The Wall Street Journalopined on a crazy proposal from Biden’s team a few days ago. Here are some excerpts.
Income redistribution is an abiding value of the Biden Administration, and now it wants to spread that to mortgage lending. A new rule will raise mortgage fees for borrowers with good credit to subsidize higher-risk borrowers. Under the rule, which goes into effect May 1, home buyers with a good credit score over 680 will pay about $40 more each month on a $400,000 loan, and upward depending on the size of the loan. Those who make down payments of 20% on their homes will pay the highest fees. Those payments will then be used to subsidize higher-risk borrowers through lower fees. This is the socialization of risk, and it flies against every rational economic model, while encouraging housing market dysfunction and putting taxpayers at risk for higher default rates. …selling people houses they can’t afford has never been a good idea. See the subprime loan collapse of 2008. …the Federal Housing Administration…want[s] to punish those who have maintained good credit while rewarding those who haven’t.
The editors of National Review are similarly disgusted by the Biden Administration’s scheme.
The federal government props up the housing market in too many ways to count. The U.S. is unique among rich countries in having the national government insure mortgages, guarantee mortgage securities, and finance mortgages with government-sponsored enterprises. …When government isn’t getting the results it wanted with all of its previous involvement, it tries a little more intervention to “fix” its previous interventions. To help out homebuyers with poor credit scores, the Federal Housing Finance Agency has decided that homebuyers with good credit scores will pay a little more for their mortgages. …FHFA director Sandra Thompson said the new rules…would “increase pricing support for purchase borrowers limited by income or by wealth.” But income and wealth are and should be limiting factors in lending. It’s not good for borrowers to take on loans that may prove beyond their means to pay back. …this policy reduces the incentive to be responsible…and…has the added twist of penalizing people with high credit scores. …That’s one way to get more poor decisions and fewer good ones.
For all intents and purposes, the Biden Administration wants more redistribution.
P.S. Some of my left-wing friends say the 2008 crisis was caused by “Wall Street greed.” I respond by asking them whether there was greed on Wall Street in the 1980s and 1990s, or at other times. They usually have to admit that greed is always present, so I then tell them greed only becomes a big problem when mixed with upside-down government policies.
It was amusing, of course, but also made a serious point about “moral hazard,” which is what happens when government policy rewards bad behavior.
I’m in favor of risk taking, and I certainly don’t object to people earning lots of income when they make astute choices.
But it sends a terrible signal if we bail them out when they make bad choices.
That approach tells others to go overboard with speculation. After all, heads they win, tails the taxpayers lose (as illustrated by this clever cartoon).
And now we can add union pension plans to the list. Here are some excerpts from an editorial in yesterday’s Wall Street Journal.
Democrats sold their $1.9 trillion spending bill in 2021 as Covid “relief,” but it included some $86 billion to shore up more than 200 ailing union multi-employer pension plans. The $36 billion for the Teamsters’ Central States Pension Fund is the largest tranche awarded so far, but Mr. Biden assured his labor friends on Thursday that more is on the way. …Central States last year was only 17% funded and projected to collapse in a few years. …Congress in 2014 acted to prevent this death spiral by passing bipartisan legislation that let sick plans reduce benefits and make other changes to avoid insolvency. Eighteen plans took advantage of the law, but Democrats then had second thoughts and decided to ding taxpayers instead. …Last year’s union, er, Covid relief bill lets the PBGC make lump sum payments to keep some sick 200 multi-employer plans solvent through 2051 and fully restore benefits in the 18 plans that had cuts. Notably, the law prohibits the PBGC from conditioning aid on governance reforms or funding rules. But it doesn’t forbid benefit increases. So the failings that got these plans in trouble will continue and may lead to future bailouts. Government unions with under-funded pensions in New Jersey and Illinois will surely demand one too.
Back in July, Eric Boehm of Reason warned that this was going to happen and that it would be a very bad idea.
The bailout was approved last year as part of the American Rescue Plan, the $1.9 trillion emergency spending bill…the multiemployer pension plan bailout is arguably the least defensible provision in a bill that was full of indefensible spending. …Reps. Virginia Foxx (R–N.C.) and Rick Allen (R–Ga.), respectively the top Republicans on the Education and Labor Committee and the Health, Employment, Labor, and Pensions Subcommittee, in a joint statement…added, “creates perverse incentives for further mismanagement and underfunding and leaves the taxpayer holding the bag.” …this is something of a no-brainer. Biden delivered a major win to his labor union allies, put the cost on the taxpayers’ tab, and took a victory lap for doing it. …And everyone else gets to pay for it.
That same month, Howard Adler and Alex Pollock made similar points in a column for the Wall Street Journal.
Multiemployer plans often promise beneficiaries more benefits than they can afford. Many are governed by a board of trustees with equal representation from unions and employers—a recipe for increasing benefits but not funding them. …Congress and the Biden administration wrote a blank check to political supporters under the guise of Covid relief. …The most egregious aspect of the bailout is that it made no attempt at structural reform. Plans are free to continue the practices that got them into trouble in the first place. …The PBGC’s new projected insolvency date is 2055, four years after the bailout funds end. The pension scheme is set up for failure—or another bailout—in three decades. Bailouts should be conditioned on reforms. In prior bailout legislation…Congress tried to address the causes of the failures that made a bailout necessary. But with multiemployer pension plans, lawmakers made no attempt to fix anything—they merely spent taxpayer money.
What’s most upsetting about this bailout is not the money that’s being squandered today.
But future spending on additional bailouts is just part of the problem. There’s also a macro cost to the economy because the allocation of capital will be distorted.
Investors will take imprudent risks because there is a greater-than-zero chance (in some cases, probably close to 100 percent) that politicians will shift future losses on to the backs of taxpayers.
Today, here are my thoughts on why there should not be a bailout if/when a crisis occurs.
I have moral objections to bailouts, but let’s focus in this column on the practical impact.
And let’s start with this chart, which shows debt levels in Portugal, Italy, Greece, and Spain (the so-called PIGS) ever since the misguided bailout of Greece about a dozen years ago.
As you can see, OECD data reveals that there’s been no change in these poorly governed nations. They have continued to over-spend and accumulate ever-higher levels of debt.
Defenders of bailouts assert that Greece was forced to engage in “austerity” as a condition of getting a bailout.
I have two problems with that argument.
First, notice how Greece’s debt has continued to go up. If that’s a success, I would hate to see an example of failure.
Second, the main effect of the so-called austerity is a much higher tax burden and a somewhat higher spending burden.
If there’s a bailout of Italy (or any other nation), I suspect we’ll see the same thing happen. Higher taxes, higher spending, and higher debt.
I’ll close by acknowledging that there are costs to my approach. If Italy is not given a bailout, the country may have a “disorderly default,” meaning the government simply stops honoring its commitments to pay bondholders.
That is bad for individual bondholders, but it also could hurt – or even bankrupt – financial institutions that foolishly decided to buy a lot of Italian government bonds.
But there should be consequences for imprudent choices. Especially if the alternative is bailouts that misallocate global capital and encourage further bad behavior.
The bottom line is that the long-run damage of bailouts is much greater than the long-run damage of defaults.
The monetary cost is significant, but I get even more upset that responsible people are forced to finance other people’s irresponsible choices.
It’s such a bad policy that even Bernie Sanders favors reform.
And it’s such a bad policy that politicians in Hawaii decided it is worth copying. But they chose to subsidize building homes that are vulnerable to volcanic eruptions.
I’m not joking. Joe Kent of the Grassroot Institute wrote about this foolish system.
…the state originally encouraged the building of homes in this dangerous area by offering lava insurance where no private company would. …In response to the absence of private insurance, the state Legislature created the Hawaii Property Insurance Association (HPIA), whose job is to provide coverage for homes in areas that private insurance won’t touch. The law requires private insurance companies to pool their money to subsidize the expense of offering insurance in high-risk lava zones. …This resulted in a boom in the housing market below the active Kilauea volcano. …The moral hazard of this new insurance program gave a false sense of security to homebuilders in Leilani Estates.
Given my libertarian sympathies, I think people should have the right to build in dangerous areas.
But I also think that they should bear the risks. Including what happened a few years ago.
…that hazard is very real for families watching their homes be engulfed by magma. What was seen as a “market failure” was really a warning sign to those building in Lava Zones 1 and 2. If the state had stayed out of the situation, probably fewer families would have built in the area, and today there might be less housing destruction.
Why is this unfortunate? Because there are some policy changes that may be costly in the short run, but they are nonetheless very worthwhile because they generate big long-run benefits.
Messy fights over the debt limit create (almost certainly exaggerated) concerns about potential default, but that potential cost would be trivial compared to the long-run benefits of figuring out how to limit the growing burden of federal spending.
I offer the above examples because similar short-run and long-run tradeoffs exist when looking at what happens when the International Monetary Fund provides bailouts for profligate governments.
The Economist has an article that perfectly illustrates the IMF’s pernicious role.
The year was 1958. …Argentina turned to the fund for its first “standby arrangement”, a line of credit accompanied by a plan to stabilise the economy. …Sixty years later, in June 2018, Argentina was back for its 21st arrangement: a $50bn loan, later increased to $57bn, backed by the government’s promises to cut the budget deficit and strengthen the central bank in the hope of quelling inflation and stabilising the peso. The loan was the largest in the imf’s history. …Despite its size, the rescue failed to save Argentina from default and despair. …Foreign capital kept retreating, the peso kept falling and inflation kept rising. The evaluation speculates that the size of the imf’s loan may even have been “self-defeating”, eroding confidence rather than inspiring it.
Just in case you missed it, the article mentions that Argentina has received 21 different bailouts since 1958, which works out to be one bailout every three years (Professor Steve Hanke counts 22 bailouts, for what it’s worth).
In probably every case, IMF bureaucrats presumably thought a bailout was a way of minimizing economic pain (and they probably thought the same thing for dozens of bailouts provided to Haiti, Colombia, Peru, Honduras, Philippines, etc).
But what actually has happened is that politicians – in Argentina and elsewhere – have learned that it’s okay to pursue bad policy because there’s always another bailout.
In other words, IMF policy is a glaring example of “moral hazard.” By shielding politicians from the consequences of bad policy, the bureaucracy is actually encouraging those politicians to engage in additional bad policy.
To be blunt, the IMF is the arsonist rather than the firefighter.
The article in the Economist included this observation.
Conservative critics think the fund has been seduced by its dance partner, wasting public money in a futile battle.
My right-leaning friends are correct, but their criticisms are too mild.
It’s not just that the IMF is wasting money. It’s dampening growth by pushing policies that misallocate capital.
Here’s what should have happened to Argentina in 1958 (and what should have happened in 2018, and what should happen when there’s pressure for yet another bailout).
The politicians in Argentina who spend excessively should learn that there’s a tipping point when they can no longer borrow.
The interest groups in Argentina should learn that parasites also suffer when they kill their host animal by being too greedy.
The voters in Argentina should learn that there are serious adverse consequences when you elect “Peronist” politicians.
Sadly, none of these lessons get learned so long as the IMF is standing by to provide never-ending bailouts.
So instead of some short-run pain, which is then offset by better long-run policy, we get bailouts that mask short-run pain and encourage more long-run damage.
P.P.S. To be fair, the IMF recommends tax increases even in the years when bailouts aren’t needed, so at least the bureaucrats have a consistent (albeit nutty) message.
But the biggest problem with the IMF is that it promotes “moral hazard.” More specifically, it provides bailouts for irresponsible governments and for those who foolishly lend to those governments.
All of which explains why some nations (and their foolish lenders) have received dozens of bailouts.
Oh, and let’s not forget that these endless bailouts also lead to a misallocation of capital, thus reducing global growth.
In an article for the New York Times, Patricia Cohen reports on discussions to expand the IMF’s powers.
Once narrowly viewed as a financial watchdog and a first responder to countries in financial crises, the I.M.F. has more recently helped manage two of the biggest risks to the worldwide economy: the extreme inequality and climate change. …long-held beliefs like the single-minded focus on how much an economy grows, without regard to problems like inequality and environmental damage, are widely considered outdated. And the preferred cocktail for helping debt-ridden nations that was popular in the 1990s and early 2000s — austerity, privatization of government services and deregulation — has lost favor in many circles as punitive and often counterproductive.
There’s a lot to dislike about the above excerpts.
Looking at the text, the part about “extreme inequality” is nonsensical, both because the IMF hasn’t done anything to “manage” the issue, other than to advocate for class-warfare taxes.
Moreover, there’s no support for the empty assertion that inequality is a “risk” to the world economy (sensible people point out that the real problem is poverty, not inequality).
Ms. Cohen also asserts that the “preferred cocktail” of pro-market policies (known as the Washington Consensus) has “lost favor,” which certainly is accurate.
But she offers another empty – and inaccurate – assertion by writing that it was “counterproductive.”
Here are some additional excerpts.
The debate about the role of the I.M.F. was bubbling before the appointment of Ms. Georgieva… But she has embraced an expanded role for the agency. …she stepped up her predecessors’ attention to the widening inequality and made climate change a priority, calling for an end to all fossil fuel subsidies, for a tax on carbon and for significant investment in green technology. …Sustainable debt replaced austerity as the catchword. …The I.M.F. opposed the hard line taken by some Wall Street creditors in 2020 toward Argentina, emphasizing instead the need to protect “society’s most vulnerable” and to forgive debt that exceeds a country’s ability to repay.
The last thing the world needs is “an expanded role” for the IMF.
It’s especially troubling to read that the bureaucrats want dodgy governments to have more leeway to spend money(that’s the real meaning of “sustainable debt”).
And if the folks at the IMF are actually concerned about “society’s most vulnerable” in poorly run nations such as Argentina, they would be demanding that the country copy the very successfulpoverty-reducingpolicies in neighboring Chile.
Needless to say, that’s not what’s happening.
The article does acknowledge that not everyone is happy with the IMF’s statist agenda.
Some stakeholders…object to what’s perceived as a progressive tilt. …Ms. Georgieva’s activist climate agenda has…run afoul of Republicans in Congress… So has her advocacy for a minimum global corporate tax.
It would be nice, though, if Ms. Cohen had made the article more balanced by quoting some of the critics.
The bottom line, as I wrote last year, is that the world would be better off if the IMF was eliminated.
P.S. The political leadership of the IMF is hopelessly bad, as is the bureaucracy’s policy agenda. That being said, there are many good economists who work at the IMF and they often produce high-quality research (see here, here, here, here, here, here, here, here, here, and here). Sadly, their sensible analyses doesn’t seem to have any impact on the decisions of the organization’s top bureaucrats.
