as wholly accurate:

“CEOs … mostly [reject] the ethos of rugged individualism in favor of a more collectivist view of the world. The capitalists [are] not much interested in defending the culture of capitalism. … the psychological and operational mechanics of large corporations [are] much like those of other large organizations, including government agencies … American CEOs [believe] that expertise deployed through bureaucracy [can] impose rationality on such unruly social entities as free markets, culture, family, and sexuality. The supplanting of spontaneous order with political discipline is the essence of progressivism….“

I changed the tenses used above by Kevin Williamson, who attempts to explain why American corporations became such progressive activists. The beginning of the quote describes interviews conducted by William H. Whyte in the 1950s, but it’s as true now as it was then, and probably much more so. The technocratic view of organizational efficacy may be true up to a point. In fact, there is undoubtedly an optimal size for any organization that is dependent upon it’s mission, the technologies at its disposal, and the range of prices it is likely to face in input and output markets. It’s all too easy for a successful firm to expand beyond that point, however, as many now-defunct businesses have learned the hard way. However, the quote merely highlights the sympathetic view often held by corporate managements toward the notion of a planned society, guided by a class of technocrats. They share this scientistic line of thinking with the statist left, though the corporatist vision is a world in which their private organizations play a critical role, with risks mitigated by “partners” in government.

Private incentives can produce wonderful results, but they are corrupted by the scent of private advantage that can be gained via government intervention in markets. The corporate practice of seeking rents through legislative and administrative action has been going on since at least the 1880s, when railroads sought protection from competition and other shipping interests via federal regulatory action.The symbiosis between government and corporate interests, or corporatism, has been growing ever since. Whether it is lucrative contract awards, subsidies, or favorable regulation, government has lots of goodies at its disposal by virtue of its exclusive ability to exert coercive power. This quote of David Cay Johnston describes the end-product of corporate rent-seeking behavior:

“Corporate socialism is where we socialize losses and privatize gains. Companies that have failed in the marketplace stick the taxpayers with their losses, but when they make money they get to keep it, and secondly, huge amounts of capital are given to companies by taxpayers.”

Risk mitigation is at the heart of a second variety of corporate leftism, and Williamson notes the asymmetry in the political risks faced by most corporations:

“Conservatives may roll their eyes a little bit at promises to build windmills so efficient that we’ll cease needing coal and oil, but progressives (at least a fair portion of them) believe that using fossil fuels may very well end human civilization. The nation’s F-150 drivers are not going to organize a march on Chevron’s headquarters if it puts a billion bucks into biofuels, but the nation’s Subaru drivers might very well do so if it doesn’t. … The same asymmetry characterizes the so-called social issues.“

At this point, Williamson goes on to describe a few social issues on which corporate leaders are frequently harangued by the left. Those leaders may view conservative positions on those issues as aberrant, according to Williamson, because the leaders inhabit an insulated world of elitist, media-driven, politically-correct opinion. They wish to be seen as “progressive” and discount the risk of offending conservatives. While I do not take Williamson’s side on all of the social issues he mentions, I concede that there is some truth to the asymmetry he describes.

An avenue through which corporate America is strongly influenced by the left is identity politics. This is partly an unfortunate side-effect of civil rights legislation and other anti-discrimination law, but in today’s litigious environment, there are excessive legal risks against which corporations must take precautions. This is embedded in human resource policies to the point at which hiring the best individual to fill a role is subject to a series of costly, time-consuming hurdles, and is sometimes impossible. Then, there are the mandatory “Diversity and Inclusion” courses that all employees are required to complete. These overbearing attempts to “educate” the work force consume valuable staff time and are of questionable value in light of the aggravation and resentment they inspire in employees. Finally, I can’t keep count of all the corporate-sponsored activities devoted to celebrating one identity group after another. Can we please get back to work?

Today, as a consumer, it is becoming more difficult to engage in commerce without exposure to a seller’s political positioning. For example, I buy about 90% of my clothing from a particular clothier, but last weekend I learned that the company had taken an objectionable position (to me) in the debate over gun legislation. I am certain that activists badgered the company, and it succumbed, and so I will change my shopping habits. People often find that it’s easier to engage in arms-length transactions when the other party stays off the soapbox. But it goes further than that. Here is Williamson:

“Whereas the ancient corporate practice was to decline to take a public position on anything not related to their businesses, contemporary CEOs feel obliged to act as public intellectuals as well as business managers.“

Well, “ancient” might take it a bit too far, but as a customer, employee, and especially as a shareholder, I would urge any company to steer clear of political posturing. Do not dilute your mission of delivering value to customers, which dovetails with serving the interests of shareholders. You must pursue that mission in a way that you consider responsible and ethical, which just might narrow the scope of the mission. And that’s okay. Just be as neutral as possible on extraneous issues as you reach out to potential customers, and do not respond to politically-motivated threats except in the most diplomatic terms.

