We’re #1!

Jay Greene—a man known for producing some of the most interesting (and voluminous) education research in the country—today published the most important finding of his career: When it comes to readership, Cato [at] Liberty.org crushes all other education blogs!

OK, as Greene points out, Cato@Liberty is not strictly an education blog. (I have little doubt that readers come for the brilliant education coverage first and consider the rest of the content mainly an added — but outstanding! — bonus.) Even if that’s not the case, we thank all of you who take the time to read our education posts and want to tell lesser education bloggers that we think you’re very nice. And who knows, maybe some day In-Bev will buy us and someone else can be the king.

‘Ballooning Commodities’?

“The S&P GSCI commodities index is up 73% in the past 12 months,” writes Edward Hadas of breakingviews.com in The Wall Street Journal.

The author goes on to speculate about speculation, concluding, “This bubble could get bigger still.” Unfortunately, he assumes the S&P commodity index (which is shown in a graph) demonstrates a huge ongoing boom in the prices of commodities in general. In reality, all the index shows is that oil prices doubled over the past year and that most of that increase happened in the past four months. Energy commodities (mainly crude oil) account for 78 percent of the S&P GSCI commodity index.

The price of crude oil rose from $100 a barrel on March 4 to $136 on July 8, so the energy-dominated S&P GSCI index naturally soared too.

What happens to the widely reported “commodities boom” if you leave out oil? Look at The Economist’s index of 25 farm and industrial commodities, which excludes oil. The Economist’s commodity price index fell from 271.9 on March 4 to 265.6 on July 8.

It is on the basis of such fatally flawed evidence as the S&P commodity index that Congress has been trying to bully the Commodities Futures Trading Commission into bullying U.S. commodity traders to stop some sort of “commodity boom.”

The dollar was also quite stable during the past four months, contrary to numerous angry and overconfident Journal editorials about the alleged commodity boom being caused by the supposedly falling dollar. The Fed’s broad index of the dollar’s value was 95.97 on February 28 and 95.97 on July 8.

Do We Need Fannie and Freddie?

All eyes were on Wall Street Monday morning as Freddie Mac, one of the two giant government-sponsored enterprises that dominate U.S. mortgage finance, floated $3 billion in bonds to continue its role as a buyer and reseller of mortgage obligations. The bond sale came after a week in which Freddie’s stock, and the stock of its sister Fannie Mae, plummeted as analysts and economists worried that the housing bubble collapse would push the two GSEs into insolvency. To fortify Fannie and Freddie, the Bush Treasury Department, with blessings from the Democratic Congress, worked feverishly over the weekend to cobble together a bailout plan should the GSEs’ conditions worsen to the point that they can no longer function. The successful bond sale indicates the Bush plan has reassured the market — albeit barely.

It is an article of faith across the political spectrum that Freddie and Fannie cannot be allowed to fail — especially not at this time when the broader housing market is undergoing painful correction. Why do they have such exalted status?

Before Fannie Mae — the first of the twins — was created amidst the “Recession within the Depression” in 1938, home mortgage lending was highly risky for banks. State regulation kept banks small and geographically limited in order to make them better targets for taxation and political manipulation. As a result, banks could not geographically diversify their loan risk, leaving them highly vulnerable to localized economic downturns. Because they lent money (as mortgages and business loans to farms and other firms) to local borrowers for long periods of time but they had to honor local depositors’ withdrawal requests, banks were often one bad harvest and one bank run away from insolvency. For that reason, they shied away from financing long-term home loans.

Fannie Mae (formally, the Federal National Mortgage Association) provided badly needed lubricant to the mortgage industry. It purchased loan obligations from banks, putting money back in the banks’ vaults and making that money available for more home loans. Fannie financed its operations by borrowing on Wall Street and, later, by pioneering the creation and sale of mortgage-back securities (MBSs) — selling large “bundles” of loans to investors and then servicing the loans on the investors’ behalf. In this way, Fannie diversified loan risk, allowing a nationwide (and worldwide) pool of investors to finance (at first indirectly, then directly) a nationwide pool of mortgages. This wasn’t the ideal solution that banking reform would have been, but Fannie was a good second-best solution.

