In Bootleggers & Baptists: How Economic Forces and Moral Persuasion Interact to Shape Regulatory Politics, economists Bruce Yandle and Adam Smith explain how money and morality are often combined in politics to produce arbitrary regulations benefiting cronies, while constraining productive economic activities by the general public.
The news right now is full of retrospective stories about 2011. Not to be left out, here are a few observations on the real if modest progress made in 2011 to expand the freedom of Americans to trade in the global economy. (I’ll add links along the way to related Cato work.)
After four years of stalemate, this fall Congress passed and President Obama signed legislation implementing three pending free-trade agreements, with South Korea, Colombia, and Panama. When fully implemented, these FTAs will eliminate just about all barriers to trade with three key allies. The U.S. International Trade Commission estimates the three agreements will boost U.S. exports and output by more than $12 billion.
Just as importantly, their passage signals that the two major parties can still work together to promote trade liberalization. Republicans voted overwhelmingly for the agreements, including freshman members connected to the Tea Party movement, and enough Democrats joined in to pass them all by comfortable margins. President Obama, to his credit, found a political path to support the agreements despite the opposition of his labor-union base.
With the passage of the agreements with Panama and Colombia, the Pacific Coast of the Americas has been effectively transformed into a free-trade area. (Ecuador is the lone hold-out.) When combined with NAFTA, CAFTA-DR, and FTAs with Peru and Chile, the United States now has free-trade agreements with neighbors that account for 87 percent of our two-way trade in the Western Hemisphere. The vision of a free trade area of the Americas from the Yukon to Tierra del Fuego has been effectively realized.
2011 also witnessed the United States and Mexico sort out the dispute over cross-border trucking—the last piece of unfinished business from the 1994 North American Free Trade Agreement. Under a pilot program put forward by the Obama administration, safety-certified Mexican trucks can now deliver goods within the United States, and U.S. trucks can do the same in Mexico. Now that the U.S. government is finally complying with its commitments, Mexico lifted sanctions on $2.4 billion of U.S. exports. This is real progress for economic freedom, the rule of law, and showing respect for our 100 million Mexican neighbors.
The United States and eight other Pacific Rim nations made substantial progress in negotiating the Trans-Pacific Partnership, a regional agreement that could bear fruit in 2012 or 2013. Japan, Canada, and Mexico have expressed interest in joining the talks.
Even the hapless World Trade Organization managed a bit of forward progress this year. While the Doha round of talks remains comatose, its 153 members agreed at its ministerial meeting this month in Geneva to admit Russia as a member next year. And a critical mass of its members, including the United States, agreed at the same meeting to open their government procurement to more international competition.
Free trade made progress this year in practice as well as in policy. Through the first three quarters of 2011, American exports of goods and services were up 16 percent compared to the same period in 2010; imports were up 15 percent. Compared to gross domestic product, U.S. exports have reached a record high of 18.8 percent. The ratio of imports to GDP has yet to return to its pre-recession peak, but it is also expanding once again. As government barriers continue to recede, Americans are choosing everyday to trade more and more in the global marketplace.
Our freedom to trade remains less than it should be. The U.S. government continues to impose an array of barriers on trade and investment, including quotas on imported sugar, regressive tariffs on shoes and clothing, unfair and economically damaging anti-dumping duties, and restrictions on foreign investment in media, inter-coastal shipping, and air travel (all of which I describe in Chapter 9 of my 2009 book Mad about Trade). But those can all be resolutions for 2012.
For now, let all of us who favor economic liberty and limited government take due satisfaction in the welcome expansion of our freedom to engage in commerce with our fellow human beings.
The latest example of this process involves the Foreign Account Tax Compliance Act, a piece of legislation that was imposed in 2010 because politicians assumed they could collect lots of tax revenue every single year by getting money from so-called tax havens.
