Archive for July, 2011
Who Wants To Be ‘Too-Big-To-Fail’?
I’ve argued that the Dodd-Frank financial reform bill does not end “too-big-to-fail”, that is the belief that certain companies are implicitly backed by the government because policy-makers are unlikely to let said institutions actually fail. By naming some companies as ”systemically important” — as required by Dodd-Frank — the government is actually sending a signal as to who is likely to be bailed out.
As evidenced by regulators’ behavior during the financial crisis, the prime beneficiaries would be the creditors of these companies, as even when shareholders and management suffered, creditors generally did not. This should allow such firms to borrow at a cost lower than firms not deemed systemically important.
Given this funding advantage, it would seem natural that firms would want to be included as systemically important. Sure they might be examined by bank regulators more often, but that’s hardly a large cost compared to the funding advantage.
Congressman Frank has attempted to refute that there are any benefits from being deemed “systemically important” by the fact that ”so many financial institutions have lobbied against being designated in this way.” What his argument misses, or chooses to ignore, is that these benefits are not the same for all institutions. It is companies that rely heavily on debt market financing, such as banks, that have the most to gain. And under Dodd-Frank, the largest banks are automatically included. They have no opportunity to lobby to be in or out. The firms that are not automatically in, the most important of which are insurance companies, do not fund themselves primarily via the debt markets. Insurance companies get most of their funding from the premiums paid by their policyholders. And those premiums must be sufficient to cover expected losses, which have little to do with funding costs in the debt markets. Other non-bank financial companies, such as hedge funds and private equity, do not gain to the same extent that banks do because they have traditionally been a lot less leveraged than banks.
So the answer to Mr. Frank’s point is that those who have the most to gain from being ”systemically important” are already included, those with the least the gain are the very ones lobbying against being included. The real perversity is that once they are included, they will have a strong incentive to shift their business models toward more debt funding, making them riskier and more likely to fail (debt markets are far more fickle than insurance policy-holders). We are left relying solely on the judgment of the regulators to avoid this outcome, the same regulators who were asleep at the wheel as the housing bubble expanded.
Could You Modify It ‘To Stop Students From Becoming This Advanced?’
The free Web tutoring service “Khan Academy” has gotten much well-deserved attention, including a feature story in the current issue of Wired. That story includes a quote that literally took my breath away:
Even if Khan is truly liberating students to advance at their own pace, it’s not clear that the schools will be able to cope. The very concept of grade levels implies groups of students moving along together at an even pace. So what happens when, using Khan Academy, you wind up with a kid in fifth grade who has mastered high school trigonometry and physics—but is still functioning like a regular 10-year-old when it comes to writing, history, and social studies? Khan’s programmer, Ben Kamens, has heard from teachers who’ve seen Khan Academy presentations and loved the idea but wondered whether they could modify it “to stop students from becoming this advanced.”
This attitude is a natural outgrowth of our decision to operate education as a monopoly. In a competitive marketplace, educators have incentives to serve each individual child to the best of their ability, because each child can easily be enrolled elsewhere if they fail to do so. That is why the for-profit Asian tutoring industry groups students by performance, not by age. There are “grades,” but they do not depend on when a student was born, only on what she knows and is able to do.
But why should a monopolist bother doing that? It’s easier just to feed children through the system on a uniform conveyor belt based on when they were born.
US Has Already Been Downgraded
Lost in all the concerns over how Moody’s and S&P will view any deal to raise the debt ceiling and whether such a deal addresses our country’s long term budget imbalances is the fact that at least three rating agencies have already downgraded U.S. government debt. One of these agencies, Weiss Ratings, treats U.S. government debt as barely better than “junk” or speculative grade.
It would be easy to dismiss these agencies as irrelevant and attempting to simply grab attention, but at least one of these agencies, Egan-Jones, has a track record of correctly predicting problems at such companies as Enron, WorldCom, Global Crossing, Bear Stearns and Lehman Brothers that the major rating agencies missed until it was too late. Egan-Jones also employs a business model of having investors pay for its services, rather than the debt issuer.
