Archives: 07/2011

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%.  

What could have contributed to this increase? Perhaps, just maybe, the removal of branch banking restrictions in the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994. Prior to the passage of Riegle-Neal many states had substantial restrictions on the number of branches a bank could have, which severelylimited the size of banks. In Texas for instance, banks were limited to a single location.

Before the passage of Riegle-Neal, the large bank share of assets stood at 38%.  In the few years, between its passage and that of GLB, this 38% shot up to 65%.   Far more than GLB, Riegle-Neal was the legislative driver of commercial bank consolidation.  But then a banking deregulation passed by a Democratic Congress and signed by a Democratic president just doesn’t garner the blind emotion of blaming everything on Phil Gramm.

It should, of course, be said that  the removal of branching banks restrictions was a great thing.  There is a substantial body of academic work supporting the notion that such restrictions increased the risk of the banking system.  Because of Riegle-Neal we had a safer banking system than we would have had otherwise.  It was indeed a deregulation — one that matter and one that vastly improved our financial system.

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.

Debate: Colleges Getting Rich Off Students and Taxpayers?

On Tuesday, Cato held a forum on the big profits made by putatively “nonprofit” colleges, the subject of a new Cato Policy Analysis. Not surprisingly, Peter McPherson, president of the Association of Public and Land-grant Universities, objected to the use of the term “profits” to categorize the excess money colleges take in through undergraduate students, but all the panelists seemed to agree that there is both significant waste in higher ed, and that the Capitol Hill obsession with unabashedly for-profit institutions misses big cracks all over the Ivory Tower.

Unfortunately, of course, many of you couldn’t join us on Tuesday. Thankfully, you can now take in the entire bit of illuminating infotainment right here:

On a related note, give George Leef’s latest commentary a read. He does a nice job of pointing out all the major flaws in perhaps the most politically powerful argument for ever-greater government spending on higher education: because degree-holders tend to earn more, we need oodles more people with degrees. I’ve taken a whack at that dubious argument recently, but George gives it a far more comprehensive treatment.

TSA’s Partial Retreat From Full-Body Scans

It’s tempting to believe that the Transportation Security Administration’s move to change the software in strip-search machines is a response to the court ruling finding that it violated the law in rolling out the machines, but it’s almost surely coincidence.

The new software will show items that the software deems suspicious on a generic outline of a body rather than showing a detailed body image. The change will indeed reduce the invasiveness of the machine strip-search process. And because the image is less revealing, it can be viewed in the screening area instead of at a remote location. That means there doesn’t need to be a person dedicated to looking at denuded images of travelers. A major cost of running these machines—payroll—drops by a substantial margin.

The software will almost certainly not do as good a job of discovering hidden weapons as a human looking at a detailed image would. If it’s calibrated to over-report, TSA agents will rightly start to ignore its alerts on belt buckles and underwire bras. If it’s calibrated to under-report, well, it might fail to alert on an actual weapon or bomb. But those things are exceedingly rare, and the increased risk probably won’t make a difference.

In fact, that’s the interesting thing happening here: the TSA is allowing a small increase in risk in exchange for large gains in privacy and cost savings. The reason it took years of complaints, litigation, legislation, and other conflict is because the TSA did not analyze the risks and its responses before going forward with strip-search machines as it did. Trial-and-error isn’t costly to the government. The taxpayer fronts the money and gives up the privacy.

None of this means the TSA has now gotten the balance right. The airport security gauntlet will still be an overwrought mess and an affront to constitutional liberty. We will have to remain insistent on principle, on dignity and privacy, and on sound risk management while TSA gets a public relations bump from being less awful than it was before.

How Much Defense Acquisition Waste Is Enough?

Stories in DoD Buzz and the Christian Science Monitor this week cover a new Center for Strategic and Budgetary Assessment report on the Pentagon’s 2012 budget request. Both articles focus on the insightful section of the report explaining how the post 9-11 defense spending explosion has barely increased our war-fighting capacity. Unfortunately, both echo the report’s claim that all money spent on cancelled programs is money wasted and an indictment of the Pentagon acquisition system (page 36 and 37).

Here’s how the Monitor put it:

The new spending involves considerable waste, the report says. The Pentagon has spent nearly $50 billion since the 9/11 attacks on weapons systems that it never used due to technological failures or cost overruns, according to the study.

“These are weapons systems that have been started and then canceled without using any of them – we never saw one system fielded as a result of these programs,” says Todd Harrison, defense budget studies senior fellow with CSBA. “We can’t keep starting programs that are unrealistic and unaffordable and getting them canceled without getting anything out of it.”

In some ways, that complaint is sound. At least some of these programs suffered troubles made predictable by an acquisition process that often allows overly ambitious projects to break the bank. The Marines’ Expeditionary Fighting Vehicle is an example.

The main problem with this analysis is the implication that the correct acquisition failure rate is zero. Reward rarely comes without risk. Successful enterprises often fail. Apple failed with the Newton. Great base stealers often get thrown out.

Militaries are particularly prone to missteps because of their uncertain environment. Their business is competitive as can be, but the competitions (wars) are rare and thus hard to predict. Platforms last longer than enemies and cutting edge technology. This uncertainty means that programs should often be found wanting and cancelled. The question is not how to build an acquisition system that never fails but the right ratio of success to failure.

CSBA counts $46.4 billion in spending over the past decade on programs that got cancelled before procurement. That’s a big number. But it is a modest failure rate. It’s just 6.3 percent of total RDT&E (Research, Development, Testing and Evaluation) spending in the period, 2.4 percent of total acquisition spending (RDT&E plus procurement) and 2.7 percent of the Pentagon’s ongoing major acquisition programs. You could add percentage point or two in each category by including programs that got cancelled after we bought only a handful, like the DDG-1000 destroyer.

I don’t know what the perfect rate of failure is. But I see no reason why this one is unsustainable, as Harrison says. I actually suspect, for a couple reasons, that the numbers are too low; that the Pentagon should fail more.

First, bad programs often survive thanks to the iron triangle—services bureaucracies that want a new platform, contractors that make it, and Congressmen representing districts where they build. Cancellation shows that the political system can make choices serving the national interest at the expense of parochial ones. Parochialism usually wins.

Second, we foolishly limit competition that would increase cancellations. Our four services largely manage their own procurement, with oversight from feuding officials in two branches. This dispersal of power produces diverse solutions to military challenges. We also launch more acquisition programs than we can afford, encouraging low bids to hide costs that everyone knows are coming. Wealth encourages us to replace manpower with technology, increasing the need for innovation. The natural result of these forces is competition for survival among programs. Contrary to conventional wisdom, that competition is useful. It encourages program managers to outshine rivals on cost and capability.

Rather than harvest this creative destruction, we suppress it. The Pentagon’s culture of jointness quiets public fights where program managers attack rival programs. Fixed budget shares encourage them to cover procurement shortfalls by growing the entire pie, rather than competing. Ever-increasing defense budgets delay reckoning. Embracing competition would produce more innovation and more cancelled programs, which CSBA would call waste.

* Cross-posted on National Defense Magazine’s blog.