Should I bother to say that corporations should eschew public subsidies? That they should respond to competition by improving value, rather than lobbying for advantages and protection from lawmakers or regulators? That they should not badger their employees to give to their company’s Political Action Committee (PAC)?

I must be fantasizing! Corporations would never follow that advice, not as long as they can capture rents through the seductive expedient of big government. If that were the only reason for the hate reserved by leftists for corporate America, I’d be right with them. But in fact, leftist rhetoric condemns the profit motive generally, both in principle and as a method of scapegoating for any social ill. Williamson marvels at the incredible irony of the corporate enterprise-cum-lapdog of the Left, which is especially palpable as the Left beats the dog so unrelentingly.

Bankers, Risk and the Rents of Slippery Skin

12 Monday Mar 2018

Posted by in Banking, rent seeking

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Risk taking is important to the economic success of a nation. Creative energy demands it, and it is critical to achieving economic growth and wealth creation. But it’s obviously possible to take too much risk or risks that are ill-considered, and that is all the more likely when risk-takers are absolved of the consequences of their actions. That is, healthy risk-taking and responsibility are inextricably linked. One can’t truly be said to take a risk if the cost of failure is borne by another party. It’s easy to understand why risk-taking becomes excessive or misdirected when that is the case.

Risk Shifting

There are various ways in which a party can parlay risky undertakings into easy gains by shifting the risks to others. For example, any piece of merchandise comes with the risk that it will not perform as advertised. Some traders might be tempted to sell unreliable merchandise and shift risk to the buyer without recourse. This is an area in which we must rely on a bulwark of private governance: caveat emptor. On the other hand, government tends to subsidize risk-taking in various ways: limited liability under the corporate form of business organization, bank deposit insurance, bankruptcy laws, the implicit government guarantee on mortgage assets, and the “too-big-to-fail” mentality of government bailouts.

Whose Skin In the Game?

These are examples of what Nassim Taleb bemoans as the failure to have “skin in the game”. The quoted expression happens to be the title of his new book. I have both praised and castigated Taleb’s work in the past. He made an interesting contribution about the nature and risk of extreme events in his book “Black Swan”, such as his application of so-called “fat tails” in probability distributions, though some have claimed the ideas were anything but original. I was highly critical of Taleb’s alarmist hyperbole on the effects of GMOs. In the present case, however, he considers “the asymmetry of risk bearing” to be a major social problem, and I’m generally in agreement with the point. The most interesting part of the brief discussion at the link is the following:

“In Taleb’s universe, the fieriest circle of hell is reserved for bankers and neoconservatives. ‘The best thing that could happen to society is the bankruptcy of Goldman Sachs,’ he tells me. ‘Banking is rent-seeking of industrial proportions.’ Taleb, who became rich as a derivatives trader, is not a foe of capitalism but of ‘cronyism’. ‘If you’re taking risks, God bless you. This is why I accept inequality. I’ve seen people go from trader to cab driver and back again.’“

Banks are a prominent example of the risk-shifting phenomenon. First of all, banking institutions are not required to hold much capital against their assets. In fact, recently banks have had average equity of less than 6% of assets. That’s much higher than during the financial crisis of ten years ago, but it is still rather thin and hardly represents much “skin in the game”.

Fractional Reserves

It should come as no surprise that a bank’s assets are funded largely by account balances held by depositors (liabilities), and not by equity capital. But your bank balance is not kept as cash in the vault. Instead, it is loaned out to the bank’s credit clients or used to purchase securities. This is facilitated by “fractional reserve banking”, whereby banks need only keep a fraction of their depositors’ money on hand as cash (or in their own reserve deposit accounts with the Federal Reserve). This generally works well on a day-to-day basis because depositors seldom ask to redeem more than a small fraction of their money on a given day.

