Tag Archives: financial markets

Conservatives, Liberals, and Privilege

Utah Senator Mike Lee (R) delivered an important, and timely address at the Heritage Foundation this week. It was focused squarely on what he called “America’s crisis of crony capitalism, corporate welfare, and political privilege.”

It is a problem, he said, that “simultaneously corrupts our economy and our government.” He pointed to a number of ways in which it manifests itself, including “direct subsidies,” “indirect subsidies, like loan guarantees,” “tax carve-outs and loopholes,” “bailouts,” the implicit bailout of “too big to fail,” and “complicated regulations.”

The Senator is careful to point out that the problem has a long history:

Just like the crises of lower-income immobility and middle class insecurity, the crisis of special-interest privilege is not Barack Obama’s fault. It predates his presidency. And though his policies have made it worse, past Republican presidents and Congresses share some of the blame.

He also stresses that the problem is bipartisan:

Too many in Washington have convinced themselves that special-interest privilege is wrong only when the other side does it.

And he’s willing to call Republicans to task for the part they have played:

We [Republicans] have tried being a party of corporate connections and special-interest deal-making. And we’ve lost five of the six presidential popular votes since [Reagan left office].

But though he believes Republicans bear some blame, the Senator contends that government-granted privilege is fundamentally incompatible with conservatism:

Properly considered, there is no such thing as a conservative special interest.

While I agree, I have a more ecumenical view of the issue.

Yes, privilege is incompatible with properly-considered conservatism, but I also think it incompatible with properly-considered progressivism (and properly-considered libertarianism, for that matter). The Senator, on the other hand, believes that “Liberals have no problem privileging special interests, so long as they’re liberal special interests.” As evidence, he quotes progressive thinker Herbert Croly, who wrote:

In economic warfare, the fighting can never be fair for long, and it is the business of the state to see that its own friends are victorious.

I won’t dispute that many progressives continue to view things this way. But I think there is value in framing the elimination of government-granted privilege in terms that attract progressives to the cause rather than in terms that seem destined to repel them.

And there is plenty of evidence that many progressives are at least open to the anti-privilege agenda. As I note in the beginning of the Pathology of Privilege, both the Tea Party and the Occupy movements oppose corporate bailouts. Consider the way progressive economist and Nobel Laureate Joseph Stiglitz framed the issue in Zuccotti Park:

Our financial markets have an important role to play. They are supposed to allocate capital and manage risk. But they’ve misallocated capital and they’ve created risk. We are bearing the cost of their misdeeds. There’s a system where we socialized losses and privatized gains. That’s not capitalism, that’s not a market economy, that’s a distorted economy and if we continue with that we won’t succeed in growing, and we won’t succeed in creating a just society.

Those words could have come out of Milton Friedman’s mouth.

Or consider the way progressives Mark Green and Ralph Nader framed regulatory capture in 1973:

The verdict is nearly unanimous that economic regulation over rates, entry, mergers, and technology has been anticompetitive and wasteful.

The result, they wrote, is a system which “undermines competition and entrenches monopoly at the public’s expense.”

Green and Nader’s concern about regulatory capture wasn’t just an academic exercise. It helped propel one of the most successful eliminations of government-granted privilege in U.S. history: the deregulation of trucking, air travel, and freight rail in the late 1970s. To the considerable benefit of consumers, these industries were substantially deregulated and de-cartelized. And it happened because liberals like Ted Kennedy and Jimmy Carter eventually joined the cause.

Our task today is to get modern libertarians, conservatives, and progressives to once again rally against government-granted privilege.

The Economic Consequences of Misreading Statutes

When Congress adopted the Dodd-Frank financial reform law, it included a number of provisions that had nothing to do with financial markets.  One of these was a requirement that oil companies and other natural resources companies to report annually to the Securities and Exchange Commission payments they make to foreign governments in connection with extracting those countries’ natural resources.  Human rights advocates viewed the SEC’s disclosure system as a convenient tool for influencing how countries use their natural resource revenues.  The statute sets a bad precedent for using the SEC to accomplish goals unrelated to its mission.  To make matters worse, the SEC’s ruleinterpreted the statute in a way that would frustrate the SEC’s mission of protecting investors, fostering fair and well-functioning markets, and facilitating capital formation.   The rule was thrown out by a federal court today.