This FATCA law basically imposes a huge regulatory burden on all companies that have international transactions involving the United States, and all foreign financial institutions that want to invest in the United States. It is such a disaster that even the New York Times has taken notice, recently reporting that:
[T]he Foreign Account Tax Compliance Act, or Fatca, as it is known, is now causing alarm among businesses outside the United States that fear they will have to spend billions of dollars a year to meet the greatly increased reporting burdens, starting in 2013. American expatriates also say the new filing demands are daunting and overblown.
…The law demands that virtually every financial firm outside the United States and any foreign company in which Americans are beneficial owners must register with the Internal Revenue Service, check existing accounts in search of Americans and annually declare their compliance. Noncompliance would be punished with a withholding charge of up to 30 percent on any income and capital payments the company gets from the United States.
…The I.R.S., under pressure from angry and confused financial officials abroad, has extended the deadline for registration until June 30, 2013, and is struggling to provide more detailed guidance by the end of this year. But beginning in 2012, many American expatriates — already the only developed-nation citizens subject to double taxation from their home government — must furnish the I.R.S. with detailed personal information on their overseas assets.
But as is so often the case with politicians, they chose not to fix bad policy and instead decided to impose one bad policy on top of another. Hence, the crowd in Washington enacted FATCA and sent the IRS on a jihad.
By the way, the New York Times was late to the party. Many other news outlets already have noticed that the United States is about to suffer a big self-inflicted economic wound.
Indeed, what’s remarkable about Obama’s FATCA policy is that the world in now united. But it’s not united for something big and noble, such as peace, commerce, prosperity, or human rights. Instead, it’s united in opposition to intrusive, misguided, and foolish American tax law.
Let’s look at some examples.
* From the United Kingdom, a Financial Times column warns, “This summer, the senior management of one of Asia’s largest financial groups is quietly mulling a potentially explosive question: could it organise some of its subsidiaries so that they could stop handling all US Treasury bonds? …What is worrying this particular Asian financial group is … a new law called the Foreign Account Tax Compliance Act… [T]he new rules leave some financial officials fuming in places such as Australia, Canada, Germany, Hong Kong and Singapore. Little wonder. Never mind the fact that implementing these measures is likely to be costly. …Hence the fact that some non-US asset managers and banking groups are debating whether they could simply ignore Fatca by creating subsidiaries that never touch US assets at all. “This is complete madness for the US – America needs global investors to buy its bonds,” fumes one bank manager. “But not holding US assets might turn out to be the easiest thing for us to do.”
* From India, the Economic Times reports, “FATCA, or the Foreign Account Tax Compliance Act, will require overseas banks to report U.S. clients to the Internal Revenue Service, but its loose definition of who is a U.S. citizen will create a huge administrative burden and could push non-residents to slash their U.S. exposure, some bankers say. …Bankers say the scheme will be extremely costly to implement, and some say that as the legislation stands, any bank with a client judged to be a U.S. citizen will be also obliged to supply documentation on all other clients. ‘FATCA will cost 10 times to the banks than it will generate for the IRS. It is going to be extremely complicated,’ said Yves Mirabaud, managing partner at Mirabaud & Cie and Swiss Bankers Association board member.”
* Discussing the impact in Canada, Reuters notes, “The new regulation has drawn criticism from the world’s banks and business people about its reach and costs. …’Hundreds of millions of dollars spent on developing compliance processes to target Canadian citizens would not be a useful exercise, and they are, for the most part, people who actually have no tax liabilities because they do not earn income in the United States,’ [Canadian Finance Minister] Flaherty said.”
* A Taiwan news outlet said, “Taiwan’s domestic banks will reportedly reduce holdings of American bonds worth an estimated NT$100 billion (US$3.33 billion) due to the U.S. government’s recent decision to impose 30% tax on foreign-investment income in U.S. securities as bonds. Taiwan’s eight government-linked banks reportedly hold U.S. financial products worth over US$2 billion… On April 8, 2011, the U.S. government issued a notice advising foreign financial institutions to meet certain obligations under the Foreign Account Tax Compliance Act (FATCA), under which foreign financial institutions are subject to complex reporting rules related to their U.S. accounts.”