Unless my memory is more faulty than usual, I don’t think I’ve written a single favorable article about any of Joe Biden’s policies. Which isn’t a surprise considering his knee-jerk embrace of higher taxes and bigger government.
But it’s now time to praise the President.
Why?
Because his administration is taking some long-overdue steps to reduce the damaging impact of federal flood insurance.
Darryl Fears and Lori Rozsa explain what’s happening in an article for the Washington Post.
…8 million Americans…moved to counties along the U.S. coast between 2000 and 2017, lured by the sun, the sea and heavily subsidized government flood insurance that made the cost of protecting their homes much less expensive, despite the risk of living in a flood zone near a vast body of water. …the Federal Emergency Management Agency willincorporate climate risk into the cost of flood insurance for the first time, dramatically increasing the price for some new home buyers. Next April, most current policyholders will see their premiums go up and continue to rise by 18 percent per year for the next 20 years. …wealthy customers with high-value homes will see their costs skyrocket by as much as $14,400 for one year. About 3,200 property owners — mostly in Florida, Texas, New Jersey and New York — fall in that category. …Homeowners in inland states such as Iowa, Missouri and Nebraska, where creeks, streams and rivers overflow during heavy rains, will also see price increases in their government-backed flood insurance. …“It is now going to say if you’re in a risky place, you’re going to get charged more for it, and other people aren’t footing the bill,” VinZant said. …As of last year, the National Flood Insurance Program (NFIP) run by FEMA was $20 billion in debt from massive payouts to customers.
And here’s some of what the Wall Street Journal reported, in an article by Arian Campo-Flores.
Chris Dailey and his wife are building a new home in coastal St. Petersburg, Fla., that will sit 7 feet above the flood level expected during a major storm. So he was stunned to learn that under the federal flood insurance program’s revamped pricing, his annual premium is slated to soar to $4,986 from $441. …he plans to go through with the project, which is about a block and a half from a canal that leads to Tampa Bay, but worries about the ability to sell it in the future. The National Flood Insurance Program—the main provider of flood coverage in the U.S., with more than five million policies—is rolling out an overhauled pricing method starting Friday in an effort to reflect more accurately the flood risk that individual properties face. …Under the new system, dubbed “Risk Rating 2.0,” some policyholders in especially vulnerable areas will face big premium increases while others in less-exposed spots will see smaller increases or even decreases. …Developers may rethink where they build, and coastal real-estate markets could take a hit. “There is no greater risk-communication tool than a pricing signal,” said Roy Wright, president of the Insurance Institute for Business and Home Safety… Some members of Congress, mainly from coastal states, are urging a delay in implementing the new rating system. Senators including Chuck Schumer (D., N.Y.) and John Kennedy (R., La.) wrote a letter last week to the FEMA administrator expressing concern about sharp premium increases.
The most important sentence in the above excerpt was Roy Wright’s observation about the role of prices.
In a free market, by contrast, prices force people to internalize costs and benefits.
Indeed, in an article for Reason, Ronald Bailey points out that private insurers use prices to – gasp – reflect actual risk.
“Insurers cherry-pick homes, leave flooded ones for the Feds,” runs a very odd headline over at E&E News. The article goes on to explain, “Taxpayers could be forced to spend billions of dollars to bail out the federal government’s flood program as private-sector insurers begin covering homes with little risk of flooding while clustering peril-prone properties in the indebted public program.” Well, yes. …The E&E News article strangely claims that “an increased number of people with flood coverage could help reduce flood damage by making homeowners more aware of their risk.” Of course that’s right, but not being able to purchase any flood insurance at all would be a much more effective and compelling way to make homeowners aware of their risks. …Instead of decrying private insurers for sensibly refusing to cover houses located in high-risk flood zones, the E&E News article should instead have been arguing for ending the government’s National Flood Insurance Program altogether.
Let’s close by looking at how Canada handles this issue.
In a 2019 article for the New York Times, Christopher Flavelle explains that Canada recognized years ago that it doesn’t make sense to subsidize homeowners who make risky decisions.
Unlike the United States, which will repeatedly help pay for people to rebuild in place, Canada has responded to the escalating costs…by limiting aid after disasters, and even telling people to leave their homes. …In 2015, Canada made it harder for lower levels of government to get federal money after disasters. The next year, British Columbia said flood victims who had chosen not to buy private flood insurance would be ineligible for government aid. This year the federal government went further still, warning that homeowners nationwide would eventually be on their own. If people deliberately rebuild in danger zones, at some point “they are going to have to assume their own responsibility for the cost burden,” Public Security Minister Ralph Goodale told reporters in April. “You can’t repeatedly go back to the taxpayer and say, ‘Oh, it happened again.’” …Quebec also limited disaster aid, and not just inside the special zone. After this spring’s flooding, the province said it would set an upper threshold for assistance at $100,000 over the lifetime of the house. After that, homeowners face a choice: They can sell to the government, which will pay no more than $250,000, regardless of market value. Or they can get money to rebuild one last time — but in doing so, they forfeit any future financial assistance.
Two cheers for the Canadians. They’ve been more rational than policy makers in the United States (the ones at FEMA, at least in the past, have been especially incompetent).
But not three cheers. In a column for the Wall Street Journal, Professor Walter Block explains how our neighbors to the north are still imperfect.
The best policy is…laissez-faire capitalism. Treat people as adults—allow them to take whatever flooding risks they choose, but on their own nickel. They should be free to build wherever they want, and to indemnify themselves against risk by buying insurance on the open market. But they should not receive a dime of taxpayers’ money for rebuilding.
Which, of course, is exactly what happened with the coronavirus.
As is so often the case, Washington responded in an imprudent manner. As part of multi-trillion dollar emergency legislation (the CARES Act), Congress directly funneled hundreds of billions of dollars to state and local governments.
That legislation also gave the nation’s central bank, the Federal Reserve, the authority to steer money to those same governments.
Notwithstanding all this generosity, state and local politicians are now asking for even more money. In part, this is a fight over the provisions of a potential new “stimulus” bill from Congress.
But it’s also a battle over the fate of the Federal Reserve’s ability to interfere with the allocation of capital by directing money to state and local governments.
In a report for the New York Times, Jeanna Smialek and Alan Rappeport explain what’s happening.
A political fight is brewing over whether to extend critical programs that the Federal Reserve rolled out to help keep credit flowing to…municipalities amid the pandemic-induced recession. …Those programs expire on Dec. 31, and it is unclear whether the Trump administration will agree to extend them. The Federal Reserve chair, Jerome H. Powell, and Treasury secretary, Steven Mnuchin, must together decide whether they will continue the programs — including one that buys state and local bonds, another purchasing corporate debt and another that makes loans to small and medium-size businesses. …Mnuchin…has signaled that he would favor ending the one that buys municipal bonds. And he is under growing pressure from Republicans to allow all five of the Treasury-backed programs to sunset. …The financial terms for buying state and local debt…are not generous enough to compete in a market functioning well… Their main purpose has been to reassure investors that the central bank is there as a last-ditch option if conditions worsen.
However, economic conditions have dramatically improved since the coronavirus first hit, so there’s no longer any argument that financial markets are dealing with crisis conditions.
But that doesn’t seem to matter to politicians who want to subsidize bad fiscal policy at the state and local level.
Some Democrats had begun eyeing the municipal program as a backup option in the event that state and local government relief proved hard to pass through Congress. While the program’s terms are unattractive now, they could in theory be sweetened under a Biden administration Treasury Department. …If a coronavirus vaccine is rolled out in the coming weeks, the Treasury Department may be less inclined to extend the programs. Mr. Trump could also block a reauthorization by pressuring Mr. Mnuchin, leaving Mr. Biden with fewer economic stimulus tools at his disposal. …state and local governments are facing budget shortfalls, albeit smaller ones than some had initially projected.
Nick Timiraos reports on the issue for the Wall Street Journal.
Divisions over their future are being amplified by partisan gridlock in Congress over whether to provide more economic stimulus. Democrats, looking ahead to President-elect Joe Biden’s inauguration in January, see the programs as a potential tool to deliver more aid if Congress doesn’t act, while some Republicans are worried about relying on central bank lending powers as a substitute for congressional spending decisions. …A decision not to renew the programs…could also deprive some…governments of access to low-cost credit if market conditions worsen. …If the Trump administration decides not to extend the programs, Mr. Biden’s Treasury Department could determine whether to reactivate them in some fashion after the new administration takes office Jan. 20.
The bottom line is that a Biden Administration likely will be able to give states and localities a bailout, even if Congress doesn’t approve a new “stimulus,” and even if the Trump Administration doesn’t extend the Federal Reserve’s authority. But at least the incoming Biden people would have to jump through a few hoops.
Which is very unfortunate since it will reward the jurisdictions that behaved recklessly. A classic example of “moral hazard.”
I’ll close with this critical bit of data from Chris Edwards. As you can see, state and local governments actually have profited from the coronavirus since they got far more money from the CARES Act than they lost because of diminished tax revenue.
P.S. For what it’s worth, the Federal Reserve has always had the ability to steer money to state and local governments, both as part of normal monetary policy operation and because of its vast emergency powers. The good news is that it has not gone down that path.
And the best way to make sure it doesn’t go down that path in the future is to eliminate or restrict such powers. Private markets, which reflect the preferences of consumers, should determine the allocation of capital. We don’t want to copy the mistakes of China and have government making those choices.
But the silver lining to that dark cloud is that Fannie and Freddie were placed in “conservatorship,” which basically has curtailed their actions over the past 10 years.
Indeed, some people even hoped that the Trump Administration would take advantage of their weakened status to unwind Fannie and Freddie and allow the free market to determine the future of housing finance.
Those hopes have been dashed.
Cronyists in the Treasury Department unveiled a plan earlier this year that will resuscitate Fannie and Freddie and recreate the bad incentives that led to the mess last decade.
This proposal may be even further to the left than proposals from the Obama Administration. And, as Peter Wallison and Edward Pinto of the American Enterprise Institute explained in the Wall Street Journal earlier this year, this won’t end well.
…the president’s Memorandum on Housing Finance Reform…is a major disappointment. It will keep taxpayers on the hook for more than $7 trillion in mortgage debt. And it is likely to induce another housing-market bust, for which President Trump will take the blame.The memo directs the Treasury to produce a government housing-finance system that roughly replicates what existed before 2008: government backing for the obligations of the government-sponsored enterprises Fannie Mae and Freddie Mac , and affordable-housing mandates requiring the GSEs to encourage and engage in risky mortgage lending. …Most of the U.S. economy is open to the innovation and competition of the private sector. Yet for no discernible reason, the housing market—one-sixth of the U.S. economy—is and has been controlled by the government to a far greater extent than in any other developed country. …The resulting policies produced a highly volatile U.S. housing market, subject to enormous booms and busts. Its culmination was the 2008 financial crisis, in which a massive housing-price boom—driven by the credit leverage associated with low down payments—led to millions of mortgage defaults when housing prices regressed to the long-term mean.
Wallison also authored an article that was published this past week by National Review.
He warns again that the Trump Administration is making a grave mistake by choosing government over free enterprise.
Treasury’s plan for releasing Fannie Mae and Freddie Mac from their conservatorships is missing only one thing: a good reason for doing it. The dangers the two companies will create for the U.S. economy will far outweigh whatever benefits Treasury sees. Under the plan, Fannie and Freddie will be fully recapitalized… The Treasury says the purpose of their recapitalization is to protect the taxpayers in the event that the two firms fail again. But that makes little sense. The taxpayers would not have to be protected if the companies were adequately capitalized and operated without government backing. Indeed, it should have been clear by now that government backing for private profit-seeking firms is a clear and present danger to the stability of the U.S. financial system. Government support enables companies to raise virtually unlimited debt while taking financial risks that the market would routinely deny to firms that operate without it. …their government support will allow them to earn significant profits in a different way — by taking on the risks of subprime and other high-cost mortgage loans. That business would make effective use of their government backing and — at least for a while — earn the profits that their shareholders will demand. …This is an open invitation to create another financial crisis. If we learned anything from the 2008 mortgage market collapse, it is that once a government-backed entity begins to accept mortgages with low down payments and high debt-to-income ratios, the entire market begins to shift in that direction. …why is the Treasury proposing this plan? There is no obvious need for a government-backed profit-making firm in today’s housing finance market. FHA could assume the important role of helping low- and moderate-income families buy their first home. …Why this hasn’t already happened in a conservative administration remains an enduring mystery.
I’ll conclude by sharing some academic research that debunks the notion that housing would suffer in the absence of Fannie and Freddie.
A working paper by two economists at the Federal Reserve finds that Fannie and Freddie have not increased homeownership.
The U.S. government guarantees a majority of mortgages, which is often justified as a means to promote homeownership. In this paper, we estimate the effect by using a difference-in-differences design, with detailed property-level data, that exploits changes of the conforming loan limits (CLLs) along county borders. We find a sizable effect of CLLs on government guarantees but no robust effect on homeownership. Thus, government guarantees could be considerably reduced,with very modest effects on the homeownership rate. Our finding is particularly relevant for recent housing finance reform plans that propose to gradually reduce the government’s involvement in the mortgage market by reducing the CLLs.
For those who care about the wonky details, here’s the most relevant set of charts, which led the Fed economists to conclude that, “There appears to be no positive effect of the CLL increases in 2008 and no negative effect of the CLL reductions in 2011.”
And let’s not forget that other academic research has shown that government favoritism for the housing sector harms overall economic growth by diverting capital from business investment.
The bottom line is that Fannie and Freddie are cronyist institutions that hurt the economy and create financial instability, while providing no benefit except to a handful of insiders.
There are many reasons to oppose the various bailouts of the Greek government. Here are my two main reasons.
I don’t like rewarding investors who make imprudent decisions, and it really galls me to bail out the (mostly) rich people who bought Greek bonds.
I don’t like rewarding politicians who make imprudent decisions, and it really galls me since bailouts encourage additional imprudent behavior.
Let’s focus today on the second point.
Here’s Greece’s score for the “Size of Government” component from Economic Freedom of the World. As you can see, bailouts have actually subsidized a decline in fiscal responsibility.
And it’s worth pointing out that Greek politicians have been doing a bad job in other areas.
The burden of red tape has been, and remains, stifling.
Greece ranks at the top in difficulty in setting up and running a business among 75 countries, according to the Global Business Complexity Index for 2019. The difficulty in starting an enterprise in Greece is mainly due to a labyrinth bureaucracy, frequent changes in legislation, differences in taxation and VAT rates in regions and unpredictable treatment of businesses by authorities. Indonesia, Brazil, the United Arab Emirates, Bolivia, and Slovakia follow Greece in the first six places. The easiest state to start and run a business is in the Cayman Islands.