The SEC’s rule mandated that company’s disclosures—which were required to be very granular—be publicly available.  Because the requirement applied only to companies that file with the Securities and Exchange Commission, it would—in the SEC’s words—“impose a burden on competition.”  The SEC explained that affected companies “could be put at a competitive disadvantage with respect to private companies and foreign companies that are not subject to the reporting requirements of the United States federal securities laws and therefore do not have such an obligation.”  Rules like these are costly to companies and consequently serve as a disincentive for companies to list in the United States.  Moreover, because some countries prohibit public disclosure of the sort the rule required, the SEC acknowledged that companies “may have to choose between ceasing operations in certain countries or breaching local law, or the country’s laws may have the effect of preventing them from participating in future projects.”  Not a great choice.

The SEC was sued for, among other things, interpreting the rule in a manner that was a lot more damaging to companies than Congress intended.  The court agreed and threw the rule out.  The court faulted the SEC for reading the statute to require that company’s filings be made available to the public, when it plainly did not contain such a requirement.  Moreover, the SEC “abdicated its statutory responsibility to investors” by failing to even consider whether an exemption from the rule would be appropriate for payments in countries that prohibit disclosure.

The SEC’s unwillingness to exercise discretion afforded to it by Congress is just one example of how a regulatory agency’s actions can have real effects on the competitiveness of American companies and the returns to investors in those companies.

Maryland realtors fight to protect their subsidy

Image via Flickr user Images_of_Money

We’ve already explored Governor O’Malley’s proposal for the Maryland budget here and here, but recently, a perhaps unintended consequence of the budget came to light. By limiting the deduction that residents earning over $100,000 can make on their state income taxes, the proposed budget would limit the size of the mortgage interest tax deduction for many taxpayers.

I stand by my earlier argument that reducing deductions for only one group of people is not a step in the direction of fairness, but a reduction in the mortgage interest tax deduction may be a positive side effect of an otherwise bad policy. From a limited-government perspective, the obvious downside of a reduction in the mortgage-interest tax deduction is that this represents a revenue-positive change in Maryland’s tax code in a state that already has one of the highest tax burdens in the country. Overall though, I think reducing this tax expenditure is a positive change because the policy has many negative consequences.

While the causes of the financial crisis were many, by subsidizing investment in homes, the mortgage interest tax deduction played some part in the overvaluation of housing stock. Aside from the poor incentives that this tax expenditure creates in financial markets, it amounts to favoritism of suburbs over cities. In Triumph of the City, Ed Glaeser argues that the deduction leads many people to abandon renting in a city center for homeownership in the suburbs. However the Federal Reserve Bank of Boston provides evidence that the policy is more likely to lead people to buy larger homes than they otherwise would rather than trading renting for buying a home. Richard K. Green and Andrew Reschovsky write:

If one set out to design a policy to encourage homeownership, it would make sense to target the
largest subsidies to the households least likely to be homeowners, while providing little or no subsidy to
households likely to become homeowners even without a subsidy. Data from countries that do not
subsidize homeownership (such as Canada, Australia, and Japan) indicate, not surprisingly, that
homeownership rates rise with household income. This suggests that a policy to encourage
homeownership should give the largest incentives to households with modest incomes and no subsidies
to high-income households.

The MID, however, does exactly the opposite. For low- to middle-income taxpayers, the mortgage
deduction provides little financial incentive to abandon renting for homeownership. For those
purchasing modestly priced houses and facing the lowest marginal tax rate (currently 10 percent) the
benefits of the mortgage deduction are small. In fact, for households with low state income taxes, the
mortgage deduction may be of no value at all, because the mortgage deduction, even when combined
with other itemized deductions, may be smaller than the standard deduction.