* From the Persian Gulf, the Bahrain Daily News noted, “A US law … has drawn the criticism of the world’s banks and business people, who dismiss it as imperialist and ‘the neutron bomb of the global financial system.’ The unusually broad regulation, known as FATCA, or the Foreign Account Tax Compliance Act, makes the world’s financial institutions something of an extension of the tax-collecting Internal Revenue Service—something no other country does for its tax regime. …Even the European Commission has objected, and experts say other countries may create their own FATCA-style regimes for US banks or withdraw from US capital markets. In a barrage of letters to the Treasury, IRS and Congress, opponents from Australia to Switzerland to Hong Kong assail FATCA’s application to a broad swath of institutions and entities.”
* A story from Singapore finds, “For many years, thousands of foreign investors have put their money into American shares or other investments. Now, however, a somewhat obscure law called the Foreign Account Tax Compliance Act (FATCA) may make investments in the United States for everyone, from billionaires to the man on the street, here in Singapore far less attractive. …[S]ome banks or investment managers may advise customers not to invest in the US. … ‘[P]rivate bankers are publicly advising their clients to clear their portfolios of all US securities’. A fund manager here told me his company is also advising clients to avoid US investments, and other companies may similarly start telling large clients as well as smaller ones the same story. Investors could then see recommendations not to invest in the US, and they may put their money elsewhere. …As consulting firm PwC said, ‘some institutions could decide that complying with the due diligence and verification provisions may not be cost effective’ so they may stop making investments in the US. Banks or other asset managers may similarly decide it is easier not to offer US investments than to try and comply with the FATCA.”
o From Switzerland, a story “about the backlash from United States expats and the financial sector to the Foreign Account Tax Compliance Act (FATCA)” reports that, “Growing numbers of American expatriates are renouncing their US citizenship over a controversial new tax law and ever more burdensome fiscal and reporting obligations. …[B]anks and business people who are supposed to enforce it on behalf of the US tax man are worried about its costly administrative burden… [I]t’s just too expensive. The consequence will be that they cut out US clients and stop investing in the US. …Three or four years ago no one talked about renouncing nationality – now it’s an open discussion. That’s a major shift in mentality.
o Writing about the reaction from Europe, one columnist noted, “FATCA encourages foreign financial institutions to limit their exposure to U.S. assets. In a joint letter to the Treasury and the IRS, the European Banking Federation and the Institute of International Bankers, which together represent most of the non-U.S. banks and securities firms that would be affected by FATCA, warned that ‘many [foreign financial institutions], particularly smaller ones or those with minimal U.S. investments or U.S. customers, will opt out of U.S. securities rather than enter into a direct contractual agreement with a foreign tax authority (the IRS) that imposes substantial new obligations and the significant reputational, regulatory, and financial risks of potentially failing those obligations.’ A widespread divestment of U.S. securities by institutions seeking to avoid the burdens of FATCA could have real and harmful effects on the U.S. economy.”
These press excerpts help demonstrate the costs of FATCA, but what about the benefits? After all, maybe the law will lead to lots of good results that offset the high regulatory costs and lost investment for the American economy.
Well, the only “benefit” anybody had identified is that FATCA will transfer more money from the productive sector of the economy to the government. Indeed, Obama argued during the 2008 campaign that cracking down on “tax havens” with proposals such as FATCA would give politicians lots of additional money to spend.
But when the legislation was approved in 2010, the Joint Committee on Taxation estimated that the new law would raise only $8.7 billion over 10 years, not the $100 billion that Obama claimed could be collected every single year. This video has some of the damning details.
One final point demands attention:
While it appears that the rest of the world is against FATCA, that’s not completely true. Some international bureaucrats in Paris, funded by American tax dollars, actually want the rest of the world to adopt the same Orwellian system. Here’s a blurb from the New York Times story:
Jeffrey Owens, a tax expert at the Organization for Economic Cooperation and Development, said catching tax evaders was “a concern that many member countries share.” If countries could agree to new global reporting standards for exchanging information, he said, then “maybe there’s a way forward.”
