Archives: 08/2012

One of Many Ways the SEC Contributed to the Financial Crisis

I was recently reminded that in its infinite wisdom, the Securities and Exchange Commission (SEC) actually sued banks as the housing bubble was building for putting aside too much money to coverage potential loan losses.  It seems that while many banks were worried that bubble lending could turn out bad, the SEC felt that recent history did not offer banks enough justification for setting aside such funding (after all housing prices were going up).  The most significant example was the SEC suit against SunTrust.  In November 2004 the SEC actually pushed SunTrust to fire its Chief Risk Officer for setting aside too much to cover bad loans, while also pushing SunTrust to reduce its loan loss reserves.

The worst part is that the rest of the banking industry clearly got the message.  Before the SEC’s attacks on SunTrust, commercial banks held loan loss reserves, as a percent of total loans, equal to 1.67% (in 2003 Q1), by the peak of the housing bubble that was down to 1.07% (in 2006 Q4), a decline of over 50 percent.  While I don’t mean to exaggerate the impact of this change, had banks kept their loan loss reserves at pre-SunTrust levels, there would have only been about $30 billion more to absorb losses, I do believe this illustrates just how clueless the financial regulators were as to the risks building behind the housing bubble.  And we are being asked, via Dodd-Frank, to give this same SEC lots more discretionary authority in the vain hope that maybe next time they might get it right?

‘The President’s Utility’

According to a recent article in the New York Times, that’s what a lobbyist for Exelon Corp. “proudly” called the Illinois-based energy company. It appears to be an appropriate label.

From the article:

Exelon’s top executives were early and frequent supporters of Mr. Obama as he rose from the Illinois State Senate to the White House. John W. Rogers Jr., a friend of the president’s and one of his top fund-raisers, is an Exelon board member. David Axelrod, Mr. Obama’s longtime political strategist, once worked as an Exelon consultant, and Rahm Emanuel, the Chicago mayor and Mr. Obama’s former chief of staff, helped create the company through a corporate merger in 2000 while working as an investment banker.

With energy an increasingly pivotal issue for the Obama White House, a review of Exelon’s relationship with the administration shows how familiarity has helped foster access at the upper reaches of government and how, in some cases, the outcome has been favorable for Exelon.

White House records show that Exelon executives were able to secure an unusually large number of meetings with top administration officials at key moments in the consideration of environmental regulations that have been drafted in a way that hurt Exelon’s competitors, but curb the high cost of compliance for Exelon and its industry allies.

In addition, Exelon, which provides power to more than 6.6 million customers in at least 16 states and the District of Columbia, was chosen as one of only six electric utilities nationwide for the maximum $200 million stimulus grant from the Energy Department. And when the Treasury Department granted loans for renewable energy projects, Exelon landed a commitment for up to $646 million allowing it, on extremely generous financial terms, to finance one of the world’s largest photovoltaic solar projects.

The NYT piece is worth reading in its entirety as it’s a textbook example of the sort of crony capitalism that undermines the economy. Unfortunately, if the reader comments at the end of the article are any indication, most people are viewing the story through a partisan lens. As I demonstrate in my Cato policy paper on corporate welfare in the federal budget, crony capitalism has a long, bipartisan history.

On the Wages of Obamacare’s Sins

Today POLITICO Arena asks:

 Does the appearance of New York Cardinal Timothy Dolan (who is suing the Obama administration) to deliver a blessing to the GOP convention blur the line between religion and politics?

My response:

The invocation of blessings from above is as old as the nation’s founding document, the Declaration of Independence. So if Democrats want to take exception to Cardinal Dolan’s appearance at the GOP convention, they’ll do so at their peril.

Some of course will use this appearance as a way to try to keep alive the alleged Republican “war on women.” But that charge is wearing thin. And it too is fraught with peril for Democrats, because the dozens of suits that have been brought against Obamacare’s contraceptive and abortifacient mandate are really about religious liberty, not about preventing access to contraception. So if anything, the cardinal’s appearance will shift the focus back to the compulsion that runs through Obamacare, the unpopularity of which is why Obama so seldom mentions it.

Voters Want Smaller Government

The Washington Post reports today:

Most Americans in a new Washington Post-ABC News poll want a shrunken federal government, and most believe Romney wants that too. …Support for “smaller government” is up significantly in recent years, and marks a pivotal issue where voters view Obama as far out of step with public opinion.

