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The Volcker Rule Isn't the Best Way to Prevent Risky Bank Trading

Hester Peirce — Mon, 09 Dec 2013 16:26:44 -0500

Expert Commentary

Federal financial regulators are getting set to vote on the long-awaited Volcker rule, a key part of the Dodd-Frank financial reform law that aims to prohibit banks relying on deposit insurance from engaging in risky trading activities. In the words of the provision's authors, it reflects the view "that high-risk, conflict-ridden trading should not be subsidized by taxpayer insured deposits and cheap credit from the Federal Reserve."

That laudable goal must be assessed in light of the provision's unintended consequences and its administrative complexities. Policymakers have other options that could address the issue of taxpayer-subsidized risk-taking more effectively than the Volcker rule will.

Lawmakers included the Volcker rule in Dodd-Frank based on rhetoric rather than careful deliberation. Proprietary trades were not a significant cause of the financial crisis. More importantly, it is not clear that prohibiting firms from trading will make them safer.

Read full article

President Obama’s Budding Nanny State

Richard Williams — Mon, 09 Dec 2013 19:03:41 -0500

Expert Commentary

Parents often try to motivate their children with rewards, from stickers to ice cream to toys. Thousands of books and websites offer suggestions for how to get kids to do homework or clean up their rooms. But is it a mayor’s job to motivate you to drink less soda? Is it government’s job to urge you to sign up for health care by way of schools stealthily sending messages home through your children? Should bureaucrats find ways to change your mind about which washing machine you buy?

Whether you realize it or not, this so-called “nudging” of consumer choice, at the hand of government, is underway: Earlier this year, the White House revealed that it is establishing a task force dedicated to studying how to motivate you—just as parents do—to do what the government thinks is best for you. Maya Shankar, a senior adviser in the White House Office of Science and Technology Policy who is assembling the team, recently told the New York Times the task force will use “evidence-based policymaking” so that “government services are efficient, effective, and serve the needs of the American people.” To be clear, Congress did not pass legislation authorizing such activity; this is something dreamt up by bureaucracies to force their own preferences on citizens, whether by combatting obesity or discouraging procrastination when it comes to saving for retirement.

If the idea of federal government officials treating you like a child makes you squeamish, you must first understand the rise of “behavioral economics” in politics—a practice that is expanding rapidly with very little public involvement, transparency, or oversight.

Behavioral economics—the study of how psychology affects people’s decisions—most recently became a buzzword when former White House official Cass Sunstein co-authored, with University of Chicago economist Richard Thaler, the book Nudge while Sunstein was still a law professor at Harvard. In 2009, Obama appointed him as administrator of the Office of Information and Regulatory Affairs, where Sunstein championed cost-benefit analysis of regulation, as well as “nudges.” Sunstein left government in 2012 to return to academia, but the “nudge” school of thought has clearly lingered in the Oval Office: The newly created behavioral economics task force is the most prominent—and most disconcerting—example yet.

In May of this year, the White House convened a group of experts for a workshop—along with the National Institute on Aging (part of the National Institutes of Health), the White House Office of Science and Technology Policy, the White House Council of Economic Advisers and the Association for Psychological Science—to discuss how behavioral economics can better serve public policy. The NIA says that while it “does not support policy research per se, findings from the basic behavioral and social science research that it does support are an important resource for informing policies.” Much of this research is now featured on the NIA’s website, under its Division of Behavioral and Social Research.

According to a government document obtained by Fox News, the task force is modeled after Britain’s Behavioural Insights Team, or “nudge unit,” which is itself based on Sunstein and Thaler’s ideas. The American version will consist of four to five behavioral science experts working with more than a dozen federal departments and agencies to “help design public policies that work better, cost less, and help people to achieve their goals.” While most uses for behavioral economics fall to regulation, the task force has not announced exactly how it will function or whether it is confined just to the regulatory process. In fact, there is very little public information about the team at all.

But behavioral economics carries serious risks, because it’s not really about helping you achieve your own goals. Think about the range of questions you might ask yourself when buying a new car: Which is the safest, or the cheapest? Which gets good gas mileage? Which is the best fit for your family? Which has enough payload capacity to meet your small-business needs? Now think about what would happen if, instead of you answering these questions for yourself, it was government bureaucrats nudging you away from your preferences and toward theirs.

The Economic Situation: A Quarterly Commentary December 2013

Bruce Yandle — Mon, 09 Dec 2013 12:03:34 -0500

Publication

Prospering and Tapering in a Struggling Economy

With autumn leaves falling and leftover Halloween jack-o-lanterns still grinning, first estimates for 3Q2013 GDP growth and news of October’s employment went bump in the night and rattled the spirits of Washington’s chatterbox. GDP growth came in with a “lofty” 2.8 percent real growth, which was much more than most soothsayers expected. Tapering is on the way! Or so it seemed. The stock marked tanked. Then the Bureau of Labor Statistics announced that 204,000 jobs had been added to the economy in October; this also exceeded analysts’ expectations. The market recovered; the economy can handle tapering!

But while 2.8 percent growth surely looked good, when folded into a four-quarter moving average, the 2013 economy was still operating well below the 3.14 percent long-run average pace. Buried in the labor data were numbers indicating most of the growth was in relatively low-paying sectors. But they were jobs!

As indicated in the next chart, GDP’s par 3.14 percent has not been meaningfully exceeded since the early 2000s, when the economy was responding to tax cuts, increased spending, and accelerated government-sponsored home lending. We know what that witch’s brew fomented.

Digging into the GDP Numbers

Probing a bit deeper into the GDP analysis, one finds that the higher than expected numbers were associated with lower than expected consumer purchases. This means that about 0.8 percentage points of the 2.8 percent growth came with a run-up in final good inventories—stuff retailers hoped to sell but didn’t. This doesn’t augur well for 4Q2013 GDP growth, as those retailers may cut their purchases to bring inventories in line with expected sales.

