Monthly Archives: January 2012

Detroit’s Finances in Worse Shape than Previously Thought

Image via Flickr User Bernt Rostad

For years Detroit’s has faced budget challenges with a declining tax base and increasing debt obligations. For the past few months, budget analysts have been predicting that the city will file for bankruptcy this year, and a new report provides evidence that Detroit’s finances are in even worse shape than previously thought.

Concerns about the city’s finances led the state to appoint a team to review the budget. If the team determines that the city is in a state of “fiscal emergency,” the state will appoint an independent financial manager under Michigan’s controversial Public Act 4 of 2011. However, if Mayor Bing can successfully negotiate some concessions with public sector unions, this fate may be avoided:

Mayor Bing said he expects to reach an agreement with the city’s unions by the end of the month.

“I’m sitting in a lot of meetings,” said Bing during an appearance at the auto show. “(City unions) are open-minded to change finally. We don’t have any options.”

While the review team’s complete findings are not yet available to the public, preliminary reports indicate that the city’s budget is in worse shape than previously thought. The city had not been factoring public employee retiree health benefits into its budget, and current estimates put this unfunded liability at $5 billion, bringing Detroit’s total debt to $20 billion.

Retiree health benefits, known as Other Post-Employment Benefits, or OPEB, present a challenge in many municipal budgets. Localities are often not held to the General Accepted Accounting Principles when reporting their budgets, leaving the potential for these liabilities to be left off of the books. Eileen Norcross’ research in New Jersey uncovered a similar problem in two localities that were treating OPEB as pay-as-you-go obligations rather than contributing to retiree’s OPEB requirements as they were employed.

Obscuring these liabilities in Detroit has painted an overly rosy picture of the city budget for many years. Now the city is home to more retired public employees than active workers, making it difficult to fund these increasing benefits.

Betty Buss of the Citizens Research Council sums up the current situation accurately:

“The city has made a lot of promises. Past leaders have entered into a lot of agreements; have made a lot of decisions that cost huge amounts of money. But, at the same time that its developed huge debts that go out to 2036 and beyond, revenues have been shrinking.”

While the city’s fiscal distress may lead to increased willingness for union concessions, it remains to be seen whether Bing will achieve enough concessions to close Detroit’s $150 million budget shortfall in the face of this debt burden.

CalPERS proceeds with lawsuit against credit ratings agencies

A judge in San Francisco has ruled that the California Public Employees Retirement System (CalPERS) may proceed with a lawsuit against Moody’s and Standard and Poors. The suit was brought in July 2009 on the grounds that the credit ratings agencies misled CalPERS investors by giving its highest ratings to three companies that tanked in 2007 and 2008.The ratings agencies claim the suit is groundless since ratings opinions are a matter of free speech. CalPERS counters that the agencies furnish investors with supposedly factual information, and “without reasonable grounds to believe that the representations were true.”

The three companies that defaulted on their payments to CalPERS: Cheyne Finance LLC, Stanfield Victoria Funding LLC and Sigma Finance Inc were “structured investment vehicles” or SIVs. The assets underlying the SIVs (packages of loans, debt and sub-prime mortgages) were only known to the SIVs. CalPERs lost $1 billion in the investment. A similar suit brought by CalPERS against Fitch Ratings was dropped in August 2011.

Other public pension systems that have sued ratings agencies due to bad investments include the state of Ohio on behalf of the Ohio Police and Fire Pension Fund and the Ohio Public Employee Retirement System. In September a judge ruled that the opinions of ratings agencies are protected speech, dismissing Ohio’s $457 million suit.

What Illinois’s Credit Rating Downgrade Really Means

Last week Moody’s Investment Service downgraded Illinois’s credit rating from A2 to A1, thus labeling the state’s debt as the riskiest in the nation. There seems to be some confusion, however, on what this downgrade means for state borrowing, how it will affect taxpayers, and how it will impact the state’s fiscal future.

