Topic: Regulatory Studies

Fannie and Freddie

The IBD has an excellent front page summary of the 1990s roots to the Fannie Mae and Freddie Mac disaster.

One issue IBD touches on is the ineffectiveness of the regulating agency OFHEO. Here is OFHEO giving Fannie and Freddie a clean bill of health just last December.

One reason that having regulatory agencies is worse than having no suchagencies is the false sense of security provided to markets by such apparently off-base seals of approval.

Blame Urban Planning

The credit crisis has led to numerous calls for bigger government. Yet the truth is that big government not only let the crisis happen, it caused it.

This truth is obscured by most accounts of the crisis. “I have a four-step view of the financial crisis,” says Paul Krugman. “1. The bursting of the housing bubble.”

William Kristol agrees. His account of the crisis begins, “A huge speculative housing bubble has collapsed.” “The root of the problem lies in this housing correction,” said Secretary of the Treasury Henry Paulson.

So it all started with the bubble. But what caused the bubble? The answer is clear: excessive land-use regulation. Yet while many talk about re-regulating banks and other financial firms, hardly anyone is talking about deregulating land.

The housing bubble was not universal. It almost exclusively struck states and regions that were heavily regulating land and housing. In fast-growing places with no such regulation, such as Dallas, Houston, and Raleigh, housing prices did not bubble and they are not declining today.

The key to making a housing bubble is to give cities control over development of rural areas – a step that is often called “growth-management planning.” If they have such control, they will restrict such development in the name of stopping “urban sprawl” – an imaginary problem – while their real goal is to keep development and its associated tax revenues within their borders. Once they have limited rural development, they will impose all sorts of conditions and fees on developers, often prolonging the permitting process by several years. This makes it impossible for developers to respond to increased housing demand by stepping up production.

In contrast, when cities do not have control of rural areas, developers can step outside the cities and buy land, subdivide it, and develop it as slowly or rapidly as necessary to respond to demand. The cities themselves respond by competing for development – in other words, by keeping regulation and impact fees low. The Houston metro area, for example, has been growing at 130,000 people per year, yet it was readily able to absorb another 100,000 Katrina evacuees with virtually no increase in housing prices.

Before 1960, virtually all housing in the United States was “affordable,” meaning that the median home prices in communities across the country were all about two times median-family incomes. But in the early 1960s, Hawaii and California passed laws allowing cities to regulate rural development. Oregon and Vermont followed in the 1970s. These states all experienced housing bubbles in the 1970s, with median prices reaching four times median-family incomes. Because they represented a small share of total U.S. housing, these bubbles did not cause a worldwide financial meltdown.

In the 1980s and 1990s, however, several more states passed laws mandating growth-management planning: Arizona, Connecticut, Florida, Maryland, Rhode Island, and Washington. Massachusetts cities took advantage of that state’s weak form of county government to take control of the countryside. The Denver and Minneapolis-St. Paul metro areas adopted growth-management plans even without a state mandate. As a result, by 2000, prices of nearly half the housing in the nation were bubbling to four, six, and in some places ten times median-family incomes.

In the meantime, Congress gave the Department of Housing and Urban Development (HUD) oversight authority over Fannie Mae and Freddie Mac. While this was supposedly aimed at protecting taxpayers, Congress knew that HUD’s main mission is to increase homeownership rates, and Congress specifically pressured HUD to increase homeownership among low income families. So HUD responded to the housing bubble by directing Fannie and Freddie to buy increasingly high percentages of mortgages made to low income families, eventually setting a floor of 56 percent. This led Fannie and Freddie to significantly increase their purchases of subprime mortgages, which legitimized the secondary market for such mortgages.

Though everyone knows that the deflation of the housing bubble is what caused the financial meltdown, few have associated the bubble itself with land-use regulation. Back in 2005, Paul Krugman observed that the bubble was caused by excessive land-use regulation. Yet nowhere in his current writings does he suggest that we deregulate land to prevent such bubbles from happening again. Such suggestions have come only from the Cato Institute, Heritage Foundation, and a few other think tanks.

We know that if the regulation is left in place, housing will bubble again – California and Hawaii housing has bubbled and crashed three times since the 1970s. We also know, from research by Harvard economist Edward Glaeser, that each successive bubble makes housing more unaffordable than ever before – and thus leaves the economy more vulnerable to the inevitable deflation. This is because when prices decline, they only fall about a third of their increase, relative to “normal” housing, before bottoming out.