But it’s not likely that Black Friday and later holiday shopping will give the economy a shot in the arm. Back-to-school sales, which generally foreshadow December’s holiday shopping, were below expectations this year. Big-ticket durable goods purchased partly with low-interest debt set a high pace. Retailers offered large discounts to get apparel and lower-priced goods off the shelf and out the door. There are always surprises, but fourth quarter performance will likely be well below the 2.8 percent first estimate for 3Q2013.

Probing Additional Data

The stronger than expected job numbers put the effects of the government shutdown under a statistical magnifying glass. The data seem to say the government closing did not hit the economy as hard as some expected. After all, there was full expectation that furloughed workers would be paid later.

There are more data to consider. According to the Institute for Supply Management’s monthly monitors, the US economy is clearly accelerating. The recent ISM numbers are well above 50—the neutral point—for both the manufacturing and nonmanufacturing economies. Perhaps more importantly, the forward-looking Manufacturer’s Alliance for Productivity Improvement’s leading indicator, shown below with the ISM numbers, is pointing north, which predicts higher growth in 2014’s second half.

Comparing President Obama’s Early Budget with His Mid-Session Review

Veronique de Rugy — Mon, 09 Dec 2013 18:38:38 -0500

Publication

How realistic are presidential budget projections? Even the most careful calculations are susceptible to inappropriate assumptions, misplaced optimism about economic and political conditions, and unavoidable uncertainty about what the future will hold.This week’s charts use data from the Office of Management and Budget to compare the Obama administration’s different budget projections over time. The charts display budgetary estimates of expected revenues, outlays, and deficits from 2008 until 2019. The projections in the Obama administration’s first budget, “A New Era of Responsibility” (NER) are compared against his “Mid-Session Review” (MSR) to see how expectations aligned with reality.

The first chart analyzes the differences in revenue projections among the two estimates. The chart suggests that the revenue projections in the NER were far too optimistic. The Obama administration believed that revenues would climb to over $3,023 billion in 2013, but the revised MSR predicts a much more modest yield of $2,777 billion for this year. This trend continues throughout 2019: the original NER revenue projections are considerably more optimistic than the revised MSR calculations.The second chart, which compares outlay projections among the same sources, tells a similar story. The original NER outlay projections were more optimistic than what actually came to pass. Although President Obama hoped for a more ambitious stimulus program of almost $4,000 billion in outlays to pull the nation out of recession in 2009, actual outlays amounted to a more modest $3,518 billion. Only in 2011 did expected NER outlays match actual outlays. For all other years, the president’s revised MSR outlay projections appear much less sanguine than his rookie NER expectations.

The final chart displays deficit projections from the two budgets. In this case, the NER overestimated deficits in 2009, but its projections fell short of the deficits actually incurred from 2010 to 2013. Even though the administration spent less than planned in its original NER, the lackluster revenue performance during this time was enough to increase the deficit considerably more than anticipated.

The MSR projects that deficits will fall below the original NER projections by 2016, dropping under $500 billion by 2018. Like most budget projections beyond a short-time horizon, this should be taken with a grain of salt; long-term projections are based on uncertain assumptions that often fail to provide an accurate picture, as shown in the original NER projections. Why should we expect that the president’s revised MSR deficit projections will be any less incorrectly optimistic this time? If recent history is any guide, we should expect the MSR deficits to be similarly distorted by these rose-colored assumptions.

Labor Market Still Struggling Despite Positive November Gains

Keith Hall — Fri, 06 Dec 2013 11:45:54 -0500

Expert Commentary

Although the Bureau of Labor Statistics announcement that the economy added 203,000 jobs in November has been welcomed as positive news, the overall numbers show that the labor market remains a concern. Mercatus Center senior research fellow Keith Hall, a former BLS commissioner, notes that the labor force participation rate is still worryingly low.

“At 203,000 jobs this month and an average of 189,000 per month so far this year, we have averaged about the same rate of job growth as last year, and the unemployment rate rebounded from last month’s rise, dropping to 7.0 percent. However, while the November data is generally positive, it is hard to be too encouraged when labor force participation remains so low.

“After dropping by whopping 720,000 last month, we added back just 455,000 to the labor force. Over the past two months, the size of the labor force as a share of working age population (62.8 and 63.0 percent, respectively) has been at its lowest level in nearly 35 years.

So far this year, the working age population has grown by 2.2 million, but the labor force has declined by 217,000. This decline in the labor force has been entirely responsible for the drop in the unemployment rate over the past 11 months from 7.8 to 7.0 percent. In fact, if the participation rate had held constant this year, the unemployment rate would be a full percentage point higher at 8.0 percent.”

Exploring The Affordable Care Act: What Is The Impact and What Is Necessary for Successful Reform?

Robert Graboyes — Mon, 09 Dec 2013 18:50:34 -0500

Video

To explore the fiscal realities of the ACA and discuss principles for successful healthcare reform, the Mercatus Center at George Mason University hosted a new Capitol Hill Campus featuring Dr. Robert Graboyes, Mercatus Center senior research fellow specializing in the economics of healthcare. This discussion concentrated on the economic implications of healthcare reform.

Full video:

Current State of the Affordable Care Act:

Critique of Decentralizers:

Breaking the Health Care Cost Curve:

Ideal Health Care System: Why Is There No Steve Jobs?

Impediments to Innovative Medicine:

Health Insurance vs Health Care:

Closing Remarks on Innovation, Final Thoughts on Centralizers and Decentralizers:

A Reality Check on the Pension Crisis

Eileen Norcross — Fri, 06 Dec 2013 10:37:40 -0500

Expert Commentary

The New York Times Room for Debate posted this question:

It’s been a bad week for public workers. On Tuesday, in a ruling that has implications for other cities, a federal judge ruled that Detroit’s public employee pensions are not protected in a federal Chapter 9 bankruptcy. On that same day, the Illinois legislature passed a deal trimming retiree benefits and increasing state contributions, providing a template for other states to follow.

Amid all this, is the continuing refrain that Wall Street fat cats are responsible for “looting the pension funds.” Are government retirees being forced to pay for pension fund problems caused by bad investments? If so, what’s the solution?

