Tag: finance

Crazy Law Allows “Discounts” for Cash but Not “Surcharges” for Credit

In Federalist 10, James Madison warned of “a number of citizens, whether amounting to a majority or minority of the whole, who are united and actuated by some common impulse of passion, or of interest, adverse to the rights of other citizens or to the permanent and aggregate interests of the community.” These groups—“factions” in Madison’s terms—come together to seek concentrated benefits from favorable legislation and regulation rather than competing in the marketplace, while spreading the costs throughout society.

While Madison conceded that such interests could not be stopped completely, he acknowledged that certain steps could be taken to mitigate the “effects” of these groups, and the damage that they can do to the public interest. The First Amendment is one such protection. The New York legislature, however, ignored the First Amendment rights of both merchants and consumers when—at the behest of the credit-card lobby—it passed a law restricting how retailers can convey pricing schemes, as well as the public’s right to know about them. 

New York’s no-surcharge law—like those in 10 other states—insulate credit-card companies from consumer knowledge about who is actually causing the higher prices on goods when they use their credit card (“swipe fees”). The law does this not by restricting the merchants’ ability to charge different prices as between cash and credit payments—that’s legal everywhere—but by regulating the communications regarding the different prices.

To put it simply: the law allows merchants to offer “discounts” to cash-paying customers, but makes it a crime to impose economically equivalent “surcharges” on those who use plastic. By mandating how these merchants convey their pricing structure, New York is restricting speech on the basis of its content, which would seem to be an obvious First Amendment violation.

A federal district court agreed—as have two other federal courts, including the U.S. Court of Appeals for the Eleventh Circuit when it struck down a similar Florida law. The district court held that the law “plainly regulates speech”—not conduct—by drawing a line between prohibited “surcharges” and permissible “discounts” based solely on words and labels. The Second Circuit disagreed, however, holding that the law regulates “merely prices,” not speech.

Cato has now filed an amicus brief urging the Supreme Court to take up this important case and rule that collusion between business interests and state government can’t be used to circumvent constitutional rights. Indeed, the Framers sought to protect speech from the type of crony capitalism New York’s no-surcharge law manifests. We also argue that the Court should clarify that the First Amendment covers speech even if it involves commercial matters. When legislatures abridge these protections, judges should apply the highest form of scrutiny to these laws rather than limply deferring to majoritarian will. 

The Supreme Court will decide later this month, or possibly this fall, whether to take up Expressions Hair Design v. Scheniderman.

Thanks to former Cato legal intern Frank Garrison, who’ll be starting as a legal associate later this summer, for help with this brief.

Financial Transaction Tax Would Be Damaging

An editorial in today’s New York Times calls for a financial transactions tax – a tenths of a percent charge on the market value of every trade of a stock, bond, or derivative. My Working Papers column two years ago described the pitfalls of such a tax.  While tax rates in the range of tenths of a percent sound small they would have large effects on stock values.  Bid-ask spreads are now 1 cent for large cap stocks. A 0.10 percent tax would add 5 cents to the spread for a $50 stock.

The alleged purpose of such a tax is to reduce the arms race among High Frequency Traders who exploit differences in the timing of bids and offers across exchanges at the level of thousandths of a second to engage in price arbitrage.  In the Fall 2015 issue I review a paper that demonstrates that this arms race is the result of stock exchanges’ use of “continuous-limit-order-book” design (that is, orders are taken continuously and placed when the asset reaches the order’s stipulated price). The authors use actual trading data to show that the prices of two securities that track the S&P 500 are perfectly correlated at the level of hour and minute, but at the 10 and 1 millisecond level, the correlation breaks down to provide for mechanical arbitrage opportunities even in a perfectly symmetrical information environment.  In a “frequent batch” auction design (where trades are executed, by auction, at stipulated times that can be as little as a fraction of a second apart), the advantage of incremental speed improvements disappears. In order to end the arbitrage “arms race,” the authors propose that exchanges switch to batch auctions conducted every tenth of a second.  No need for a tax.      

Americans Underestimate Government School Spending

In addition to showing that American parents favor educational choice and are skeptical of Common Core, the new national survey on education policy from the Friedman Foundation demonstrates that Americans still vastly underestimate how much is spent per pupil at government-run schools. 

According to the latest National Center for Education Statistics data, the average total per pupil expenditure in U.S. public schools was $12,136 in the 2009-10 school year. However, 63 percent of respondents thought that government schools spend less than $12,000 per pupil, including 49 percent who estimated that they spend less than $8,000 per pupil. Those findings are consistent with the 2013 Education Next survey, in which the average guess was $6,680 per pupil, barely more than half of what is actually spent.