Here are the rankings. Keep in mind that “01” is the worst score and “76” is the best score (kudos to the Cayman Islands for being the most entrepreneur-friendly).
Interestingly, voters ousted a left-wing government earlier this year.
And Bloomberg reports that Greece’s new right-of-center government intends to reduce the burden of government.
Mitsotakis presented his four-year economic agenda in his first plenary speech to parliament since winning national elections on July 7. …The premier’s priority is a reform of Greece’s complex tax system to create a more pro-business environment, necessary for attracting investment to boost the economy’s recovery. Mitsotakis wants to make good on election pledges to alleviate the tax burden for crisis-weary Greeks, specifically for the middle classes who were targeted the most by the previous administration. …Mitsotakis said he will introduce legislation…to reduce the so-called Enfia property tax by as much as 30%, according to the value of properties. …The government plans to reduce the corporate tax rate to 20% in two phases. The first step, in September, will cut the rate to 24% from 28% in 2019 and to 20% in 2020. The tax on dividend payments will be slashed by half to 5%… Also planned is the privatization of Hellenic Petroleum SA and the sale of a 30% stake in Athens Airport.
Indeed, a columnist for the New York Timesfrets that the new government is hard right.
New Democracy…seems to be a right-wing party… And Mr. Mitsotakis, who promised to unite the country, is following divisive and polarizing policies. …You don’t have to search far for evidence. …Three crucial regulatory agencies — protecting the country’s finances, work force and environment — have been effectively dissolved as part of a bill, recently passed by Parliament, to restructure government. …Domna Michailidou, the vice minister of labor, personifies the cabinet’s ideological agenda. In 2017, she openly praised cuts in wages as “necessary” for the sake of competitiveness. …Greece finished its third and last bailout program last August, but remains shellshocked after nearly a decade of austerity. Official unemployment is at 18 percent; youth unemployment scores a staggering 40 percent. …None of New Democracy’s vaunted policies — to cut corporation taxes and privatize industry in an effort to stimulate economic growth and create “new jobs” — are likely to address the country’s problems. They may well do the opposite.
Some of this sounds good, but I’ll have to see concrete results before I become a believer.
Most supposed right-of-center governments are either very inconsistent (think Trump) or generally bad (think Macri or Sarkozy).
I just focus on results.
Speaking of which this chart, based on the OECD’s fiscal database, shows what happened to revenue (left side) and spending (right side) between 2007 and 2018.
As you can see on the right side, the burden of spending has actually increased. That’s not my idea of austerity.
The big change that stands out over the past 10 years, though, is that the burden of taxation has jumped. A lot.
In other words taxpayers have been forced to tighten their belts but politicians haven’t tightened government’s belt.
The moral of the story is that tax increases always make a bad fiscal situation worse. Greece has proved that over and over and over again.
Shocking, but true. The Vermont socialist actually understands that it makes no sense to subsidize new homes in flood-prone areas.
"If people want to rebuild in an area which will be devastated by the next storm, they're certainly not going to get federal assistance from my administration." -Sen. Sanders on changing FEMA rules to spur a retreat from properties suffering repeated losses. #ClimateTownHallpic.twitter.com/BC47QBZupm
I’ll probably never again have a chance to write this next sentence, so it deserves an exclamation point. Bernie is completely correct!
Flood insurance encourages people to take on excessive risk (i.e., it creates moral hazard). And the subsidies often benefit rich people with beachfront homes (which may explain why Senator Sanders is on the right side)
If nothing else, politicians are very clever about doing the wrong thing in multiple ways.
So we’re not merely talking about luring people into flood-prone areas with subsidized insurance.
Sometimes government uses rental subsidies to put people in flood-prone areas.
Here are some excerpts from a story in the New York Times.
When a deadly rainstorm unloaded on Houston in 2016, Sharobin White’s apartment complex flooded in up to six feet of water. She sent her toddler and 6-year-old to safety on an air mattress, but her family lost nearly everything, including their car. When Hurricane Harvey hit the next year, it happened all over again: Families rushed to evacuate, and Ms. White’s car, a used Chevrolet she bought after the last flood, was destroyed. …But Ms. White and many of her neighbors cannot afford to leave. They are among hundreds of thousands of Americans — from New York to Miami to Phoenix — who live in government-subsidized housing that is at serious risk of flooding… But the Department of Housing and Urban Development, which oversees some of the at-risk properties, does not currently have a universal policy against paying for housing in a designated flood zone. …Nationwide, about 450,000 government-subsidized households — about 8 to 9 percent — are in flood plains…
While FEMA and government-subsidized flood insurance wouldn’t even exist in my libertarian fantasy world, I’m willing to acknowledge that government sometimes does things that aren’t completely foolish.
For instances, it’s better to subsidize people to move out of flood-prone areas instead of subsidizing them to rebuild in those areas.
Nashville is trying to move people…away from flood-prone areas. The voluntary program uses a combination of federal, state and local funds to offer market value for their homes. If the owners accept the offer, they move out, the city razes the house and prohibits future development. The acquired land becomes an absorbent creekside buffer, much of it serving as parks with playgrounds and walking paths. …While a number of cities around the country have similar relocation projects to address increased flooding, disaster mitigation experts consider Nashville’s a model that other communities would be wise to learn from: The United States spends far more on helping people rebuild after disasters than preventing problems. …research shows that a dollar spent on mitigation before a disaster strikes results in at least six dollars in savings. There are many reasons more people end up rebuilding in place than moving away. Reimbursement is relatively quick, while FEMA’s buyout programs tend to be slow and difficult to navigate.
While it’s encouraging to see a better approach, we wouldn’t need to worry about the issue if government got out of the business of subsidizing flood insurance.
Which helps to explain why the Wall Street Journalexpressed disappointment last year when Republicans blew a golden opportunity to fix the program.
One disappointment you can count on is a GOP failure to fix one of the worst programs in government: taxpayer subsidized flood insurance. …The Federal Emergency Management Agency’s flood insurance program was set to expire on Nov. 30, and Congress rammed through a temporary extension to buy more time. Congress was supposed to deal with the program as part of the end-of-the-year rush. The program runs a $1.4 billion annual deficit, which comes from insurance priced too low to compensate for the risk of building homes near water. Congress last year forgave $16 billion of the program’s $24 billion debt to Treasury, not that anyone learned anything. The program then borrowed another $6 billion. …If Republicans can’t fix this example of failed government because it might upset parochial interests, they deserve some time in the political wilderness.
In other words, Bernie Sanders is better on this issue than last year’s GOP Congress.
I’ve criticized Republicans on many occasions, but this must rank as the most damning comparison.
But let’s set aside politics and partisanship.
What matters is that the federal government is operating an insanely foolish program that puts people at risk, soaks taxpayers, and destroys wealth.
But that’s not what worries me most about the IMF.
To be sure, higher fiscal burdens undermine economic vitality, and I regularly warn that such policies will reduce an economy’s potential long-run growth rate.
That being said, tax increases generally don’t threaten macroeconomic stability.
If we’re looking at policies that can trigger short-run crises, I’m more concerned about the IMF’s bailout policies. For all intents and purposes, the IMF subsidizes “moral hazard” by reducing the perceived cost (to financial institutions) of lending money to dodgy governments and reducing the perceived costs (to governments) of incurring more debt.
Why not take more risk, after all, if you think the IMF will step in to socialize any losses? In other words, when the IMF engages in a few bailouts today, it increases the likelihood of more bailouts in the future.
That’s the bad news. The worse news is that the bureaucrats want a bigger figurative checkbook to enable even bigger future bailouts.
The good news is that the U.S. government can say no.
But will it? The U.K.-based FinancialTimes reported a few days ago that the United States might support an expansion of the IMF’s bailout capacity.
The Trump administration has left the door open for a US funding boost to the IMF, calling for a “careful evaluation” of the global lender’s finances to make sure it has enough money to rescue struggling economies. …The IMF — led by Christine Lagarde, a former French finance minister — is hoping to get its members to increase the fund’s permanent reserves… This year, the Trump administration has been among the most enthusiastic supporters of the IMF’s $57bn loan package to Argentina— its largest in history.
The IMF is set to embark on a major fundraising drive…the success of Ms Lagarde’s campaign is highly uncertain, with potentially profound consequences not only for the fund but for the global economy. …supporters of the fund say there are many possible scenarios in which it would be essential. If a recession and financial crisis were to hit in the coming years,central bankers may well struggle to find monetary remedies… a US Treasury spokesman left the door open to new possible contributions from America to the IMF. …Optimists point to a surprise decision by the Trump administration in April to support a $13bn boost to World Bank resources… there is still scepticism of the IMF among his top lieutenants at the Treasury department, including David Malpass, the undersecretary for international affairs. …Even if they were on board, economic and national security hawks at the White House who disdain multilateralism as a loss of sovereignty could be an additional obstacle, not to mention Republican lawmakers on Capitol Hill. The previous IMF quota increase, pushed by the Obama administration — which raised America’s permanent commitment to the fund to about $115bn — finally scraped through Congress in 2016, after a half-decade delay.
I was very saddened a couple of years ago when the GOP Congress agreed to expand the IMF’s bailout authority, especially since a similar effort was blocked in 2014 when Democrats still controlled the Senate.
The issue today is whether the Trump Administration will repeat that mistake.
Back in 2012, I stated that the IMF issue was a “minimum test” for Republicans. Well, the issues haven’t changed. Everything I wrote then still applies today.
I hope Trump does the right thing and rejects expanded bailout authority for the IMF for the sensible reason that it’s foolish to subsidize more borrowing by badly governed nations.
But I’m not picky. I’ll also be happy if Trump says no simply because he’s miffed that the IMF attacked him (accurately but unfairly) during the 2016 campaign and dissed his tax plan earlier this year.
There are just two principles you need to understand.
When Washington subsidizes something, you get more of it, and the federal government subsidizes building – and living – in risky areas.
When Washington provides bailouts, you incentivize risky behavior in the private sector and “learned helplessness” from state and local governments.
If I wanted to be lazy (or to be merciful and spare readers from a lengthy column), this satirical image is probably all that’s necessary to explain the first point. The federal government’s flood insurance program gives people – often the very rich, which galls me – an incentive to build where the risk of flooding and hurricanes is very high.
But let’s look at additional information and analysis.
We’ll start with this excellent primer on the issue from Professor William Shughart.
Disaster relief arguably is, in short, something of a public good that would be undersupplied if responsibility for providing it were left in the hands of the private sector. If this line of reasoning is sound, the activity of the Federal Emergency Management Agency (FEMA) or something like it is a proper function of the national government. …even if disaster relief is thought of as a public good—a form of “social insurance” against fire, flood, earthquake, and other natural catastrophes—it does not follow that government provision is the only or necessarily the best option. …both economic theory and the historical record point to the conclusion that the public sector predictably fails to supply disaster relief in socially optimal quantities. Moreover, because it facilitates corruption, creates incentives for populating disaster-prone areas, and crowds out self-help and other local means of coping with disaster, government provision of assistance to disaster’s victims actually threatens to make matters worse. …Government agencies are created by legislation, overseen by elected officials, and operated by huge bureaucracies. Public employees’ fear of being blamed for doing something wrong (or failing to do something right) produces risk aversion…the people who set priorities and make decisions are often separated by multiple layers of management from those on the ground who know what really needs to be done.
FEMA has been shown to be responsive more to the political interests of the White House than to the needs of disaster victims on the ground. …federal emergency relief funds tend to be allocated disproportionately to electoral-vote-rich states that are important to the sitting president’s reelection strategy. …The term moral hazard refers to the reduction in the cost of carelessness… The prospect of receiving federal and state reconstruction assistance after the next hurricane creates an incentive for others to relocate their homes and businesses from inland areas of comparative safety to vulnerable coastal areas. …The expectation of receiving publicly financed disaster relief may explain why 69 percent of the residents of Mississippi’s Gulf Coast did not have federal flood insurance when Katrina hit. …the immediate reactions of for-profit businesses, nongovernmental organizations large and small, and countless individual volunteers amply demonstrate that the private sector can and will supply disaster relief in adequate and perhaps socially optimal quantities
Barry Brownstein has a sober assessment of the underlying problem.
…federal flood insurance was amplifying the impact of storms by encouraging Americans to build and rebuild in areas prone to flooding. …the case against subsidized flood insurance is not a case against growth; it is a case against distorted growth. Federally supported insurance overrides the risk-reducing incentives that insurance premiums provide and results in building in vulnerable areas. …In a free market, insurance premiums on cars, for instance, tend to settle toward an “actuarially fair price.” …If you have a history of drunk driving, that increases the chances you’ll make an insurance claim on your car – so your premiums will be higher, and that encourages you not to drive in the future (or to drive sober in the first place). …Getting the government out of the flood insurance business and having insurance companies determine actuarially sound premiums is the only way for homeowners, businesses, and builders to know the real risk they are assuming.
And here are excerpts from a column by David Conrad and Larry Larson.
…the Great Flood of 1993 in the upper Midwest. After that disaster, the Clinton administration directed an experienced federal interagency task force to report on the flood and its causes. That report…made more than 100 recommendations for policy and program changes… The government found that many policies were encouraging — rather than discouraging — people to build homes and businesses in places with increasingly high risks of flooding… That often compounded the costs and problems caused by floods. …Experts and policymakers have known for a long time that we need to change the way we approach flood mitigation and prevention, but that hasn’t stopped the nation from making the same mistakes over and over. …substantial benefits for property owners and taxpayers could be gleaned by simply removing damaged buildings, rather than repairing them only to see them flooded out again. …many flood insurance policies were heavily subsidized and underestimated risk, leading to premiums that were far too low. …Americans facing some new devastation in the future will be looking back at Harvey and wondering why we didn’t act now.
National Flood Insurance Program…an…increasingly dysfunctional program. Enacted 50 years ago…, the program made a certain sense in theory…in return for appropriate local land-use and other measures to prevent development in low-lying areas and for actuarially sound premiums. Politics being what they are, the program gradually fell prey to pressure from developers and homeowners in the nation’s coastal areas. Arguably, the existence of flood insurance encouraged development in flood zones that would not have occurred otherwise. …Ideally, more of the costs of flood insurance would be shouldered by the people and places who benefit most from it; modern technology and financial tools should enable the private sector to handle more of the business, too. Such radical reform is not on Congress’s agenda, of course.