Eileen Norcross provided the following response:

Judge Steven Rhodes’ ruling that Detroit may reduce pensions under Chapter 9 bankruptcy now means that all parties must face a hard mathematical reality with consequences for real people: The city cannot afford to pay the benefits it has promised.

Detroit’s unfunded pension liabilities are immense, at over $9 billion on a risk-free (guaranteed-to-be-paid) basis. Unfortunately, they were valued and funded incorrectly. For years, the city assumed it would earn 8 percent annually on plan assets, an uncertain expectation that did not match the certainty of pension payments.

Detroit’s story is a lesson for union leadership and for other cities.

This “asset-liability mismatch” means the plan took a gamble that didn’t pay off. Accounting tricks during boom years made the fund look flush giving the city the impression it could dole out "13th checks" for some employees.

Former Mayor Kwame Kilpatrick also engaged in “fancy financing” using pension bonds financed with interest rate swaps resulting in a $1.44 billion debt.

How does Detroit restructure public sector retirement in a “fair and equitable” manner for retirees and workers?

1. Stop the bleeding and close the defined-benefit system. Every day the defined-benefit plan is open, the liability grows.

2. Transition younger workers into a defined-contribution or private-annuity plan. They have more time to plan for retirement. Give them ownership over their retirement contributions.

3. Accurately value defined-benefit plans according to the likelihood of payment.

4. Invest the assets in a liability-matching portfolio. Do not rely on uncertain and volatile asset returns.

5. Current workers who have accrued benefits in the defined-benefit system should face higher retirement ages to collect full benefits.

6. Current retirees should bear the smallest burden. If it is necessary to trim their benefits, adjust future payments through cost of living adjustments, rather than cutting current payments.

Detroit’s story is a lesson for union leadership and for other cities. Accounting fiction and financial escapades produce the worst-case scenario for workers, retirees and residents. Toss the political rhetoric and face the real numbers before it’s too late: It’s the only way to ensure economic justice and retirement security for public-sector workers.

Shutting Down the Engines of Innovation

Nita Ghei — Fri, 06 Dec 2013 09:59:53 -0500

Expert Commentary

The unfolding drama between the Food and Drug Administration (FDA) and upstart genetic testing 23andMe is simply the latest in the long string of troubling overreach by regulators that will continue to stifle innovation and growth.

For far too long, Congress has delegated excessive power to unelected bureaucrats in Washington. The result is an alphabet soup of agencies, often acting at cross-purposes, issuing regulations based on less-than-adequate economic analysis despite being required to weigh benefits against costs, and blithely assuming engineering and technological standards that do not exist.

Caught between a rock and a hard place, businesses close, or decline to open in the first place, and the jobs are lost or never created. Nonetheless, the agencies continue issuing regulations unchecked, and regulators remain serenely unconcerned about their hubris, convinced they know better than the rest of us what is good for us.

23andMe offers a genetic-testing kit, which is essentially a tube into which the customer spits and returns to the company. The actual test is conducted at a lab that is regulated by yet another federal agency. As Cato Institute senior fellow Walter Olson points out, there are sound legal reasons for the FDA to have refrained from acting in this case. Instead, the agency chose to go after 23andMe aggressively for marketing a “medical device,” even though the only device involved is a plastic tube, and the client cannot undertake further action on the test results without consulting a health care provider. This kind of device is part of the new economy, with a strong push toward the free flow of information. It is at odds with the old, paternalistic model, in which regulators and the medical establishment control what patients learn.

The FDA’s claim of jurisdiction is questionable, but challenging a regulator is fraught with risk, as former Buckyballs CEO Craig Zucker discovered. Buckyballs are rare-earth magnets that were marketed as desk toys for adults, and came with warnings to keep them away from children. The Consumer Product Safety Commission nonetheless decided the magnets were dangerous and wanted them banned. When the company challenged the decision, the commission eventually chose to do something quite unprecedented: sue the CEO personally, after the company was forced to shut down.

Buckyballs are gone. 23andMe will probably either shut down or move offshore. In either case, regulators effectively clamp down on jobs and innovation. It doesn’t stop here.

The messy rollout of Obamacare serves as an illustration of a different kind of regulator hubris. The sustainability of the Obamacare model depends on having young, healthy people enroll in the exchanges. When policy cancellations started rolling in and Healthcare.gov didn’t work, President Obama announced that states could let people keep their old policies for a year. The problem is that it was not technically feasible for insurers to turn on a dime to make that happen within the short time window available while putting aside all the other problems.

The Renewable Fuel Standards, requiring the use of 35 billion gallons of alternative fuels by 2017, however, remain the epitome of wishful thinking by regulators. The Environmental Protection Agency enacted the standards back in 2007 with the admittedly laudable goal of promoting clean energy. Unfortunately, the goals failed to take into account the difficulty in converting that much corn into fuel, as well as the fact that the technology did not exist for producing some kinds of biofuels in commercial quantities. In addition, there were scientific studies that found that engines in older cars, which are likely to be driven disproportionately by poorer people, could be damaged by the new fuels being pushed by the agency, with increased risk of injury and death. The mandate required a significant increase in acreage planted with corn rather than soy, which is damaging to the soil and environment. The EPA has lowered this year’s goal, making virtue out of necessity but not abandoned the standards.

The latest entry in the hubris foray is the Occupational Safety and Health Administration (OSHA), which has proposed a rule to control silica exposure with little regard to current enforcement and feasibility. There is wide variation in silica exposure, and how well industries manage it. While there are many problems with the proposed regulation, Mercatus Center senior scholar Michael Marlow points out, OSHA is also contemplating a requirement that employers cut silica exposure to a level not technologically feasible. If an inspection reveals a level above this level, the facility would be subject to regular OSHA inspections.

Each regulatory excess stifles industry growth. When regulators try to fit round pegs into square holes, as is the case with 23andMe, we see innovative companies disappear. The United States has carefully cultivated a legal regime that encourages innovation over much of its existence. It would be a great pity if regulatory overreach destroyed that advantage.