In other words, the pinhead bureaucrats at the OECD think FATCA’s such a swell idea that they want to create a global network of tax police. So not only would America erode the sovereignty of other nations because of our bad tax law, but those other nations would be able to impose their bad tax law on income earned in America!
And just in case you think that’s just irresponsible demagoguery, it’s already beginning to happen. Check out this IRS regulation, proposed by the Obama administration, that would require American banks to put foreign law above American law.
Over at Downsizing the Federal Government, Chris Edwards and I have regularly complained that most policymakers have been insufficiently specific when it comes to identifying spending cuts. With the Republican primaries about to get underway, it’s a good time to see what the current crop of presidential aspirants has to offer.
There are multiple ways to skin this cat, but I decided to put together a comparison table based solely on the content found on each candidate’s campaign website. I did not consider past statements or votes, the televised debates, or outside sources (unless linked to by a campaign’s website). The idea is that statements on each candidate’s website should offer the clearest indication of their intentions should they become president.
Ron Paul is the only candidate who actually produced a proposed federal budget. Therefore, I started with his template and added additional agencies/programs cited on the websites of the other candidates. Again, the idea is to show specifically what the candidates are proposing to cut. Thus, proposed spending reforms such as a Balanced Budget Amendment or a spending cap are not included.
There is a degree of subjectivity in putting this together, but I tried to be fair and consistent. It is for informational purposes only (i.e., it should not be construed as an endorsement of any candidate(s)). Finally, it is possible that proposals were missed, but that could be a reflection of a website’s accessibility to pertinent information.
The following are brief overviews for each candidate (in alphabetical order):
Bachmann says she “supports abolishing the federal Environmental Protection Agency and Department of Education.” However, she does not say if all of those agencies’ functions would be abolished.
Bachmann says she “voted for the Ryan Plan to make sure that Medicare is secure for future generations” but that “the Ryan Plan is just the very first step on health reform, and I voted for it with an asterisk with further reforms in mind.”
Bachmann’s statements on foreign policy portend increased military spending.
The number of specific spending cuts on Bachmann’s website is paltry and it’s evident that she supports increased military spending given her hawkish statements on foreign policy.
Gingrich supports federal subsidies for agriculture and energy, but says that most of the Department of Education’s “responsibilities and positions will be eliminated.”
On the issue of foreign policy, Gingrich says “Think Big.” Gingrich’s statements on foreign policy portend increased military spending.
Gingrich offers a 49-page white paper on entitlement and welfare reform. Proposed reforms to Social Security include personal savings accounts. Medicare reforms include providing premium support for the purchase of private health insurance. Medicaid would “ideally” be block-granted to the states. In addition, the paper lists 184 federal means-tested programs that would be block granted.
Gingrich’s website provides a lot of information, but his spending proposals are a mixed-bag. He is heavy on ideas and reforms, but it appears that the federal government’s hand would also remain heavy. In addition, the budgetary effects of Gingrich’s proposals are murky. For instance, he proposes to replace the Environmental Protection Agency with a “pro-growth” Environmental Solutions Agency. Jon Huntsman
In an op-ed linked from his website, Huntsman appears to endorse ending “unaffordable subsidies for agriculture and energy.” The website also says that Huntsman will “adopt a comprehensive energy strategy that frees us from foreign oil, that eliminates all energy subsidies, and that levels the playing field for competing fuels and technologies.”
Huntsman says that he “will reform entitlement programs – based on the Ryan Plan – while holding true to our nation’s commitments to those in or near retirement.” It is not clear what reforms to Social Security he would embrace.
Huntsman’s statements on military spending and foreign policy are more reserved than the hawkish tenor exhibited by the rest of the field – Ron Paul and Gary Johnson excluded.