Because of its tax-free status and government backing (as well as banking regulations that constrained would-be competitors), Fannie quickly came to dominate the mortgage industry. This system hummed along, unchanged, until 1968 when Fannie’s costs conflicted with Lyndon Johnson’s efforts to rein in the federal budget amidst the war in Vietnam and the war on poverty. It was decided that Fannie would be spun off as a private corporation whose investors would bear its costs. However, Fannie retained its tax-free status and received a $2.25 billion line of credit at the U.S. Treasury. It also was allowed to operate with much lower reserve requirements than banks. But the most valuable of Fannie’s parting gifts was its implicit too-big-to-fail status: because of its history and role in mortgage lending, investors believe the federal government will ride to Fannie’s aid if it ever became financially unable to function. For this reason, investors buy Fannie’s stocks, bonds, and MBSs.

Congress realized that, with those perks and its original dominant position, Fannie would continue to monopolize the U.S. home loan market. In 1970 they created Freddie Mac (formally, the Federal Home Loan Mortgage Corporation) as a competitor, with the same structure and perks as Fannie. It’s unclear why Congress believed a duopoly was better than a monopoly. (For more on Fannie and Freddie’s history, listen to Peter Van Doren’s recent podcast.)

Over the last decade, analysts have offered numerous criticisms of Fannie and Freddie’s dominance and nature, and issued calls for reform. (In Regulation alone, see: Van Order 2000, Frame & White 2004, Wallison 2004, Jaffe 2006.) Besides the GSEs’ dominance of the market and the risk that their too-big-to-fail status poses to taxpayers, the implied guarantee encouraged the GSEs to retain possession of some of their mortgages instead of selling them to investors. Retaining mortgages and reaping the payments enriched Fannie and Freddie shareholders, but it subjected the two GSEs to interest rate risk as well as the default risk of all Fannie- and Freddie-guaranteed loans.

Despite the criticisms and reform calls, the issue gained little traction, even in the go-go real estate market of the mid-2000s when Freddie and Fannie were involved in a relatively small 40% of new home loans. The result is that, in the aftermath of the housing bubble collapse when preserving mortgage financing is incredibly important, the market for those loans is dominated by two teetering giants.

Fannie and Freddie are currently involved in roughly half of all U.S. mortgages. That includes a large majority of post-bubble mortgages, as private investors have pulled back from financing non-guaranteed loans. Given that position and the overall turmoil in the housing market, the federal government cannot leave Fannie and Freddie to struggle — after all, their debt equals the debt of all other U.S. corporations combined, and imagine what would happen if all U.S. corporations suddenly defaulted on their loan payments.

So, there seems little that federal policymakers can do now except promise to prop up Freddie and Fannie if they become insolvent and hope that doesn’t occur. But this situation demonstrates why the mortgage industry should not be dominated by two firms — especially two government-sponsored firms.

If Congress does adopt legislation to protect Fannie and Freddie, that legislation should spare taxpayers and the nation from a repeat of the current crisis. The legislation should include an ironclad commitment to make Fannie and Freddie fully independent of the government over the next decade. It should also require that the GSEs be broken into several smaller firms that aren’t too big to fail. Those firms would be put under strict government oversight and conservative risk controls until they are fully independent. The legislation should also strip Fannie and Freddie of their tax-free status, putting them on equal footing with private lenders (including banks, which can now geographically diversify following the 1999 banking reform). With this reform implemented, the mortgage market would become supported by numerous institutions (some of which would be Freddie and Fannie spin-offs, others not) instead of just two vulnerable pillars.

It is because policymakers refused to reform state banking regulation in the 1930s that Fannie (and later Freddie) were created. It is because Fannie and Freddie were not reformed in the last 10 years that we’re stuck with this problem now. Federal policymakers cannot disregard another opportunity at reform — or else the U.S. mortgage industry will remain at the mercy of the financial health of two firms.