Principles for Telecommunications Act Reform

Brent Skorup — Thu, 05 Dec 2013 14:42:32 -0500

Expert Commentary

Congressional lawmakers are currently considering updating the Telecommunications Act of 1996. Mercatus Center research fellow Brent Skorup says that the reform effort is long overdue and discusses how to improve and modernize the United States’ telecom, broadband, and video programming laws.

"We need a major re-write that eliminates regulatory distortions in communications, much as airlines and transportation were deregulated in the 1970s.

There is bipartisan agreement that the 1996 Telecom Act was antiquated only shortly after President Clinton’s signature had dried on the legislation. There is also consensus that spectrum policy, still largely grounded in the 1934 communications statute, absolutely distorts today’s wireless markets. And there is frequent criticism from thought leaders, right and left, that the FCC has been, for decades, too accommodating to the firms it regulates and too beholden to the status quo.

Five key reform principles would provide a good starting point for improving the legal and regulatory climate.

Eliminate regulatory silos and level the playing field through deregulation;
Comprehensively reform spectrum, not just through more auctioning but through clear property rights;
Replace the FCC’s amorphous 'public interest' standard with a more clearly defined consumer welfare standard, which is more well-established in field of antitrust law;
Reform universal service fee programs by either converting them to vouchers or giving control to the states and let them run manage their own telecom assistance programs; and
Significantly reform and downsize the scope of the FCC’s power of the modern information economy.

The FCC largely sees itself as a competition agency today, but the current statutes don’t represent that gradual change in purpose. The FCC is slow, arbitrary, Balkanizes industries artificially, and attempts to regulate in areas it isn’t equipped to regulate. These characteristics create a poor environment for substantial investments in technology and communications infrastructure. We need a framework that minimizes the effect of special interests in communications and encourages investments that improve consumers’ lives."

Breaking Down Illinois' Pension Crisis

Eileen Norcross — Fri, 06 Dec 2013 10:30:05 -0500

Expert Commentary

Illinois’ pension problems are big—far bigger than the $100 billion funding gap the legislature said it tackled earlier this week with a new set of reforms. The funding gap is actually double that—well over $200 billion—when calculated on a fair-market basis.

Illinois is committed to fully funding the actuarial liability (and some are encouraging the system to sue the state should the government not pay it). This is one of the reasons the state is in such a hole—they are well behind on payments, and those payments are calculated based on the overly optimistic expectation that they will earn 8 percent a year on investments.

The new law proposes to save $160 billion over 30 years with the following reforms:

a) Curtail cost of living adjustments for retirees on a sliding scale.

b) Offer a 401(k) option for employees.

c) Increase the retirement age for younger workers, while decreasing their contributions by 1 percent (thus increasing take home pay).

d) Guarantee the state makes its annual payment.

The plan is receiving “sniper fire from all sides,” as one lawmaker put it. Labor unions don’t like it and are certain to take the state to court, arguing that Illinois’ constitution prevents the impairment of benefits. Some legislators also don’t like it. They would prefer to see more significant structural reforms and are worried about the very large annual payments that will affect spending in other areas of the budget.

The fact is, the Illinois constitution does guarantee benefits, in strong terms, and that puts the state on the hook. Indeed, the payments, which the state grew accustomed to skipping or bonding, are going to be very painful. Yesterday’s reforms are an attempt at “shared sacrifice,” though given the actual size of the liability, legislators are overestimating the proposal’s fiscal effects.

If the proposed measures hold up to a court challenge, what will the effects be on employees?

The Center for Tax and Budget Accountability calculated three scenarios:

Employee 1: Retired teacher, 30 years of service:
Initial annual benefit: $67,000
annual pension benefit after 20 years of retirement, $120,680 a year under the current pension system; $91,000 under the proposed changes.
Cumulative 20-year decrease: $282,632.

Employee 2: Retired Department of Children and Family Services caseworker, 20 years of service:
Initial annual benefit: $50,000
annual pension benefit after 20 years of retirement, $90,306 under current system; $63,000 under proposed changes.
Cumulative 20-year decrease: $261,215.

Employee 3: Central Management Services data processor, age 43, planning to retire in 15 years with 30 years of service:
Initial annual benefit: $72,000
annual pension benefit after 20 years of retirement, $130,000 under current system; $85,400 under proposed changes.
Cumulative 20-year decrease: $441,700.

And that's just starting to solve the problem. The question legislators should be asking is: How do we stop the bleeding and finance the massive liability we’ve accumulated?

Regulatory Landscape: Burdens on Small Financial Institutions

Hester Peirce — Wed, 04 Dec 2013 16:59:35 -0500

Video

In her testimony before the House Committee on Small Business, Mercatus Senior Research Fellow Hester Peirce discusses how regulations impact small banks.

Read Peirce's testimony: Regulatory Landscape: Burdens on Small Financial Institutions

Embed Code:

Why Government Institutions Fail to Deliver on Their Promises: The Public Choice Explanation

Veronique de Rugy — Wed, 04 Dec 2013 10:56:06 -0500

Publication

Chairman Issa, Ranking Member Cummings, thank you for the opportunity to testify today regarding the limitations of government intervention.

Despite Washington’s recent focus on the disastrous Affordable Care Act website rollout, policymakers are missing what the rollout glitches symbolize: the fundamental flaws that imbue government intervention.

The work of public choice economists such as Nobel laureate James Buchanan, Gordon Tullock, Mancur Olson, and William Niskanen has shown that, despite good intentions and lavish use of taxpayer resources, government solutions are not only unlikely to solve most of our problems—they often make problems worse.

Public Choice Economics: Politics without Romance

Congress spends a great deal of time discussing the need to address market failures such as monopolies and pollution.

