Tag Archives: New York Times

Loyalton, CA and the cost of faulty actuarial assumptions

The New York Times has an interesting piece on the pension troubles facing the small town of Loyalton, California (population 769). Loyalton has seen little economic activity since its sawmill closed in 2001. In 2010 the city made a decision to exit Calpers saving the city $30,000. The City Council thought that the decision to exit would only apply to new hires and for the next three years ceased paying Calpers. Four of the the pension plan’s participants are retired and one is fully vested.

In response, Calpers sent the town a bill for $1.6 million – the hypothetical termination liability – for exiting the plan. For years Loyalton operated under the assumptions built into Calpers’ system which values the liability based on asset returns of 7.5 percent. This actuarial value concealed reality. Once a plan terminates Calpers presents employers with the real bill: or the risk-adjusted value of its pension promises based on a bond rate of 3.25 percent.

To see how big a difference that makes to the bottom line for cities, Joe Nation, Stanford professor, has built a very helpful tool that compares the actuarial liability of pension plans with the market value for individual governments in California.

The judge in the Stockton bankruptcy case Christopher Klein characterized the termination liability as presenting struggling towns with a “poison pill” for leaving the system. Another way to look at it is that the risks and costs that were hidden by faulty accounting assumptions based on risky discount rates are coming due as Calpers fails to hit its investment target. The annual costs may start to be shifted, and in the case of termination, fully imposed on local employers.

The four retirees of Loyalton are facing the possibility of drastically reduced pensions. In a town with annual revenues of $1.17 million, Calpers’ bill is far beyond the town’s ability to pay. Negotiations between Calpers and Loyalton are likely to continue. Some ideas floated include putting a lien on the town’s assets or revenues.

 

Obama Administration will bailout Detroit

The Obama administration announced today it plans to send Detroit $320 million to “aid in its recovery,” according to The Hill.

The dollars come from existing federal money that is being re-purposed. It includes $24 million to rehabilitate buses and install safety cameras, $1.35 million for a community policing program, and the underwriting of 150 new firefighters. There are also funds for streets lights, police bike patrol, $3 million to hire new police, dollars for urban revitalization, and $25.4 million for demolition. A few months ago the administration said Detroit would have to work with creditors to resolve its bankruptcy issues. The city owes its creditors $18.5 billion.

Another example of how Detroit ended up in this awful position is highlighted in yesterday’s New York Times report of how Detroit City Council members skimmed $2 billion off of the pension system’ “excess earnings” to give employees ‘extra payments’ that had nothing to do with their pension benefits. This practice which spanned a 23 year period was justified as follows, quoting the NYT:

“People were having a hard time, living hand-to-mouth, and we thought we would give them some extra,” Ms. Bassett said.

Of all the nonpension payments, she said, 54 percent went to active workers, 14 percent went to retirees and 32 percent went to the city, which used its share to lower its annual contributions to the fund. The excess payments were often made near the end of the year, when recipients needed money for the holidays, or to heat their homes.

Of course the practice sounds wrong. Except it’s really another example of what happens when pensions value their liabilities based on asset returns. Detroit gave workers these “excess earnings.” New Jersey and scores of other states believed they were overfunded also and they “skipped payments” when the market was hot in the 1990s and early 2000s. The accounting gave them the illusion that this would all work out in the end. It is a dangerous fiction that these pension systems operate under.

That illusion of “overfunding in boom years” flows from the practice – discussed often in this blog – of discounting liabilities based on expected asset returns.The math really matters. For a long discussion, see here. 

How much damage has this accounting assumption and all the behaviors that flow from it caused? For Detroit – a significant amount. The city reports its pensions are underfunded by $634 million. It’s actually $9 billion underfunded on a market basis. 

I am not entirely surprised by the bailout, which sounds like a mini-stimulus via federal municipal grant programs. And I openly wonder what it portends for other cities that find themselves looking at similarly dire economic and financial situations.

Nudges or Shoves?

David Brooks writes in the New York Times:

I’d say the anti-paternalists win the debate in theory but the libertarian paternalists win it empirically. In theory, it is possible that gentle nudges will turn into intrusive diktats and the nanny state will drain individual responsibility.