Thus, median California housing was twice median family incomes in 1960, four times in 1980, five times in 1990, and eight times in 2006. In the next bubble, it will probably be at least ten times. This means homeownership rates will decline (as it has declined in California since 1960), small business formation (which relies on the equity in the business owners’ homes for capital) will decline, and education will decline (children of families that own their homes do better in school than children of families who rent).

Worse, more states are passing growth management laws. Tennessee passed a law in 1998, too late to get into the recent housing bubble but enough to participate in the next one. Legislators in Georgia, North Carolina, and other fast-growing states are being pressured to also pass such laws. Naturally, the planners who promote such laws deny that their actions have anything to do with housing prices.

Even worse, the Environmental Protection Agency has proposed to “integrate climate and land use” – effectively using global warming fears to impose nationwide growth management. Supposedly – though there is no evidence for it – people in denser communities emit fewer greenhouse gases, and growth management can be used to impose densities on Americans who would rather live on quarter-acre lots. The California legislature recently passed a law requiring cities to impose even tighter growth restrictions in order to reduce greenhouse gases – and its implementation will be judged on the restrictions, not on whether those restrictions actually reduce emissions.

Instead of such laws, states that have regulated their land and housing should deregulate them. Congress should treat land-use regulations as restrictions on interstate mobility, and deny federal housing and transportation funds to states that impose such rules. Otherwise, hard as it may be to imagine, the consequences of the next housing bubble will be even worse than this one.

Big Victory for Economic Liberty

Amid a financial crisis that has pundits playing the game of who can come up with the most nationalization and re-regulation—and a presidential campaign where neither candidate seems to have much coherent to say about the economy—one bright ray of light shone through.

And it came from San Francisco, no less.

On September 16, the U.S. Court of Appeals for the Ninth Circuit delivered a blow against unfair economic regulation in the case of Merrifield v. Lockyer. Pacific Legal Foundation lawyer and Cato adjunct scholar Tim Sandefur argued on behalf of Alan Merrifield, a businessman prevented from building structures to keep out pests by a bizarre licensing regulation. The California law in question required people who do not use pesticides to undergo years of training and take an examination testing their knowledge of chemicals and insects before they can use pest control techniques that involve neither chemicals nor insects.The law only applies to pigeons, rats, and mice, however, so putting spikes on a building to keep seagulls off it does not require a license. But the same activity aimed at deterring pigeons does. Moreover, the record showed that the rule was designed for the sole purpose of protecting people who have licenses from having to compete in the marketplace against upstart businesses like the one operated by Merrifield.

Circuit Judge Diarmuid O’Scannlain, writing for the panel majority, succinctly explained the problem with California’s rationale:

The possibility that non-pesticide-using pest controllers might interact with pesticides or will need the skill to suggest pesticide use when it would be more effective is the very rationale that government’s counsel proffered, and we relied upon, in upholding the requirement that Merrifield obtain a license under due process grounds. We cannot simultaneously uphold the licensing requirement under due process based on one rationale and then uphold Merrifield’s exclusion from the exemption based on a completely contradictory rationale. Needless to say, while a government need not provide a perfectly logically solution to regulatory problems, it cannot hope to survive rational basis review by resorting to irrationality.” (Emphasis in original)

That is, “economic protectionism for its own sake, regardless of its relation to the common good, cannot be said to be in the furtherance of a legitimate governmental interest.”

This decision is thus a tremendous blow against the various licensing advantages granted by legislatures to the few at the expense of the many. As Sandefur put it in PLF’s press release, “This is a victory for free enterprise and for the Constitution’s safeguards for entrepreneurship.”

The battle for economic rights remains an uphill struggle, however, because the invalidation of California’s pernicious legislation rested not on the basic right to earn an honest living but on the state’s “irrational singling out of three types of vertebrate pests” to the economic benefit of some exterminators as against others.The case necessarily turned on an “equal protection” violation, instead of constitutional protection of any substantive rights. Without that arbitrary listing of pigeons, rats, and mice, the pesticide/insect requirements would have withstood Merrifield’s challenge. Judge O’Scannlain implicitly recognized that reaching the correct result in this manner was intellectually unsatisfying, but that his hands were tied by the Supreme Court’s 1873 Slaughterhouse Cases (which eviscerated the Fourteenth Amendment’s Privileges or Immunities Clause). So long as the Supreme Court shies from revisiting the twisted logic of that precedent, the Constitution will offer precious little defense against legislation that restricts the ability of individuals to freely exchange goods and services.

Nevertheless, in establishing the legal principle that mere protectionism is not a legitimate state interest, the Merrifield case is a major victory for economic liberty—and the first time the Ninth Circuit has taken up this issue.