Postscript (7/15): Cato senior fellow Gerald O’Driscoll sketches a plan for breaking up Fannie and Freddie and making them truly independent in this excellent WSJ op-ed [$].

Politicians Complaining About Budweiser Takeover Should Look in Mirror

A Belgium-based company, InBev, has reached an agreement to purchase America’s biggest brewer, Anheuser-Busch (maker of Budweiser and other well-known beers). This has triggered whining from many politicians, including senator and Democratic presidential hopeful Barack Obama.

Rather than engage in demagoguery against foreign investment, maybe Senator Obama and his colleagues should fix the tax code so that U.S. companies are not disadvantaged in global markets. America’s high corporate tax rate, combined with a pernicious policy of taxing worldwide income of American-based firms, makes it very difficult for those companies to compete.

Belgium, by contrast, has a lower corporate tax rate. More important, it has a territorial tax system — the common-sense notion of taxing only income earned inside national borders. As such, it makes sense — from the perspective of all shareholders — for Anheuser-Busch to be taken over by InBev rather than the other way around. Indeed, that is why American companies almost always become the subsidiary rather than the parent when there is a cross-border merger.

Pre-K Pushers Peddling Patent Prevarications

We left off in our last episode with a teaser on why the blessed Perry Preschool Project, Carolina Abecedarian Project, and Chicago Child-Parent Centers Program don’t prove what many people like to pretend they prove; the long-term effectiveness, let alone cost-effectiveness, of current large-scale preschool programs.

Let’s begin with the fact that these programs were all small-scale, intensive, and targeted at the most disadvantaged children.

Now let’s look at some highlights of the other problems with using these as evidence in support of government preschool programs:

The Perry Preschool Project was an early-education intervention “experiment” initiated by researchers at the High/Scope Educational Research Foundation in 1962 and concluded in 1965. Project researchers analyzed the effect of home visits and preschool on outcomes for an unusual sample of 58 low-income children with IQs between 70 and 85 compared to a “control” group of 65 other children who did not attend the preschool program or receive home visits.

Researchers concluded that the positive effects of the program on outcomes such as future earnings and crime rates far outweighed the costs, giving taxpayers a return of $7.16 for every dollar invested. However, there are a number of problems with the Perry Preschool Program and the associated analyses that render them unreliable and unsuitable for estimating the effects of the large-scale programs currently under consideration in state legislatures:

One analysis noted that “the Perry Project poses a number of methodological difficulties” that call into question any conclusions about the effects of the program, positive or negative. Assignment to the preschool treatment and “control” groups was not completely random — an absolute requirement for valid experiments. And the children in the preschool program had to have parents home during the day — a requirement “resulting in a significant difference between control and intervention groups on the variable of maternal employment” that also calls into question any results.

Other criticisms included:

  • Twisting the Data: Program researchers expanded the standard definition of “statistical significance” in order to find positive effects. Most effects disappeared when the scientific standard was used.
  • More than Preschool: The program included home visitations in addition to preschool, which made it difficult if not impossible to determine whether preschool alone had significant positive effects.

The Abecedarian Project was an intensive early-intervention program begun in 1972 that placed participating infants, who were on average at 4.4 months old, “in an eight-hour-a-day, five-day-per-week, year-round educational day care center” where they “received free medical care, dietary supplements, and social service support for their families.” Half of the children in this intensive infant intervention program received three more years of educational assistance, as did half of the children in the control group that did not participate in the intervention program as infants and toddlers.

Project researchers found that the infants who received the intensive early intervention scored higher than the control children on cognitive and academic tests at age 12 and 21. There are, however, a number of problems with the Abecedarian Project and the associated analyses that render them unreliable and unsuitable for estimating the effects of the large-scale programs currently under consideration in state legislatures:

  • Much More than Preschool: The most obvious and serious problem with this “preschool” program is that the intervention was nothing like the preschool programs currently being considered or in effect. The Abecedarian Project was an intensive, long-term intervention beginning in infancy, and it can therefore shed little if any light on the effects of preschool on 3 or 4 year-olds.
  • Methodological Problems: Studies reporting effects from the Abecedarian Project generally focus on the differences between the treatment and control groups at later ages. Herman H. Spitz, a well-respected academic psychologist specializing in measuring intelligence among those with developmental disability, notes that the advantage found later emerged when the children were just 6 months old. Spitzer rightly concludes, “We need to understand why an additional 4.5 years of intensive intervention had so little effect that, at six years of age (and older), the difference between the intervention and control groups was not appreciably different than it had been at six months of age.”