The National Flood Insurance Program, created in 1968 under LBJ on the theory that the private insurance market couldn’t handle flood damage, presumed that Washington could. Like many of his Great Society initiatives, it has turned out to be an expensive tutorial on the perils of government intervention. …A house outside of Baton Rouge, La., assessed at $56,000, has soaked up 40 floods and over $428,000 in insurance payouts. One in North Wildwood, New Jersey has been rebuilt 32 times. Nationally, some 30,000 buildings classified as “severe repetitive loss properties” have been covered despite having been swamped an average of five times each. Homes in this category make up about one percent of the buildings covered by the flood insurance program—but 30 percent of the claims. Their premiums don’t cover the expected losses. But as National Resources Defense Council analyst Rob Moore told The Washington Post, “No congressman ever got unelected by providing cheap flood insurance.” …The root of the problem is a familiar one: the people responsible for these decisions are not spending their own money. They find it easier to indulge the relative handful of flood victims than to attend to the interests of millions of taxpayers in general.
Now let’s look at some of the perverse consequences of federal intervention.
Brian Harmon had just finished spending over $300,000 to fix his home in Kingwood, Texas, when Hurricane Harvey sent floodwaters “completely over the roof.” The six-bedroom house, which has an indoor swimming pool, sits along the San Jacinto River. It has flooded 22 times since 1979, making it one of the most flood-damaged properties in the country. Between 1979 and 2015, government records show the federal flood insurance program paid out more than $1.8 million to rebuild the house—a property that Mr. Harmon figured was worth $600,000 to $800,000 before Harvey hit late last month. …Homes and other properties with repetitive flood losses account for just 2% of the roughly 1.5 million properties that currently have flood insurance, according to government estimates. But such properties have accounted for about 30% of flood claims paid over the program’s history. …Nearly half of frequently flooded properties in the U.S. have received more in total damage payments than the flood program’s estimate of what the homes are worth, according to the group’s calculations.
Disaster legislation, Rachel Bovard explained, is often an excuse for unrelated pork-barrel spending.
In 2012, President Obama requested a $60.4 billion supplemental funding bill from Congress, ostensibly to fund reconstruction efforts in the parts of the country most impacted by Hurricane Sandy. However, that’s not what Congress gave him, or what he signed. Instead, the bill was loaded up with earmarks and pork barrel spending, so much so that only around half of the bill ended up actually being for Sandy relief. Consider just a handful of the goodies contained in the final legislation…$150 million for Alaska fisheries (Hurricane Sandy was on the east coast of the US; Alaska is the country’s western most tip)…$8 million to buy cars and equipment for the Homeland Security and Justice departments (at the time of the Sandy supplemental, these agencies already had 620,000 cars between them)…$821 million for the Army Corps of Engineers to dredge waterways with no relation to Hurricane Sandy (the Corps never likes to waste a disaster)…$118 million for AMTRAK ($86 million to be used on non-Sandy related Northeast corridor upgrades). …the Sandy supplemental represented the worst of special interest directed, unaccountable, pork-barrel spending in Washington.
And as seems to always be the case with government, Jeffrey Tucker explains that disaster relief subsidizes corrupt favors for campaign contributors.
Look closely enough and you find corruption at every level. I recall living in a town hit by a hurricane many years ago. The town mayor instructed people not to clean up yet because FEMA was coming to town. To get the maximum cash infusion, the inspectors needed to see terrible things. When the money finally arrived, it went to the largest real estate developers, who promptly used it to clear cut land for new housing developments. …It does seem highly strange that this desktop operation in Montana would be awarded a $300 million contract to rebuild the electrical grid in Puerto Rico. That sounds outrageous. But guess what? …Zinke claims that he had “absolutely nothing to do” with selecting the company that got the contract, even though the company is in his hometown and his own son worked there. And yet there is more. The Daily Beast discovered that the company that is financing Whitefish’s expansions, HBC Investments, was founded by its current general partner Joe Colonnetta. He and his wife were larger donors to Trump campaign, in every form permissible by law and at maximum amounts. …FEMA has long been used as a pipeline to cronies.
The ideal solution is to somehow curtail the role of the federal government.
Which is what Holman Jenkins suggests in this column for the Wall Street Journal, even though he is pessimistic because rich property owners capture many of the subsidies.
What’s really missing in all such places is…proper risk pricing through insurance. …Now we wonder if it can even be ameliorated. …our most influential citizens all have one thing in common: a house in Florida. An unfortunate truth is that the value of their Florida coastal property would plummet if they were made to bear the cost of their life-style choices. A lot of ritzy communities would shrink drastically. Sun and fun would still attract visitors, but property owners and businesses would face a new set of incentives. Either build a lot sturdier and higher up. Or build cheap and disposable, and expect to shoulder the cost of totally rebuilding every decade or two. Faced with skyrocketing insurance rates, entire communities would have to dissolve themselves or tax their residents heavily to invest in damage-mitigation measures. …With government assuming the risk, why would businesses and homesteaders ever think twice about building in the path of future hurricanes?
Katherine Mangu-Ward of Reason offered some very sensible suggestions after Hurricane Harvey.
Many of the folks who take on the risk of heading into an unstable area do so because they are driven by the twin motivations of fellow-feeling and greed. These people are often the fastest and most effective at getting supplies where they are most needed, because that’s also where they can get the best price. This is just as true for Walmart as it is for the guy who fills his pickup with Poland Spring and batteries. Don’t use the bully pulpit to vilify disaster entrepreneurs, small or large. …by trying to control who gets into a storm zone to help, governments can wind up blockading good people who could do good while waiting for approval from Washington in a situation where communications are often bad. Ordinary people see and know things about what their friends and neighbors need and want that FEMA simply can’t be expected to figure out. …Emergency workers and law enforcement shouldn’t waste post-storm effort rooting around in people’s homes for firearms. Law-abiding gun owners do not, by and large, turn into characters from Grand Theft Auto when they get wet.
Amen to her point about so-called price gouging. The politicians who demagogue against price spikes either don’t understand supply-and-demand, or they don’t care whether people suffer. Probably both.
Sadly, FEMA, federal flood insurance, and other forms of intervention now play a dominant role when disasters occur.
That being said, let’s wrap up today’s column with some examples of how the private sector still manages to play a very effective role. We’ll start with this article from the Daily Caller.
Faith-based relief groups are responsible for providing nearly 80 percent of the aid delivered thus far to communities with homes devastated by the recent hurricanes… The United Methodist Committee on Relief, which has 20,000 volunteers trained to serve in disaster response teams, not only helps clean up the mess and repair the damage inflicted on homes by disasters, but also helps families… The Seventh Day Adventists help state governments with warehousing various goods and necessities to aid communities in the aftermath of a disaster. …Non-denominational Christian relief organization Convoy of Hope helps to provide meals to victims of natural disasters by setting up feeding stations in affected communities.
And I strongly recommend this video by Professor Steve Horwitz, my buddy from grad school.
The famous “Cajun Navy” is another example, as noted by the Baton Rouge Advocate.
The Pelican State managed Sunday to avoid most of Harvey’s fury. But around Baton Rouge, Lafayette and other parts of the state, members of the Cajun Navy sprung into action… Many who spent last August wading around south Louisiana’s floodwaters in boats packed them up Sunday and headed west to help rescue Texans caught in the floods. …”I can’t look at somebody knowing that I have a perfect boat in my driveway to be doing this and to just sit at home,” said Jordy Bloodsworth, a Baton Rouge member of the Cajun Navy who flooded after Hurricane Katrina when he lived in Chalmette. “I have every resource within 100 feet of me to help.” Bloodsworth was heading overnight on Sunday to Texas to help with search and rescue. …Others arrived in Texas earlier on Sunday. Toney Wade had more than a dozen friends…in tow as he battled rain and high water to get to Dickinson, Texas. Wade is the commander of an all-volunteer group of mostly former law enforcement officers and former firefighters called Cajun Coast Search and Rescue, based in Jeanerette. They brought boats and high-water rescue vehicles with them, along with food, tents and other supplies.
Here’s another good example of how the private sector – when it’s allowed to play a role – acts to reduce damage.
Increasingly, insurance carriers are finding wildfires, such as those in California, are an opportunity to provide protection beyond what most people get through publicly funded fire fighting. Some insurers say they typically get new customers when homeowners see the special treatment received by neighbors during big fires. “The enrollment has taken off dramatically over the years as people have seen us save homes,” Paul Krump, a senior executive at Chubb, said of the insurer’s Wildfire Defense Services. …Tens of thousands of people benefit from the programs. …The private-sector activity calls to mind the early days of fire insurance in the U.S., in the 18th and 19th centuries before municipal fire services became common. Back then, metal-plaque “fire marks” were affixed to the front of insured buildings as a guide for insurers’ own fire brigades.
It’s also important to realize that armed private citizens are the ones who help maintain order following a disaster, as illustrated by this video of a great American (warning: some strong language).
I imagine that guy would get along very well with the folks in the image at the bottom of this column.
Last but not least, here’s some analysis for history buffs of what happened after the fire that leveled much of Chicago in the 1800s.
…does the current emphasis on top-down disaster relief favored in the US and beyond represent the best strategy? Emily Skarbek, a professor at Brown University, approached this question by studying one of the most famous catastrophes of the 19th century, the Chicago fire of 1871. …scholars and laypeople alike are convinced that there is no substitute for the resources and direction that centralized governments can provide in the wake of a disaster. …This maxim was apparently inconsistent with the Chicago fire, however, as the Midwestern city was reconstructed in a remarkably short period of time, and without the supervision of an overbearing central government. …in 1871 there was no analogue to the present-day, Federal Emergency Management Agency (FEMA), meaning that relief efforts had to be decentralized. Moreover, there was no institutionalized source of government financial aid…it was up to Chicago’s residents to develop solutions to the calamity that they faced. …The Chicago Relief and Aid Society was founded, and set about coordinating the funds and efforts, including sophisticated bylaws regarding who merited support, and at what level. …the society exhibited the flexibility and adaptability necessary for it to expand dramatically immediately after the fire…and to subsequently contract once the needs for its services fell. This latter feature distinguishes Chicago’s relief efforts from those of 21st century government agencies.
Since I started with an image that summarizes the foolishness of government-subsidized risk, let’s end with another visual showing the impact of government.
Sadly, I predict that politicians will ignore these logical conclusions and immediately clamor after Hurricane Florence for another wasteful package of emergency spending, most of which will have nothing to do with saving lives and have everything to do with buying votes. Trump, being a big spender, will be cheering them on.
Which will then encourage more damage and risk more lives in the future. Lather, rinse, repeat.
This is one of the reasons I’m not a fan of a balanced budget amendment, Based on the experiences of American states and European countries, I fear politicians in Washington would use any deficit-limiting requirement as an excuse to raise taxes.
I much prefer spending caps, such as those found in Hong Kong, Switzerland, and Colorado. If you cure the disease of excessive government, you automatically ameliorate the symptom of too much borrowing.
That being said, the fiscal chaos plaguing European welfare states is proof that there is a point when a spending problem can also become a debt problem. Simply stated, the people and institutions that buy government bonds at some point will decide that they no longer trust a government’s ability to repay because the public sector is too big and the economy is too weak.
And even though the European fiscal crisis no longer is dominating the headlines, I fear this is just the calm before the storm.
For instance, the data in a report from Citi about the looming Social Security-style crisis are downright scary.
…the total value of unfunded or underfunded government pension liabilities for twenty OECD countries is a staggering $78 trillion, or almost double the $44 trillion published national debt number.
And the accompanying chart is rather appropriate since it portrays this giant pile of future spending promises as an iceberg.
But it’s also important to realize that government policies also can encourage excessive debt in the private sector.
Before digging into the issue, let’s first make clear that debt is not necessarily bad. Households often borrow to buy big-ticket items like homes, cars, and education. And businesses borrow all the time to finance expansion and job creation.
But if there’s too much borrowing, particularly when encouraged by misguided government policies, then households and businesses are very vulnerable if there’s some sort of economic disruption and they no longer have enough income to finance debt payments. This is when debt becomes excessive.
Yet this is what the crowd in Washington is encouraging.
Writing for the Wall Street Journal, George Melloan warns that misguided “stimulus” and “QE” policies have created a debt bubble.
…while Mr. Bernanke and Ms. Yellen were trying to prevent deflation, the federal government was engineering its cause, excessive debt. And the Fed abetted the process by purchasing trillions of dollars of government paper, aka quantitative easing. Near-zero interest rates also have encouraged consumers and business to releverage. Cars are now financed with low or no-interest five-year loans. With the 2008 housing debacle forgotten, easier mortgage terms have made a comeback. Corporations also couldn’t let cheap money go to waste, so they have piled up debts to buy back their own stock. Such “investment” produces no economic growth, but it has to be paid back nonetheless. Amid the Great Recession, many worried that the entire economy of the U.S., or even the world, would be “deleveraged.” Instead, we have a new world-wide debt bubble.
The numbers he shares are sobering.
Global debt of all types grew by $57 trillion from 2007 to 2014 to a total of $199 trillion, the McKinsey Global Institute reported in February last year. That’s 286% of global GDP compared with 269% in 2007. The current ratio is above 300%.
Professor Noah Smith writes in Bloomberg about research showing that debt-fueled bubbles are especially worrisome.
…since debt bubbles damage the financial system, they endanger the economy more than equity bubbles, which transmit their losses directly to households. Financial institutions lend people money, and if people can’t pay it back — because the value of their house has gone down — it could cause bank failures. …Economists Oscar Jorda, Moritz Schularick, and Alan Taylor recently did a historical study of asset price crashes, and they found that, in fact, debt seems to matter a lot. …To make a long story short, they look at what happened to the economy of each country after each large drop in asset prices. …bubbles make recessions longer, and credit worsens the effect. …the message is clear: Bubbles and debt are a dangerous combination.
To elaborate, equity and bubbles aren’t a good combination, but there’s far less damage when an equity bubble pops because the only person who is directly hurt is the person who owns the asset (such as shares of a stock). But when a debt bubble pops, the person who owes the money is hurt, along with the person (or institution) to whom the money is owed.
Desmond Lachman of the American Enterprise Institute adds his two cents to the issue.
…the world is presently drowning in debt. Indeed, as a result of the world’s major central banks for many years having encouraged markets to take on more risk by expanding their own balance sheets in an unprecedented manner, the level of overall public and private sector indebtedness in the global economy is very much higher today than it was in 2008 at the start of the Great Economic Recession. Particularly troublesome is the very high level of corporate debt in the emerging market economies and the still very high public sector debt levels in the European economic periphery. …the Federal Reserve’s past policies of aggressive quantitative easing have set up the stage for considerable global financial market turbulence. They have done so by artificially boosting asset prices and by encouraging borrowing at artificially low interest rates that do not reflect the likelihood of the borrower eventually defaulting on the loan.
In other words, artificially low interest rates are distorting economic decisions by making something (debt) seem cheaper than it really is. Sort of financial market version of the government-caused third-party payer problem in health care and higher education.