For most high-income taxpayers, the tax savings resulting from the MID are a minor influence on
their decision to become homeowners; these households are likely to own a home regardless of the tax
treatment of housing. Rather than encouraging homeownership among high-income households, the
MID provides an incentive to buy a larger house and to take out a bigger mortgage. Economists have
long argued that the result is an inefficient pattern of investment, with too many resources invested in
housing and too few resources placed in more productive investments in factories and machinery (Mills,
1989; Poterba, 1992).

This analysis ignores that those at the margin of being least likely to be homeowners are likely the riskiest loan candidates and those most likely to foreclose, but they do make a strong case for why the MID leads to larger homes. Regardless of whether the deduction primarily increases homeownership or leads to larger houses, it results in a subsidy for suburban sprawl and its negative side effects of traffic congestion and demand for public services across a wider geographic area.

Unsurprisingly, the Maryland Association of Realtors is strongly opposed to a budget that would lead to lower tax expenditures on housing. The current policy directly subsidizes their industry. The Washington Post reports:

The Greater Capital Area Association of Realtors says that mortgage interest and property taxes account for almost 70 percent of total itemized deductions in Maryland, and they argue that the proposal, if passed, would further harm the area’s housing market, which has struggled to recover.

WAMU interviewed a leader among MD realtors on the issue:

Jim Scurvin, past president of the Howard County Realtors Association says it’s just wrong to jeopardize an industry responsible for 49 percent of revenue that goes to state and local government

“When someone buys a house, on the average you employ two people, and you put $60,000 into the economy right then and there,” he says. “Real estate is the lead when it comes to getting the economy moving again. We have the wind in our sails, the last thing we need is someone to knock the wind out.”

Scurvin, however, is acknowledging only the visible impact of the tax expenditure. As Frederic Bastiat artfully explained, all policies have unseen consequences. In this case, the unseen impact is that the mortgage interest tax deduction fuels malinvestment in housing at the expense of other, more productive sectors of the economy. While Governor O’Malley’s budget proposal has many negative features, the potential for reducing the state subsidy to housing could be its silver lining. Unfortunately as Maryland realtors demonstrate, eliminating tax expenditures is a painful and politically difficult process.

Risky Business: Stuyvesant Town and Public Sector Pensions

NPR reports the financial collapse of the Stuyvesant Town and Peter Cooper Village renovation and the massive unfunded debt in state pensions are intertwined. When the backers of the $5.4 billion high-profile Manhattan real estate venture declared bankruptcy in January part of the reason was the collapse of California’s pension system, CalPERS, which had invested $500 million in the deal. When CalPERS assets were slashed after the financial markets tanked, California suddenly found itself with a $59 billion unfunded pension liability. Florida’s pension system also put money into what became the biggest real estate debt collapse in U.S. history.

Why would state pension managers risk employees’ retirements on high-risk investments? In pursuit of a high return, pointing to a fundamental flaw in how state and local pensions are valued and financed.

Rather than invest worker and employer contributions in lower-risk and lower-return bonds state pension systems tried to lessen the amount the government needed to contribute to public pensions by relying on a higher rate of return on pension investments. It turned out to be a bad strategy based on unsound financial economics.

Can the Greek Crisis Happen Here?

Greek-ProtestChris Papagianis of E21 asks the question: Can the Greek crisis happen in the United States? Papagianis suggests that the problem lies not on the federal level, but at the state level:

Obviously, states – like the Eurozone members – don’t have their own individual currencies to devalue during a budget crisis. It’s also not simply whether California, Nevada, or Arizona’s deficit and gross debt compare with those of Greece, but how financial markets would deal with a state default and to what extent the political culture in these state capitols can be counted on to avert such an outcome.