Here’s a graph of what registered voters told the Post:

The striking thing, of course, is that voters think Romney supports smaller government. It’s not a conclusion they could draw from his fiscal record as governor, or from his Massachusetts health care plan, or from his current position on budget cuts, or even from his running mate’s budget proposal. I think you have to conclude that voters believe Mitt Romney wants smaller government because President Obama keeps telling them so.

Voters have a better sense of Obama’s own preferences: 73 percent say he wants larger government. You’ve got to wonder about the 15 percent who think he wants smaller government, though. Which words in that simple question do they not understand?

Meanwhile, I’ve always thought the “smaller government” question is incomplete. It offers respondents a benefit of larger government – “more services” – but it doesn’t mention that the cost of “larger government with more services” is higher taxes. The question ought to give both the cost and the benefit for each option. The Rasmussen poll does often ask the question that way. In fall 2010, when the Post poll showed 56 percent support for smaller government, a Rasmussen poll with the more balanced question found that 68 percent of voters said that they prefer smaller government with fewer services and lower taxes, while only 24 percent would rather see a more active government with more services and higher taxes. Along with other contemporaneous comparisons, it’s reasonable to conclude that if you remind respondents that “more services” means higher taxes, the margin by which people prefer smaller government rises by about 9 to 12 points. 

And remember, swing voters support smaller government by even higher percentages.


Getting Class Action Rules Right Makes Markets More Efficient

Getting the rules governing class actions right means balancing the need to keep the courthouse door open for legal claims not lucrative enough to pursue individually with the need to prevent wholesale extortion by opportunistic would-be plaintiffs (and their lawyers) who know that the settlement values of class actions are generally much larger than those of individual lawsuits.

In its recent (2011) decision in Wal-Mart v. Dukes, the Supreme Court reiterated that when considering whether to certify a lawsuit as a class action (which aggregates presumptive claims from a national “class” of plaintiffs), a trial court must conduct a “rigorous analysis” to determine that the putative plaintiffs satisfy the key requirements of Federal Rule of Civil Procedure 23: (1) the class is so large that each potential plaintiff can’t join the suit individually (“numerosity”); (2) questions of law or fact are common to the class (“commonality”); and (3) the claims/defenses of the plaintiff representatives are typical of the class as a whole (“typicality”). Despite Dukes, many courts have fallen back on a misinterpretation of an earlier Supreme Court decision, Eisen v. Carlisle & Jacquelin, to hold that a court can’t consider at the class-certification stage any issue that will overlap with the merits of the case.

In Comcast v. Behrend, the Philadelphia-based U.S. Court of Appeals for the Third Circuit affirmed the district court’s certification of a class of nearly two million past and present Comcast cable customers in an antitrust action against the company. In certifying the class, the district court refused to evaluate the admissibility of testimony presented by plaintiffs’ expert witness regarding the ability to calculate class-wide damages, considering such an inquiry to go to the merits of the case. The court thus failed to conduct “rigorous analysis” with respect to that issue, and so the Supreme Court decided to review whether a class can be certified without first determining, as part of the Dukes analysis, whether a plaintiff’s methodology for calculating damages is admissible.

Cato has filed an amicus brief urging the Court to clarify that what it meant in Dukes was that a full inquiry into the reliability and admissibility of expert testimony (a so-called Daubert inquiry) is required at the class-certification stage. A lower standard would obviously prejudice defendants because class certification “magnifies and strengthens the number of unmeritorious claims” and creates “insurmountable pressure on defendants to settle.” But it would also prejudice absent class members because certification based on inadmissible evidence may distort their perception of the likelihood of success and encourage the members to stay in the class. Since all class members who don’t opt out of the class are ultimately bound by a class action judgment, there’s a large potential for harm to these potentially valid claims as well.

The only way to sufficiently protect the interests of defendants and absent class members, as well as to stay faithful to the basic commonality requirement of Rule 23 — which balances the overall social interests described above — is for the Supreme Court to reverse the Third Circuit and clarify that the Daubert standard applies at the class-certification stage, not just at trial.

The Supreme Court will hear the case of Comcast v. Behrend on November 5.