However, even when such a problem does exist, the policies implemented to address it are often ineffective or undesirable.¹ That’s because, as public choice economists have pointed out, while there may be market failures, there are also government failures. In his Nobel Prize acceptance speech, popularized in his famous essay “Public Choice: Politics without Romance,” James Buchanan explains why looking to government for solutions often results in more harm than good.²

Public choice theory applies economic analysis—or the study of how incentives influence behavior—to politics. For instance, economists assume that people interacting in the marketplace are mostly driven by self-interest. That doesn’t mean that people aren’t concerned about others, or can’t act charitably. It simply means that their dominant motive—whether they are employers, employees, or consumers—is a concern for themselves. Public choice economists make the same assumption about government actors. As Jane S. Shaw writes in a primer about public choice economics, “although people acting in the political marketplace have some concern for others, their main motive, whether they are voters, politicians, lobbyists, or bureaucrats, is self-interest.” ³

In other words, unlike many economists before them, public choice economists revolutionized the field of economics by having symmetric assumptions about humans in public and private settings and replacing “romantic and illusory notions about the workings of governments” with more realistic ones.

Government Incentives

In the marketplace, scarcity guarantees that people compete for resources. In that environment, the price system and the risk of losses, combined with the prospect of potential profit, are powerful signals that guide people’s decisions to prudently buy, sell, invest, and save.

But unlike in the marketplace, the incentives for good management in government are very weak. For instance, even though lawmakers are expected to pursue the “public interest,” they make decisions that use other people’s money rather than their own. This means that their exposure to the risk of a bad decision is fairly limited, and there is little to no reward for spending taxpayers’ money wisely or providing a service effectively or efficiently.

Furthermore, because each voter bears a very small part of the cost of these bad decisions, and they have their daily lives to manage, voters lack the incentives to sufficiently monitor the government.⁴ And, as Shaw explains, voter ignorance can be quite rational:

Even though the result of an election may be very important, an individual’s vote rarely decides an election. Thus, the direct impact of casting a well-informed vote is almost nil; the voter has virtually no chance to determine the outcome of the election. So spending time following the issues is not personally worthwhile for the voter. Evidence for this claim is found in the fact that public opinion polls consistently find that less than half of all voting-age Americans can name their own congressional representative.

That is not, of course, the case in the private sector. Consumers have great incentives to make sure the car or the house they buy is worth the price they will pay for it. Employers also have great incentives to make sure they hire the best employees, as there is a high and direct cost for employing someone who can’t perform the job he or she is hired for.

Yet lawmakers—however well-intentioned—face serious difficulties in making the right decision. Many factors come into play, but it is worth highlighting the following two. First, the government does not have better information than private agents operating in the market, whether this be the health care market or any other market (financial, housing, etc.).⁵ Making matters worse, government decision-makers are usually insulated from market signals, and thus often lack important information about the problem at hand and the market itself.

Second, the resources government provides are often so enticing that companies may switch their focus from meeting the needs of customers to meeting the wishes of government officials—thus producing a less effective outcome.

Regulatory Conceit Is Strangling Tomorrow's Start-Ups

Hester Peirce — Wed, 04 Dec 2013 10:15:54 -0500

Expert Commentary

At Thanksgiving dinner last week, talk turned quickly from turkey to regulation. One of the dinner guests, along with a couple other computer whizzes, has designed software for which they think there is a real market. There is just one problem-regulation. The company can't even pilot test its product without first getting the blessing of state and federal regulators. The company's three employees know their way around computer codes, but regulatory codes are a different matter. The consequences of getting it wrong can be stiff penalties or, as my guest pointed out, "people get thrown in jail for this kind of stuff." The reality is that well-intentioned regulations may kill his company before its product goes live. If it does see the light of day, another set of regulations may make banks less likely to lend to the company.

My dinner guest's story is just one of thousands of similar ones. A great product and a willingness to pour hours into perfecting it are not enough. You also need regulatory expertise. Usually when two guys start a business in one of their garages, neither one of them is, aspires to be, or even knows a regulatory geek. Hourly rates driven by ever-increasing regulatory complexity make hiring an expert out of the question. You might set out to redesign your product so that the regulations don't cover it, but even that requires a deep understanding of government rules. So your only hope is to get bought out by a bigger company with a whole staff of regulatory experts.

Start-ups that do manage to figure their way through the regulatory maze may find themselves confronted by another problem-funding. The small banks that small companies often turn to for funding are themselves overwhelmed by regulation. Adding an extra compliance person to deal with the regulatory burdens emanating from Dodd-Frank, for example, may be the difference between a small bank staying in business and closing its doors or merging with another bank to spread out the regulatory costs.

A community banker may have sufficient familiarity with a local small business and the area in which it operates to know that a loan to the company will get repaid. But worries about justifying it to a regulator without the same local knowledge may keep him from making the loan. A banker that went into banking because she enjoyed working with growing small businesses in her community might leave banking because she does not enjoy working through an increasingly complex regulatory environment that steers time and resources away from customer service.

Regulators can create exemptions for small banks, but even figuring out whether an exemption applies and what its conditions are can be difficult work. For example, the staff of the Commodity Futures Trading Commission issued regulatory relief for small banks earlier this year in the form of a "no-action" letter. The letter allowed the banks an extra month to comply with a requirement that makes them eligible for an exemption from certain onerous CFTC rules, but not without reminding them that the requirement at issue "was expressly noted in the Federal Register" when the agency adopted the exemption. Expecting small bankers to have searched through thousands of pages of technical CFTC documents in order to find buried within them a brief mention of something pertinent to them seems impractical. Small banks are too busy absorbing regulations issued by their banking regulators to closely monitor the rulemaking activities of an agency that doesn't usually regulate them.

Even the people who devise complicated banking regulations are starting to ask whether they have gone a bit too far. Earlier this fall, the Bank for International Settlements-the institution that developed the international bank capital standards that are the basis for our domestic capital standards-issued a discussion paper about regulatory complexity. Rather timidly it suggests that "[t]here is some evidence that some parts of the capital framework have become unduly complex and that the marginal benefits from incremental complexity may be small, or even negative." While U.S. regulators have taken some steps to reduce the complexity of capital standards as they apply to small banks, they have a lot of regulatory simplification work yet to do.

Regulatory complexity should not be the stuff of Thanksgiving dinner conversations. But until we find effective ways to get rid of excess regulations and simplify the remaining ones, the people who run small banks and small businesses are going to be worrying about regulations, even during holiday dinners.