However the Greek situation is resolved, it is a reminder that financial panics are not just about specific debt-to-income ratios, but investor sentiment and the financial system’s ability to absorb a default. As more investors become aware of their exposure to the unthinkable, they take actions to hedge that risk. This leads to greater awareness of the risks, an erosion of confidence among counterparties, and the potential for the kind of “run on the bank” that ultimately did in Bear Stearns and Lehman Brothers.

Whole thing here. Niall Ferguson wrote about this prospect earlier this week in the Financial Times. Here’s an easy backgrounder on the Greek crisis.

Gambling with public money:Interest rate swaps and bonds unsold

New Jerseyans are paying $657,000 a month to the Bank of Montreal for bonds that were never sold. Back in 2004, New Jersey planned to issue a $250 million bond to be sold in 2007. To save money, the state sought to lock in a lower interest payment on the bond issue, and entered into an interest rate swap agreement – exchanging a variable rate for a fixed rate on a set amount of debt to protect against rising borrowing costs. The problem: the interest rate swap contract was signed and the state decided not to issue the bonds.

Such swap penalties are also hitting Massachusetts, Pennsylvania, California, Texas, Tennessee, and famously, Birmingham, Alabama.

The Pennsylvania Auditor General calls interest rate swaps, “gambling with public funds.” His report is here.

The Delaware Port Authority made two such agreements in 2000 and 2001, securing $45 million for which it now faces a $242 million liability. When the deals were made variable rates on notes were lower than fixed rates. The collapse of the financial markets exposed public authorities to “unanticipated risks.” Therein lies the problem. It is not the fault of financial instruments but bad fiscal practice: the tendency of governments to assume away risk and favor unrealistic scenarios.

Pennsylvania State Rep. Gordon Delinger would like to ban them. A total of 107 school districts and 86 other local government bodies entered into swaps in recent years. In the case of one Bethlehem school district it’s a decision that has tacked an additional $15.5 million bill for local taxpayers.

Desperate Times: Arizona Leases State House

cap_museumCalifornia’s budget crisis is remarkable for the sheer magnitude of its deficit. New Jersey’s and New York’s revenue streams are entwined with the decimated financial markets. Florida experienced the worst of the housing market collapse.

And Arizona faces its own catastrophe. Its budget shortfall, while at $3.4 billion not as large as California’s, represents 30 percent of its $10.7 billion budget.

After months of wrangling over how to meet the shortfall — program cuts versus tax cuts — a possible solution was reached this week, four weeks into the state’s new fiscal year: the lease of 32 government-owned properties including the State House, a prison, and a state hospital.

The plan involves selling the properties for a quick infusion of cash, and their leaseback over a period of years.

This is the plan’s second go-round. Governor Brewer vetoed it last month. But the state has few options left. Arizona has a constitutional debt limit of $350,000. Under the deal, the state would also have the option of walking away from the lease payments — effectively turning over some of the buildings to the private sector.

Lamentations over the leasebacks are misplaced. Unlike other states — California is “borrowing” money from its cities, New Jersey secured a line of credit from J.P. Morgan to pay its debts — Arizona is taking a step in the right direction.

In fact, looking at the proposed list, it’s not clear why several of the properties aren’t just sold outright.

Does the state need to own a Coliseum and Exposition Center? Simply because it hosts the state fair doesn’t make it a state business.

With a price tag of $84.3 million, privatization is a win-win situation.  Take a non-essential, non-public good off the state’s books, and it has a chance of becoming a profitable (i.e., job-creating) business for a willing investor.

The Arizona Exposition and State Fair’s executive director sees it differently. He writes that the fair is 100 percent self-supporting, and receives no money from the General Fund but, that proposed budget cuts of $2.7 million will mean the Fair will “cease to exist.”

Sounds familiar. Last month, the New England Zoo made even more serious threats when faced with budget cuts: keep our funding, or we’ll have to euthanize these animals.

Maybe under a private owner, the fair will find there’s a lot more it can do before shutting down “one of the most popular all-Indian Rodeos in the Southwest.”