Reserve requirements are set by the Federal Reserve and range from 0-10%, depending on the size of a banks’ deposit account balances. At the upper figure, a dollar of new cash deposits would allow a bank to extend new loans of up to $0.90. This legal practice divides many in the economics profession. Some believe it represents fraud rather than sound banking. This article by Frank Hollenbeck at the Mises Canada web site states that it is improper for a bank to lend a depositor’s money to others:

“Suppose you lived in the 18th century and had 100 ounces of gold. It’s heavy and you do not live in a safe neighborhood, so you decide to bring it to a goldsmith for safekeeping. In exchange for this gold, the goldsmith gives you ten tickets where eachis clearly marked as claims against 10 ounces. …

… Quickly the goldsmith realizes there is an easy, fraudulent, way to get rich: just lend out the gold to someone else by creating another 10 tickets. Since the tickets are rarelyredeemed, the goldsmith figures he can run this scam for a very long time. Of course, it is not his gold, but since it is in his vault, he can act as though it is his money to use. This is fractional reserve banking with a voluntary reserve requirement of 50%. Today, modern US banks have a reserve requirement of between 0% and 10%. This is also how the banking systemcan create money out of thin air, or basically counterfeit money, and steal the purchasing power from others without actually having to produce real goods and services.”

Another aspect of the argument against fractional reserves is that it creates economic instability, fueling booms and busts as the quantity of money in circulation sometimes exceeds or falls short of the needs of the public. Many authorities have taken a negative view of fractional reserve banking through the years: Irving Fisher, Milton Friedman, John Cochrane, Ralph Musgrave, and Laurence Kotlikoff, to name a few prominent economists (see this recent paper by Musgrave).

In Defense of Fractional Reserves

Others have defended fractional reserves as a practice that has and would again arise in a free market environment. According to this view, depositors would accept the logic of allowing banks to lend a portion of the funds in their accounts in order to generate income, rather than charging larger fees for “storage” and administration. If the depositing public is aware of the risk and has competing choices among banks, then the argument that banks expose depositors to excessive risk via fractional reserves is moot. Fractional reserves can exist in a private money economy in which competitive pressures reward banks (and their privately circulating notes) having sound lending practices. In fact, some would say that the very idea of a 100% reserve requirement is an unacceptable government intrusion into the private relationship between banks and their customers. All of that is true.

Some have compared fractional reserve banking to the sale of insurance. Consumers buy insurance to take advantage of pooled risk, but they have no expectation of a refund unless they incur the kind of insured loss in question. Bank depositors, on the other hand, expect a return of their funds in-full. Yes, low risk is an attribute they desire, and pooling across the withdrawal needs of many depositors is one reason why banks can invest and pass a part of the return on to depositors, both in interest and reduced fees. So, despite the differing needs and expectations of their customers, there is some validity to the comparison of insurers to fractional-reserve bankers.

Amplification of Shifted Risks

Do fractional reserves allow banks to take risks without having skin in the game? Absolutely! With as little as 6% equity at risk, banks have relatively little to lose relative to depositors. Yes, banks pay the FDIC to insure deposits, and premiums are higher for riskier banks. However, not all deposits are insured by the FDIC. More importantly, at the end of 2017, the entire FDIC deposit insurance fund was about 0.7% of commercial bank assets. One big bank failure would wipe it out, or a few hundred small ones. That’s well within the realm of possibility and historical experience. So, where does that leave depositors? Their skin is very much in the game, and the game is about the risks taken by banks in investing depositors’ funds.

We now live in the era of “too-big-to-fail” (TBTF), whereby large banks (and sometimes industrial firms) are viewed as so “systemically important” that they cannot be allowed to fail. Taxpayers must bail them out in the event they become insolvent. Thus, taxpayers have skin in the game. Banks collect rents to the extent that their returns exceed those commensurate with the risks for which they are actually “on the hook”.

Another avenue through which banks off-load risk is the extent to which Fannie Mae and Freddie Mac are still presumed to have the federal government’s implicit guarantee against default on the mortgage debt they purchase from banks. That is beyond the scope of the present discussion, however. And I have not discussed the role of large investment banks in the capital markets. That’s a whole other dimension of the story. This article by Guatam Mukunda in the Harvard Business Review provides a perspective on rent seeking in investment banking.

Conclusion

The combination of deposit insurance, TBTF and other risk-insulating subsidies, layered on top of a fractional reserve banking system, places banks into Taleb’s “fieriest circle of hell”. These factors blunt bank incentives to manage risk effectively as well as consumer incentives to conduct adequate due diligence in their banking relationships. It means that risk is not priced properly, because banks are likely to ignore risks from which they are shielded. Therefore, banks may allocate resources into excessively risky uses. The consequences for depositors and taxpayers can be dramatic.