The simple truth is that the U.S. government has made more future promises than it will have the capacity to pay, under almost any circumstances. The fact that the major rating agencies downplay these long term imbalances is further testament to their entrenched monopoly status. But then when the government provides you with some regulatory protections, its only natural to assume the government will expect one to return the favor.
For more on the issue, check out Cato’s latest daily podcast.
The Norwegian Killer’s Anti-individualist Nationalism
Does it matter what political agenda motivated Anders Behring Breivik, who is allegedly responsible for two attacks in Norway that killed some 93 people? In some sense, no. He’s a mass murderer, and he deserves society’s severest punishment (which in Norway is apparently 21 years in prison, or approximately three months for each murder). But as with each such attack, there’s been a rush to blame some ideological faction or other. As usual these days, some writers didn’t bother waiting for evidence before assuming that the perpetrator was Islamic and rushing into print with condemnation of people who would make cuts in a U.S. defense budget as large as the rest of the world combined or begin to wind down the Afghan war after 10 years (!).
But surely NPR takes the cake for the most ridiculous name-dropping. This morning Linda Wertheimer, who has 40 years of journalistic experience at NPR, interviewed Goran Skaalmo of the Norwegian Business Daily about Breivik. At about 3:20 of the audio, Wertheimer asks Skaalmo:
I was reminded of the American writer Ann [sic] Rand, in that he talks in his manifesto about the government being too soft, too sort of politically afraid to draw the kind of nationalist lines that he calls for.
Say what? When did Ayn Rand ever call for a hard, nationalist government? She was an immigrant, of course, and Breivik was greatly motivated by anti-immigration sentiment. She was staunchly individualist, just the opposite of nationalism. And she favored a government strictly limited to the protection of individual rights. Wertheimer reaches new depths in stupid Ayn Rand references.
A Norwegian newspaper’s report on Breivik (in an automatic Google translation) includes this telling line:
In one of the posts he states that politics today no longer revolves around socialism against capitalism, but that the fight is between nationalism and internationalism.
His online posts and his 1500-page online book seem to point to a fairly consistent nationalist, anti-immigrant, anti-Islamic “cultural conservative” defense of Europe’s “Judeo-Christian culture.”
Meanwhile, Norwegian bloggers have discovered that he lifted large passages from the 35,000-word manifesto of the anti-capitalist “Unabomber” Theodore Kaczynski.
Bastiat on Free Trade and Living on the State
The estimable James Grant reviews a new collection of writings of the brilliant Frederic Bastiat, published by the beneficent Liberty Fund, in the always scintillating Review section of the Saturday Wall Street Journal:
Because nobody else can understand them, modern economists speak to one another. They gossip in algebra and remonstrate in differential calculus. And when the pungently correct mathematical equation doesn’t occur to them, they awkwardly fall back on the English language, like a middle-aged American trying to remember his high-school Spanish. The economist Frédéric Bastiat, who lived in the first half of the 19th century, wrote in French, not symbols. But his words—forceful, clear and witty—live to this day.
Bastiat might have something to say about the attitudes and policies that have brought both Europe and the United States to the brink of debt disaster:
“The dominant notion, the one that has permeated every class of society,” he wrote in the wake of the Revolution of 1848, “is that the state is responsible for providing a living for everyone.”
“Poor people!” he lamented of the duped French populace in the same tumultuous year. “How much disillusionment is in store for them! It would have been so simple and so just to ease their burden by decreasing their taxes; they want to achieve this through the plentiful bounty of the state and they cannot see that the whole mechanism consists in taking away ten to give it back eight, not to mention the true freedom that will be destroyed in the operation!”
And of course, taking away eight to give back ten is fun while it lasts. But it can’t last forever.
This Week in Government Failure
Over at Downsizing the Federal Government, we focused on the following issues this past week:
- It’s time to repeal New Deal labor laws.
- A new Cato video on the “Cut, Cap, and Balance” proposal.
- $2 trillion in spending cuts in exchange for raising the debt ceiling isn’t enough.
- Congratulations to Sen. Tom Coburn’s staff for producing a massive study chock-full of specific spending-cut ideas.
- The Gang of Six deficit reduction plan is lousy.
- Chris Preble on the hysteria over potential cuts in military spending.