Huntsman doesn’t offer much when it comes to specific spending cuts. The absence of specifics and details leaves a lot of question marks. Huntsman does not propose any spending increases and his relatively reserved views on foreign policy indicate that military spending cuts could be possible.
Johnson calls for repealing the Medicare prescription drug benefit and block-granting the entire program – along with Medicaid – to the states. On Social Security, he only proposes to “fix Social Security by changing the escalator from being based on wage growth to inflation.”
Johnson says the government should “stop spending on the fiscal stimulus, transportation, energy, housing, and all other special interests.” He also proposes to “reduce or eliminate federal involvement in education” and end “unnecessary farm subsidies.” And Johnson’s proposal to rein in the failed “war on drugs” would generate savings at the Department of Homeland Security.
Johnson proposes to bring the troops home from Afghanistan and an end to nation-building. He clearly envisions a less interventionist foreign policy, which should translate into reduced military spending.
Johnson embraces a sizable reduction in the scope of the federal government’s activities, but more details and elaboration would be helpful – especially on entitlement programs. Johnson’s intentions on foreign policy are best encapsulated by his statement that “it’s time to recognize that you can’t have limited government at home, but big government abroad.” Overall, Johnson’s spending proposals reflect a vision for a federal government more limited in size and scope.
Paul’s “Plan to Restore America” would eliminate the departments of Commerce, Education, Energy, Housing & Urban Development, and Interior. Numerous agencies and programs would be eliminated or cut.
Paul supports allowing younger people to opt-out of Social Security and Medicare. Medicaid and other mandatory programs like food stamps would be block-granted to the states. Funding would be cut and froze. Further elaboration on his ideas for Social Security and Medicare would be helpful.
Paul proposes to end all foreign aid. Military spending cuts would be achieved by bringing troops home from overseas and pursuing a non-interventionist foreign policy.
When it comes to proposing specific spending cuts and identifying the dollars amounts, Paul’s website is unrivaled. He is the only candidate to put together an actual budget proposal. Paul’s spending proposals would amount to the largest reduction in the size and scope of the federal government of any candidate.
Perry proposes to eliminate the departments of Commerce, Education, and Energy. However, he is not proposing that all of the functions contained within those departments be eliminated. For example, Perry proposes “block-granting all funding for elementary and secondary education,” which means federal taxpayers would still be on the hook.
Perry’s proposals on entitlements are consistent with the GOP field. Proposed Social Security reforms include the creation of personal retirement accounts for younger workers. He would block-grant Medicaid to the states and Medicare would be “reformed” to be “sustainable for the long-term.”
In comparison to economic issues, Perry has relatively little to say on foreign policy. Although Perry does not strike the hawkish tone of other GOP candidates, there’s nothing on his website to suggest that he’ll rein in military spending.
Like Gingrich, Perry’s website contains a healthy amount of content. Perry deserves credit for offering specific spending cuts and elaborating on why he believes those cuts would be prudent. However, unlike Paul, Perry proposes to eliminate departments without also eliminating the functions contained within them. And unlike Johnson and Paul, Perry does not embrace a reduced U.S. military presence abroad, which implies that he would not rein in military spending.
Romney’s “Plan for Jobs and Economic Growth” is 87 pages long. Nine pages are devoted to fiscal policy. Those nine pages don’t offer much in the way of specific spending cuts. Romney does suggest some good cuts, but they are not large in budgetary terms.
When it comes to entitlements, Romney has virtually nothing to say on Social Security. He does propose block-granting Medicaid to the states. On Medicare, Romney says “the plan put forward by Congressman Paul Ryan makes important strides in the right direction by keeping the system solvent and introducing market-based dynamics.” Romney then says that his “own plan will differ, but it will share those objectives.”
Despite the fact that Romney’s website offers a lot of content, he doesn’t offer many specifics when it comes to spending. The spending cuts that Romney does specify are not easily found on his website. They are also relatively small cuts that would have little effect on the size and scope of the federal government. It’s also evident that Romney supports increased military spending.