Fractional reserves are not “fraud” in the sense that the system has unsuspecting victims. Anyone who has watched “It’s a Wonderful Life” knows that banks lend your deposits to others. But fractional reserves magnify the risk-mitigating privileges conferred upon the banking industry by government through various mechanisms. This “risk-cleansing” is converted to rents and collected by banks for their shareholders, but the risks are still borne by society. To the extent that fractional reserves create instability, deposit insurance is viewed as a necessity, but banks should pay a market premium to an insurer to cover the actual risk inherent in the system. Too-big-to-fail should end, as should the implicit subsidy collected by banks through the government-sponsored enterprises.

Clinton Foundation Domain of Darkness

23 Saturday Jul 2016

Posted by in Privilege, rent seeking

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Clinton-Foundation-600-LA

Hillary and Bill Clinton provide a fascinating case study in the art of graft, and the Clinton Foundation provides them with brilliant cover. The foundation masquerades as a legitimate charity, avoids taxes, and provides a vehicle for what’s known as “pay-to-play” influence-buying. It appears that Bill Clinton made a lucrative career of this while his wife was serving in public office. It was a sensitive issue when Hillary was Secretary of State, given the potential for compromising national objectives. It is still sensitive in view of the many gifts to the Clinton Foundation provided by foreign entities, not to mention the handsome speaking fees paid by foreign entities directly to the Clintons.

Here, I discuss some of the suspicious activities of the Clinton Foundation. This post is the last in a three-part series on Hillary’s most recent scandals. The first in the series covered Hillary’s Benghazi disaster; the second post dealt with her negligent email practices and handling of classified information, as well as her prevarication in responding to investigative efforts.

Last year, the New York Times published a report on the Clinton Foundation’s (CF) connections to a series of deals that ultimately gave a Russian company control of a large share of worldwide uranium supplies:

“At the heart of the tale are several men, leaders of the Canadian mining industry, who have been major donors to the charitable endeavors of former President Bill Clinton and his family. Members of that group built, financed and eventually sold off to the Russians a company that would become known as Uranium One. … the sale gave the Russians control of one-fifth of all uranium production capacity in the United States. … Among the agencies that eventually signed off was the State Department, then headed by Mr. Clinton’s wife, Hillary Rodham Clinton.

As the Russians gradually assumed control of Uranium One in three separate transactions from 2009 to 2013, Canadian records show, a flow of cash made its way to the Clinton Foundation. Uranium One’s chairman used his family foundation to make four donations totaling $2.35 million. Those contributions were not publicly disclosed by the Clintons, despite an agreement Mrs. Clinton had struck with the Obama White House to publicly identify all donors. Other people with ties to the company made donations as well.“

The amounts involved are far greater than the figures in the quote suggest. One individual with intimate connections to the deals gave in excess of $31 million to the CF. The Times report gives details on the shifty ways in which some donor money found its way into CF coffers, often not attributed to the donors themselves in official records. These practices look an awful lot like a sophisticated way of laundering money for influence buying:

“A person with knowledge of the Clinton Foundation’s fund-raising operation, who requested anonymity to speak candidly about it, said that for many people, the hope is that money will in fact buy influence: ‘Why do you think they are doing it — because they love them?’“

There are many other suspicious links between the CF and rent-seeking individuals and institutions. Jonathan Turley has detailed the unsavory nature of the Clinton’s connection to Laureate International Universities, an online college that encompasses Walden University Online, known in some circles as an operator of scams far-exceeding the allegations against Trump University. The chairman of Laureate, Douglas Becker, has been a major donor to the Clintons and their foundation. As it happens, Laureate received $55 million in funds from State Department Grants. Bill Clinton was paid $16 million to serve as Laureate’s “Honorary Chancellor”. Here is one interesting comment from Turley:

“Laureate has come up in the Clinton email scandal. In her first year as Secretary of State, Clinton is quoted as directly asking that Laureate be included in a high-profile policy dinner — just months before the lucrative contract was given to Bill Clinton. Hillary Clinton later references ‘Laureate Universities, started by Doug Becker who Bill likes a lot.’“

There might not be anything to top the cronyism inherent in the activities of the CF in pretending to rebuild Haiti after a massive earthquake struck the island in 2010. The article at the last link offers descriptions of a number of projects, ostensibly funded for the benefit of Haiti, that involve double-dealing by the Clintons and CF:

“The Haitian protesters noticed an interesting pattern involving the Clintons and the designation of how aid funds were used. They observed that a number of companies that received contracts in Haiti happened to be entities that made large donations to the Clinton Foundation. The Haitian contracts appeared less tailored to the needs of Haiti than to the needs of the companies that were performing the services. In sum, Haitian deals appeared to be a quid pro quo for filling the coffers of the Clintons.“

Foreign governments gave to the CF while Hillary Clinton was serving as Secretary of State and have continued to do so even after her presidential candidacy was made clear. This was reported more recently, and includes gifts from “friends” of foreign governments and other foreign interests including Mexico, Turkey, Japan, Saudi Arabia, the UAE, and of course Russia. Many contributions are “bundled” by third-party entities, an apparent but ineffective effort to obscure the true sources of gifts:

“A number of Hillary Clinton’s top lobbyist bundlers, who have raised millions for her presidential campaign, either directly represent foreign entities or work at firms that represent foreign entities, according to documents from the Justice Department’s Foreign Agents Registration Unit.“

Here is a New York Times review of “Clinton Cash: The Untold Story of How and Why Foreign Governments and Businesses Helped Make Bill and Hillary Rich”, by Peter Schweitzer. Rep. Marsha Blackburn (R – TN) is urging the FBI, the IRS and the FTC to investigate the activities of the Clinton Foundation.

The CF is guilty of ignoring widely accepted charitable best practices, according to this report. Its small board of directors is insular and lacking a sufficient degree of independence. Its record-keeping is suspicious, such as a $12.6 million expense for Bill Clinton’s 60th birthday expensed as “fund raising costs”. Inappropriate gifts to the Clintons from directors have raised eyebrows, and apparent “payoffs” for retiring directors, in the form of appointments to powerful positions, have made the CF into a veritable revolving door for Clinton insiders.

I include this last bit because it amuses me: according to Dr. Ben Carson, Hillary Clinton is Lucifer in the flesh. The explanation is that Hillary liked Saul Alinsky in college (and maybe still does), and Alinsky acknowledged Lucifer as the “first radical”. That probably leaves a few degrees of separation between the two. Economist Tyler Cowan does not agree with Carson, but he toys with the notion in a short analysis on Marginal Revolution. Here are a few of his bullets on the topic:

“This topic seems to have entered the news cycle. I am not sure how, so I thought I would add a few observations in the interests of clarity: 

1. Under the most plausible ‘yes’ scenario, Lucifer inhabits the corpus of us all, not just the Clinton family, grandchildren included. 

2. The correct answer is still ‘probably not.’ 

3. Is there a greater chance that Hillary Clinton is in fact Lucifer himself, rather than merely being possessed by him? (Would that not also be a new kind of transgender relation?) No, more likely she would have a Satanic familiar. In most equilibria, the number of familiars is greater than the number of Satans. Far greater.“

A better argument for Hillary’s connection to the Prince of Darkness would rely on the self-serving nature of the “charitable” Clinton Foundation while disguised as a charity. It is both a repository for future policy influence and a pool for enrichment of the Clintons themselves and their cronies. The CF represents a grotesque distortion of the charitable motive. Let’s hope James Comey, Director of the FBI, can direct a competent investigation into the CF’s activities. More importantly, let’s hope that come November, the better judgement of American voters will deny Hillary the presidency.

Postscript: The FBI’s original investigation of Hillary’s emails, presided over by former Director James Comey, was an apparent effort to exonerate her. An investigation of the CF is underway, and the investigation of Hillary’s email shenanigans has been renewed.

Seeding the Grapes of Graft

23 Saturday Apr 2016

Posted by in Big Government, rent seeking

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Government-Bounty-Hunter

Are you investing in graft and rent-seeking activity without knowing it? Is a significant share of your saving channeled into sectors that profit from political influence over politicians, regulators and government planners? Maybe it’s no surprise, and you knew all along that your capital backs firms who manipulate the political system to extract resources beyond what they can earn through honest production. You have an interest in the success of the rent seekers, and you might well get a tax benefit to go along with it!

All this is almost certainly true if your savings are in a 401k, an IRA, a public or private pension fund, or in publicly-traded stocks. These sources of investor funding are dominated by firms that rent seek…. an indication of just how far the cancer of corporatism has gone toward completely subverting free market capitalism. It can be turned back only by ending the symbiosis between industry and government and encouraging real competition in markets.

