Tag Archives: wall street journal

Paving over pension liabilities, again

Public sector pensions are subject to a variety of accounting and actuarial manipulations. A lot of the reason for the lack of funding discipline, I’ve argued, is in part due to the mal-incentives in the public sector to fully fund employee pensions. Discount rate assumptions, asset smoothing, and altering amortization schedules are three of the most common kinds of maneuvers used to make pension payments easier on the sponsor. Short-sighted politicians don’t always want to pay the full bill when they can use revenues for other things. The problem with these tactics is they can also lead to underfunding, basically kicking the can down the road.

Private sector plans are not immune to government-sanctioned accounting subterfuges. Last week’s Wall Street Journal reported on just one such technique.

President Obama recently signed a $10.8 billion transportation bill that also included a provision to allow companies to continue “pension smoothing” for 10 more months. The result is to lower the companies’ contribution to employee pension plans. It’s also a federal revenue device. Since pension payments are tax-deductible these companies will have slightly higher tax bills this year. Those taxes go to help fund federal transportation per the recently signed legislation.

A little bit less is put into private-sector pension plans and a little bit more is put into the government’s coffers.

The WSJ notes that the top 100 private pension plans could see their $44 billion required pension contribution reduced by 30 percent, adding an estimated $2.3 billion deficit to private pension plans. It’s poor discipline considering the variable condition of a lot of private plans which are backed by the Pension Benefit Guaranty Corporation (PBGC).

My colleague Jason Fichtner and I drew attention to these subtle accounting dodges triggered by last year’s transportation bill. In “Paving over Pension Liabilities,” we call out discount rate manipulation used by corporations and encouraged by Congress that basically has the same effect: redirecting a portion of the companies’ reduced pension payments to the federal government in order to finance transportation spending. The small reduction in corporate plans’ discount rate translates into an extra $8.8 billion for the federal government over 10 years.

The AFL-CIO isn’t worried about these gimmicks. They argue that pension smoothing makes life easier for the sponsor, and thus makes offering a defined benefit plan, “less daunting.” But such, “politically-opportunistic accounting,” (a term defined by economist Odd Stalebrink) is basically a means of covering up reality, like only paying a portion of your credit card bill or mortgage. Do it long enough and you’ll eventually forget how much those shopping sprees and your house actually cost.

Municipal pension news: Baltimore to offer DC plan

Earlier this month, Baltimore’s city council approved a measure to give the city’s workers a choice between a defined contribution or defined benefit plan plan. According to Pensions and Investments, new hires will contribute 5 percent of their salary to whichever plan they choose, a significant increase from the 1 percent that workers were required to begin contributing to the city’s pension system last year. (Previously, workers had not contributed to their pension). As the article notes, the choice between a DB and a DC plan is a compromise. Mayor Rawlings-Blake preferred to move all newly hired employees to a DC plan, but this was not agreed upon by unions. In total, Baltimore two pension systems have an unfunded liability of $1.4 billion on a GASB-basis.

Baltimore’s proposed reforms are a bit stronger than the plan currently considered by Chicago mayor Rahm Emanuel, which is largely focused on filling in very daunting funding gaps in the city’s multiple plans. The Wall Street Journal reports that the mayor’s plan to raise property taxes by $250 million represents an increase of about $50 a year for the owner of a $250,000 home. And, it’s not enough to cover the gap. The state will demand an additional $600 million in annual payments for the city’s police and fire funds by 2016. In addition, Mayor Emanuel proposes benefit cuts, such as  increased employee contributions and reduced COLAs. But structural reforms aren’t being pushed too strongly, instead, the focus in Chicago appears to be a search for more revenues. Consider a proposal floated by The Chicago Teachers Union. They would like to see a per-transaction tax levied on futures, options, and stock trades processed on the Chicago Mercantile Exchange (CME) and Chicago Board Options Exchange.  Both the CME and Mayor Emanuel oppose the idea recognizing that it will simply drive the financial industry out of town.

 

Varying Priorities in Municipal Bankruptcy

On Monday Reuters reported that a federal judge has found Stockton, CA to be eligible for bankruptcy protection. This decision came despite protests from Wall Street arguing that the city had options available that would have allowed it to pay its creditors in full, such as raising taxes or cutting benefits for city employees:

Creditors have claimed a lack of good faith by Stockton in its decision to fully pay its obligation to the $254 billion Calpers system but impose losses on bondholders and bond insurers.

The expected move by the California city of 300,000 – along with Jefferson County in Alabama and San Bernardino in California – breaks with a long-standing tradition to fully repay bondholders the principal in most major municipal bankruptcies.

While both the judge and city manager Bob Deis have harshly criticized bondholders who refused to negotiate with the city before bankruptcy proceedings began, other cities have taken a very different approach to their creditors in the bankruptcy process. In 2011, the Rhode Island policymakers adopted a law that puts municipal creditors at the head of the line in municipal bankruptcy proceedings. In the state’s  Central Falls bankruptcy, the requirement to pay bondholders 100 cents on the dollar has meant that the city’s pensioners have taken steep benefit cuts, in some cases losing nearly half of their defined benefit pensions.

After Rhode Island enacted this law, the Wall Street Journal explained:

Despite the financial failure, Central Falls suddenly is attractive to some investors because the law makes them more confident about getting paid.

“If we can find someone selling, we will be a buyer” of Central Falls bonds, says Matt Dalton, chief executive of Belle Haven Investments, a White Plains, N.Y., firm with $800 million in municipal-bond investments under management.

The difference in legal climates for bondholders in Rhode Island and California unsurprisingly fosters different attitudes from creditors.  Former Los Angeles Mayor Richard Riordan explains the dangers of cutting off a city’s access to credit by failing to pay bondholders in full:

“I think the unions ought to be scared stiff. This could be a lot worse than just the pensions. What about government bonds? If government bonds can also be restructured, who will buy them?

“The city and the state all issue tax anticipation bonds to meet their payrolls, but if those can be restructured, no one will buy them. Think about what that means for libraries, parks, street paving, police. It will all be on the line.

While cities on both coasts are facing insolvency in their efforts to meet their obligations to their employees and their creditors, they vary in their approaches as to who is first in line for scarce tax dollars.

Political espionage and government intervention

“To govern is to choose,” John F. Kennedy famously declared. And when governments intervene in markets, they inevitably choose to favor some business forms over others.

Sometimes this is obvious, as when a local government considers a regulation which conspicuously privileges one type of operator at the expense of another. Sometimes this is less-obvious, as when a licensing regime raises barriers to entry, privileging incumbent firms at the expense of those that might enter the market.

Sometimes the privilege is nearly hidden. Last year, I wrote about laws banning old-fashioned incandescent light bulbs. NPR’s Peter Overby had reported that major light bulb manufacturers actually liked the ban and spent money lobbying to maintain it. Why would a firm possibly want to limit its options? After all, it can make curly-Q light bulbs whether the old kind are legal or not. The answer seems to be that the ban benefited large, established firms because it kept customers from buying the older, cheaper alternative bulbs from rivals who weren’t as good at making the newfangled kind.

The point is that it is nearly impossible to formulate an intervention that treats all firms equally. Even a flat rate tax will fall more heavily on small firms because they lack the compliance resources that the big ones have. It goes without saying that this tendency is even greater when interventions violate generality.

When government policy can make or break a business, you can bet that the business will take an interest in policy. Very large sums of money are at stake when a city council considers a new regulation, when Congress considers requiring customers to buy a certain product, or when the FDA considers approving a new drug. It should come as no surprise, then, that some enterprising folks have set up firms that specialize in reading the tea leaves of government policy. These firms help their clients predict what new rules, regulations, taxes, subsidies, etc. might be coming down the pike. And firms are willing to pay pretty hefty sums for these prognostications, especially when policy is difficult to predict (as, for example, when it turns on the arbitrary beliefs of certain regulators).

Brody Mullins and Susan Pulliam write about just such a firm in a fascinating article in yesterday’s Wall Street Journal.

Naturally, lawmakers take a dim view of this activity. Senator Charles Grassley (R-IA) wants these “political intelligence specialists” to disclose their clients, activities, and fees: “We ought to know who these people are that seek political and economic espionage,” he says.

I have another idea. Rather than regulate the firms that are trying to figure out whom government is going to punish and whom it is going to privilege, why not eliminate discriminatory government policy? Why not limit government intervention in the market? And why not ensure that policy turns on predictable rules rather than arbitrary decisions?

If government cannot privilege some and punish others, then insider information will be worth next to nothing. If government interventions are limited, then firms will not live or die at the whim of politicians and regulators. And if policy is predictable and rational, share prices will reflect policy expectations, and there will be no way to profit from insider information.

If to govern is to choose some business forms over others, then sometimes the best option is not to govern and to let people choose for themselves.

Economic Freedom and Economic Privilege

Heritage indexLast week, the Wall Street Journal and the Heritage Foundation released their annual Index of Economic Freedom by Terry Miller, Kim Holmes, and Edwin Feulner. I was delighted to contribute a chapter on government-granted privilege. I began by noting that despite the manifest evidence of a strong empirical link between economic freedom and economic prosperity, large numbers of people still lack basic economic freedoms.

In the latest edition of the Index, for example, 92 countries—home to nearly 70 percent of all of humanity—were listed as “mostly unfree” or “repressed.” Even among the freer nations such as the United States, economic freedom in recent years has been declining.

Why? I suggest two answers. The first is that ideas matter and we are currently losing the battle of ideas.

The second answer is more difficult:

Put simply, some entrenched interests benefit from the current lack of economic freedom and are prepared to go to great lengths to maintain the unfree status quo.

If this is not immediately obvious, it may be because the advocates of economic freedom often fail to emphasize it. Too often, those of us who argue for freedom highlight the fact that taxes are crushing, that regulations are burdensome, and that government involvement in the economy is an impediment to progress. While this is typically true, it is also true that tax dollars line the pockets of some well-connected companies, that regulations often allow some firms to profit at the expense of customers and competitors, and that almost every intervention in the market creates both losers and winners.

The chapter, adapted from The Pathology of Privilege, can be found here.

There are other interesting contributions from Robert Barro on “Democracy, Law and Order, and Economic Growth”; James Roberts and John Robinson on how “Property Rights Can Solve the Resource Curse”; and by Myron Brilliant on how “Good Business Demands Good Governance.”

Also, don’t miss Miller’s OpEd from the Wall Street Journal. It offers a nice overview of the latest data and a summary of the chapters. Lastly, be sure to spend some time exploring the data and the website. They’ve done a brilliant job of bringing all of this information together and presenting it in a user-friendly way.

My thanks to Heritage and especially to Terry Miller for the opportunity.

If Obamacare is Repealed, Maybe We Should Replace it With George McGovern’s Plan?

The editorial board in today’s Wall Street Journal eulogizes George McGovern. At the end, they point to a 1992 OpEd that McGovern wrote for the journal. It talks about the regulatory burdens he encountered after he gave up the trappings of public office to become an inn-keeper:

My own business perspective has been limited to that small hotel and restaurant in Stratford, Conn., with an especially difficult lease and a severe recession. But my business associates and I also lived with federal, state and local rules that were all passed with the objective of helping employees, protecting the environment, raising tax dollars for schools, protecting our customers from fire hazards, etc. While I never have doubted the worthiness of any of these goals, the concept that most often eludes legislators is: “Can we make consumers pay the higher prices for the increased operating costs that accompany public regulation and government reporting requirements with reams of red tape.” It is a simple concern that is nonetheless often ignored by legislators.

Scott Sumner also linked to it. But as Nick Gillespie points out in a must-read piece for Bloomberg, McGovern had another—in my view, far more libertarian—piece in the Journal in 2008. Arnold Kling picked up on it at the time. Here is McGovern in 2008:

 There’s no question, however, that delinquency and default rates are far too high. But some of this is due to bad investment decisions by real-estate speculators. These losses are not unlike the risks taken every day in the stock market.

…Health-care paternalism creates another problem that’s rarely mentioned: Many people can’t afford the gold-plated health plans that are the only options available in their states.