Santorum’s website doesn’t offer many details or elaboration, but he does list a number of proposals to cut spending. For example, he proposes to “eliminate all agriculture and energy subsidies within four years letting the markets work.”
Santorum’s proposals for entitlement programs are vague: “reform Social Security and Medicare for sustainable retirements.” However, he does allude to having supported private retirement accounts in the past. He also proposes to “block grant Medicaid, Housing, Job Training, and other social services to the States.”
Santorum’s statements on foreign policy – arguably the most hawkish of the candidates – clearly indicate that he favors increases in military spending.
Santorum’s statements on foreign policy put him at odds with Johnson’s view that “you can’t have limited government at home, but big government abroad.” However, he does suggest broad spending cuts – although more details and elaboration would be helpful.
The New York Times editorializes that if Ron Paul can’t separate himself from his unsavory writings and supporters, “he will leave a lasting stain on his candidacy, on the libertarian movement and, very possibly, on the Iowa caucuses.” Certainly it’s a problem Paul is struggling to deal with. As for the Iowa caucuses, if they could survive strong votes for Pat Robertson and Pat Buchanan and an actual win for Mike Huckabee, I dare say they can survive Ron Paul. But should these things “stain … the libertarian movement”? Not in a rational world.
Libertarianism is a philosophy of peace, freedom, toleration, and individual rights – just the opposite of the collectivist racist and homophobic ideas that appeared in newsletters written under Ron Paul’s signature. As I wrote in Libertarianism: A Primer, “Libertarianism is the view that each person has the right to live his life in any way he chooses so long as he respects the equal rights of others.” Those ideas have played an important role throughout American history, from the American Revolution to abolitionism to the Tea Party.
And now Ron Paul is attracting support for his advocacy of the ideas of small government and free enterprise. As the Times notes in a dispatch from Iowa, Paul “is drawing supporters for his libertarian and antiwar views. …For the students, much of Mr. Paul’s appeal derives from civil libertarian views like ending the federal ban on marijuana and other drugs, as well as his desire to end foreign wars and his small-government credo.” That’s the message that has moved Ron Paul to the top of the polls in Iowa.
Still, he did allow associates of his to write racist and homophobic screeds in “The Ron Paul Political Report” and other newsletters. And that has created a stench around his candidacy. Some people want that stench to envelop and stain the libertarian movement. Jamie Kirchick, the anti-Paul jihadi who brought the newsletters to light in 2008, asks, “Why Don’t Libertarians Care About Ron Paul’s Bigoted Newsletters?” But of course many libertarians have expressed revulsion at the newsletters. Ilya Somin noted at the Volokh Conspiracy (one of the few conspiracies not denounced in the Ron Paul newsletters) that he himself had condemned the newsletters in 2008, as had his co-blogger David Bernstein. And Virginia Postrel, the former editor of Reason, and various current writers at Reason. And a leading Austrian economist, Steven Horwitz. And Ed Crane, the founder and president of Cato.
Kirchick identified Conor Friedersdorf of the Atlantic as a libertarian who supported Ron Paul despite the bigotry in the newsletters that bore his name. But in fact Friedersdorf wrote a long and tortured article acknowledging the “egregiously offensive … racially bigoted … execrable” content of the newsletters. He went on to say that there was still a good case for supporting the only candidate who has consistently opposed the Iraq War, indefinite detention, drone strikes, anti-Muslim bigotry, and the war on drugs. Other libertarians who know about the newsletters are no doubt making similar calculations. And as David Weigel of Slatenotes today, many less-engaged voters – such as American Idol winner Kelly Clarkson – still haven’t heard about the whole issue; they like Ron Paul for the issues he talks about, smaller government, budget cuts, sound money, and noninterventionism.