Congratulations to Tim and to Pacific Legal!

The United States of Permanent Receivership

Next year marks the 30th anniversary of the appearance of the second edition of Theodore J. Lowi’s The End of Liberalism, subtitled The Second Republic of the United States. The preface to the second edition ends, “I want to express a very belated thanks to Friedrich A. Hayek. His work had much more of an influence on me than I realized during the writing of the First Edition. I neither began nor ended as a Hayekist but instead found myself confirming, by process of elimination and discovery, many of his fears about the modern liberal state.”

Lowi argues that the Second Republic is marked by “the state of permanent receivership,” which is defined as “a state whose government maintains a steadfast position that any institution large enough to be a significant factor in the community may have its stability underwritten. It is a system of policies that sets a general floor under risk, either by attempting to eliminate risk or to reduce or share the costs of failure.” This state includes anticipatory receivership, which includes “businesses that are not actually on the brink of bankruptcy but are in a sector of the economy where bankruptcies or reorganizations are likely unless there is some kind of a preventive measure.”

Thirty years out, Ted Lowi looks pretty good this morning. Not much else looks good, but the second edition of The End of Liberalism shows that this dour morning has been coming for some time.

Read the book.

Be Afraid — Be Very Afraid

Light rail is on the ballot this November in Kansas City and Seattle. Commuter rail is on the ballot in Sonoma and Marin counties, California. BART heavy rail is on the ballot in San Jose.

These rail plans will cost billions of dollars each (hundreds of millions in the case of Sonoma-Marin), yet take few to no cars off the roads. The energy, pollution, and greenhouse gases generated during construction will vastly outweigh any operational savings, which in some cases will be nil. The plans are supported by a baptists-and-bootleggers combination of rail nuts and companies, like Parsons Brinckerhoff, that expect to make millions during construction.

But the real ballot measure to fear is California’s proposition 1A, which would authorize the sale of nearly $10 billion in general obligation bonds to build a high-speed rail network from Sacramento and San Francisco to Anaheim and San Diego. This $10 billion, combined with $10 billion from the feds and $5 billion in private money, was supposed to pay for the $25 billion system. The plan was to turn the system over to the private investors, who would operate it and keep 100 percent of the profits.

The first problem is that even the California High Speed Rail Authority admits that the real cost will be at least $43 billion. Considering the history of similar megaprojects – and this would be the largest state-sponsored megaproject in history – the final cost will probably be at least $60 billion.

The second problem is that the Authority has probably overestimated demand. It projects the system will carry 3 to 6 times as many passengers as Amtrak carries on its Northeast Corridor trains, which serve a higher population.

If the costs are high, the benefits are minuscule even if rail attracts the projected number of riders. The environmental impact statement for the project projects that it will take, at most, 3.8% of cars off the road, reduce air pollution by about 1%, and reduce transport-related greenhouse gases by 1.4%.

Considering the underestimated costs and overestimated ridership, it seems unlikely that private investors will put up $5 billion, much less a 20 percent share of whatever the final cost turns out to be. The danger for California taxpayers is that the Rail Authority will spend its $10 billion building as far as it can and then ask for more money. How far will $10 billion go? Not much further than San Francisco to San Jose.

Nor is there any guarantee that Congress will match the state’s money. But the danger for non-California taxpayers is that it does match the money – which will lead to demands for high-speed rail support from the rest of the country. Ten other high-speed corridors have received official recognition from the Federal Railroad Administration. Then there are various ad hoc proposals, such as Albuquerque to Casper and even Fargo to Missoula.

The likely cost of a national high-speed rail network will be in the hundreds of billions of dollars. Except to the contractors that build it, the benefits will be largely imaginary. We can see that by looking at high-speed rail elsewhere.

Japan’s bullet trains were a feather in that country’s technological cap, but they sent the formerly profitable Japanese National Railways (JNR) into virtual bankruptcy. The government was forced to absorb $200 billion in high-speed debt. Meanwhile, far from attracting people out of their cars, high-speed rail accelerated the growth in driving as JNR raised fares to cope with its losses.

Europe’s record with high-speed rail hasn’t been much better. Though nations in the European Union spend an estimated $100 billion per year subsidizing intercity rail, rail has slowly but steadily lost market share since Italy opened the continent’s first high-speed line in 1978. Today, less than 6 percent of passenger travel goes by rail.

We car-crazy Americans drive for 85 percent of our travel. Europeans drive for 79 percent. Spending several hundred billion dollars to get, at best, 5 or 6 percent of people out of their cars is not worthwhile. The real impact of high-speed rail is that it replaces private air service with heavily subsidized rail service.

Rail is not just a waste of money, it is an intrusion on personal freedom. That’s because it is inevitably accompanied by restrictions on people’s property rights. Buses and airlines can follow demand by changing routes. Rails cannot, so rail agencies conspire with land-use planners to reshape society and make it more “rail friendly.” That means upzoning areas near rail stations to higher-than-marketable densities while downzoning other areas to keep developers from building the kind of low-density housing most Americans prefer.

For more information about high-speed rail, see the Antiplanner, which is blogging about it in a series of nine posts.

Space Privatization—from Cato to the BBC

In the premier issue of BBC Knowledge, the Cambridge University astrophysicist Martin Rees makes several provocative arguments about manned space flight. They are:

  • The completion of the International Space Station (ISS) comes with a price tag of $50 billion, with the only profit being the cooperation with foreign partners.
  • There is no scientific, commercial, or military value in sending people to space.
  • Future expeditions to the Moon and beyond will only be politically and financially feasible if they are cut-price ventures.

He concludes that fostering good relations with other countries is insufficient justification for the expenditures, and that NASA should move aside and allow the private sector to play a role in manned space flight. The cost of these activities must lessen if they are to continue, and that will only happen with a decrease or removal of government involvement. Rees observes that only NASA deals with science, planetary exploration, and astronauts, while the private sector is allowed to exploit space commercially for things such as telecommunications. However, there is no shortage of interest in space entrepreneurship: wealthy people with a track record of commercial achievement are yearning to get involved. Rees sees space probes plastered with commercial logos in the future, just as Formula One racers are now.

Those ideas may sound radical, but not if you’ve been following the work of the Cato Institute. As long ago as 1986, Alan Pell Crawford wrote hopefully that “space commercialization … is a reality,” and looked forward to the country making progress toward a free market in space. The elimination of NASA was a recommendation in the Cato Handbook for Congress in 1999.

Edward L. Hudgins, former editor of Regulation magazine, wrote a great deal about private options in space. In 1995, he testified before the House Committee on Appropriations that the government should move out of non-defense related space activities, noting the high costs and wastefulness incurred by NASA. In 2001, Hudgins wrote “A Plea for Private Cosmonauts,” in which he  urged the United States to follow the Russians (!) in rediscovering the benefits of free markets after NASA refused to honor Dennis Tito’s request for a trip to the ISS. Hudgins testified again before the House in 2001, this time before the Subcommittee on Space and Aeronautics. He noted that since the beginning of the Space Age, NASA has actively discouraged and barred many private space endeavors. This effectively works against the advancement and expansion of technology, while pushing out talent to foreign countries who court American scientists and researches to launch from their less-regulated facilities. In “Move Aside NASA,” Hudgins reported that neither the station nor the shuttle does much important science. This makes the price tag of $100 billion for the ISS, far above its original projected cost, unjustifiable.

Michael Gough in 1997 argued that the space “shuttle is a bust scientifically and commercially” and that both successful and unsuccessful NASA programs have crowded out private explorers, eliminating the possibility of lessening those problems. Molly K. Macauley of Resources for the Future argued in the Summer 2003 issue of Regulation that legislators and regulators had failed to take into account “the ills of price regulation, government competition, or command-and-control management” in making laws for space exploration.

We welcome the BBC and the Astronomer Royal to the cause of private, entrepreneurial exploration of the cosmos.

Hat tip to Michael Gough and Diana Lopez.

DoJ Trustbusters to Attack Google?

C|Net’s Charles Cooper reports today that Department of Justice trustbusters are considering a comprehensive antitrust attack on Google.

Sources who have provided testimony to the government say a departmental debate revolves around whether antitrust regulators should challenge Google’s proposed revenue-sharing deal with Yahoo, or go for the whole enchilada–and haul Google into court on broader charges related to its dominance in search advertising.

C|Net’s Declan McCullagh speculated earlier this week about how Google would fare under an Obama administration:

[Obama’s] technology campaign platform pledges to “reinvigorate antitrust enforcement” and “step up review of merger activity.” He complained to the American Antitrust Institute that “the current administration has what may be the weakest record of antitrust enforcement of any administration in the last half century.” If the Bush administration’s current antitrust probe of Google, coupled with this week’s apparent threat of a federal lawsuit, amounts to a “weak” record, imagine what antitrust true believers in an Obama administration might do. (A three-way split of Google into search, applications, and display ads, anyone?)

I’m not sure whether structural separation is on Google’s near-term horizon, but Washington, D.C.’s parasite economy will make its move.