Buying health insurance on the Internet and across state lines, where less expensive plans may be available, is prohibited by many state insurance commissions. Despite being able to buy car or home insurance with a mouse click, some state governments require their approved plans for purchase or none at all. It’s as if states dictated that you had to buy a Mercedes or no car at all.

…Economic paternalism takes its newest form with the campaign against short-term small loans, commonly known as “payday lending.”

…Anguished at the fact that payday lending isn’t perfect, some people would outlaw the service entirely, or cap fees at such low levels that no lender will provide the service. Anyone who’s familiar with the law of unintended consequences should be able to guess what happens next.

Researchers from the Federal Reserve Bank of New York went one step further and laid the data out: Payday lending bans simply push low-income borrowers into less pleasant options, including increased rates of bankruptcy. Net result: After a lending ban, the consumer has the same amount of debt but fewer ways to manage it.

 

Where is the coercion in land use?

On Wednesday, The Wall Street Journal published an article about Denver’s light rail expansion plan. Two Cato analysts came down on different sides of the issue. Randall O’Toole, writing at Cato-at-Liberty, says that the expansion is a waste of money. He writes:

Under RTD’s latest “rethink,” transit will no longer take people from where they are to where they want to go. Instead, planners will try to coerce and entice people to live in places served by rail transit and go where those rail lines go.

The expansion comes with a steep $7.4 billion price tag, and O’Toole is likely correct that this is too much to spend; light rails across the country lose money, and the 122-mile above-ground expansion has experienced a cost overrun from $4.7 billion in 2004. The United States is notorious for unreasonably high transit construction costs compared to other countries. Additionally, the light rail is an airport connector, an often poor use of tax dollars, particularly when the airport is located far from downtown, as in Denver.

However, O’Toole’s judgment that the new plan amounts to coercion seems to be based not primarily on the light rail’s cost, but rather on zoning rules that will distinguish the new light rail stations from some of Denver’s existing light rail stations. The land around the new stations will not be dedicated to government-owned parking lots; instead developers will have the freedom to put housing or commercial uses adjacent to the stations with parking garages as far away as 1000 feet.

Timothy Lee, a Cato adjunct scholar writes at Forbes:

If the plan is to dump government-owned parking garages and instead sell the land to private developers, that’s a clear win from a free-market perspective. And if planners liberalize zoning rules to allow high-density construction that’s illegal in most suburbs, so much the better. On the other hand, if the plan is to actively subsidize or even require dense development, that is worth criticizing. But it’s important to be clear that the problem is coercive means, not the goal of providing more walkable neighborhoods.

Lee makes a key point here. The suburban style development that we see in many parts of Denver is not the free market at work, as O’Toole assumes. Rather, more dense, urban development is outlawed in many parts of Denver and cities across the country. Both O’Toole and Lee make some good points on the plan, but if a city is going to spend too much on transit, that doesn’t mean the transit should be strangled with liberty-limiting suburban zoning laws.

Health Care and the Dynamics of Intervention

At the heart of the government’s defense of its health insurance mandate is the premise that, as Wall Street Journal reporter Jess Bravin puts it, “40 million uninsured Americans are distorting the health-care market by shifting costs of free emergency-room care to taxpayers and insurance ratepayers.”

In other words, the government believes that there is an externality problem with health insurance. If healthy people aren’t compelled by law to buy insurance, then they will drop out of the insurance pool. This will mean that the average health level of those who remain in the pool will decline. This, in turn, will raise the cost of insurance for all remaining members of the pool.

Of course, insurance companies have a way of dealing with this by attempting to charge people for the (statistical) cost that they impose on the pool. They can do this by charging higher rates for riskier people such as those who are overweight or those who are smokers (this, by the way, is why kids with bad grades pay higher rates for their auto insurance). But the government doesn’t like this solution because it means that some people who are higher risk through no fault of their own (for example, those with unlucky genetics), may end up paying higher rates. So the Patient Protection and Affordable Care Act made it more difficult for insurance companies to charge higher rates to higher risk customers (this is known as “community rating”). They also made it impossible for these companies to deny care to those with preexisting conditions.