But, in practice, it is hard to feel that my decision-making powers have been weakened because when I got my driver’s license enrolling in organ donation was the default option. It’s hard to feel that a cafeteria is insulting my liberty if it puts the healthy fruit in a prominent place and the unhealthy junk food in some faraway corner. It’s hard to feel manipulated if I sign up for a program in which I can make commitments today that automatically increase my charitable giving next year. The concrete benefits of these programs, which are empirically verifiable, should trump abstract theoretical objections.

I agree with Brooks that arguments over nudges should be based on empirical evidence rather than a purely theoretical discussion. So let’s examine the evidence.

As I pointed out in a recent op-ed:

On the federal level, energy efficiency regulations costing billions of dollars are justified by claiming to correct consumers’ irrational choices. Regulators claim that given the lifetime energy savings, rational consumers would demand more efficient vehicles and appliances voluntarily. They take the fact that many consumers are willing to forego efficiency in favor of other attributes, such as style, safety or lower upfront costs, as a clear proof that consumers are irrational. Hence, regulators force consumers to save by reducing their choices.

Below is a list of recent major federal regulations that use behavioral economics arguments to justify government intervention in markets. While far from exhaustive, it should give you some idea as to the magnitude of “intrusive diktats” that are justified using the nudge philosophy. Note that these regulations are not nudges. This is hard paternalism. Federal regulations do not gently push you towards better choices or give you a chance to opt-out. Contrary to Brooks’ assertion, it is not only in theory that “gentle nudges turn into intrusive diktats.”

For comparison, I can think of no major federal policy that actually nudges. When one looks at the evidence, federal regulators give consumers few nudges but plenty of shoves.

Agency Rule Cost (millions)
EPA/DOT Control of Greenhouse Gases from Light-Duty Vehicles

$176,995

EPA/DOT Greenhouse Gas & Fuel Efficiency for Medium/Heavy Duty Vehicles

$9,600

DOE Energy Conservation Program: Small Electric Motors

$514

DOE Energy Efficiency Standards for Pool Heaters and Direct Heating Equipment and Water Heaters

$1,012

DOE Energy Efficiency Standards for Commercial Clothes Washers

$23

DOE Energy Efficiency Standards for Residential Refrigerators and Freezers

$1,849

DOE Energy Efficiency Standards for Microwave Ovens

$1,341

DOE Energy Conservation Program: Energy Conservation Standards for Fluorescent Lamp Ballasts

$425

DOE Energy Conservation Program: Energy Conservation Standards for Distribution Transformers

$289-$351

DOE Energy Conservation Program: Energy Conservation Standards for Battery Chargers and External Power Supplies

$247

DOE Energy Conservation Standards for General Service Fluorescent Lamps and Incandescent Reflector Lamps

$77-$139

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Addendum: Some of these costs are annualized; some are total. There is no consistency in the way they are reported. Agencies report one or the other but not both. In addition, in an earlier version of this post, two figures were transposed. I have now corrected this.

Do targeted economic development deals work as advertised?

Every so often, journalists write quid pro quo stories about government officials who accept favors (campaign donations, sports tickets, airplane rides, etc.) from people who stand to benefit from government-granted privileges (special tax deals, subsidies, favorable government contracts, etc.).

Like this report in the Post this weekend, most of these stories seem to nudge the reader in the direction of thinking that the solution is more regulation of campaign activity or more oversight of gifts to politicians. My question is: why focus exclusively on the gifts that politicians receive instead of on the privileges that politicians dispense? Why focus on the quid and not the quo?

That’s where a five part series by WAMU’s Julie Patel and Patrick Madden comes in. They are only two stories in, but it is shaping up to be an excellent critique of the entire practice of local economic development privileges:

Construction cranes can be seen throughout the district. Less visible are the symbiotic relationships between land developers and city officials awarding tax breaks and discounted land deals. Those government subsidies are meant to revive neighborhoods, and to create jobs and affordable housing. But in some cases, the benefits never materialized, or the subsidies simply weren’t needed.

And what began as a targeted economic development tool now looks to some like government hand outs that could have paid for other city services.

Appropriately, Patel and Madden plumb the data to look for insider deals and conflicts of interest. But their analysis seems to go beyond that. In tomorrow’s segment, for example, they plan to look at whether targeted economic development tools work as advertised:

Developers receiving subsidies pledge jobs, affordable housing and other benefits for D.C. residents. Yet with little oversight and enforcement, many of the promises were downsized, delayed or broken.

Another intrepid reporter who recently asked this question is Louise Story of the New York Times. She and her team “spent 10 months investigating business incentives awarded by hundreds of cities, counties and states” and assembled a unique database along the way.