Those words are not libertarian words. Maybe they reflect “paleoconservative” ideas, though they’re not the language of Burke or even Kirk. But libertarianism is a philosophy of individualism, tolerance, and liberty. As Ayn Rand wrote, “Racism is the lowest, most crudely primitive form of collectivism.” Making sweeping, bigoted claims about all blacks, all homosexuals, or any other group is indeed a crudely primitive collectivism.
Libertarians should make it clear that the people who wrote those things are not our comrades, not part of our movement, not part of the tradition of John Locke, Adam Smith, John Stuart Mill, William Lloyd Garrison, Frederick Douglass, Ludwig von Mises, F. A. Hayek, Ayn Rand, Milton Friedman, and Robert Nozick. Shame on them.
The fact is, there’s a small band of self-styled “libertarians” who over the past two decades have associated the great ideas of Austrian economics and libertarianism with bigotry, reflexive anti-Americanism, and vitriol directed at everyone from the Trilateral Commission to Cato and Reason. They have very little association with the larger libertarian movement or with such libertarian-inspired movements as the Tea Party, the drug reform movement, or the school choice movement. Virtually their only point of contact with the broader constituency for smaller government is through Rep. Ron Paul, who, for whatever reasons, has unfortunately continued his association with the people who have tarred him and the causes that are drawing many voters to him.
Libertarians have been fighting ignorance, superstition, privilege, and power for centuries, and we will continue to do so in the future. Libertarians reject bigotry and advocate equal rights for every individual. Ron Paul’s very bad decision to outsource his writing to reprehensible characters doesn’t change that.
I analogized to the World Wide Web. The structure that allows you to find and then view a blog post as a blog post is called hypertext markup language, or html. HTML is what made the Internet into the huge, rollicking information machine you see today. Think of the darkness we lived in before we had it.
Government information is not yet published in useable formats—as data—for the public to use as it sees fit. We need government information published as data, so we can connect it in new ways, the way the World Wide Web allowed connections among documents, images, and sounds.
And when you connect data together, you get power in a way that doesn’t happen with the web, with documents. You get this really huge power out of it.
Tim Berners-Lee was not thinking of wresting power from government when he said that, but the inventor of the World Web does a better job than I could of arguing for getting data and making it available for any use. We’ll look back on today with bemusement and surprise at the paucity of information we had about our government’s activities and expenditures.
Two Cato scholars have offered devastating critiques of the Federal Reserve in the op-ed pages of the Wall Street Journal over the last two days.
This morning, in “The Fed’s Mission Impossible,” adjunct scholar John Cochrane takes a look at the latest list of bank regulations under Dodd-Frank. Although the proposal “opens with an eloquent ode to the evils of too-big-to-fail,” he writes, it then “spends 168 pages describing exactly how it’s going to stop any large financial institution from ever failing again.”
According to Cochrane, the proposal “exemplifies” the core problem withWashington’s heavy hand: “Everything under the sun gets regulated, with no attempt to measure benefits or costs.” This scenario, of course, is nothing new:
For 70 years, our government has sought to stop crises by guaranteeing more and more debts, explicitly with deposit insurance, or informally with predictable too-big-to-fail bailouts. Guaranteeing debts gives obvious incentives to gamble at taxpayer expense, so we try to limit risks with regulation. But big banks still have every incentive to avoid, evade and financial-engineer their way around the rules, and they have lots of lawyers, lobbyists and ex-politicians to pressure regulators to use their wide discretion. The government has lost this arms race time and time again.
Unfortunately, it seems to be taking this arms race across the Atlantic. Yesterday, in “The Federal Reserve’s Covert Bailout of Europe,” Cato senior fellow Gerald P. O’Driscoll, Jr., examined the Fed’s bailout of European banks through what is called “a temporary U.S. dollar liquidity swap arrangement”—an operation that has gone “largely unnoticed here.” O’Driscoll explains:
Simply put, the Fed trades or “swaps” dollars for euros. The Fed is compensated by payment of an interest rate (currently 50 basis points, or one-half of 1%) above the overnight index swap rate. The ECB, which guarantees to return the dollars at an exchange rate fixed at the time the original swap is made, then lends the dollars to European banks of its choosing.