To put this downgrade into perspective, it’s important to consider that it came just a few days before the state had planned to borrow $800 million to pay for roads, schools, and bridges. Many individuals predicted that this downgrade would make it more expensive for the state to follow through with its planned bonds sale. Illinois Treasure Dan Rutherford estimated that the downgrade would likely cost the state an additional $65 million in order to issue the $800 million in bonds. Bloomberg predicted that Illinois would face borrowing costs more than quadruple the average that it has paid over the past ten years.

But if the rating downgrade was supposed to make borrowing more expensive, how then was Illinois able to secure historically low interest rates in its bond sale this week?

This is precisely the source of much of the confusion and there are a few things that need to be considered. First and foremost, it’s important to point out that a credit downgrade does not necessarily increase the cost of borrowing (as we saw when the cost of borrowing decreased after the U.S treasury was downgraded). A downgrade is just that, a grade. It’s an assessment by a credit rating agency. A downgrade will generally only change lending terms if it teaches the lenders something new. For example, if lenders (i.e. bond buyers) know that Illinois is flunking math, then they have already built that into their lending habits – the information is “baked into the price.” It’s well known that Illinois is in poor fiscal shape and thus this downgrade did not surprise lenders.

Another thing that needs to be considered is the fact that interest rates on all bonds are currently very low which certainly helped the state obtain the low rate. Additionally, as the Wall Street Journal points out, the relative scarcity of new bonds in the municipal bond market this year aided the reception of Illinois’s $800 million bond sale. And finally, it’s true that Illinois secured historically low rates on its recent bond sale but, more importantly, it’s also true that the state may have secured even lower rates if its credit rating would have been higher. In other words, even though the state was able to borrow at relatively low rates, the borrowing may have been more expensive than it would have otherwise been in the absence of a rating downgrade.

Adding to the confusion, Governor Quinn described the state’s downgrade as an “outlier decision.” It’s difficult to label this downgrade as an outlier, however, considering that Illinois has had its credit rating downgraded nine times in three years.

Not only was the downgrade not an outlier but there is simply no reason to believe that the state’s credit is going to improve in the near future. Given Illinois’s habitual utilization of budgetary gimmicks, its customary practice of issuing debt to avoid making necessary budget cuts and its vastly underfunded pension system – it’s likely that the state’s credit rating will continue to decrease unless Quinn and the state legislature start making serious institutional reform.

Most importantly, this downgrade could mean that Illinois taxpayers will now get less bang for their buck. As legislators continue to push off significant reform, borrowing costs will likely continue to increase and more taxpayer dollars will be going towards interest payments instead of building schools and roads. Paying more money for fewer services is something Illinoisans can simply not afford – especially in the wake of last year’s tax hike which increased the average family’s state tax bill by $1,594.

So to clear up any confusion, what Illinois’s recent credit downgrade really means is that the state’s long run borrowing costs may be higher than they would have otherwise been, Illinois taxpayers are now paying more for less, and Illinois’s fiscal future will suffer if the state continues to hold the riskiest debt in the nation.

Washington Needs to Abandon the Quick Fix

In a strange new ritual, Washington routinely grinds to a halt to deal with some crisis or another. One moment it’s a looming tax hike, the next a government shutdown. One week it’s a threatened default on our national debt; the next, triggered sequesters or benefit cuts.

The common thread in these episodes: a politician with a quick fix. Each aims to address our government’s fiscal problems without significant policy reform or sacrifice by any American (voter). And, ironically, though each was designed to avoid short-term economic pain, the gimmicks have only deepened our fiscal hole and made genuine economic recovery less likely. The parade of clever ideas has ensnared Washington in a never-ending cycle of self-inflicted crises and hyped-up doomsday deadlines. “Oh what a tangled web we weave, when first we practice to deceive.”

That’s me, writing in The Hill. I also touch on the Bush tax cuts and highlight new research on the economic consequences of policy uncertainty.

Using incentives to save the prairie dogs

Growing up in Western Colorado, I was never aware that prairie dog populations were threatened. Frankly, I always considered them to be about one step up from rats. In fact though, the Utah prairie dog is an endangered species, causing challenges for developers in Iron County.