Scottsdale Supporter and Friend Lunch

Keith Hall — Tue, 03 Dec 2013 17:56:31 -0500

Events

The diagnosis of the economy and, specifically, the problems of the labor market portrayed in the news are often incomplete. Most Americans want to know what the employment numbers mean for our economic outlook. What’s driving these statistics and more importantly, what’s standing in the way of employing the millions of Americans who are currently without a job?

Mercatus Senior Research Fellow Keith Hall explains the economics behind the jobs numbers and how to read between the lines to get a better understanding of what they mean for our economy and different groups of Americans.

Keith brings a keen knowledge of this topic from his former role as Commissioner of the Bureau of Labor Statistics.

This is not a fundraising event and there is no charge to join us. We are pleased to have you as our guest to show our thanks and appreciation to our donors. Dress is business casual. Please invite friends or associates who might be interested.

Questions? Contact Erin Connolly at econnolly@mercatus.gmu.edu or (925) 408-2918.

Tucson Supporter and Friend Lunch

Keith Hall — Tue, 03 Dec 2013 17:52:42 -0500

Events

Keith brings a keen knowledge of this topic from his former role as Commissioner of the Bureau of Labor Statistics.

Questions? Contact Erin Connolly at econnolly@mercatus.gmu.edu or (925) 408-2918.

Allowing Cellphone Use in Airplanes Won't Create Chaos

Jerry Brito — Tue, 03 Dec 2013 16:35:46 -0500

Expert Commentary

When it was announced last month that the Federal Aviation Administration was relaxing the rules on personal electronic devices during take-off and landing on commercial passenger flights, Americans rejoiced. No longer would we have to suffer the indignity of staring blankly at the tray table before us for the 15 minutes it takes a flight to reach cruising altitude, or worse, touch ink-stained dead tree bits to occupy ourselves. Yet when the Federal Communications Commission soon thereafter similarly announced that it to was reconsidering its prohibitions on in-flight cell phone use, all hell broke loose.

"Imagine being in the middle seat trapped between two idiots yabbering on about their love life or whatever else, or how important they are for five hours on a transcontinental flight—it’s going to be chaos,” said Rep. Peter DeFazio (D-Ore.), echoing the sentiment of most Americans according to a HuffPost/YouGov poll.

The New York Times, USA Today, and many other news media ran opinion pieces with the consistent theme that flying was already a pretty miserable experience and that cell phones would only make it worse. And the flight attendant’s union also opposed changing the rules calling such a move potentially “unsafe” and noting in a statement that “flight attendants, as first responders and the last line of defense in our nation’s aviation system, understand the importance of maintaining a calm cabin environment.”

Tom Wheeler, the new chairman of the FCC, found himself in crisis communications mode just a couple of weeks into his tenure, saying in a statement that he too would rather not see any calls on planes. The FCC’s ban on in-flight cellphone use, however, is a technical one meant to address radio interference, not politeness. “[A]dvances in technology likely no longer warrant—on a technological basis—the prohibition of in-flight phone use with the appropriate on-board equipment,” Wheeler said.

And therein lies the rub. If a technology is safe, but potentially annoying or discomforting to most people, should the government ban its use? Most people seem to think so, including putative small-government Republicans like Sen. Lamar Alexander (Tenn.) who said he would introduce legislation to ban in-flight chatting if the FCC loosened its regulations. What this misses is that the government is not the only one that can make and enforce rules.

What deregulation like that being pursued by the FAA and FCC does is create new options and introduce choice where there was none before. Cellphones don’t work at 30,000 feet unassisted; they can’t communicate with cell towers. In order for cellphones to work in the air, airlines have to install special equipment. Today they are not allowed to install that equipment, and all FCC deregulation would do is give them the option.

The FAA’s move to allow use of electronics during take-off and landing worked the same way. Airlines can still decide not to allow device use on their airplanes, and indeed it took a while for each airline to change its rules to permit device use. Deregulation just means airlines now have the option. This means that if the FCC were to change its cellphone rules, folks like Sen. Alexander could nevertheless fly airlines like Delta, which announcedthat in response to customer demand it won’t ever allow calls.

If that demand is there, as it certainly seems to be, airlines will respond with private rules and bans on cellphone use without government’s help. And private rules have the advantage of being much more varied and flexible than the difficult-to-change, one-size-fits-all rules we can get from government. We can see this at work in Europe and Asia, which already allow cellphone use in-flight. According to the New York Times, “Virgin Atlantic allows unlimited data connections, but it lets only six people talk on a cellphone at once. Some Lufthansa flights allow data connections through a cellphone, but no phone calls.”

Even on flights that do allow cell phone use, it won’t be “chaos” as Rep. DeFazio predicts. Humans have a pretty good history of eliciting good behavior from each other through the development of norms without the need for codified rules–public or private. According to the FAA, civil authorities in countries were in-flight cellphone use is permitted reported no “cases of air rage or flight attendant interference related to passengers using cell phones on aircraft equipped with on-board cellular telephone base stations.”

The likely reason is simply that very few people are so shameless or tone-deaf as DeFazio and Alexander imagine. Just as we don’t see boom boxes blaring now that electronic devices are allowed on take-off and landing, we’ll probably see very few people on their phones “babbling about last night’s love life [or] bathroom plans,” as Alexander put it. Indeed, Emirates has no restrictions on the number of passengers who can talk on their phones, yet few apparently do.

Before reactively banning a potentially uncomfortable technology, how about first giving markets and human norms a shot? If nothing else, it would be worth seeing if a problem really emerges before foregoing the benefits of the technology. In most cases the likely outcome will be that imagined horrors won’t materialize, and if some problems do crop up, human adaptation, norms, and private rules are often more than enough to deal with them.