If local subsidies worked as advertised, we’d expect to see greater economic growth in those states that give away more subsidies. But simple analysis of Story’s data suggests that, if anything, there is a negative relationship between per capita subsidies and economic growth:

Subsidies and growth

In this graph, the x-axis plots per capita subsidies and the y-axis plots real (inflation-adjusted) state economic growth from 1997 to 2011 (the general time period over which Story has data).

I also ran a series of econometric tests, sometimes controlling for other factors (regional effects, the initial size of state economies, and economic freedom) and sometimes not. In every test I ran, per capita subsidies were negatively associated with state economic growth and often the relationship was statistically significant (I should note that the Mercatus measure of economic freedom was always positively and statistically significantly related to growth).

I’ll be the first to admit that this is a back-of-the-envelope exercise (for example I do not try to control for reverse causality). I hope to see more careful research based on Story’s database soon. But based on what I’ve seen so far, I see no reason to presume that local, targeted economic development schemes work as advertised.

Given the social and economic problems associated with government-granted privileges, I think we should view such schemes with a healthy dose of skepticism.

Why did the ratings agencies mess up so badly?

When companies or countries issue debt, ratings agencies assign grades based on how creditworthy the issuers are believed to be. Low grades can cost the issuers dearly.

But during the housing crisis, the major ratings firms gave the highest grades to mortgage-based securities that proved worthless. This month, the government sued one of the three dominant agencies, Standard & Poor’s, saying its evaluations of some of those securities were fraudulent.

What should be done to reform the ratings industry?

That is the introduction to the latest New York Times Room for Debate forum. There are contributions from:

Reggie Middleton: “The root cause of the agencies’ problems is the outrageous conflict created by having their primary revenue sources be the entities they rate, or the agents of those entities.”

Lawrence J. White: “The Dodd-Frank Act of 2010 instructed federal regulators to eliminate their mandated reliance on ratings, and some bank regulators have done so. But, maddeningly, for money market funds and broker-dealers, the Securities and Exchange Commission continues to mandate reliance on ratings.”

James H. Gellert: “The poor work of credit rating agencies undoubtedly played a role in the subprime mortgage crisis. But the government’s lawsuit against Standard & Poor’s is freighted with unintended consequences.”

Claire A. Hill: “Ideally, ratings would matter less. Fewer and less precipitous actions would be taken solely because of ratings. A money manager should not be able to justify having purchased a badly performing investment by saying that he relied on the rating agencies.”

And yours truly: “Since the days of Adam Smith, economists have known that a tightly restricted market will often result in higher prices and lower quality. So it was—and continues to be—with the ratings industry.”

 

The New York Times Database on Government Granted Privilege

Louise Story of the New York Times has earned her salary many times over this week. She and her colleagues have created a searchable database of targeted incentives (read: privileges) that states offer particular firms. To my knowledge, it is the most comprehensive database on the subject to date, containing information on over 150,000 awards.

Among her findings: Alaska, West Virginia, and Nebraska give up more per resident than any other state and Oklahoma and West Virginia “give up amounts equal to about one-third of their budgets, and Maine allocates nearly a fifth.”

Here is the database.

Also check out her articles, “How Taxpayers Bankroll Businesses,” “Winners and Losers in Texas,” and “When Hollywood Comes to Town.”

Readers of this blog know where to go for more information on the economic and social costs of government-granted privilege.

New Levels of Paternalism Promoted in New York

Image via Flickr user freedryk

Earlier this week, New York City Mayor Michael Bloomberg introduced a proposal to ban the sale of sodas larger than 20 ounces by any retailers regulated by the city’s health department. This proposal has many New Yorkers upset, and even the New York Times says this would be a step too far toward paternalism.

While many agree that banning a product goes beyond the bounds of what we can tolerate from the nanny state, writers including Matt Yglesias support additional soda taxes instead. Yglesias suggests that a soda excise tax is a good idea primarily because it will raise revenue and that one good use of this revenue would be increased welfare payments.

The problem with suggesting excise taxes as revenue raisers to support welfare programs is that low-income people are those who are disproportionately hurt by these taxes. Yglesias suggests that the tax will fall in large part on tourists, but I’m not convinced that tourists drink a large percentage of sodas sold throughout the city. Further, a study of soda consumption in New York shows that people in a household at 200% of the poverty or below drink more soda than the average New Yorker. If this statistic were adjusted for the percent of income spend on soda, the results would be even more striking. This tax will also fall the hardest on those who have the strongest preferences for soda over other drinks, the same people who are the least likely to change their behavior as a result of the tax.