Until recently, landowners in Utah had to obtain permission to build on land that is considered prairie dog habitat in accordance with the Endangered Species Act. They would have to relocate the animals to a suitable new habitat, after which they would typically be allotted only a 60-day window in which to begin building, resulting in uncertain property rights and incentives to rush development. Now, developers can instead purchase Habitat Credits, or the right to build on current prairie dog habitats, from farmers and ranchers who own land suitable for prairie dogs.

The Associated Press reports:

The program works like a bank, allowing private landowners to sell “credits” if they own prairie dog habitat they’re willing to protect. Buyers who purchase those credits gain permission to develop other habitat areas on their own timeframes.

The number of credits up for purchase and the cost of the credits will vary depending on the population of prairie dogs on the land.

The arrangement would fulfill the Endangered Species Act requirement that bars destruction of a listed species’ habitat without developing new habitat.

Environmentalists are hopeful that this program will boost prairie dog populations enough to get them off of the endangered species list, and the policy change has made life easier for developers. Furthermore, this change is good for residents of Iron County, as reducing obstacles to development will result in an improved built environment.

This seemingly simple policy change illustrates the power of property rights. Assigning them in a way to better align incentives benefits everyone by allowing for improvements in land allocation.

Cocktails, Community Transformation Grants and the City

The Department of Health and Human Services has a new program: The Community Transformation Grant (CTG). To date $103 million in CTG funding has been awarded to 61 cities to, “support community-level efforts to reduce chronic diseases…by promoting healthy lifestyles” thereby reducing spending on health care.

According to The New York Post,“The city Health Department’s far-reaching Partnership for a Healthier New York City initiatives proposes to slash the number of establishments in the city that sell booze.” The proposal includes a few other ideas like limiting liquor advertising on subways, department stores and restaurants.

As a result of the news coverage, the Mayor’s office issued a statement hours later spiking the proposal. But since it was proposed, let’s give it some consideration.

Will limiting the sale of alcohol reduce alcoholism? Prohibition was repealed in 1933. Recent history should be a guide here.

Many pin the birth of the Temperance movement on America’s Puritan roots but history tells a more nuanced story. Alcohol was consumed regularly in Colonial America. Moderate consumption of drink was praised by Increase Mather in his sermon Wo to Drunkards.

Research by David Hanson of SUNY links the rise of the Temperance movement to rapid societal change in the early 19th century that altered American drinking habits from social to solitary. The move from a rural society to an urban and mobile society meant the disappearance of many of social mechanisms that encouraged moderate drinking and maintained,”the expectation that abuse of alcohol was unacceptable.”

Interestingly, Hanson cites the tavern as one such social control:

Central to the drinking culture of colonial life was the tavern … The role of the tavern in colonial America and the attitudes toward it were quite different from what they would become in the nineteenth century. The tavern was considered an integral part of community life, second only in importance to the meetinghouse, which served as the church, town hall, and courtroom. The laws of most colonies required towns to license suitable persons to sell wine and spirits for the convenience of travelers and town dwellers; failure to do so could result in a fine. Contrary to the modem practice of keeping alcohol outlets a certain distance from schools and churches, colonial taverns were often required to be located near the meetinghouse or church. In towns that lacked a meetinghouse or in those where the meetinghouse did not provide sufficient warmth in winter, “religious services and court sessions were held in the great room of the principal tavern; there, ecclesiastical affairs were managed, the town selectmen and county justices met to conduct the business of government, and the voters assembled for town meetings” (Popham, 1978, p. 271). Those who attended these gatherings naturally took advantage of the hospitality of the tavern, the expenses not infrequently being paid out of town funds. People also came to taverns to see plays and concerts, to attend lodge meetings, to participate in lotteries, to read newspapers, and to engage in political debate. Taverns were, in fact, more important as centers of social activity than as places in which to drink. Most drinking took place in the home or at communal gatherings. (Popham, 1978, pp. 267-277; Conroy, 1984) (Prendergast, 1987, p. 27)

Late 19th and early 20th century Temperance advocates believed that limiting access to alcohol would end the social and physical ills produced by alcoholism. But by outlawing the saloon and sale of alcohol with the passage of the 18th Amendment the only thing the movement did was to turn America into “a nation of scofflaws,” as well as amateur still-operators; sometimes with deadly results. As Hanson notes, driving drink underground didn’t decrease drinking, it increased it; it didn’t eliminate crime but created it. The saloon was replaced by the speakeasy.