And Holman Jenkins of the Wall Street Journal makes the very important point that debt is encouraged by bailouts and subsidies.
Big banks aren’t automatically bad or badly managed because they are big, but it’s hard to believe big banks would exist without an explicit and implicit government safety net underneath them. …None of this has changed since Dodd-Frank, none of it is likely to change. …we know where the crisis will come from and how it will be transmitted to the financial system. The Richmond Fed’s “bailout barometer” shows that, since the 2008 crisis, 61% of all liabilities in the U.S. financial system are now implicitly or explicitly guaranteed by government, up from 45% in 1999. …Six years after a crisis caused by excessive borrowing, McKinsey estimates that even visible global debt has increased by $57 trillion, while in the U.S., Europe, Japan and China growth to pay back these liabilities has been slowing or absent.
The bottom line is that government spending programs directly cause debt, but we should be just as worried about the private debt that is being encouraged and subsidized by other misguided government policies.
And surely we shouldn’t forget to include the pernicious role of the tax code, which further tilts the playing field in favor or debt.
P.S. Let’s briefly divert to another issue. I wrote last Christmas that President Obama may have given the American people a present.
But the Washington Examinerreports that gift has turned into a lump of coal.
The Department of Justice announced this week that it is resuming its Equitable Sharing program…that allows state and local police to get around tough state laws that limit how much property can be taken from citizens without being charged with wrongdoing, let alone convicted of a crime. …money-hungry police departments can exploit these lax federal rules about confiscating people’s property. The feds like this because they get a cut of the loot. …there is no presumption of innocence. …civil forfeitures by the feds amounted to $4.5 billion in 2014, which is more than the $3.9 billion that all of America’s burglars stole that year. It’s hard to imagine more compelling evidence of gross wrong.
Wow, so the government steals more money than burglars. I guess I’m not surprised.
But if you really want to get upset, check out real-world examples of asset forfeiture by clicking here, here, here, here, and here.
Thankfully, some states are seeking to curtail this evil practice.
Well, it’s becoming an issue in the 2016 presidential race, with some folks criticizing Donald Trump for siding with Bush and Obama on the issue.
I suppose I could make a snide observation about the absurdity of Trump being perceived as an anti-establishment candidate when he supported a policy that had unanimous support from political insiders.
But I would much rather focus on the policy implications. So when Neil Cavuto asked me to comment on Chris Christie’s rejection of bailouts, I took the opportunity to stress (once again) that it wasn’t a TARP-or-nothing choice and that there was a sensible, non-corrupt, way of dealing with failing financial firms. Simply stated, only bail out depositors and let bondholders and shareholders take the hit.
For the geeks who are reading this, you’ll recognize that the policy I’m advocating is often called the FDIC-resolution approach.
And it’s worth noting that this was used at the beginning of the financial crisis. As I pointed out in the discussion, two of the big financial institution that first got in trouble – WAMU and IndyMac – were liquidated.
But once Bush’s execrable Treasury Secretary, Hank Paulson, took control of the process, decisions were made to rescue the fat cats as well as the depositors.
The bottom line is that a lot of establishment figures, including GOPers like Dick Cheney and Mitt Romney, argue that TARP was necessary because the financial system needed to be recapitalized.
Yet that’s also what happens with the FDIC-resolution approach. The only real difference is whether financial institutions should be rescued along with depositors.
P.S. The other guest in the interview made a very good point about America becoming “bailout nation.” I fully agree. To the extent that we have private profits and socialized losses, we’ll have bigger and bigger problems with moral hazard. After all, if you’re in Las Vegas and someone else is covering your losses, why not make high-risk/high-reward bets.
P.P.S. If anyone cares, my driveway is finally clear. A special thanks to the family next door. Not only were they smarter than me (as I wrote yesterday, they parked their cars near the end of their driveway), they’re also nicer than me. They came over and helped me finish when they were done!
Actually, I like to think I’d be equally thoughtful. I’ll have to look for a chance to repay their good deed.
P.P.P.S. In hopes of convincing some of my leftist friends, I can’t resist making one final point.
When government gets to pick winners and losers, it’s highly probable that those who get the handouts, bailouts, and subsidies will be rich, powerful, and politically connected. Heck, just think of the Ex-Im Bank.
As noted by my former colleague, Will Wilkinson, “…the more power the government has to pick winners and losers, the more power rich people will have relative to poor people.”
I realize that statists won’t agree with me that it’s wrong for the federal government to redistribute from rich to poor. But I hope they’ll be on my side in fighting against redistribution from poor to rich!
Now we have a third big bailout, with China seeking to stabilize that nation’s faltering stock market. So anybody want to guess how this will work out?
Beijing…officials pumped public money into the market. It hasn’t worked; the Shanghai Composite Index closed Thursday at 3661, 29% below its June peak. …Peking University economist Christopher Balding has added up the bailout and stimulus measures announced since the market panic started in late June. They total $1.3 trillion, or more than 10% of GDP.
So why is this a bad thing?
For two reasons, as the WSJ explains. First, it’s an unjustified wealth transfer. Second, it creates an economic environment contaminated by moral hazard.
Investors who bought when the market was already frothy are getting a chance to exit with some of their profits intact. But Chinese who don’t own stocks are justified in asking why they must subsidize their fellow citizens’ poor decisions. Mr. Balding’s spreadsheet shows that the market-rescue measures represent a huge transfer of wealth to investors who should have been prepared to shoulder the risks when they bought shares. The failed bailout reinforces the expectation that Beijing will attempt to manage the financial markets in the future. This moral hazard means the volatility will continue, along with the costs of future bailouts.
You won’t be surprised to learn that I share the Wall Street Journal’s skepticism. In a recent interview with Neil Cavuto, I said the Chinese government (like just about all governments) is too focused on short-run pain avoidance.
In other words, by trying to prop up markets in the short run, I think the Chinese government will cause a far greater amount of economic pain in the long run.
Two other points from the interview deserve highlighting.
China’s economy needs more economic liberalization (as opposed to the snake oil being peddled by the IMF) if it hopes to become a first-world nation. While there’s been a lot of progress since the wretched deprivation and poverty of Mao’s era, China is still way behind the United States and other nations with more capitalistic systems. Hong Kong, Singapore, and Taiwan are appropriate role models.
Whenever folks on the left point to a “success story” that ostensibly proves big government and central planning are more successful that capitalism, it’s just a matter of time before they’re proven wrong. Some of them were delusional enough to think the Soviet Union was economically successful (see bottom of this post) and events proved them wrong. As I pointed out in the interview, some of them thought Japan’s model of central planning was the ticket for prosperity and events proved them wrong. More recently, some of them have argued that China’s state-driven economy was a role model and they’re now being shown to be wrong.
P.S. Let’s close with some economic humor.
Fans of old-time comedy are probably familiar with the famous who’s-on-first exchange between Abbott and Costello.
Well, here’s a modern version of that exchange that showed up in my mailbox yesterday, only it deals with joblessness. I won’t strain credibility by asserting it’s as funny as the original sketch, but it does indirectly highlight the fact that we should focus primarily on labor force participation since that measure how many people are producing wealth for the nation.
COSTELLO: I want to talk about the unemployment rate in America.
ABBOTT: Good Subject. Terrible times. It’s 5.6%.
COSTELLO: That many people are out of work?
ABBOTT: No, that’s 23%.
COSTELLO: You just said 5.6%.
ABBOTT: 5.6% unemployed.
COSTELLO: Right, 5.6% out of work.
ABBOTT: No, that’s 23%.
COSTELLO: Okay, so it’s 23% unemployed.
ABBOTT: No, that’s 5.6%.
COSTELLO: Wait a minute! Is it 5.6% or 23%?
ABBOTT: 5.6% are unemployed. 23% are out of work.
COSTELLO: If you are out of work, you are unemployed.
ABBOTT: No, Congress said you can’t count the “out of work” as the unemployed. You have to look for work to be unemployed.
COSTELLO: But they are out of work!
ABBOTT: No, you miss his point.
COSTELLO: What point?
ABBOTT: Someone who doesn’t look for work can’t be counted with those who look for work. It wouldn’t be fair.
COSTELLO: To whom?
ABBOTT: The unemployed.
COSTELLO: But ALL of them are out of work.
ABBOTT: No, the unemployed are actively looking for work. Those who are out of work gave up looking; and if you give up, you are no longer in the ranks of the unemployed.
COSTELLO: So if you’re off the unemployment rolls, that would count as less unemployment?
ABBOTT: Unemployment would go down. Absolutely!
COSTELLO: The unemployment rate just goes down because you don’t look for work?
ABBOTT: Absolutely it goes down. That’s how it gets to 5.6%. Otherwise it would be 23%.
COSTELLO: Wait, I got a question for you. That means there are two ways to bring down the unemployment number?
ABBOTT: Two ways is correct.
COSTELLO: Unemployment can go down if someone gets a job?
ABBOTT: Correct.
COSTELLO: And unemployment can also go down if you stop looking for a job?
ABBOTT: Bingo.
COSTELLO: So there are two ways to bring unemployment down, and the easier of the two is to have people stop looking for work.
ABBOTT: Now you’re thinking like an economist.
COSTELLO: I don’t even know what the hell I just said!
I’ve shared lots of analysis (both serious and satirical) about the mess in Greece and I feel obliged to comment on the latest agreement for another bailout.
I explained a few days ago that the bailouts have simultaneously enabled the delay of much-needed spending reforms while also burdening Greece with an impossible pile of debt.
Here’s a look at how banks in various European nations have been able to reduce their exposure to Greek debt.
Sure, the banks almost surely still lost money, but they also transferred a lot of the losses to taxpayers.
To get a sense of the magnitude of handouts, here’s a chart from a Washington Poststory.
And now, assuming the deal gets finalized, that pile of foolish and unsustainable debt will be even bigger.
One of the main components of the new agreement is that Greece supposedly will raise revenue by selling $50 billion of state-owned assets.
Don’t believe that number. But not because there aren’t plenty of assets to sell, but rather because the track record on privatization proceeds suggests that there is a giant gap between what Greece promises and what Greece delivers.
To understand why assets aren’t being sold, just keep in mind that most of the assets are under the control of the government in order to provide unearned benefits to different interest groups.
If you’re an overpaid unionized worker at a government-owned port, for instance, the last thing you want is to have that port sold to a private investor who presumably would want to link pay to productivity.
Here’s the best bit of humor I’ve seen about the negotiations this past weekend. It purports to show a list of demands from Germany to Greece.
While this image is funny, it’s also wrong.
Germany isn’t imposing anything on Greece. The Germans are simply stating that Greek politicians need to make some changes if they want more handouts.
Moreover, it’s quite likely that Germany will wind up being a big loser when the dust settles. Here’s some of what Gideon Rachman wrote for the U.K.-based Financial Times.
If anybody has capitulated, it is Germany. The German government has just agreed, in principle, to another multibillion-euro bailout of Greece — the third so far. In return, it has received promises of economic reform from a Greek government that makes it clear that it profoundly disagrees with everything that it has just agreed to. The Syriza government will clearly do all it can to thwartthe dealit has just signed. If that is a German victory, I would hate to see a defeat.
So true.
I fear this deal will simply saddle Greece with a bigger pile of debt and set the stage for a more costly default in the future.
The title of this column is about pictures. But let’s close with some good and bad analysis about the Greek mess.
Writing for Real Clear Markets, Louis Woodhill has some of the best insight, starting with the fact that the bailout does two things.
First, this new bailout is largely just a mechanism to prevent default on past bailouts. Sort of like making a new loan to your deadbeat brother-in-law to cover what he owes you on previous loans.
…the €53.5 billion in new loans…would just be recycled to Greece’s creditors (the IMF, the EU, and the ECB) to pay the interest and principal on existing debts.
Second, it prevents the full meltdown of Greek banks.
The key point is that a bailout agreement would restore European Central Bank (ECB) “Emergency Liquidity Assistance” (ELA) to the Greek banking system. This would allow Greeks that still have deposits in Greek banks (€136.5 billion as of the end of May) to get their money out of those banks.
That’s good news if you’re a Greek depositor, but that’s about it.
In other words, those two “achievements” don’t solve the real problem of Greece trying to consume more than it produces.
Indeed, Woodhill correctly identifies a big reason to be very pessimist about the outcome of this latest agreement. Simply stated, Greek politicians (aided and abetted by the Troika) are pursuing the wrong kind of austerity.
…what is killing Greece is a lack of economic growth, and the meat of Tsipras’ bailout proposal consists of growth-killing tax hikes. The media and the economics profession have been framing the alternatives for Greece in terms of a choice between “austerity” and “stimulus.” Unfortunately for Greece, austerity has come to mean tax increases, and stimulus has come to mean using “other people’s money” (mainly that of German taxpayers) to support Greek welfare state outlays. So, if “other people” aren’t willing to fund more Greek government spending, then the only option the “experts” can imagine is to raise taxes on an economy that is already being crushed by excessive taxation.
Joseph Stiglitz accused Germany on Sunday of displaying a “lack of solidarity” with debt-laden Greece that has badly undermined the vision of Europe. …”Asking even more from Greece would be unconscionable. If the ECB allows Greek banks to open up and they renegotiate whatever agreement, then wounds can heal. But if they succeed in using this as a trick to get Greece out, I think the damage is going to be very very deep.”
Needless to say, I’m not sure why it’s “solidarity” for one nation to mooch in perpetuity from another nation. I suspect Stiglitz is mostly motivated by an ideological desire to redistribute from the richer Germans to the poorer Greeks,
But I’m more interested in why he isn’t showing “solidarity” to me. I’m sure both his income and his wealth are greater than mine. So if equality of outcomes is desirable, why doesn’t he put his money where his mouth is by sending me a big check?
Needless to say, I won’t be holding my breath waiting for the money. Like most leftists, Stiglitz likes to atone for his feelings of guilt by redistributing other people’s money.
And I also won’t be holding my breath waiting for a good outcome in Greece. As I wrote five-plus years ago, Greece needs the tough-love approach of no bailouts, which would mean a default but also an immediate requirement for a balanced budget.
Last but not least, I’m going to confess a possible mistake. I always thought that Margaret Thatcher was right when she warned that the problem with socialism is that you eventually run out of other people’s money. But this latest bailout of Greece shows that maybe politicians from other nations are foolish enough to provide an endless supply of other people’s money.
When debating and discussing the 2008 financial crisis, there are two big questions. And the answers to these questions are important because the wrong “narrative” could lead to decades of bad policy (much as a mistaken narrative about the Great Depression enabled bad policy in subsequent decades).
What caused the crisis to occur?
What should policy makers have done?