According to the Journal, plaintiff’s attorney Michael Carvin doesn’t buy this reasoning. In yesterday’s oral argument he averred:

The failure to buy health insurance doesn’t affect anyone. Defaulting on your payments to your healthcare provider does. Congress chose for whatever reason not to regulate the harmful activity of defaulting on your health-care provider.

In other words, he agrees that there is an externality problem but it is entirely of the government’s making; it isn’t in any way inherent to the industry. There would be no externality if those who defaulted on their health care providers could be held liable.

Image by Duncan Lock

This is an example of what economists call the “dynamics of intervention.” Sanford Ikeda explores the concept in his 1997 book on the topic and credits Ludwig von Mises for its initial development. The basic idea is that one intervention often begets further interventions. Once government says that doctors can’t sue patients for defaulting on their bills and once government says that insurance companies can’t charge higher prices to riskier clients, then the argument for forcing everyone to buy insurance becomes stronger.

(Economists who aren’t familiar with Mises’s or Ikeda’s arguments will still recognize them as a version of “the theory of the second-best” BTW: read the link; it remains one of my favorite blog posts five years after first reading it).

The dynamics of intervention are strong enough to convince plenty of otherwise free-market advocates to countenance new government intervention in the marketplace. Milton Friedman, for example, famously said that as long as we have a welfare state, it makes sense to regulate the border. And a lot of free market advocates are willing to say that as long as we have Federal Deposit Insurance, the government should be allowed to regulate the risk profile of banks.

When PPACA was passed, self-described libertarian economist Kevin Grier found himself countenancing regulation of fast food, sugar, and even exercise (he also hated himself for thinking that way).

Of course, the other interpretation of the dynamics of intervention is that you shouldn’t start down the path to intervention in the first place because it will inevitably lead to much more intervention than you initially intended. That’s my take on it, at least.

I’ll end this already-long post by noting that Congress might have gone about this a different way and greatly reduced the dynamics of intervention problem. Instead of making it impossible to deny care to those with preexisting conditions, and instead of requiring community rating, and instead of requiring everyone to buy insurance, Congress might have left the insurance market alone and reformed Medicaid. It could have turned Medicaid into a voucher program that would allow qualifying recipients to use their voucher to either purchase insurance, or–in the event that no insurers will pick them up–to purchase health care services on the open market. If they were so inclined, Congress could have made the voucher more generous for those with pre-existing conditions (ideally, people wouldn’t be eligible for more generous benefits if they brought on the pre-existing condition themselves through their own health decisions). These reforms would best be coupled with other market-oriented reforms such as equalizing the tax treatment of employer-provided and individually-purchased insurance, legalizing the cross state purchase of insurance, and reforming medical malpractice laws.

My own view is that the most vulnerable in society would be best served by a robust private and charitable market (consider how well the poor are served by our mostly-private markets for necessities like food and clothing). The next best option would be for the states to develop their own safety nets. But the federal reforms in the preceding paragraph seem to me to be far superior to both the status quo and the mess that is PPACA.

It Isn’t Easy to Count Stimulus Jobs

Image courtesy of chrisroll

The 1603 program gave $10.7 billion to 5,098 businesses for 31,540 projects, according to the Treasury Department. Recipients were generally reimbursed 30% of their costs after projects were finished.

Those businesses claimed on federal applications that they created 102,883 jobs directly. But the Journal found evidence of far fewer.

About 40% of the funding, $4.3 billion, went to 36 wind farms. During the peak of construction, they employed an average of 200 workers apiece—a total of roughly 7,200 jobs.

Now, those projects employ about 300 people, according to the companies and economic development officials. Their parent companies employ many more, both in the U.S. and abroad.

This is from a lengthy and fascinating story by Ianthe Jeanne Dugan and Justin Scheck on the front page of today’s Wall Street Journal. Keep in mind that this is only focusing on what Frederick Bastiat would call “what is seen.” There is an unseen side to stimulus spending which is the degree to which it crowds out or crowds-in private sector economic activity.

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.