The CTG program is new and it is part of the larger health care reform of the Obama administration. Other CTG projects critiqued as lacking in evidence: an e-cigarette campaign in Boston and a $15.8 million garden co-op and composting initiative in Pima, Arizona.

Genuine Economic Progress is about Higher Incomes AND Lower Prices

A few months back I wrote:

From the perspective of a worker, the point of a job is not simply to have a paycheck; it is to have a paycheck that permits one to buy useful goods and services.

This is an important point to keep in mind because so many policies—from subsidies and regulations to occupational licenses—simultaneously increase the prices paid by consumers and the incomes received by (some) producers. In fact, I’d go so far as to speculate that a majority of policies have this effect. (There are, of course, exceptions; taxes push consumer prices up and producer net-of-tax revenues down). From a public choice perspective, this makes sense: any one of these policies is likely to raise the incomes of a few well-connected producers by quite a bit while it is likely to raise the prices paid by a vast multitude by only a little. Even if, in aggregate, the price increases outweigh the income increases, it makes political if not economic sense for a politician to favor such a policy.

This is tragic because genuine economic progress is about both rising real incomes and falling real prices.

The indispensable Mark Perry makes this point beautifully in a classic and brief post from 2010 (I’m sorry, Mark, to quote the entire thing. But I can’t find anything worth leaving out):

In 1964, here’s what the average American consumer could afford after working 152 hours (almost a full month) at the average hourly wage then of $2.50: a “moderately priced, excellent stereo system” from Radio Shack on sale for $379.95.

In contrast, the typical consumer today working 152 hours at the current average hourly wage of $19 could afford this “cornucopia” of electronic goods:

Keep this in mind the next time you hear a politician plugging some new policy that promises to raise incomes. Will it also raise prices above what they would otherwise be? Is it worth it, on net?

Why Would Light Bulb Manufacturers Want to Be Regulated?

Image courtesy of "posterize"

NPR’s Peter Overby had an interesting (pre-holiday) story on recently-passed legislation to save the incandescent light bulb. In Robert Siegel’s intro he tells us:

Last weekend, Congress passed a trillion-dollar budget bill. Among its provisions, plenty of things not related to spending. One of these so-called riders is aimed at saving the hundred-watt incandescent light bulb. But as NPR’s Peter Overby tells us, the move by Republicans is more about politics than light bulbs.

Here is Overby:

Old-fashioned incandescent bulbs waste a lot of energy. So under federal law, they’re being slowly phased out. And the first to go, starting on New Year’s Day, is that old reliable of home lighting: the 100-watt bulb. But what looked like energy efficiency when President George W. Bush signed to law four years ago now looks like oppressive big government to many conservatives.

So the conservatives made sure that the spending bill had a rider which says the Energy Department cannot spend money to enforce the phase out of the 100-watt bulb. Here is where things get interesting. Overby went and talked to industry representatives and found that few if any actually wanted to repeal the ban:

But from the perspective of the lighting industry, this rider is several years too late to make a difference, and they don’t want Congress changing things now….

companies long ago started changing their product lines from traditional incandescents to halogens, compact fluorescents and LEDs.

The National Electrical Manufacturers Association’s Joseph Higbee tells Overby:

Delaying enforcement undermines those investments and creates regulatory uncertainty.

So far, so interesting. The companies being regulated actually want the regulation and getting rid of it would create uncertainty. So, “the move by Republicans is more about politics than light bulbs.”