This question of investing in rent seekers is raised by Guy Rolnik at Pro-Market (the blog of the Stigler Center at the University of Chicago Booth School of Business):

“Put another way, are we facing an economic model in which tens of millions of Americans’ pensions are relying on the ability of companies to extract rents from consumers and taxpayers?“

Rolnik’s emphasis is primarily on mergers and acquisitions, industrial concentration, diminished competition, and monopoly profits extracted by the surviving entities. As Alex Tabarrok at Marginal Revolution notes, “The Number of Publicy Traded Firms Has Halved” in the past 20 years. At the same time, the trend in business startups has been decidedly negative. While I strongly believe in the benefits of a healthy market for corporate control, these trends are a sign that the rent seekers and their enablers in government are gaining an upper hand.

Monopoly must be condoned if there are natural barriers to entry in a market, but such monopolists are generally subject to regulation of price and service levels (complex issues in their own right). If there are other legitimate economic barriers to entry such as differentiated products and strong brand reputations, there is no reason for concern, as those are signs of value creation. And given the private freedom to innovate and compete, there is little reason to suspect that above-normal profits can persist in the long run, as new risk-takers are ultimately drawn into the mix. That is how a healthy economy works and how prices direct resources to the highest-valued uses.

Rent seekers, on the other hand, always have one of the following objectives:

Government Protection: Increased concentration in an industry is a concern if there are artificial barriers to entry. One sure way to protect a market is to enlist the government’s help in locking it down. This happens in a variety of ways: tariffs and other restrictions on foreign goods, patent protection, restrictions on entry into geographic markets, implicit government guarantees against risk (too big to fail), union labor laws, and complex regulatory rules and compliance costs that small competitors can’t afford. The upshot is that if we want more competition in markets, we must reduce the size of the administrative state.

Subsidies: Another aspect of rent seeking is the quest for taxpayer subsidies. These are often channeled into politically-favored activities that can’t be sustained otherwise, and the recipients are always politically-favored firms with friends in high places. This is privilege! Look no further than the renewable energy industry to see that politically-favored, subsidized, and uneconomic activities tend to be dominated by firms with political connections. Naturally, good rent-seekers have an affinity for central planning and its plentiful opportunities for graft. With big-government control of resources you get big-time rent seeking.

Contracts: Government largess also means that big contracts are there to be won across a range of industries: construction, defense, transportation equipment, office supplies, computing, accounting and legal services and almost anything else. Because these purchases are made by an entity that uses other people’s money, incentives for efficiency are weak. And while private firms may compete for these contracts, there is no question that political connections play an important role. As government assumes control of more resources, more favorable rent-seeking opportunities always appear.

Influencing public policy is a game that is much easier for large firms to play. Moreover, the revolving door between government and industry is most active among strong players. This is not to say that large corporations don’t engage in many productive activities. They often excel in their areas of specialization and therefore earn profits that are economically legitimate. However, when government is involved as a buyer, subsidizer or regulator, the rewards are not as strongly related to productive effort. These rewards include above-normal profits, a more dominant market position, a long-term pipeline of taxpayer funding, the prestige of running a large operation with armies of highly-skilled employees engaged in compliance activities, and prestigious appointments for officers. Some of these gains from graft are shared by investors… and that’s probably you.

For society, the implications of channeling saving into rent-seeking activities are unambiguously negative. To say it differently, the private return to rent seeking exceeds the social return, and the latter is negative. Successful rent seekers artificially boost their equity returns and may simultaneously undermine returns to smaller competitors. The outcomes entail restraint of trade and misallocation of resources on a massive scale. The public-sector largess that makes it all possible gives us high rates of taxation, which retard incentives to work, save and invest. If taxes aren’t enough to cover the bloat, our central bank (the Fed) is not shy about monetizing government debt, which distorts interest rates, inflates asset prices and  inflates the prices of goods. In the aggregate, these things warp the usual tradeoff between risk and return and worsen society’s provision for the future.

How should you feel about all this? And your portfolio? As an investor, you might not have much choice. It’s not your fault, so take your private returns where you can find them. Some firms swear off rent seeking of any kind, like Koch Industries, but it is not publicly traded. You could invest in a business of your own, but know that you might compete at a disadvantage to rent seekers in the same industry. Most of all, you should vote for lower subsidies, less regulation and less government!