Budget Conference 2013: Principles For A Credible Deal

Jason J. Fichtner, Veronique de Rugy — Wed, 04 Dec 2013 11:50:15 -0500

Publication

A credible budget conference agreement would take a first step toward improving the nation’s dire fiscal outlook and achieve the following:

maintain sequester spending levels in addition to—not in exchange for—other spending reductions;
begin structural reform of the largest and least sustainable entitlement programs—the key drivers of future spending and debt; and
avoid attempts to solve the spending problem by raising taxes.

Regrettably, the goal of this year’s budget negotiations appears to have shifted from improving the nation’s finances to eliminating the modest spending sequester to which both sides have already agreed. This would be a mistake with lasting repercussions.

Below, Mercatus Center scholars review the principles for a credible deal for the fiscal year 2014 budget.

Maintain the Sequester

Sequestration was implemented as the consequence of the Budget Control Act of 2011, which raised the federal government’s debt ceiling (or the borrowing authority) by approximately $2 trillion. Relative to the nation’s fiscal imbalance, the sequester’s spending cuts are admittedly tiny. But it is not the size of the sequester that is most important; it is Congress’ commitment to its implementation.

Maintaining sequester spending levels is a critical marker of Congress’ will to gain control of federal spending. It signals that Congress can honor its agreements, and—in following through on this small effort—has the potential to meet the far greater challenge of correcting the nation’s longer-term spending and debt crisis.

Despite Washington rhetoric, the sequester’s spending reductions are far from “draconian cuts”; the sequester does not even reduce overall spending levels. Rather, the sequester slightly slows the projected growth in overall spending between 2013 and 2023.

Even with the sequester, federal spending will grow by $1.8 trillion—more than 50 percent—between 2013 and 2021, the period during which spending cuts from sequestration will take place.
Total federal spending still increases under sequestration because any spending cuts are up front and fall mostly on the discretionary side of the budget; the main drivers of future spending and debt—entitlement programs—are largely untouched.

Begin Credible Entitlement Reform

Maintaining sequester spending levels is the absolute least Congress must do. The long-term fiscal imbalance is driven primarily by growth in the costs of Medicare, Medicaid, Social Security, and the new health-insurance exchanges established as part of the 2010 Affordable Care Act. Left unchecked, the unsustainable cost growth of these programs will result in considerable tax increases, reduced economic growth, fewer resources for every other federal program,severe benefit cuts in the entitlement programs themselves, or—most likely—some combination of these things.
Structural and cost-reducing reforms to the largest entitlement programs need to begin immediately. Any strategy that fails to reform these entitlement programs will inevitably fail to correct the federal government’s fiscal imbalance; merely tweaking these programs for short-term political gain only slightly forestalls their inevitable insolvency.

Don’t Attempt to Tax Away the Spending Problem

Some in Washington claim the federal spending and deficit problem is solved. While the deficit has been cut in half (from a record-high of $1.4 trillion in FY09 to $680 billion in FY13), this reduction can be attributed to several singular events, such as the end of the payroll tax “holiday” and higher receipts from Fannie Mae and Freddie Mac. Over the longer term, deficits and debt are projected to continue increasing.

Attempting to fix the unsustainable federal spending growth through tax increases would wreak havoc on the economy, as taxes would have to more than double just to fund entitlement spending. Further, expansive academic research shows the “balanced approach” does not work.

The general consensus in the academic literature is that fiscal adjustments based more on spending cuts were much more likely to achieve successful and lasting reductions in debt-to-GDP ratio than tax-base adjustments. This is particularly true of spending-based adjustments that reform entitlements and public pay.
Data from Greece, Italy, and Japan show that tax increases don’t effectively reduce debt levels; evidence from Canada, Germany, and Finland show that cutting spending and implementing structural reforms are the most successful policies.
Sweden’s experience indicates that significantly cutting government spending without an equivalent increase in taxes can provide a path to fiscal sustainability.

· Sweden successfully reduced welfare spending and pursued economic stimulus through a permanent reduction in the country’s taxes, including a 20-point reduction in the top marginal income tax rate.

· Sweden’s recent economic growth has trumped that of every other European country.

Data from past fiscal adjustments show that while spending cuts will effectively reduce a country’s debt, they do not necessarily hurt the economy in the short-term.

∙ Evidence shows that if an economic slowdown follows the spending-cut based adjustment, it is generally mild and short lived. Conversely, tax-based adjustments result in significant economic slowdowns.

∙ A leading paper in the austerity debate by International Monetary Fund economists shows that while spending cuts can hurt the economy in the short run, they probably don’t hurt the economy as much as tax increases do.

Regulatory Landscape: Burdens on Small Financial Institutions

Hester Peirce — Wed, 04 Dec 2013 17:27:42 -0500

Publication

Chairman Schweikert, Ranking Member Clarke, and members of the Subcommittee, thank you for the opportunity to be part of today’s hearing on regulatory burdens on small financial institutions.¹

In financial services, as in every other sector, the United States is not a one-size-fits-all nation. Financial institutions of all different sizes coexist, and customers choose among them based upon their needs. A regulatory environment that is increasingly unwelcoming to small financial institutions may curtail customer choice.

Increasingly burdensome regulation is not the only challenge facing small banks and credit unions. They are also confronting slow economic growth, declining populations in rural areas, the increasing technological sophistication of banking, the sustained low–interest-rate environment, competition from new types of financial services providers, and difficult capital markets. Small financial institutions can adapt and excel in the face of such challenges, but not if regulation stands in the way and absorbs resources and managerial attention that would otherwise be devoted to dealing with them.

Today I will briefly discuss the importance of small financial institutions and then talk about three ways in which regulation or regulators are threatening their future prospects. First, the regulatory framework accommodates large financial institutions better than it does small ones. Second, the increased regulatory and compliance burden is felt most heavily by the smallest financial institutions. Finally, regulators’ lackluster commitment to fundamental administrative process protections takes a particular toll on small financial institutions.