But is this really the whole story? I think it would be natural to ask just a few more questions. If the ban were lifted, nothing would keep the companies from making the newfangled bulbs anyway, right? So why in the world would a firm favor legislation that limits its options? Why would it expend scarce resources lobbying Congress to keep the ban? Overby says that they “spent months giving show-and-tell demonstrations to lawmakers.” That must have taken up a fair amount of company time. But why do it?

My guess is that it has less to do with the firms wanting to limit their own options and more to do with them wanting to limit the options of would-be competitors who haven’t made investments in the newer technologies. They must worry that there is still a market for the older bulbs and they’d prefer that other firms be forbidden from serving that market.

Economists will recognize this as a simple story of regulatory capture. As Barry Mitnick put it in his classic study, The Political Economy of Regulation:

Much relatively recent research has argued that regulation was often sought by industries for their own protection, rather than being imposed in some ‘public interest.’ Although the distinction is not always made clear in this recent literature, we may add that regulation which is not directly sought at the outset is generally ‘captured’ later on so it behaves with consistency to the industry’s major interests, or at least has been observed to behave in this manner.

When I used to teach capture theory to my students, I’d often encounter incredulity. It sounds like formalized conspiracy theory. Are we
really supposed to believe that all regulations come about because industries have somehow greased the palms of politicians? Well, no. Sometimes it’s that obvious. But often, it is subtler.

As the light bulb story illustrates, some regulations come about because some politician has some well-meaning belief that the regulation will improve lives. But once the regulation is on the books, it tends to favor incumbent firms. So even if it proves to be inefficient, the incumbent firms are willing to exert a great deal of pressure to keep it there lest the market be opened up to others with different business models.

For a helpful and enlightening compendium of observations about capture, see this post by my colleague, Adam Thierer. It is interesting to note that progressive thinkers have often been the first to uncover these stories.

NJ Legislators Eye Changes for State Wine Industry

Although New Jersey is not typically on the short list of states that produce quality American wine, several of its vineyards have won critical acclaim in a variety of categories. However, the state’s wine industry is facing legal setbacks and policy uncertainty that could prevent it from expanding.

Last year, lawmakers threatened to shut down New Jersey wine production after a federal law made it illegal for the state to prevent out-of-state wineries from operating tasting rooms. Instead, lawmakers opted to stop issuing licenses for new wineries to begin operation and banned some existing ones from distributing their product. Now, the Wall Street Journal reports that proposed legislation could allow wineries to begin selling again and benefit wine consumers:

Powerful state Senate President Stephen Sweeney has introduced legislation that would, for the first time, allow both New Jersey and out-of-state producers to operate tasting rooms that sell directly to customers. It would also, for the first time, let New Jersey vineyards ship directly to consumers and let Garden State wine lovers buy from vineyards in the 38 states that allow it, including New York and Connecticut.

Vineyards would pay up to $1,000 for the shipping license and could produce up to 250,000 gallons of wine a year.

The bill would also help at least 16 new producers who have been issued temporary licenses allowing the harvesting of grapes and bottling of wine. But those producers can’t sell their products.

In addition to permitting tasting rooms, the bill would allow New Jersey winemakers to begin selling their product through direct shipping, increasing their potential customer base. It would also allow limited direct shipping from out-of-state producers. Direct ordering wine is crucial for the success of small vintners. Wineries that produce a limited number of cases per year might not be attractive to distributors, but direct shipping allows them to profit and provides greater variety for consumers.

Unsurprisingly, though, the state’s liquor stores oppose the bill, as the change would subject them to increased competition. While vintners favor the proposed legislation, the liquor store lobby suggests that it would hurt local wine makers by allowing the sale of California wines in tasting rooms. In this case, the liquor retailers’ lobby is playing both the bootlegger and the baptist, protecting their own interests while pretending to be looking out for the interest of New Jersey winemakers at the same time.

State Senator Sweeney’s bill has passed the senate already, but it must pass in the assembly by January 10th to be adopted. The bill would be a gain for consumers and small businesses in New Jersey, but stands a chance of falling victim to special interests.

Neighborhood Effects

State and Local Public Policy from the Mercatus Center