Like the Education Next survey, the Friedman survey asked respondents whether they thought public school spending was too high, about right, or too low, after first randomly assigning the respondents into two groups: one that first heard a prompt explaining that the average U.S. public school spends $10,658 per pupil (this is average operating expenditure per pupil), while the other group was not given any prompt. Whereas 56 percent of the uninformed group thought spending was too low, only 47 percent of the informed group agreed. (It’s likely that the shift would have been even more pronounced had the Friedman Foundation cited the higher total per pupil expenditures in the prompt rather than the partial figure. Indeed, a previous Friedman survey found that the public prefers to know the total figure.) Those findings are consistent with the 2013 Education Next survey, which found that 63 percent of uninformed respondents wanted to increase public school spending but only 43 percent of informed respondents agreed.

At an American Enterprise Institute event discussing the findings, AEI’s Ramesh Ponnuru observed that politicians could loudly promise to spend $9,000 per pupil and most voters would think that they were calling for an increase in school funding rather than a significant cut.

Osborne Risks a Triple-Dip for the UK

U.K. Chancellor of the Exchequer George Osborne has resumed his saber-rattling over raising capital requirements for British banks. Most recently, Osborne has fixated on alleged problems with banks’ risk-weighting metrics that, according to him, have left banks undercapitalized. Regardless of Osborne’s rationale, this is just the latest wave in a five-year assault on the U.K. banking system – one which has had disastrous effects on the country’s money supply. The initial rounds of capital hikes took their toll on the British economy – in the form of a double-dip recession. Now, Osborne appears poised to light the fuse on a triple-dip recession.

Even before the Conservative, Osborne, took the reins of Her Majesty’s Treasury, hiking capital requirements on banks was in vogue among British regulators. Indeed, it was under Gordon Brown’s Labour government, in late 2007, that this wrong-headed idea took off.

In the aftermath of his government’s bungling of the Northern Rock crisis, Gordon Brown – along with his fellow members of the political chattering classes in the U.K. – turned his crosshairs on the banks, touting “recapitalization” as the only way to make banks “safer” and prevent future bailouts.

It turns out that Mr. Brown attracted many like-minded souls, including the central bankers who endorsed Basel III, which mandates higher capital-asset ratios for banks. In response to Basel III, banks have shrunk their loan books and dramatically increased their cash and government securities positions, which are viewed under Basel as “risk-free,” requiring no capital backing. By contrast, loans, mortgages, etc. are “risk-weighted” – meaning banks are required by law to back them with capital. This makes risk-weighted assets more “expensive” for a bank to hold on its balance sheet, giving banks an incentive to lend less as capital requirements are increased. 

Five years later, Osborne is attempting to ratchet up the weights on these assets. Indeed, he is taking another whack at banks’ balance sheets – and the result will be the same as when the U.K. Financial Services Authority first took aim at the banking system (under Gordon Brown). As the accompanying chart shows, the first round of capital requirement hikes (in 2008) dealt a devastating blow to the U.K. money supply. Indeed, it tightened the noose on the supply of bank money – the portion of the total money supply produced by the banking system, through deposit creation.

Not surprisingly, this sent the British economy spiraling into its first recessionary dip. The second hit to the money supply came shortly after the Bank for International Settlements announced the imposition of capital hikes under the Basel III accords, in October 2010. Despite numerous infusions of state money (reserve money) via the Bank of England’s quantitative easing schemes, these first two squeezes on bank money have put the squeeze on the U.K.’s total money supply.

This is the case because state money makes up only 16.3% of the U.K.’s total money supply. The remaining 83.7% of the money supply is made up of bank money. In consequence, the Bank of England would have to undertake a massive expansion of state money, via quantitative easing, to offset the U.K.’s bank money squeeze.

It is doubtful, however, that the British pound sterling would be able to withstand such a move. Indeed, there are more storm clouds brewing over Threadneedle Street. The sterling recently touched a 15-month low against the euro, and it has fallen 8% against the euro since late July. For the time being, at least, the pound’s tenuous position will likely put a constraint on any further significant expansion of state money, through quantitative easing. It appears markets simply wouldn’t tolerate it.

Accordingly, the only viable option to jumpstart the faltering U.K. economy is to release the banking system from the grips of the government-imposed bank-money squeeze. Alas, Osborne’s most recent initiative on bank recapitalization goes in exactly the wrong direction.

Congressional Insider Trading: Is It Legal?