The Importance of Small Institutions

With one-fifth of one percent of the banking industry controlling two-thirds of its assets,² it is easy to forget the important role that the remaining financial institutions—most of which are small—play. Many have served their communities for decades and continue to serve the financial needs of millions of retail customers and small businesses. Community banks are particularly important in rural areas. The FDIC reported that community banks serve “more than 1,200 US counties (out of a total of 3,238), encompassing 16.3 million people, who would have limited physical access to mainstream banking services without the presence of community banks.” ³ They are also key providers of small business loans. By one measure, “$1 out of every $2 lent to small businesses comes from community banks.” ⁴ Federal Reserve Governor Jerome Powell has noted that “as auto, mortgage, and credit card loans have become increasingly standardized, community banks have had to focus to a greater extent on small business and commercial real estate lending—products where community banks’ advantages in forming relationships with local borrowers are still important.” ⁵ Credit unions are also an increasingly important source of small business loans.⁶More generally, credit-union lending expanded by thirteen percent between the end of 2007 and the end of 2012.⁷

Community-based financial institutions are able to distinguish themselves from larger competitors by developing firsthand knowledge about their customers. This enables them to provide personalized service and meet the needs of the local residents and businesses in ways that a larger, nonlocal bank, which does not know the unique characteristics of the community, cannot. The Government Accountability Office explained:

Despite the decline in their number, community banks and credit unions have maintained their relationship-banking model, relying on their relationships with customers and local knowledge to make loans. Such institutions can use their relationship-based information to make loans to small businesses and other borrowers that larger banks may not make because of their general reliance on more automated processes.⁸

Federal Reserve Governor Elizabeth Duke likewise cited the following “natural advantages” of community banks: “deep community ties, daily interaction between senior managers of banks and their customers, and the dexterity to customize financial solutions.” ⁹

Logan City’s Adventures in Micro-Hydropower: How Federal Regulations Discourage Renewable Energy Development

Megan E. Hansen, Randy Simmons, Ryan M. Yonk, Ken J. Sim — Tue, 03 Dec 2013 10:34:59 -0500

Publication

Small-scale hydropower is one of the most promising new sources of clean power. Cities like Logan, Utah,¹ are taking advantage of the opportunity to develop green energy in their own backyards by installing micro-hydropower systems. As they do so, they often find themselves trapped in a frustrating regulatory system that costs them time and money.

In 2004, Lance Houser saw an opportunity. As assistant engineer for Logan City, Houser recognized the potential for the city’s culinary water system to generate clean, low-cost electricity. All it needed was the installation of a micro-hydro turbine within the existing pipeline. This project would create enough energy to power 185 local homes. It would require no new construction, but rather would modify an existing pipeline within an existing building. The project would have no additional environmental impacts. It would solve a problem while providing extra benefits to the city. In short, Houser’s idea made sense.

With the encouragement of federal policies, cities like Logan are implementing renewable energy projects such as small and micro-hydropower. The American Recovery and Reinvestment Act of 2009 (ARRA), commonly known as the Recovery Act or the stimulus bill, officially provided $16.8 billion for “Energy Efficiency and Renewable Energy.” ²

The Department of Energy, however, measures this number differently, and estimated the actual number to be closer to $90 billion (DOE 2012). Part of that funding went to renewable energy projects like Logan City’s micro-hydro project. In total, the city planned to spend up to $1.4 million to complete the project, of which half was local funding and half was the ARRA supported grant.

Unlike traditional large-scale hydropower, small and micro-hydropower systems often do not require dams, reducing the technology’s environmental impacts. Micro-hydro systems most commonly work through a “run-of-the-river” system in which water from a river is diverted to a pipeline. This water then flows through a turbine or waterwheel, powering a generator and producing electricity (DOE 2012). Micro-hydro turbines take advantage of the kinetic energy in flowing water by converting that energy into usable electricity. A system generating only 10 kilowatts can power a large home, small resort, or hobby farm (DOE 2012).

Small and micro-hydropower systems are indeed small, but collectively they have high energy-generation potential. According to a feasibility assessment of small and low-power hydroelectric plants, generation of as much as 30,000 megawatts of energy is possible through small and low-power hydroelectric projects³ throughout the United States (Idaho National Laboratory 2006, 1). This is enough energy to power more than 65,000 homes on an annual basis.⁴ If developed, this system would more than double total hydroelectric generation in the United States (Idaho National Laboratory 2006, v).

Although micro-hydro projects usually have limited or even no environmental effects, the federal permitting process is onerous. Logan City’s micro-hydro project would generate electricity from a renewable source, reducing the city’s reliance on energy generated from higher-emission coal and natural gas. As of 2012, over half of the city’s electricity generation came from coal and about 6 percent came from gas (Logan City Light & Power, n.d.). As the EPA website notes, “Hydropower’s air emissions are negligible because no fuels are burned” (2013). If Logan City’s project were to run 24/7 for one year, and if all of the energy it replaced came from coal-powered plants, the project would offset approximately 3.7 million pounds of carbon dioxide (US Energy Information Administration 2013).⁵

The Fed Is Biting Off More Than It Can Chew

Hester Peirce — Tue, 03 Dec 2013 21:45:33 -0500

Expert Commentary

With the full Senate likely voting to confirm her nomination later this month, Janet Yellen is now poised to take over as chair of the Federal Reserve when current chairman Ben Bernanke's term expires on Jan. 31.

Unlike most regulators, the Fed chair shows up often enough on television screens and in newspapers to become familiar to Americans far removed from Washington, D.C. From the imposingly tall Paul Volcker to the large-spectacled Alan Greenspan to the current professorially bearded Ben Bernanke, Fed chairmen enjoy their 15 minutes of fame.

And yet, as significant a role as this person plays in the lives of everyday Americans, the duties of the central-banking wizard are largely shrouded in ambiguity. Given the rapid growth in the Fed's portfolio, the likelihood that the central bank is taking on more than it can handle and the possibility that it will be a source of — not a solution for — financial instability, it's time to look behind the curtain.

Some confusion stems from the fact that the job of the Fed chair has changed over the years, with missions ranging from providing services to banks, to regulating, to setting monetary policy. The latter, whereby the Fed attempts to keep prices stable and unemployment low, gets the most attention. That dual mission, which many believe to be hopelessly broad, sounds pretty impressive in theory, but has not worked well in practice.