In a new video for Prager University, Nicole Gelinas of the Manhattan Institute succinctly and effectively provides very valuable information to help answer these questions. Particularly if you want to understand how the government promoted bad behavior by banks and created the conditions for a crisis.
Here are some further thoughts on the issues raised in the video.
Deregulation didn’t cause the financial crisis – Nicole explained that banks got in trouble because of poor incentives created by previous bailouts, not because of supposed deregulation. As she mentioned, their “risk models” were distorted by assumptions that some financial institutions were “too big to fail.”
But that’s only part of the story. It’s also important to recognize that easy-money policies last decade created too much liquidity and that corrupt subsidies and preferences for Fannie Mae and Freddie Mac steered much of that excess liquidity into the housing sector. These policies helped to create the bubble, and many financial institutions became insolvent when that bubble burst.
TARP wasn’t necessary to avert a meltdown – Because the video focused on how the “too big to fail” policy created bad incentives, there wasn’t much attention to the topic of what should have happened once big institutions became insolvent. Defenders of TARP argued that the bailout was necessary to “unfreeze” financial markets and prevent an economic meltdown.
But here’s the key thing to understand. The purpose of TARP was to bail out big financial institutions, which also meant protecting big investors who bought bonds from those institutions. And while TARP did mitigate the panic, it also rewarded bad choices by those big players. As I’ve explained before, using the “FDIC-resolution” approach also would have averted the panic. In short, instead of bailing out shareholders and bondholders, it would have been better to bail out depositors and wind down the insolvent institutions.
Bailouts encourage very bad behavior – There’s a saying that capitalism without bankruptcy is like religion without hell, which is simply a clever way of pointing out that you need both profit and loss in order for people in the economy to have the right set of incentives. Bailouts, however, screw up this incentive structure by allowing private profits while simultaneously socializing the losses. This creates what’s known as moral hazard.
I’ve often used a simple analogy when speaking about government-created moral hazard. How would you respond if I asked you to “invest” by giving me some money for a gambling trip to Las Vegas, but I explained that I would keep the money from all winning bets, while financing all losing bets from your funds? Assuming your IQ is at least room temperature, you would say no. But our federal government, when dealing with the financial sector, has said yes.
Good policy yields short-run pain but long-run gain – In my humble opinion, Nicole’s most valuable insight is when she explained the long-run negative consequences of the bailouts of Continental Illinois in 1984 and Long-Term Capital Management in 1998. There was less short-run pain (i.e., financial instability) because of these bailouts, but the avoidance of short-run pain meant much more long-run pain (i.e., the 2008 crisis).
Indeed, this “short termism” is a pervasive problem in government. Politicians often argue that a good policy is unfeasible because it would cause dislocation to interest groups that have become addicted to subsidies. In some cases, they’re right about short-run costs. A flat tax, for instance, might cause temporary dislocation for some sectors such as housing and employer-provide health insurance. But the long-run gains would be far greater – assuming politicians can be convinced to look past the next election cycle.
Let’s close by re-emphasizing a point I made at the beginning. Narratives matter.
For decades, the left got away with the absurd statement that the Great Depression “proved” that capitalism was unstable and destructive. Fortunately, research in recent decades has helped more and more people realize that this is an upside-down interpretation. Instead, bad government policy caused the depression and then additional bad policy during the New Deal made the depression longer and deeper.
Now we have something similar. Leftists very much want people to think that the financial crisis was a case of capitalism run amok. They’ve had some success with this false narrative. But the good news is that proponents of good policy immediately began explaining the destructive role of bad government policy. And if Nicole’s video is any indication, that effort to prevent a false narrative is continuing.
P.S. The Dodd-Frank bill was a response to the financial crisis, but it almost certainly made matters worse. Here’s what Nicole wrote about that legislation.
There’s a big fiscal battle happening in Europe. The relatively new Greek government is demanding continued handouts from the rest of Europe, but it wants to renege on at least some of the country’s prior commitments to improve economic performance by reducing the preposterous burden of spending, regulation, and intervention.
That seems like a rather strange negotiating position. Sort of like a bank robber holding a gun to his own head and saying he’ll shoot himself if the teller doesn’t hand over money.
At first glance, it seems the Greeks are bluffing. Or being suicidally self-destructive.
And maybe they are posturing and/or being deluded, but there are two reasons why the Greeks are not totally insane.
1. The rest of Europe does not want a Greek default.
There’s a famous saying, attributed to J. Paul Getty, that applies to the Greek fiscal fight. Simply stated, there are lots of people and institutions that own Greek government bonds and they are afraid that their investments will lose value if Greece decides to fully or partially renege on its debts (which is an implicit part of Greece’s negotiating position).
So while Greece would suffer if it defaulted, there would be collateral damage for the rest of Europe. In other words, the hypothetical bank robber has a grenade rather than a gun. And while the robber won’t fare well if he pulls the pin, lots of other people may get injured by shrapnel.
And to make matters more interesting, previous bailouts of Greece have created a rather novel situation in that taxpayers are now the indirect owners of a lot of Greek government debt. As you can see from the pie chart, European taxpayers have the most exposure, but American taxpayers also are on the hook because the IMF has participated in the bailouts.
The situation is Greece is akin to a bankruptcy negotiation. The folks holding Greek government debt are trying to figure out the best strategy for minimizing their losses, much as the creditors of a faltering business will calculate the best way of extracting their funds. If they press too hard, the business may go bust and they get very little (analogous to a Greek default). But if they are too gentle, they miss out on a chance of getting a greater share of the money they’re owed.
2. Centralization is the secular religion of the European elite and they want Greece in the euro.
There’s a general perception that a default would force the Greek government to pull out of the euro and re-create its own currency. And for the European elite who are committed to “ever closer union,” this would be perceived as a major setback. As such, they are willing to bend over backwards to accommodate Greece’s new government.
Given the somewhat blurry battle lines between Greece and its creditors, what’s the best outcome for advocates of limited government and individual liberty?
That’s a frustrating question to answer, particularly since the right approach would have been to reject any bailouts back when the crisis first started.
Without access to other people’s money, the Greek government would have been forced to rein in the nation’s bloated public sector. To be sure, the Greek government may also have defaulted, but that would have taught investors a valuable lesson about lending money to profligate governments.
But there’s no point in crying about spilt milk. We can’t erase the mistakes of the past, so what’s the best approach today?
Actually, the right answer hasn’t changed.
And just as there are two reasons why the Greek government is being at least somewhat clever in playing hardball, there are two reasons why the rest of the world should tell them no more bailouts.
1. Don’t throw good money after bad.
To follow up on the wisdom of J. Paul Getty, let’s now share a statement commonly attributed to either Will Rogers or Warren Buffett. I don’t know which one (if either) deserves credit, but there’s a lot of wisdom in the advice to stop digging if you find yourself in a hole. And Greece, like many other nations, has spent its way into a deep fiscal hole.
There is a solution for the Greek mess. Politicians need to cut spending over a sustained period of time while also liberalizing the economy to create growth. And, to be fair, some of that has been happening over the past five years. But the pace has been too slow, particularly for pro-growth reforms.
But this also explains why bailouts are so misguided. Politicians generally don’t do the right thing until and unless they’ve exhausted all other options. So if the Greek government thinks it has additional access to money from other nations, that will give the politicians an excuse to postpone and/or weaken necessary reforms.
2. Saying “No” to Greece will send a powerful message to other failing European welfare states.
Now let’s get to the real issue. What happens to Greece will have a big impact on the behavior of other European governments that also are drifting toward bankruptcy.
Here’s a chart showing the European nations with debt burdens in excess of 100 percent of economic output based on OECD data. Because of bad demographics and poor decisions by their politicians, every one of these nations is likely to endure a Greek-style fiscal crisis in the near future.
And keep in mind that these figures understate the magnitude of the problem. If you include unfunded liabilities, the debt levels are far higher.
So the obvious concern is how do you convince the politicians and voters in these nations that they better reform to avoid future fiscal chaos? How do you help them understand, as Mark Steyn sagely observed way back in 2010, that “The 20th-century Bismarckian welfare state has run out of people to stick it to.“
Well, if you give additional bailouts to Greece, you send precisely the wrong message to the Italians, French, etc. In effect, you’re telling them that there’s a new group of taxpayers from other nations who will pick up the tab.
That means more debt, bigger government, and a deeper crisis when the house of cards collapses.
P.S. Five years ago, I created a somewhat-tongue-in-cheek 10-step prediction for the Greek crisis and stated at the time that we were at Step 5. Well, it appears my satire is slowly becoming reality. We’re now at Step 7.
P.P.P.P.P.P.S. Since we once again have examined a very depressing topic, let’s continue with our tradition of ending with a bit of humor. Clickhere andherefor some very funny (or sad) cartoons about Obama and Greece. And here’sanother cartoon about Greecethat’s worth sharing. If you like funny videos, clickhereand here. Last but not least, here’s some very un-PC humor about Greece and the rest of Europe.
I periodically comment about government corruption, often in the context of trying to make the general point that shrinking the size and scope of the public sector is the most effective way of reducing sleaze in Washington.
Now let’s get specific. I’ve already cited Obamacare, the tax code, and the Export-Import Bank as facilitators of corruption. Let’s augment that list by looking at government intervention in the financial sector.
We’ll start with some findings on the effectiveness of lobbying. In some new research, two professors at George Mason University’s Mercatus Center found that being active in Washington is beneficial for top executives, but it doesn’t help a company’s bottom line.
Here’s how the Washington Examiner summarized the study.
What is the return on investment in lobbying? Does a PAC contribution actually pay for itself? There are so many cases of a lobbyist winning an earmark, or a PAC contribution immediately preceding a subsidy, that it’s hard not to see politics as a good investment. …But for every company that hits the jackpot after lobbying campaign, scores of others end up throwing away money on lobbyists — and scores of executives whose PAC contributions don’t help the company a bit. Business professors Russell Sobel and Rachel Graefe-Anderson of the Mercatus Center at George Mason University collected the data and dug into the bigger question: Do lobbying expenditures and PAC contributions increase corporate profits, on average? Their answer: No… When Sobel and Graefe-Anderson crunched numbers, conducted regressions, and controlled for firm size, industry and other factors, they arrived at data “suggesting that any benefits gained from corporate political activity are largely captured by firm executives.” In short, when a CEO and a lobbyist decide to get their company more involved in politics, the CEO and the lobbyist benefit, while not helping the company.
These findings at first struck me as counterintuitive. After all, there are plenty of companies, such as General Electric and Archer Daniels Midland, that seem to obtain lots of unearned profits thanks to their lobbying activities.
But don’t forget that government – at best – is a zero-sum game. So for every company, industry, or sector that “wins,” there will be lots of companies, industries, and sectors that suffer.
And speaking of industries that benefit, there was one exception to the Mercatus Center findings.
The only exception was the banking and financial sectors, where they found “positive and significant correlations between firm lobbying activity and three measures of firm financial performance,” including return on investment and return on equity.
At this stage, let’s be careful to specify that lobbying is not necessarily bad. If a handful of business owners want to join forces to fight against higher taxes or more regulation, I’m all in favor of that kind of lobbying. They’re fighting to be left alone.
But a big chunk of the lobbying in Washington is not about being left alone. It’s about seeking undeserved benefits by using the coercive power of government.
And this latter definition is a good description of what the financial industry has been doing in Washington. That’s bad for taxpayers, but it’s also bad for the financial sector and the overall economy. Here are some of the conclusions from a recent study published by the New York Federal Reserve Bank.
…there have been many concerns with banks deemed “too big to fail.” These concerns derive from the belief that the too-big-to-fail status gives large banks a competitive edge and incentives to take on additional risk. If investors believe the largest banks are too big to fail, they will be willing to offer them funding at a discount. Together with expectations of rescues, this discount gives the too-big-to-fail banks incentives to engage in riskier activities. …The debate around too-big-to-fail banks has given rise to a large literature. … we study whether banks that rating agencies classify as likely to receive government support increase their risk-taking. …The results of our investigation show that a greater likelihood of government support leads to a rise in bank risk-taking. Following an increase in government support, we see a larger volume of bank lending becoming impaired. Further, and in line with this finding, our results show that stronger government support translates into an increase in net charge-offs. Additionally, we find that the effect of government support on impaired loans is stronger for riskier banks than safer ones, as measured by their issuer default ratings. …the level of impaired loans in a bank loan portfolio increases directly with the level of government support. …riskier banks are more likely to take advantage of potential sovereign support.
Isn’t that wonderful. Our tax dollars have been used to increase systemic risk and undermine economic growth. Though none of us should be surprised.
Since this has been a depressing column, let’s enjoy some morbid TARP humor.
Here’s a cartoon from Robert Ariail about the cronies who got rich from the Bush-Obama bailouts.
Good to see Hank Paulson getting ripped. At the end of the Bush Administration, I attempted to convince the White House that “FDIC resolution” was a much better way of recapitalizing the banking system. I was repeatedly told, though, that Paulson was in charge and there was no way of stopping him from bailing out his former cronies on Wall Street.
Oh well, at least I tried.
Here’s another cartoon about the real victims of TARP. Like the first cartoon, it’s an oldie but goodie and it’s a good illustration of how government is a zero-sum scam.
But let me re-emphasize a point I made above. Taxpayers aren’t the only ones to lose. The entire economy suffers from bailouts and subsidies. Such policies distort the allocation of capital and lead to slower long-run growth.
That may not be easy to measure, but it matters a lot.
This is a good time to recycle the famous poster about supposed government solutions.
P.S. Not all financial institutions are corrupted by government. The nation’s 10th-largest bank, BB&T, did not want and did not need a bailout. But as the bank’s former CEO (and, I’m proud to say, current Cato Institute president) explained in his book, thugs from Washington threatened to use regulatory coercion if BB&T didn’t participate.
To be sure, some of these votes were merely window dressing, but it’s still better to have symbolic victories rather than symbolic defeats.
Today, however, I want to report on a real victory against statism. The Senate Majority Leader, Harry Reid, has been forced to give up on his effort to ram through an expansion of IMF bailout authority as part of legislation giving money to Ukraine.
This is the second time that this White House initiative has been blocked.
Senate Majority Leader Harry Reid will drop a provision to reform the International Monetary Fund from a bill to help Ukraine… Reid acknowledged that while the Ukraine package would likely have passed the Senate, it was “headed to nowhere” in the GOP-led House. …the administration did not hide its disappointment Tuesday afternoon over the removal of the IMF language. “We are deeply disappointed by the news that Republican opposition has forced the Senate to remove the [IMF] reforms from the Ukraine assistance package,” said Treasury Department spokeswoman Holly Shulman. …Backers of including the IMF reforms in the Ukraine deal note that it will help boost the organization’s lending capacity. …The United States is the lone holdout country that has not ratified the IMF deal, which was struck more than three years ago. But many congressional Republicans have raised concerns about potential taxpayer risk with the IMF agreement.