Washington has been buzzing for the past 48 hours over revelations that some of Capitol Hill’s best-known lawmakers have been making fortunes speculating in the stocks of companies affected by official actions, typically while in possession of market-moving inside information. Rep. John Boehner (R-OH), Senatorial wife Teresa Kerry and others made bundles trading in health companies’ stocks shortly before Congressional or executive-branch action affecting the companies’ fortunes. After closed-door 2008 meetings in which Fed chairman Ben Bernanke briefed Congress on the gravity of the financial collapse, some lawmakers dumped their own stockholdings or even placed bets that the market would fall. Rep. Nancy Pelosi (D-CA) got access to highly desirable IPO (initial public offering) stock placements, some in companies with business before Congress. And so on. Studies have found that lawmakers as a group reap far above-average returns on their investments—suggesting either that these politicians are among the world’s cleverest investors, or else that they are profiting from inside information. All this has been turned into a front-page issue thanks to Throw Them All Out, a book by Hoover fellow Peter Schweizer, whose findings were showcased the other night on 60 Minutes.

So the question is: is all this legal? While there’s some difference of opinion on the issue among law professors, the proper answer to that question is most likely going to be, “Yes, it’s legal.” As UCLA’s Stephen Bainbridge points out, existing insider trading law, developed by way of a long series of contested cases under the Securities and Exchange Commission’s Rule 10b-5, assigns liability to persons who are not corporate insiders if they are violating a recognized duty of loyalty to those for whom they work. As applied to the investment whizzes of the Hill, this implies that trading on inside information might be a violation if done by Congressional staffers (since they owe a duty of loyalty to higher-ups) but not when done by members of Congress themselves.

It is tempting to approach the new revelations the way an ambitious prosecutor might, trying to stitch together a test-case indictment from, say, the penumbra of the mail and wire fraud statutes bulked up with a bit of newly hypothesized fiduciary duty here and a little “honest services” there. But that’s not how criminal law is supposed to work: for the sake of all of our liberties, prohibited behavior needs to be clearly marked out as prohibited in advance, not afterward once we realize it doesn’t pass a smell test. But we are still free to deplore the hypocrisy of a Congress that has long been content to criminalize for the private sector—often with stiff jail sentences—behavior not much different from what lawmakers are happy to engage in themselves.

Do We Need China to Fund Our Mortgage Market?

Earlier this week I repeatedly heard the claim that if the federal government does not guarantee credit risk in the mortgage market, foreigners won’t buy U.S. mortgage-related debt.  Before we test whether that claim is true, let’s first determine just how important are foreign investors in the U.S. mortgage market.

For the most part, foreign investors do not hold U.S. mortgages directly, but either hold Fannie and Freddie debt and mortgage-backed securities (MBS) or hold private-label MBS.  As the private-label securities lack a government guarantee, we can ignore that segment of the market.  The chart below depicts the percentage share of foreign ownership of these securities in recent years:

The chart illustrates that, at times (particularly around the peak of the recent housing bubble), foreign investors have been large providers of capital to the GSEs.  In 2007, over 20% of GSE debt was held outside the United States, double the percentage from only a few years earlier.  The increase was driven almost exclusively by purchases by foreign governments (mostly central banks for the purpose of currency manipulation).  In 2007, this amounted to just over $1.5 trillion. 

However, if we went back and looked at a year prior to the super-heated housing market — say 2003 — then this total is about $650 billion.  Given that U.S. commercial banks now have about $1 trillion in cash sitting on their balance sheets, it appears that domestic sources could completely fund the U.S. mortgage market without any foreign funds.

But let’s say we want to keep the option of living beyond our means and have the rest of the world fund a large part of our mortgage market.  Would they?  Given that foreign investors currently hold over $5.4 trillion in U.S. corporate bonds and equities (not all guaranteed by the U.S. taxpayer), I think it’s fair to assume that these foreign investors have some appetite for U.S.  assets. 

Now does that mean foreigners would buy the debt of massively leveraged, mismanaged mortgage companies subject to constant political-cronyism, without some guarantee?  Probably not.  But then, it strikes me that a better way to attract foreign investment into the U.S. mortgage market is to deal with those issues, rather than paper over those problems with a taxpayer-funded guarantee. 

It is also worth noting that when we most needed foreign support for the U.S. mortgage market, in 2008, foreign investors were dumping Fannie and Freddie debt in significant amounts.  And obviously I think we’d prefer that the Chinese Central Bank stop using the purchase of Fannie and Freddie debt to depress the value of their own currency.

Federal Government Is a Lucrative ‘Industry’

The Bureau of Economic Analysis latest release of industry compensation levels shows that the average federal worker ranks up at the top along with employees in the finance and energy industries. That’s not exactly popular company these days.

The BEA presents compensation data for 72 industries that span the U.S. economy. Figure 1 shows the 20 industries with the highest levels of average compensation, which includes wages and benefits. It also shows the average for all U.S. private industries and the average for the industry with the lowest compensation. (The names of the industries have been simplified in some cases).

Federal civilian workers have the sixth highest average compensation of the 72 industries:

As yesterday’s post showed, federal employee compensation has exploded over the course of the decade. Figure 2 shows that this federal employee compensation growth has been the fifth highest of the 72 industries measured by the BEA: