The Legacy of TARP: Crony Capitalism

Posted by Jeffrey A. Miron

When Treasury Secretary Hank Paul proposed the bailout of Wall Street banks last September, I objected in part because the TARP meant that government connections, not economic merit, would come to determine how capital gets allocated in the economy. That prediction now looks dead on:

As financial firms navigate a life more closely connected to government aid and oversight than ever before, they increasingly turn to Washington, closing a chasm that was previously far greater than the 228 miles separating the nation’s political and financial capitals.

In the year since the investment bank Lehman Brothers collapsed, paralyzing global markets and triggering one of the biggest government forays into the economy in U.S. history, Wall Street has looked south to forge new business strategies, hew to new federal policies and find new talent.

“In the old days, Washington was refereeing from the sideline,” said Mohamed A. el-Erian, chief executive officer of Pimco. “In the new world we’re going toward, not only is Washington refereeing from the field, but it is also in some respects a player as well. . . . And that changes the dynamics significantly.”

Read the rest of the article; it is truly frightening. We have taken a huge leap toward crony capitalism, to our peril.

Administration Reform Plan Misses the Mark

Posted by Mark A. Calabria

The Obama Administration is presenting a misguided, ill-informed remake of our financial regulatory system that will likely increase the frequency and severity of future financial crises. While our financial system, particularly our mortgage finance system, is broken, the Obama plan ignores the real flaws in our current structure, instead focusing on convenient targets.

Shockingly, the Obama plan makes no mention of those institutions at the very heart of the mortgage market meltdown – Fannie Mae and Freddie Mac. These two entities were the single largest source of liquidity for the subprime market during its height. In all likelihood, their ultimate cost to the taxpayer will exceed that of TARP, once TARP repayments have begun. Any reform plan that leaves out Fannie and Freddie does not merit being taken seriously.

Instead of addressing our destructive federal policies aimed at extending homeownership to households that cannot sustain it, the Obama plan calls for increased “consumer protections” in the mortgage industry. Sadly, the Administration misses the basic fact that the most important mortgage characteristic that is determinate of mortgage default is the borrower’s equity. However, such recognition would also require admitting that the government’s own programs, such as the Federal Housing Administration, have been at the forefront of pushing unsustainable mortgage lending.

While the Administration plan recognizes the failure of the credit rating agencies, it appears to misunderstand the source of that failure: the rating agencies’ government-created monopoly. Additional disclosure will not solve that problem. What is needed is an end to the exclusive government privileges that have been granted to the rating agencies. In addition, financial regulators should end the outsourcing of their own due diligence to the rating agencies.

The Administration’s inability to admit the failures of government regulation will only guarantee that the next failures will be even bigger than the current ones.

AEI Tax Forum

Posted by Chris Edwards

Chris Edwards, Photo by Peter Holden for AEI
   Photo by Peter Holden Photography for AEI

I was a panelist at an American Enterprise Institute forum today discussing the proliferation of federal tax credits, particularly for low-income families.

AEI scholars Kevin Hassett, Larry Lindsey, and Aparna Mathur have a draft paper that looks at the idea of consolidating current individual credits into one supercredit. The idea would be to simplify the system and reduce the economic distortions created by these credits, which are valued at about $170 billion in 2009.

My observations included:

  • Obama’s Make Work Pay credit is valued at about $60 billion per year, much of which is ”refundable.” (That means it is partly a spending increase not a tax cut). Coincidentally, Obama’s proposed tax hikes for higher-income individuals are also about $60 billion per year. So Obama is damaging the economy with “Make Work Not Pay” tax increases at the top in order to fund dubious work incentives at the bottom. It makes no economic sense.
  •  The AEI scholars provide interesting calculations about how we could make the $170 billion of redistribution in these credits simpler. That’s fine as far as it goes, but I’d like to end the redistribution altogether. Let’s provide a large basic exemption in the tax code for folks at the bottom, but we don’t need any complex credits. Instead, let’s repeal federal policies that damage the budgets of struggling families at the bottom, such as import barriers that raise the price of clothing and federal milk cartels that raise the price of  dairy products.
  • Here’s my compromise redistribution plan. Let’s chop the $170 billion in tax credits in half and use the extra funds to cut the corporate income tax rate. With a purely static calculation, that would allow cutting the corporate rate  from 35% to 25%. Assuming some behaviorial feedbacks, the $85 billion in credit savings would easily allow us to reduce the corporate rate to 20% or so.
  • What do corporate taxes have to do with the workers who currently get all these tax credits? As Hassett and Mathur explained in a 2006 paper, corporate tax cuts would increase investment, improve productivity, and that in turn would raise wages of average American workers. We don’t need President Obama’s fancy new Make Work Pay credits. Instead, we need to cut the corporate tax rate to make the economy boom and raise worker’s wages and incomes in the private marketplace.