Why are the two central banks doing this? O’Driscoll explains that they are engaged in this “Byzantine financial arrangement” because “each needs a fig leaf” for past transgressions:
The Fed was embarrassed by the revelations of its prior largess with foreign banks. It does not want the debt of foreign banks on its books. A currency swap with the ECB is not technically a loan.
The ECB is entangled in an even bigger legal and political mess. What the heads of many European governments want is for the ECB to bail them out. The central bank and some European governments say that it cannot constitutionally do that. The ECB would also prefer not to create boatloads of new euros, since it wants to keep its reputation as an inflation-fighter intact. To mitigate its euro lending, it borrows dollars to lend them to its banks. That keeps the supply of new euros down. This lending replaces dollar funding from U.S. banks and money-market institutions that are curtailing their lending to European banks—which need the dollars to finance trade, among other activities. Meanwhile, European governments pressure the banks to purchase still more sovereign debt.
Recently Cato scholars Lawrence H. White and George Selgin asked, “Has the Fed Been a Failure?” Read much more on the Federal Reserve and monetary policy here.
I take some pride, but little satisfaction, from having tried to fix several of the systemic flaws that ultimately led to the financial crisis. I also was fortunate to spend that time serving under Senate Banking Committee leadership that was more often right than wrong. But I’m only human and did miss a few things. In the spirit of the new year, here is my, far from exhaustive, list of things I missed:
1. The extent of house price declines. While I never bought the housing industry line “prices never go down”, my sense back in 2005 was that we’d see something like a 10 to 15 percent decline. It was well known before the bubble that inflation-adjusted home prices have declined nationally on several occasions.
2. Growth of strategic default. In previous housing busts, the percent of borrowers who simply walked away only because of their negative equity position was small. Boston Fed economists have estimated 6% during the last bust. We are likely between 20 and 30% this time around.
3. There’s no substitute for a downpayment. I served as the primary drafter of the American Dream Downpayment Act. While small in impact, it did offer an experiment in downpayment assistance. Its results have not been good in my view. That bill was a mistake.
4. Bailouts for everyone. Don’t believe the spin, the rescues of AIG, Bear, Fannie, Freddie, the autos were all bailouts of choice. While I had serious reservations about Paulson, Bernanke and Geithner, I underestimated their willingness to just throw money at every problem. Accordingly I now have far less trust in the discretion of regulators (not that I had much before).
5. Receivership doesn’t end too-big-to-fail. The primary reason that Democrats, and some Republicans, opposed GSE reform beginning in 2004 was over the creation of a receivership (bankruptcy) mechanism for Fannie/Freddie. Such a mechanism was finally put into place in July 2008. It was ignored and the GSEs were rescued. It is partly for this reason that I don’t see the receivership authority in Dodd-Frank as very credible. If we won’t wind down Fannie, why would we wind down Citi.
6. GSE role in the re-po market. While banks regulators did nothing to reduce the exposure of the banking system to GSE debt, they at least knew about it. What was less understood was that about a third of the collateral in the overnight re-purchase market (called by some “shadow-banking”) was GSE debt. When hair-cuts on GSE debt expanded in 2008, liquidity in the re-po market contracted.
7. Level of Pure Speculation in the Housing Market. Setting aside that every home purchase entails a degree of speculation, the amount of pure investor sales as a percent of single family home sales turns out to be about double what I had thought back in 2005-06.
Obviously this doesn’t cover the things that caused the crisis which I did see coming. And perhaps an even bigger surprise to me was the degree during, and since, the crisis that many continue to hold onto certain beliefs even in the face of compelling evidence otherwise. For instance, it seemed clear to me as early as 2007 that “exploding adjustable rate mortgages” were not the primary driver of default. Anyway, we could all use a little more modesty when it comes to discussing the financial crisis.