Paternalists may suggest that low income soda drinkers are behaving irrationally and that a higher soda tax will help them make better choices. However, it’s impossible for regulators or supporters of paternalistic policies to understand consumers’ preferences better than consumers themselves. While increased health outcomes may be an objective for policymakers, this is not to say that it is or should be everyone’s objective. Almost none of us acts in accordance with seeking the lowest risk choices in diet or any other area of life, and trying to enforce healthy choices with tax policy is going to make some people worse off with the highest burden falling on those at the low end of the income distribution.

However, a policy choice is available to policy makers not in New York but at the federal level that would decrease the deficit, make soda a little more expensive, and likely lead consumers to make healthier choices at the grocery store. Corn subsidies totaled an estimated $3.5 billion in 2010, making food made with corn products relatively cheaper than food that is less heavily subsidized. Rather than targeting a specific product, large sodas, Bloomberg should put his efforts toward advocating a more fair national food policy in which food prices more accurately reflect their true costs.

Government Spending Has Shrunk…When You Ignore 44 Percent of Government Spending

Floyd Norris has made an astounding discovery. When you don’t count 44 percent of government spending, it appears that government spending has shrunk in recent years.

Writing in the New York Times, Mr. Norris asserts:

Spending by the federal government, adjusted for inflation, has risen at a slow rate under President Obama. But that increase has been more than offset by a fall in spending by state and local governments, which have been squeezed by weak tax receipts.

In the first quarter of this year, the real gross domestic product for the government — including state and local governments as well as federal — was 2 percent lower than it was three years earlier, when Barack Obama took office in early 2009.

The operative phrase here is “real gross domestic product for the government.” What Mr. Norris neglects to note is that real gross domestic product for the government is only about half of what governments actually spend. And when you look at total spending, it is actually up over the last three years, not down.

Let’s begin with government gross domestic product (GDP). This is the portion of government spending which is counted by the Bureau of Economic Analysis (BEA) when it tabulates national GDP. It consists of government consumption expenditures and gross investments. You can think of it as the tab for all items that the government buys on the open market: salaries of public employees, purchases of weapons for the military, investment in infrastructure, etc.

Among other things, however, government GDP does not include transfer payments such as Medicaid, Medicare, Social Security, Unemployment Insurance, Earned Income Tax Credits, Supplemental Nutritional Assistance, Housing Assistance, Supplemental Security Income, Pell Grants, Temporary Assistance to Needy Families, WIC, LIHEAP…you get the point.

It turns out that real spending on everything other than government consumption and gross investment is up about 19 percent since Obama took office. And this is more than enough to offset what’s going on with consumption and gross investment. Thus, total spending is up 7.7 percent in real terms.

You can see this in this chart*:

There’s nothing wrong with using government GDP figures. They are used all the time to estimate things like the government purchases multiplier. And they are also helpful in understanding whether government is growing faster or slower than the private sector. But Mr. Norris does his readers a disservice to casually conflate government GDP and total government spending. How many people reading his column would know that he left out 44 percent of what government spends? Or that when you include that 44 percent, total spending actually rose over the last three years?

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*Technical note: when the BEA calculates real government GDP, it uses chained 2005 dollars. It does not calculate real total spending, offering only the nominal figures in Table 3.1. I have therefore used 2005 inflation conversion factors found here to convert total spending from Table 3.1 and government GDP from Table 1.1.5 into real figures. When you do it this way, real government GDP actually rose slightly (0.41 percent) under Obama. In other words, the 2 percent drop in real government GDP looks like a slight increase if you use a different inflation conversion method.

Detroit’s Financial Future

This post originally appeared at Market Urbanism.

After flirting with Chapter 9 bankruptcy or a state takeover of its finances, Detroit has reached a deal with the state of Michigan that will allow it to remain independently managed with a requirement for state oversight. The Detroit Free Press reports:

The city has seven days to create the positions of chief financial officer and program management director and 30 days after that to make a hire from a list of three candidates from the mayor and state treasurer. Lewis said the city is compiling a list of candidates.

“We’ve got a lot of requirements that are in the agreement,” Lewis said. “We’ve got a lot of work to do (with the agreement) and then getting to the work of fixing the city. Our focus is on executing the plan and getting the resources here to execute the plan.”