It goes without saying that the IMF won’t give up, and the Obama Administration is still pushing to expand the international bureaucracy’s bailout authority.
The battle will continue. In preparation for the next skirmish, Desmond Lachmann at AEI debunks the White House’s empty talking points.
Next week, Treasury Secretary Jack Lew will make his case before the House Financial Service Committee for linking IMF reform to U.S. bilateral aid for Ukraine. If the past is any guide, he will do so by putting forward a set of disingenuous arguments in favor of his case. …The principal argument that Secretary Lew must be expected to make is that IMF quota reform is essential for large-scale IMF Ukrainian financial support. This argument glosses over the fact that under the IMF’s lending policy under “exceptional circumstances”, which has been resorted to on many occasions since the 1994 Mexican tequila crisis, the amount that the IMF can lend a country bears little relation to the size of that country’s IMF quota. …Ukraine is reportedly currently seeking around a U.S. $15 billion IMF economic adjustment loan. If Mr. Lew were to be candid, he would inform Congress that such an amount represents only around 800 percent of Ukraine’s present IMF quota or less than half the amount of quota that the IMF recently committed to several countries in the European economic periphery. He would also inform Congress that the IMF presently has more than U.S. $400 billion in uncommitted loanable resources. This would make the IMF’s prospective loan to Ukraine but a drop in the IMF’s large bucket of available resources even without IMF reform.
Lachmann goes on to make additional points, including the fact that IMF bailouts create very real financial risks for American taxpayers.
The U.S. Treasury never tires of assuring Congress that large-scale IMF lending poses no risk to the US taxpayer. It bases its argument on the fact that the IMF enjoys preferred creditor status and that to date no major country has defaulted on its IMF loans. However, the Treasury conveniently glosses over the fact that IMF loan repayment experience with past IMF lending on a small scale might not be a good guide to what might happen on IMF loans of an unprecedentedly large scale. To understand that there now might be a real risk to the US taxpayer from IMF lending, one only need reflect on the IMF’s current Greek lending experience. Greece’s public debt is now mainly officially owned and it amounts to over 175 percent of GDP. It is far from clear that the European Central Bank will go along with the idea that the IMF enjoys senior status over the ECB in terms of Greece’s loan repayments.
His point about risks to taxpayers is right on the mark. In effect, the IMF is like Fannie Mae and Freddie Mac. For years, defenders of intervention in the housing market argued those government-created entities didn’t cost a penny. Then they suddenly cost a lot.
The same will happen with the IMF.
Lachmann closes by asking the right question, which is whether there’s any reason to expand the IMF’s authority.
I think that’s the real issue. And to answers that question, let’s go to Mark Hendrickson’s column in Forbes.
He starts by noting that the IMF has “re-invented” itself to justify its existence, even though it supposedly was created for a world – which no longer exists – of fixed exchange rates.
Bureaucracies are masters of mission creep. They constantly reinvent themselves, cleverly finding ways to expand in size, scope, power, and budget. The IMF has perfected this art, having evolved from its original purpose of trying to facilitate orderly currency exchange rates as countries recovered from World War II to morphing into a global busybody that makes loans—with significant strings attached—to bankrupt governments.
And what do we get in exchange for being the biggest backer of IMF bailouts?
What has the American taxpayer received in return for billions of dollars siphoned through the IMF to deadbeat governments? Nothing but ill will from abroad. First, the IMF’s policy of lending millions, or billions, to fiscally mismanaged governments is counterproductive: Such bailouts help to prop up inept and/or corrupt governments. Second, bailouts create moral hazard, inducing private corporations and banks to lend funds to poor credit risks, confident that IMF funds will make them whole. Third, typical IMF rescue packages demand…higher taxes in the name of balancing the budget.
It would be far better, Professor Hendrickson explains, if reckless governments had to immediately accept the market’s judgement whenever they overspent.
…it doesn’t take expert economists to figure out when a government is overspending. Markets will discipline spendthrift governments by ceasing to make funds available to them until they institute needed reforms. Without a bailout fairy like the IMF, government leaders will quickly learn that if they wish the government to remain viable, they must spend within available means. By telling governments what they “have” to do when it’s obvious they need to make those reforms anyhow, the IMF gives the recipient government a convenient scapegoat. It blames the pain of austerity on meddlesome foreigners, and since the U.S. is perceived as the real power in the IMF, we get painted as the bad guys. The bottom line: IMF use of our tax dollars buys us a ton of resentment from abroad.
He also points out that the IMF makes a habit of suggesting bad policy – even for the United States.
the IMF has waged war against American taxpayers and workers. Last October, the IMF released a paper suggesting both higher tax rates (mentioning a “revenue-maximizing” top marginal tax rate of around 60 percent) and possibly the confiscation of a sizable percentage of private assets to restore fiscal balance to the federal government. The IMF also has been one of the leading forces discouraging “tax competition” between countries. …It is using American tax dollars to lobby the American government to increase the flow of tax dollars from our Treasury to the IMF. We shouldn’t be surprised, then, that the IMF released a report on March 13 warning of the perils of “income inequality,” and suggesting tax increases and wealth redistribution as ways by which Uncle Sam might address the problem.
So what’s the bottom line?
If the IMF really wanted to improve the economic prospects of the world’s people, it would recommend reductions in government spending and taxation. Indeed, the overwhelming evidence is that vigorous economic growth is highly correlated with a country’s government shrinking as a share of GDP. What are the chances that the IMF will ever advocate such policies? Not very, as we realize that the IMF’s very existence depends on government taxes. …In a better world, there wouldn’t be an IMF. For the present, though, the best we can hope for is for enough members of Congress to understand that the IMF’s interests are opposed to those of the American people and to refuse any requests that the IMF makes for increased funding.
Republicans are reluctant to grant more leverage to European countries, which they blame for relaxing rules on Greece’s bailout in order to rescue the continent’s banks. …An internal audit last week also found that the fund’s growth forecasts were “optimistic” for countries like Greece and Ukraine that were granted larger loans under its “exceptional access” framework. Republicans fear the IMF is becoming a discount borrowing window for spendthrift governments trying to postpone reforms. IMF economic advice is often lousy—raise taxes and devalue… Congress ought to debate whether the IMF has outlived its usefulness as it evolves from a tool for Western interests into a global check-writing bureaucracy.
Amen. Which is why the United States should shut the Treasury door to the IMF. If other nations want to subsidize bad policy and promote bigger government, they can do it with their own money.
P.S. Here’s a list of other IMF transgressions against good public policy (all partially backed by American taxpayers).
For my birthday last year, the only present I wanted was for the Supreme Court to uphold the Constitution and reject Obamacare.
Needless to say, that didn’t happen. Instead, the Chief Justice put politics above the law and made a mockery of his Oath of Office.
So I’m now a bit superstitious and I’m not going to write about anything I want today or in the future. But I will pretend that something good happened because it’s my birthday, so let’s celebrate the fact that the European Union has basically made the right decision on how to deal with insolvent banks.
Technically, it happened yesterday, the day before my birthday, but it’s being reported today, and that’s close enough for me. Here are some details from the EU Observer.
Bank shareholders and creditors will be first in line to suffer losses if their bank gets into difficulties, according to draft rules agreed by ministers in the early hours of Thursday morning… Under the new regime, banks’ creditors and shareholders would be the first to take losses. But if this proves insufficient to rescue the bank in question, savers holding uninsured deposits worth more than €100,000 would also take a hit.
And it’s the opposite of the corrupt TARP system that the Bush and Obama Administrations imposed on the American people.
The reason this new European approach is good is that it puts the pressure for sound business decisions where it belongs – with the shareholders who own the bank and with the big creditors (such as bondholders) who should be responsible for monitoring the underlying safety and soundness of a bank before lending it money.
And rich people (depositors with more than €100,000) also should be smart enough to apply some due diligence before putting their money someplace.
The last people to bear any costs should be taxpayers. They don’t own the bank. They don’t invest in the bank. And they don’t have big bucks. So why should they bear the cost when the big-money people screw up?!? Especially when TARP-style bailouts promote moral hazard!
I’m sure the new system won’t be properly implemented, that there are some bad details in the fine print, and there will be too many opportunities for back-door bailouts and cronyism, but let’s not make the perfect the enemy of the good.
Happy Birthday to me. And such an unexpected present: Something good actually came out of Europe!
It doesn’t create a lot of confidence in Europe that tiny little Cyprus, with a GDP less than Vermont, is now causing immense turmoil.
Though to be more accurate, events in Cyprus aren’t causing turmoil as much as they’re causing people to examine both government finances and bank soundness in other nations. And that’s causing anxiety because folks have taken their heads out of the sand and looked at the reality of poor balance sheets.
But that then raises the question of why Cyprus is bailing out its banks? Why not just let the banks fail?
Well, here’s where things get messy, particularly since we don’t have a lot of details. There are basically three options for dealing with financial sector insolvency.
In a free market, it’s easy to understand what happens when a financial institution becomes insolvent. It goes into bankruptcy, wiping out shareholders. The institution is then liquidated and the recovered money is used to partially pay of depositors, bondholders, and other creditors based on the underlying contracts and laws.
In a system with government-imposed deposit insurance, taxpayers (or bank consumers via insurance premiums) are on the hook to compensate depositors when the liquidation occurs. This is what is called the “FDIC resolution” approach in the United States.
And in a system of cronyism, the government gives taxpayer money directly to the banks, which protects depositors but also bails out the shareholders and bondholders and allows the institutions to continue operating.
As far as I can determine, Cyprus wants to pick the third option, sort of akin to the corrupt TARP regime in the United States. But that approach can only work if the government has the ability to come up with the cash when banks go under.
I’m assuming, based on less-than-thorough news reports, that this is the real issue for Cyprus. It needs taxpayers elsewhere to pick up the tab so it can bail out not only depositors, but also to keep zombie banks operating and thus give some degree of aid to shareholders and bondholders as well.
But other taxpayers don’t want to give Cyprus a blank check, so they’re insisting that depositors have to take a haircut. In other words, the traditional government-imposed deposit insurance regime is being modified in an ad hoc fashion.
And this is why events in tiny Cyprus are echoing all over Europe. Folks in other nations with dodgy banks and unsound finances are realizing that their bank accounts might be vulnerable to haircuts as well.
So what should be done?
I definitely think the insolvent institution should be liquidated. The big-money people should suffer when they mismanage a bank. Shareholders should lose all their money. Then bondholders should lose their money.
Then, if a bailout is necessary, it should go only to depositors (though I’m not against the concept of giving them a “haircut” to save money for taxpayers).
But Cyprus apparently can’t afford even that option. And the same is probably true of other European nations.
In other words, there isn’t a good solution. The only potential silver lining to this dark cloud is that people are sobering up and acknowledging that the problem is widespread.
Whether that recognition leads to good policies to address the long-run imbalances – such as reductions in the burden of government spending and the implementation of pro-market reforms – remains to be seen.
To bail out the housing sector, or to bail out Medicare? Fannie and Freddie, or GM and Chrysler?
All these examples involve huge amounts of money, and both private-sector and public-sector bailouts have perverse long-run effects, but which is worse?
And don’t forget there are lots of other bailouts in our future, as discussed on this interview for Fox Business News.
The interview took place before Christmas, but the topic is even more relevant today since the budget season is about to begin.
Most of the discussion was about government agencies and programs that may get more handouts, though bailouts for the Federal Housing Administration and the Pension Benefit Guaranty Corporation would be indirect bailouts for big business and housing.
So we’d get the worst of all worlds, more government spending and more cronyism.
Or, as they call it in Washington, a win-win situation.
Simply stated, bailouts reward past bad behavior and make future bad behavior more likely (what economists call moral hazard).
But some folks think government was right to put taxpayers on the hook for the sloppy decisions of private companies. Here’s the key passage in USA Today’s editorial on bailouts.
Put simply, the bailouts worked. True, in some cases the government did not do a very good job with the details, and taxpayers are out $142 billion in connection with the non-TARP takeovers of housing giants Fannie Mae and Freddie Mac. But it’s time for the economic purists and the Washington cynics to admit that government can occasionally do something positive, at least when faced with a terrifying crisis.
Well, I guess I’m one of those “economic purists” and “Washington cynics,” so I’m still holding firm to the position that the bailouts were a mistake. In my “opposing view” column, I argue that the auto bailout sets a very bad precedent.
Unfortunately, the bailout craze in the United States is a worrisome sign cronyism is taking root. In the GM/Chrysler bailout, Washington intervened in the bankruptcy process and arbitrarily tilted the playing field to help politically powerful creditors at the expense of others. …This precedent makes it more difficult to feel confident that the rule of law will be respected in the future when companies get in trouble. It also means investors will be less willing to put money into weak firms. That’s not good for workers, and not good for the economy.
If I had more space (the limit was about 350 words), I also would have dismissed the silly assertion that the auto bailout was a success. Yes, GM and Chrysler are still in business, but the worst business in the world can be kept alive with sufficiently large transfusions of taxpayer funds.
And here’s what I wrote about the financial sector bailouts.
The pro-bailout crowd argues that lawmakers had no choice. We had to recapitalize the financial system, they argued, to avoid another Great Depression. This is nonsense. The federal government could have used what’s known as “FDIC resolution” to take over insolvent institutions while protecting retail customers. Yes, taxpayer money still would have been involved, but shareholders, bondholders and top executives would have taken bigger losses. These relatively rich groups of people are precisely the ones who should burn their fingers when they touch hot stoves. Capitalism without bankruptcy, after all, is like religion without hell. And that’s what we got with TARP. Private profits and socialized losses are no way to operate a prosperous economy.
The part about “FDIC resolution” is critical. I’ve explained, both in a post criticizing Dick Cheney and in another post praising Paul Volcker, that policymakers didn’t face a choice of TARP vs nothing. They could have chosen the quick and simple option of giving the Federal Deposit Insurance Corporation additional authority to put insolvent banks into something akin to receivership.
Indeed, I explained in an online debate for U.S. News & World Report that the FDIC did handle the bankruptcies of both IndyMac and WaMu. And they could have used the same process for every other poorly run financial institution.
But the politicians didn’t want that approach because their rich contributors would have lost money.
I have nothing against rich people, of course, but I want them to earn money honestly.
This past Monday, I took part in a panel discussion about the financial crisis at the European Resource Bank in Brussels.
One of my main points was that people in private markets always make mistakes, but that this is a healthy and necessary process so long as there is a profit and loss feedback mechanism that encourages people to quickly learn when things go wrong (and also to reward them when they make wise decisions).