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Debt Debate a Reminder of What Government Is
If it is true that a failure to increase the debt limit on August 2nd has the potential to bring about economic Armageddon, shouldn’t we be asking ourselves if it’s a good idea to allow the political class in Washington to continue collectively play God with our lives? After all, these people are fallible human beings.
In a similar vein, Sheldon Richman reminds us of what government really is in a new column on the issue of federal debt. I like Richman’s statement because one need not be a hardcore libertarian to appreciate the message:
Government is not some higher super-competent entity like the man pretending to be the Wizard of Oz wanted the people to think he was. It’s a coercive organization of limited, flawed, and essentially ignorant men and women who, having been anointed in an election after campaigns hawking snake oil, are presumptuous enough to think they are capable of making wise decisions on our behalf.
Having worked in both federal and state government, I know from first-hand experience that there’s no wizard behind the curtain. My gut tells me that some of the pundits and analysts who display an almost child-like belief in the capabilities of government might think differently had they spent time behind the curtain.
It is my hope that the circus-like atmosphere in Washington over raising the debt ceiling will cause more Americans to question why so much power and money has been placed in the hands of imperfect (to put it politely) men and women. Therefore, while I think the odds that Republicans and Democrats will strike a deal to substantively cut spending are somewhere around zero, perhaps the sordid spectacle will generate more popular support for downsizing the federal government.
Spending Cuts and National Security
An op-ed by Peter Singer and Michael O’Hanlon in today’s Politico questions the impact of spending cuts on the military. “Substantial defense budget cuts are possible, make no mistake,” the Brookings’ scholars concede, “But they could mean loss of capability, and some may increase security risks.”
Another Brookings scholar, Robert Kagan, is more emphatic, telling Jennifer Rubin of the Washington Post that “[The proposed cuts are] utterly irresponsible and dangerous to national security.” Max Boot agrees. Cuts of up to $1 trillion over the next 10 years “would be nothing short of a disaster.” Lawmakers who are considering such cuts, Boot claims, “are flirting with eviscerating American combat capabilities — and with it the role of the United States in world affairs.” AEI’s Tom Donnelly wails: “Nobody has defense as a high priority. It’s increasingly looking like everybody wants to toss the military overboard.”
Wow. Sounds scary. What is actually going on here?
For starters, the military’s budget has still not been cut. As I noted yesterday at the National Interest‘s “The Skeptics”:
The Department of Defense has enjoyed an unbroken streak of rising budgets since 1998. In real, inflation-adjusted terms, U.S. taxpayers now spend more on national security than at any time since the end of World War II. An effort led by South Carolina Republican Mick Mulvaney to hold the DoD base budget to last year’s levels failed. Mulvaney’s amendment, which would have cut $17 billion from the budget voted out of committee, attracted support from more than a quarter of the House GOP caucus, but was ultimately defeated. So the DoD base budget that emerged from the House continues its growth.
Second, the various proposed cuts to future spending are just that: proposed. As with everything else associated with the debt negotations, the details matter a lot. The cuts might never materialize; future Congresses might simply renege on deals made this summer. More importantly, in nearly every case, they aren’t actual cuts. They are projections based against certain assumptions about future spending. And depending on inflation, the growth of the economy, and a host of other factors, those assumptions will change.
The Banking Deregulation that Mattered (and Actually Happened)
One commonly heard refrain is that the deregulation of banking caused the financial crisis. To those of us that have actually spent years working on banking policy, such a claim is met with surprise. What banking deregulation? The usual response, with generally an absolute lack of detail or argument, is the repeal of Glass-Steagall by the Gramm-Leach-Bliley Act (GLB). When the proponents of this claim bother to offer any explanation (in some circles simply invoking the name “Phil Gramm” substitutes for any analysis), it usually goes like this:
With Glass-Steagall dead and gone, financial institutions were now free to grow large.
That’s taken from the recent book Reckless Endangerment. What it misses that is that Glass-Steagall placed zero constraints on the size of banks.
The following graph shows the share of total commercial bank assets held by banks over $10 billion in assets. Its been quite a change, and obviously one toward growing concentration. But was this caused by GLB? Recall GLB was not signed into law until 1999. By 1999 the share of assets held by the largest banks was already 65%, at the height of the bubble in 2005 it had risen to 73%. 
Ayn Rand on the Front Page of Ecuador’s Major Newspaper
El Universo, the newspaper with the largest circulation and the paper that publishes my weekly column, ran a mostly blank front page today that features only this quote from Ayn Rand’s Atlas Shrugged:
When you see that trading is done, not by consent, but by compulsion–when you see that in order to produce, you need to obtain permission from men who produce nothing–when you see that money is flowing to those who deal, not in goods, but in favors–when you see that men get richer by graft and by pull than by work, and your laws don’t protect you against them, but protect them against you–when you see corruption being rewarded and honesty becoming a self-sacrifice–you may know that your society is doomed.
This quote is from Francisco D’Anconia’s speech on “The Meaning of Money” which you can read here. (I used it in my column last month.) How did Rand’s quote get there? It’s a response to the latest and most prominent attack on freedom of the press in Ecuador and Latin America.
In less than four months the Ecuadorian courts, known for being slow, resolved the specious lawsuit President Rafael Correa filed against op-ed writer and editor Emilio Palacio, the directors of El Universo and the newspaper itself for libeling the country’s president. According to Correa, Palacio slandered him in this op-ed (in Spanish), and the newspaper and its directors “contributed” to committing the supposed crime. Incidentally, this court has had five different judges overseeing this case since February; the last one came in on Monday and issued his judgment yesterday, minutes before his authority expired.
The court’s decision sentences the directors of El Universo and Emilio Palacio to three years in jail and orders them to pay a total of $30 million to the President. The judge also ordered that the newspaper company pay an additional $10 million to President Correa.
This decision sets a dangerous precedent of making third parties responsible for what an individual says. It is a clear act of intimidation of all independent media outlets and of the citizens of Ecuador. Even though this is not the first blow to freedom of expression during this government, it certainly is the most radical given the context. On May 7th, a referendum gave the President unprecedented power to essentially pack the courts. Soon, the entire judiciary will be on the long list of state institutions captured or co-opted by the executive (including the constitutional court, the electoral authority, and the national assembly, among others).
Once the judiciary is completely captured and after this historic decision, we can expect more self-censorship or more people sued/jailed for expressing their opinions, or a combination of both. It is a harsh blow against liberty in our country, but a logical outcome of Correa’s populist push to centralize ever more economic and other power in his own hands.
Requiring Consensus in Congress
Yesterday Cato hosted a book forum on Joe Gibson’s new book, A Better Congress: Change the Rules, Change the Results. The author had a lot of thoughtful ideas, and the event is worth watching (its also a short book, easy read). Several of the book’s proposals move toward getting greater consensus in Congress and more agreement across the parties. Which got me thinking, if you want consensus, why don’t you start by just requiring it. Something like a 300 vote requirement in the House with a 80 vote requirement in the Senate. There’s nothing in our Constitution that requires simple majorities (or 60 for that matter), at least for routine business (yes there are rare exceptions). This would not stop every bad law, far from it, but it would require laws to have more support, with the result that would have more legitimacy in the eyes of the public.
Now the biggest problem with this proposal would be that it favors the status quo, as changing the status quo would become far more difficult. The solution is to require every federal program and authority to have a sunset date, something like 5 or at most 7 years. If you can’t get broad consensus to keep a program, then it sunsets and goes away. If the program is much loved, then it should have no problem staying. Worth keeping in mind that the vast majority of bills pass the Senate by unanimous consent, almost in effect requiring 100 votes. So I don’t see either of these changes being that disruptive to the Senate and would likely improve the process in the House.
Rahm Emanuel Practices School Choice… Grouchily
Chicago’s new mayor, Rahm Emanuel, has followed in the footsteps of President Obama and Education Secretary Arne Duncan, choosing to send his kids to the elite private UC Lab School. It’s a very good school by all accounts, so it’s probably an excellent choice. So why did Rahm get so grouchy when asked about it?
I think it might have something to do with the obvious hypocrisy of cherishing and exercising educational choice for one’s own kids while advocating a one-size fits-few state monopoly school system that makes private schooling unaffordable to the majority of your fellow citizens. Just a thought.
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