Snyder reiterated that the city “shouldn’t expect” a cash bailout, adding that Detroit is one of many troubled communities in the state. But he said the state would use its resources in a variety of ways to help the city.

Snyder said the agreement assures the things that need to be done will get done, describing it as a “progressive series of steps” that first allow the mayor and the council to make the decisions, and then empowers the project manager to do so if they don’t. “This is a legal document designed to deal with situations when they don’t go right,” he said.

While bankruptcy protection offers the advantage to cities of achieving a more manageable debt load, it doesn’t come without a cost. Bankruptcy would add an additional stigma to Detroit, already known for municipal financial distress, encouraging business disinvestment.

Vallejo, CA filed for bankruptcy in 2008, and as the New York Times explains, the city is still in a difficult financial position. After bankruptcy cities have less room in their budgets to provide public services such as infrastructure, parks, and schools while their tax rates don’t fall accordingly. This contributes to further erosion of the tax base as businesses and residents leave the city.

Municipal bankruptcy is always a two-sided issue involving both revenue and debt. At The Atlantic Cities, Emily Badger covers the equation from the revenue side. While cities often both subsidize and enforce sprawl through road-building, parking requirements, and minimum lot sizes, these policies are detrimental to their property tax equations. She cites the positive example of Asheville, NC as a city that has taken advantage of denser downtown redevelopment to improve its ratio of property taxes to infrastructure costs:

Asheville has a Super Walmart about two-and-a-half miles east of downtown. Its tax value is a whopping $20 million. But it sits on 34 acres of land. This means that the Super Walmart yields about $6,500 an acre in property taxes, while that remodeled JCPenney downtown is worth $634,000 in tax revenue per acre. (Add sales tax revenue, and the downtown property is still worth more than six times as much as the Walmart per acre.)

[. . .]

All of this is also just looking at the revenue side of the ledger. Low-density development isn’t just a poor way to make property-tax revenue. It’s extremely expensive to maintain. In fact, it’s only feasible if we’re expanding development at the periphery into eternity, forever bringing in revenue from new construction that can help pay for the existing subdivisions we’ve already built.

[. . .]

“The thing is it all works fine when you have all this new growth and the new gap is met by all these new permit fees – that’s like free money,” Joe Minicozzi [of Public Interest Projects] says.

Cities should not be in the business of requiring the sort of development that is most expensive for them to support. However, this analysis ignores the debt side of Chapter 9, one that may be even more difficult to tackle politically. Despite the harm that poor financial management causes, local elected officials simply do not have the proper incentives to avoid it.

Politicians operate on election cycles, and during their time in office they generally seek to provide their constituents with the best possible services at the lowest tax rate. This leads them to put off payment on long term debt and liabilities using accounting gimmicks and fiscal evasion techniques to spend more on goods that residents will see in the near term.

A combination of debt and declining revenue has put Detroit in the position it’s in today. Its urban development strategy must be a part of the property tax revenue solution. Perhaps the new officials that the city hires will help with debt management, but this additional oversight is unlikely to overcome the incentives of election cycles.

A Bill to Increase Discrimination Against All Workers?

According to Robert Pear of the New York Times, the President’s latest stimulus bill includes a provision allowing unsuccessful job applicants to sue if they believe they were denied a position because they are unemployed.

The advocates of the proposal, of course, are hoping that this will discourage discrimination against the unemployed. Indeed, we can be pretty sure that it would discourage open discrimination against the unemployed (according to the EEOC, some want ads openly say that the unemployed need not apply). But, of course, ending open discrimination doesn’t end actual discrimination. More importantly: might this have just a few unintended consequences?

Some critics worry that this would just lead to more costly, frivolous law suits. Probably. But I’d also guess it will lead to less employment of people.

The key to understanding why is to think of a worker the way a firm’s owner does: as one among many inputs in the production process. A worker helps a firm make its product or service, but there are other ways to skin that cat. Instead of hiring one more worker, the firm’s owner could just increase the hours of her current employees, or she could buy a few more machines to do the work, or she could outsource aspects of the production process to other companies (perhaps those who work in places without such laws?), or she could simply not expand. The point is that a firm has lots of choices and anything that makes one of those choices (probabilistically) more expensive will cause the firm to rely more-heavily on its other options.

Maybe this should be called the full-employment-for-machines act?