The Chicago Child Parent Center Program was an early-education and family intervention begun in 1985 involving 989 low-income children in Chicago. Researchers concluded that, compared to the 550 children who did not receive the intervention, children in the program had a “higher rate of high school completion; more years of completed education; and lower rates of juvenile arrest, violent arrests, and school dropout.” This study has been used in recent years by a RAND analysis that claims a universal preschool program would return $2.62 for every dollar invested.

Again, however, there are a number of problems with the Chicago Child Parent Center Program and the associated analyses that render them unreliable and unsuitable for estimating the effects of the large-scale programs currently under consideration in state legislatures:

  • More than Preschool—Parenting: As the name of the program implies, the Chicago Child Parent Center Program involved extensive interventions with parents that involved “a multifaceted parent program that includes participating in activities in the parent resource room with other parents (e.g., educational workshops, reading groups, and craft projects), volunteering in the classroom, attending school events and field trips, and completing high school; outreach activities including resource mobilization, home visitation, and enrollment of children.”
  • More than Preschool—Tutoring: The intervention continued through 3rd grade for some students, and involved tutoring, speech therapy, and medical services that are not a part of current preschool proposals and significantly raise the costs and difficulties of expanding to a state-wide program.
  • Wild Extrapolations: The RAND study does not consider these important concerns regarding the Chicago Child Parent Center Program. Instead they uncritically apply the findings from this intensive family intervention program to a state-wide, universal preschool-only program. The researchers also arbitrarily assign middle and upper-income children benefits from preschool that no study of the Chicago Child Parent Center Program suggests they receive.

The fourth and final post is coming soon, with a response to some other objections …

Federal Prosecutors

Today, Cato is publishing an article about some disturbing trends that have emerged in federal criminal law. Washington, D.C. attorney Richard Janis explains that business executives saw what happened to Arthur Andersen when that firm tried to defend itself by going to trial. To avoid the potential catastrophe of a full-blown trial and a criminal conviction, firms will now do almost anything to placate federal prosecutors and avoid an indictment, including waiving the attorney-client privilege and firing employees at the direction of the government — even if the firm concludes that such employees were just following directions and are otherwise innocent of any wrongdoing.

Janis observes that federal prosecutors have so much leverage over business firms these days that the very nature of our adversary system of justice is in jeopardy. Companies must too often cough up millions of dollars for “settlements” that are wildly out of proportion to any perceived wrongdoing.

Janis’s paper is short but potent. To check it out, go here.

Tony Snow’s Sunny Conservatism

Whether you agreed with him or not, former presidential press secretary Tony Snow was a class act. During his time as President Bush’s chief spokesman, from April 2006 to September 2007, Snow sparred with gusto with the White House press corps but always remained cheerful and collegial. News stories about his death over the weekend report that he was unfailingly upbeat even in the final months of his battle with cancer.

I only met Tony Snow once, and that was in June 2007 at a White House briefing on immigration reform. Also speaking at the briefing were two cabinet secretaries, but we all knew who was the star attraction that day. Snow did not bring a particular expertise to the briefing, but he did express a passion for the president’s commitment to expanding opportunities for legal immigration.

In conversation after the meeting, Snow told a small group of us that it was the president’s views on immigration more than anything else that convinced him that he wanted to be part of the administration.

None of this is a big revelation if you read Tony Snow’s pre-White House writings on the subject, but it is worth remembering that this conservatives’ conservative, sometime Bush critic, and former editorial page editor of the Washington Times embraced a pro-immigration view that was at odds with much of the rest of the movement and most Republican members of Congress. One more reason to mourn his passing.