Topic: Regulatory Studies

Real Regulators: Madoff’s Accomplices

In his “Talking Business” column, Joe Nocera explores Bernie Madoff’s accomplices: the victims themselves, and the SEC. He quotes James R. Hedges IV of LJH Global Investments:

“It is a real lesson that people cannot abdicate personal responsibility when it comes to their personal finances.” And that’s the point. People did abdicate responsibility — and now, rather than face that fact, many of them are blaming the government for not, in effect, saving them from themselves. Indeed, what you discover when you talk to victims is that they harbor an anger toward the S.E.C. that is as deep or deeper than the anger they feel toward Mr. Madoff. There is a powerful sense that because the agency was asleep at the switch, they have been doubly victimized. And they want the government to do something about it.

Nocera ably acknowledges the hurt and suffering of Madoff’s victims while pointing out their thoroughgoing irresponsibility — especially in the suggestion that someone else should pick up the pieces.

I’m less sanguine: The more thoroughly their cascading delusions of government aid and protection are shattered, the better. And yours, too. And mine. No bailout.

(Earlier posts in this “real regulators” thread here and here.)

Not-so-COOL Rules Stoke Xenophobia

Come Monday you can thank the federal government for making food more expensive by requiring retailers to provide useless information.

On March 16, federal regulations will finally kick in that require perishable food at the grocery store to sport “country of origin labeling,” known as COOL. The rules were originally passed by Congress as part of the 2002 farm bill, but are only being implemented now because of understandable resistance from retailers.

The COOL regulations will require that all perishable food products be labeled at retail to indicate the country of origin. The regulations cover beef, pork, lamb, goat, chicken; wild and farm-raised fish and shellfish; fresh and frozen fruits and vegetables; peanuts, pecans, macadamia nuts, and ginseng.

In a recent statement announcing final implementation, Obama administration agriculture secretary Tom Vilsack said, “I strongly support Country of Origin Labeling — it’s a critical step toward providing consumers with additional information about the origin of their food.”

This is nothing but a form of regulatory harassment designed to play to anti-foreign prejudices. COOL provides zero health or safety information; foreign meat and produce must conform to exactly the same health and safety standards that apply to domestic-made goods.

In the past, the U.S. Department of Agriculture had estimated that COOL regulations will cost $89 million to implement in the first year and $62 million annually. (My Cato colleague Dan Ikenson wrote the definitive critique of COOL not long after Congress first mandated the rules.)

The fact that a piece of meat or a fresh vegetable comes from a foreign country tells us nothing about its quality or safety. In the past three years, Americans have been sickened and even killed by baby spinach from California and ground beef from Nebraska tainted by E. coli bacteria, chicken from Pennsylvania tainted with listeria, and peanut butter and peanut products from Georgia tainted with salmonella. Would Americans have been any safer if those products had been labeled, “From California” or “From Georgia” or “From Nebraska”?

Country-of-origin labeling was not meant to serve the public but instead to provide yet another unfair advantage to domestic producers at the expense of the public.

Why Bank Stocks Rose on Bernanke’s Remarks

In a CNBC spot with Steve Liesman & Erin Burnett, I tried to explain why investors in bank stocks had good reason to be pleased with part of Fed Chairman Ben Bernanke’s speech.  Judging by the response of Steve and Erin, and others on CNBC over the following day,  I must not have been persuasive.

For clarification, I am quoting the exact language from Bernanke’s talk, with my emphasis added.

My main point is that Bernanke admitted that when it comes to the “financial crisis” of some big banks, this is largely an artifact of unduly harsh regulation being applied at the worst possible time:

There is some evidence that capital standards, accounting rules, and other regulations have made the financial sector excessively procyclical–that is, they lead financial institutions to ease credit in booms and tighten credit in downturns more than is justified by changes in the creditworthiness of borrowers, thereby intensifying cyclical changes.

For example, capital regulations require that banks’ capital ratios meet or exceed fixed minimum standards for the bank to be considered safe and sound by regulators. Because banks typically find raising capital to be difficult in economic downturns or periods of financial stress, their best means of boosting their regulatory capital ratios during difficult periods may be to reduce new lending, perhaps more so than is justified by the credit environment. We should review capital regulations to ensure that they are appropriately forward-looking…

Bernanke emphasized the regulators’ dangerous habit of raising capital requirements and loan loss reserves simply because of a strict mark-to-market misinterpretation of the “fair value” of mortgage-backed securities.

He noted that:

Determining appropriate valuation methods for illiquid or idiosyncratic assets can be very difficult, to put it mildly. Similarly, there is considerable uncertainty regarding the appropriate levels of loan loss reserves over the cycle. As a result, further review of accounting standards governing valuation and loss provisioning would be useful, and might result in modifications to the accounting rules that reduce their procyclical effects without compromising the goals of disclosure and transparency.

The key here is Bernanke’s criticism of the rigid use of Basel capital standards, not mark-to-market information per se (which would be harmless if it did not trigger foolish regulations). When combined with Barney Frank’s similar comments on the same day, it begins to look as though sensible economics might finally take priority over dubious bookkeeping.

Regulations vs. Rate Cuts

A set of stories in International Tax Review today illustrate the backwards nature of U.S. corporate tax policy. The first story discusses the high-profile chest-thumping in Washington over corporate “tax haven abuse.” The congressional response to greater international tax competition is to load even more regulations on American businesses.

The second story is entitled “Taiwan Slashes Corporate Tax Rate”:

Taiwan’s government has approved plans to cut the country’s corporate tax rate from 25% to 20%. Ministers hope the cut will encourage investment in the country and stimulate growth in the economy…

America is in the worst recession in decades and it desperately needs to cut its 40 percent corporate tax rate to reinvigorate business investment. Why are U.S. policymakers so clueless about the most obvious way to spur investment when that policy imperative is clear to leaders just about everywhere else?

New Podcast: ‘War on Drugs, War on Guns’

Attorney General Eric Holder said recently that in order to quell the violence spilling over from the drug war in Mexico he will push to reinstate the ban on “assault weapons” in the United States.

But, says Legal Policy Analyst David Rittgers in today’s Cato Daily Podcast, a policy like that won’t do much to quell violence.

The [drug] cartels have access to lots and lots of money because of our prohibitionist policies in the US. And because of this money they can get these weapons whether we have them legal or illegal…and they’ll have access to the black market to get fully automatic machine guns if they want them.

… If you like the war on drugs, you’re going to love the war on guns.

‘Real Regulators’ Redux

Sunday’s episode of 60 Minutes featured a man named Harry Markopolos who repeatedly reported Bernie Madoff’s scam to the Securities and Exchange Commission. The SEC did not investigate.

Steve Croft: How many times did you send material to the SEC?

Markopolos: May 2000. October 2001. October, November, and December of 2005. Then again, June 2007. And finally, April 2008. So, five separate SEC submissions.

Croft: And in spite of all of the things that you did, it still ended up in disaster.

This is a reminder of what I observed in a recent post here called “A Real Regulator.” CNBC’s Erin Burnett had called for a “real” regulator in the wake of Madoff, to which I replied:

When regulators fail to address a problem ahead of time, when they regulate inefficiently, when they hand their rulemaking organs to the industries they are supposed to oversee, those are all the actions of real regulators. That’s what you get with real regulation.

Markopolos isn’t grinding this same ax against goverment regulation. He says, “… [S]elf-regulation on Wall Street doesn’t work.”

So the question is posed: What allowed this to happen?

I don’t think this huge fraud occured in a “self-regulatory” environment. It occured in a regulated environment. Regulators failed to do their jobs, but investors had abandoned their responsibility to look into the people and firms with which they placed their money. They believed that the SEC was taking care of that.

It wasn’t, so nobody was minding the store. Ultimately, the SEC served as a partner to the crime, providing the “confidence” that made a success of Bernie Madoff’s confidence game.

Back to Markopolos:

That’s typically how the SEC does it. They come in after the crime has been committed, they toe-tag the victims, count the bodies, and try to figure out who the crooks were, after the fact, which does none of us any good.

Is “self-regulation” the alternative to government regulation? No. And neither is deregulation. The alternative is market regualtion, where individuals, responsible for the soundness of their purchases and investments, investigate and study who they do business with. Scams like Madoff’s would have shorter duration and do less damage if investors were not under the impression that they were protected by government regulators. Of course, our policymakers are likely to double-down on the bet on governmental regulation, even though we all just witnessed its failure.

The Foreclosure Five Dominate Case-Shiller Price Indexes

A CNNMoney.com report, “Home prices in record drop,” posted a scary map labeled “Falling Homes Sales.” But it actually shows falling home prices. Within the S&P Case-Shiller sample of 20 metropolitan areas, the steepest drop in prices (not sales) were in Phoenix, Las Vegas, San Francisco, Los Angeles, San Diego, Tampa and Detroit.

All 7 of those metropolitan areas (7 out of 20 in that index) lie within 5 states with by far the worst mortgage problems, as shown in my February 21 article, “The Foreclosure Five.” Yet I also showed that states with the steepest price declines also have had huge increases in home sales, which makes the label on the CNNMoney map doubly misleading.

My article used third quarter house prices because fourth quarter figures were not yet available. That turns out to make even less difference than I expected.

The fourth quarter Federal Housing Finance Agency (FHFA) figures show home prices down 21.8% for the year in Nevada, 20.5% in California, 15.2% in Arizona, 19.5% in Florida, and 11.8% in Michigan. Prices were down 3.7% in the median state, North Carolina, but up 21.6% over five years. That means prices fell by less than 3.7% last year in 24 states— including a half dozen states with home prices up a bit, and New York with only a 3.3% decline.

CNNMoney says, “The decline does not seem to be slowing - just the opposite. The average home price dropped 2.5% between November and December in the 20 top metro areas.” The FHFA data for all 50 states, by contrast, show a small 0.1% increase in home prices between November and December.

The article goes on say, “The S&P Case-Shiller National Home Price Index reported that prices sank a record 18.2% during the last three months of 2008, compared with the same period in 2007. Case-Shiller’s index of 20 major metropolitan areas fell 18.5%, also a record.” The FHFA, by contrast, shows that prices fell just 8.2% during the last three months of 2008, or 3.7% if using a median average. Ten percentage points is quite a wide gap.

What accounts for such huge differences between Case-Shiller and federal price indexes? CNNMoney imagines it’s because “Homes purchased without financing or ones too expensive to qualify for a Fannie-Freddie loan are not counted in the FFHA (sic) statistics.” That’s more than unlikely. The inclusion of cash sales and jumbo loans (larger than $729,750 in pricey area) can’t possibly explain why price declines in the Case-Shiller index look so much more dramatic those in the OFHEO/FHFA index.

The real reason is simple: Case-Shiller indexes are hugely dominated by the Foreclosure Five. In the Case-Shiller index of only 20 “top” metro areas, the Foreclosure Five account for 41.2% of that value-weighted index with California alone accounting for 27.4%.

The “national” Case-Shiller index totally excludes 13 states, such as Indiana and South Carolina, and samples only a fraction of many others. The Foreclosure Five account for 28.3% of that “national” index, with California amounting to 17.1%.

As is true of nearly all reprorting about foreclosures, underwater mortgages and falling house prices, what the Case-Shiller price index really shows is that many people are confusing what has been happening in the Foreclosure Five with what has been happening in the nation as a whole.