The Ballad of Ron Paul, 2012

Four years ago the Onion offered a lyrical farewell to the Ron Paul campaign:

WASHINGTON—After piling the last of his Campaign for Liberty signs in the back of a beat-up Ford truck Thursday, Rep. Ron Paul (R-TX) once again abandoned his candidacy for president and rode on out toward the low western sun, but not before vowing to come back to Washington “when [the country] is ready.” “When the river swirls and the wind blows, and when uncontrollable inflation forces us to revert to the gold standard, and the Federal Reserve bank is exposed as the unconstitutional, neofascist cabal it really is, you’ll see me coming over that hill,” said Paul, leaving a dusty cowboy hat and a stack of “no” votes on his seat in the House of Representatives. “But don’t you fret, America. If you ever feel like your government is getting too big or too intrusive, just give a little whistle, and there I’ll be. I’ll be there quicker’n you can spit.” Although no one has seen or heard from the Texas congressman since Thursday, sources report the Ron Paul for President campaign has gained an additional $2.3 million in contributions since his disappearance.

As it turned out, it wasn’t long until America did begin to “feel like your government is getting too big or too intrusive,” and Paul came back with his message of smaller government, sound money, constitutionalism, and an end to endless debt and endless war. And the voters were a lot more receptive than they had been four years earlier. The Republican platform will reflect the efforts of Ron Paul and his movement.

Back in 2008 I heard the echoes of Tom Joad in that “final speech,” and I noticed that in fact Ron Paul had been all over the airwaves as practically the only congressional critic of the bailout and the policies that led to it. So I got to musing about another working-class icon, Joe Hill, and wrote some new words to his tune. Now that Ron Paul is ending another presidential campaign, and his career in Congress, they’re as relevant as ever:

I dreamed I saw Ron Paul last night,
Still running on TV.
Says I “But Ron, you lost ‘em all”
“I’ll never quit” said he,
“I’ll never quit” said he.

“The Money Power beat you, Ron,
They beat you, Ron,” says I.
“Takes more than Fox to beat ideas,”
Says Ron “I didn’t quit”
Says Ron “I didn’t quit.”

“In South Carolina, Ron,” says I,
“You stood up to the war.
Then Rudy knocked you back again.”
Says Ron, “But I was right.”
Says Ron, “But I was right.”

From Baghdad back to Main Street,
In every funeral hall
Where grieving moms inter their sons,
it’s there you find Ron Paul,
it’s there you find Ron Paul!

And taking on the Fed Reserve
and smiling with his eyes,
Says Ron, “The bailout cannot work,
It’s time to privatize.
It’s time to privatize.”

From Texas up to Washington,
in every lecture hall,
Where working men defend their gold,
it’s there you find Ron Paul,
it’s there you find Ron Paul!

I dreamed I saw Ron Paul last night,
Still running on TV.
Says I “But Ron, you lost ‘em all.”
“I’ll never quit” says he,
“I’ll never quit” says he.

The Road to Ruin

I have often warned against the dangers associated with conventional wisdom. With the onset of the financial crisis and the corresponding plunge in asset prices, I noted that people who were wealthy or who were close to retirement were the ones getting clobbered. New evidence now confirms this: Americans nearing retirement took the biggest hit after the financial crisis.

The sad truth is that their road to ruin was, in many cases, paved by conventional wisdom about investing.

That wisdom had many believing that, over the long run, stocks produce the highest returns; that a diversified stock portfolio protects you against loss; and that the risk of owning stocks is small, if you hold them for a long time.

While the number of decades in which U.S. equities underperform other asset classes may be small, the size of the shortfalls, when they occur, can be huge. For those who are near retirement, the shortfalls can be devastating. As a recent study from the Pew Research Center shows, the plunge in asset prices that followed the financial crisis has resulted in “a lost decade of the middle class,” with the median real net worth in America now resting roughly where it was in 1983.

And if that’s not bad enough, those folks might not ever get a shot at making up the loss in their lifetimes. As Catherine Rampell’s recent reporting in the New York Times shows, median household income has fallen most sharply among 55–64 year olds, since June 2009.

Diversification is useful, in varying degrees, most of the time. But there are occasions when all stocks dive simultaneously, and in these cases a diversified stock portfolio won’t save you.

Beware of conventional economic wisdom. Some 95% of what you read in the financial press is either wrong or irrelevant.