In the financial crisis, though, we saw the government interfere with this process. First, bad policies such as easy money from the Fed and corrupt Fannie Mae/Freddie Mac subsidies distorted market signals and caused a needlessly high level of mistakes. Second, bailouts interfered with the feedback mechanism, teaching people that large levels of imprudent risk are okay.
The politicians, unsurprisingly, didn’t learn the right lessons. Instead of reducing the level of government intervention, they imposed the Dodd-Frank bailout bill (named after two lawmakers who were pimps for Fannie and Freddie and thus disproportionately responsible for the crisis).
I don’t know if this is a case of too-little-too-late, but more and more people are waking up to the idea that regulation is the problem rather than the solution. Perhaps most important, some of these people are in positions of power.
Let’s begin with a look at how the Wall Street Journal’s editorial page reacted to some very important research by some uncharacteristically astute regulators from the Bank of England.
…the speech of the year was delivered at the Federal Reserve’s annual policy conference in Jackson Hole, Wyoming on August 31. And not by Fed Chairman Ben Bernanke. …BoE Director of Financial Stability Andrew Haldane and colleague Vasileios Madouros point the way toward the real financial reform that Washington has never enacted. The authors marshal compelling evidence that as regulation has become more complex, it has also become less effective. They point out that much of the reason large banks are so difficult for regulators to comprehend is because regulators themselves have created complicated metrics that can’t provide accurate measurements of a bank’s health. …Basel II relied far too much on the judgments of government-anointed credit-rating agencies, plus a catastrophic bias in favor of mortgages as “safe.” Instead of learning from that mistake, the gnomes have written into the new Basel III rules a dangerous bias in favor of sovereign debt. The growing complexity of the rules leaves more room for banks to pursue regulatory arbitrage, identifying assets that can be classified as safe, at least for compliance purposes. …in both the U.K. and U.S. the number of regulators has for decades risen faster than the number of people employed in finance. Complexity grows still faster. The authors report that in the 12 months after the passage of Dodd-Frank, rule-making that represents a mere 10% of the expected total will impose more than 2.2 million hours of annual compliance work on private business. Recent history suggests that if anything this will make another crisis more likely. Here’s a better idea: Raise genuine capital standards at banks and slash regulatory budgets in Washington. Abandon the Basel rules on “risk-weighting” and other fantasies of regulatory omniscience.
The references to the Basel regulations are particularly noteworthy. These are the rules, cobbled together by regulators from different nations, and they’re supposed to steer financial institutions away from excessive risk.
You won’t be surprised to learn, though, that these rules caused imprudent behavior. Indeed, one of the slides from my presentation in Brussels specifically highlighted the perverse impact of the Basel regulations.
Some American regulators also understand the inverse relationship between regulation and well-functioning markets. The Wall Street Journal opines on the words of Thomas Hoenig.
The same “fundamentally flawed” system of financial rules that failed in 2008 lives on, “but with more complexity” in the latest proposals from regulators. That was the blunt message on Friday from Federal Deposit Insurance Corporation Director Thomas Hoenig. He was talking about the pending implementation of international bank capital standards known as Basel III. …Mr. Hoenig did a public service at an American Banker symposium by reviewing the relevant history from 2008: “It turns out that the Basel capital rules protected no one: not the banks, not the public, and certainly not the FDIC that bore the cost of the failures or the taxpayers who funded the bailouts. The complex Basel rules hurt, rather than helped the process of measurement and clarity of information.” Observing a Basel system that only grows more complicated as U.S. regulators prepare to implement the latest version, the former president of the Federal Reserve Bank of Kansas City also pointed out that the biggest winners from such regulatory regimes are never the little guys. Mr. Hoenig explained that “the most brazen and connected banks with the smartest experts will game the system…”
I closed my remarks in Brussels by saying that government does have a role in financial markets, but I said that it should focus on identifying and punishing fraud. The free market, by contrast, is the best way to promote safety and soundness.
More specifically, there is nothing quite like the possibility of failure and losses to encourage prudent behavior. As I stated in this interview, capitalism without bankruptcy is like religion without hell.
Hell, by contrast, occurs when government intervenes and sets up a system of private profits and socialized losses.
But I’m tempted to say that anything he’s written to date pales into insignificance compared to his analysis of the corrupt relationship between big government and Wall Street. Here are some excerpts, but read the entire article.
He starts out with a strong claim about the Obama Administration being in the back pocket of Wall Street.
…it’s no big deal to buy a president, which is precisely what Wall Street did in 2008 when, led by investment giant Goldman Sachs, it closed the deal on Barack Obama. For a few measly millions, Wall Street not only bought itself a president, but got the start-up firm of B. H. Obama & Co. LLC to throw a cabinet into the deal, too — on remarkably generous terms. …the real bonus turned out to be Treasury secretary Tim Geithner, who came up through the ranks as part of the bipartisan Robert Rubin–Hank Paulson–Citigroup–Goldman Sachs cabal. Geithner, a government-and-academe man from way back, never really worked on Wall Street, though he once was offered a gig as CEO of Citigroup, which apparently thought he did an outstanding job as chairman of the New York Fed, where one of his main tasks was regulating Citigroup — until it collapsed into the yawning suckhole of its own cavernous ineptitude, at which point Geithner’s main job became shoveling tens of billions of federal dollars into Citigroup, in an ingeniously structured investment that allowed the government to buy a 27 percent share in the bank, for which it paid more than the entire market value of the bank. If you can’t figure out why you’d pay 100-plus percent of a bank’s value for 27 percent of it, then you just don’t understand high finance or high politics.
Later in the article, Kevin makes a case that politicians are engaging in widespread insider trading.
Nancy Pelosi and her husband were parties to a dozen or so IPOs, many of which were effectively off limits to all but the biggest institutional investors and their favored clients. One of those was a 2008 investment of between $1 million and $5 million in Visa, an opportunity the average investor could not have bought, begged, or borrowed his way into — one that made the Pelosis a 50 percent profit in two days. Visa, of course, had business before Speaker Pelosi, who was helping to shape credit-card-reform legislation at the time. Visa got what it wanted. The Pelosis have also made some very fortunate investments in gasand energy firms that have benefited from Representative Pelosi’s legislative actions. The Pelosis made a million bucks off a single deal involving OnDisplay, the IPO of which was underwritten by investment banker William Hambrecht, a major Pelosi campaign contributor. …Besting Nancy Pelosi, Rep. Gary Ackerman (D., N.Y.) got in on the pre-IPO action, without putting up so much as one rapidly depreciating U.S. dollar of his own assets, when a political supporter — who just happened to be the biggest shareholder of the firm in question — lent him $14,000 to buy shares in the private company, which he then sold for more than a hundred grand after the firm went public. There wasn’t so much as a written loan agreement. On and on and on it goes: Sen. John Kerry invested aggressively in health-care companies while shaping health-care legislation. Rep. Spencer Bachus (R. Ala.) was a remarkably apt options trader during the days when he had a front-row seat to Congress’s deliberations on the unfolding financial crisis.
Kevin also explained how Warren Buffett made a boatload of money thanks to insider knowledge about bailouts.
…during the financial crisis, a big piece of Goldman Sachs was bought by Warren Buffett, who stacked up a lot of cash when the government poured money into that struggling investment bank with the support of Barack Obama. When the federal government bought into Goldman Sachs, it negotiated for itself a 5 percent dividend. Warren Buffett got 10 percent — on top of the benefit of having Washington inundate his investment with great rippling streams of taxpayers’ money.
There’s a lot more in the article, but here’s a final excerpt that sums up Kevin’s article.
Wall Street can do math, and the math looks like this: Wall Street + Washington = Wild Profitability. Free enterprise? Entrepreneurship? Starting a business making and selling stuff behind some grimy little storefront? You’d have to be a fool. Better to invest in political favors. …hedge-fund titans, i-bankers, congressional nabobs, committee chairmen, senators, swindlers, run-of-the-mill politicos, and a few outright thieves (these categories are not necessarily exclusive) all feeding at the same trough, and most of them betting that Mitt Romney won’t do anything more to stop it than Barack Obama did. …Free-market, limited-government conservatives should be none too eager to welcome them back, nor should we let our natural sympathy with the profit motive blind us to the fact that a great many of them do not belong in the conservative movement, and that more than a few of them belong in prison.
All of this underscores why TARP was such an unmitigated disaster – and why we should be suspicious of politicians like Romney and Gingrich who supported the bailouts.
The welfare states of Europe are in deep trouble. Decades of over-taxing and over-spending have sapped economic vitality and produced high levels of debt.
The high debt levels, by themselves, might not be a problem if European governments implemented good policy. After all, debt was even higher in many nations after World War II than it is today.
But Europe also faces a demographic problem. The population is aging, meaning that the fiscal situation will get worse – in some cases, much worse. So international investors are appropriately worried that today’s high debt levels will become tomorrow’s crippling debt levels.
And the cherry on the ice cream sundae of Europe’s fiscal nightmare is that many people have been lulled into dependency thanks to excessive government handouts combined with a political culture that tells people there is nothing wrong with mooching off others (as this cartoon aptly illustrates).
This sounds quite depressing, but there is a shred of hope. Simply stated, nations that hit rock bottom presumably have little choice but to move in the right direction.
But that game, sooner or later, comes to an end. As Margaret Thatcher noted, the problem with socialism is that sooner or later you run out of other people’s money.
So what, then, should be done to address the European debt crisis? The European political elite in places such as France and Germany say more bailouts are needed. Why? Because without more bailouts, there will be contagion and the world will plunge into another 2008-style crisis.
As you might suspect, this is self-serving nonsense that would simply create a bigger debt bubble that ultimately causes bigger problems.
The right answer to the European debt crisis is simple. And it only requires two steps.
1. Do not give bailouts to nations, even if that means they default. This isn’t good news if you bought, say, Greek or Portuguese bonds, but there are two big advantages of default. First, it means that the bailouts come to an end so the debt bubble doesn’t get even worse. Second, it forces the affected governments to move – overnight – to a balanced-budget rule.
So what’s the downside? There isn’t one. The aforementioned bondholders won’t be happy. They gambled in the expectation that bailouts would enable them to get high returns, but that’s their problem. Overpaid government workers and greedy interest groups in the affected nations doubtlessly will be very upset because the gravy train gets derailed, but that’s a feature, not a bug.
2. If banks become insolvent because they recklessly lent money to governments that default, those financial institutions should be allowed to fail. More specifically, they should be put into something akin to receivership (similar to what the U.S. did 20 years ago with the S&L crisis and a few years ago with WaMu and IndyMac, and also like what Sweden did in the early 1990s). This automatically prevents financial crisis since the financial sector gets recapitalized, but without the moral hazard and/or zombie bank problems associated with TARP-style bailouts.
This raises an obvious question. If my proposed solution is so simple, why aren’t governments choosing this option?
Part of the answer is that simple solutions aren’t necessarily easy solutions. We know how to fix America’s fiscal crisis, for instance, but that doesn’t mean it will happen. Governments will sometimes do the right thing – but only after they’ve exhausted every other option.
Europe isn’t quite at that stage. Yes, Greece is being allowed to default, which is a small step in the right direction, but the political elite hope that the right blend of additional bailouts and patchwork reforms can fix the problem.
I suppose that might happen, especially if the world economy somehow begins to boom. But don’t hold your breath.
I’m not an expert on addiction, but it’s probably safe to assume that one would never treat an alcoholic by giving him more booze. Or treat an addict by giving him more drugs.
And I’m against bailing out international bureaucracies that are running short on cash because they’ve been busy engaging in bailouts, which is the point I make in this Fox News interview.
I wish there was more time in the interview to expand on the issue of corrupt investors and financial institutions that love to make big profits when a bubble is expanding, but want handouts, subsidies, and bailouts when a bubble bursts.
Another point worth making is that failure is (or should be) part of the market process. One of my favorite lines, which I should have used in the interview, is that “capitalism without bankruptcy is like religion without hell.”
This is getting surreal. We now have layers of bailouts around the world.
Different nations are doing their own bailouts. On top of that, the Europeans have set up something called the European Financial Stability Facility, which does bailouts across the continent. And then there’s the International Monetary Fund, doing bailouts on a global basis. (and we’re not even counting the indirect bailouts from the Federal Reserve and European Central Bank)
But the problems are much deeper than promoting bad behavior. Bailouts also undermine growth by misallocating capital. And, most ominously, they create even bigger problems down the road.
Which is now what’s happening. The queen bureaucracy of bailouts, the IMF, may run out of bailout money, and presumably will demand more handouts from member nations – with the United States on the hook for providing the biggest share. Here’s a blurb from the story in the Daily Telegraph.
The head of the IMF has warned that its $384bn (£248bn) war chest designed as an emergency bail-out fund is inadequate to deliver the scale of the support required by troubled states.In a document distributed to the IMF steering committee at the weekend, Ms Lagarde said: “The fund’s credibility, and hence effectiveness, rests on its perceived capacity to cope with worst-casescenarios. Our lending capacity of almost $400bn looks comfortable today, but pales in comparison with the potential financing needs of vulnerable countries and crisis bystanders.”
At the risk of stating the obvious, the IMF should not get any more money. This is one of those moments for which the phrase “Hell No!” was invented.
The time has come to stop the cycle of bailouts. As Greece has demonstrated, bailouts simply give politicians some breathing room to postpone necessary reforms.
The ideal response would have been to get rid of Fannie Mae and Freddie Mac, but politicians very rarely do the right thing.Those who make down payments of 20% on their homes will pay the highest fees. Those payments will then be used to subsidize higher-risk borrowers through lower fees. This is the socialization of risk, and it flies against every rational economic model, while encouraging housing market dysfunction and putting taxpayers at risk for higher default rates. …selling people houses they can’t afford has never been a good idea. See the subprime loan collapse of 2008. …the Federal Housing Administration…want[s] to punish those who have maintained good credit while rewarding those who haven’t.
To help out homebuyers with poor credit scores, the Federal Housing Finance Agency has decided that homebuyers with good credit scores will pay a little more for their mortgages. …FHFA director Sandra Thompson said the new rules…would “increase pricing support for purchase borrowers limited by income or by wealth.” But income and wealth are and should be limiting factors in lending. It’s not good for borrowers to take on loans that may prove beyond their means to pay back. …this policy reduces the incentive to be responsible…and…has the added twist of penalizing people with high credit scores. …That’s one way to get more poor decisions and fewer good ones.
at the end of 2010.
But other taxpayers don’t want to give Cyprus a blank check, so they’re insisting that depositors have to take a haircut. In other words, the traditional government-imposed deposit insurance regime is being modified in an ad hoc fashion.
International Liberty 