In this Cato podcast, The Daily Beast's Megan McArdle discusses her recent post, "Health and Human Services Secretary Doesn't Understand What Insurance Is."
One might note that HHS Secretary Kathleen Sebelius is also a former insurance commissioner.
On July 8th, Sheila Bair will step down as Chair of the Federal Deposit Insurance Corporation (FDIC). While I believe she's gotten a lot wrong (such as not preparing the fund for the coming crisis), she has been about the only voice among senior bank regulators for actually ending too-big-to-fail. With her departure, we might lose that one voice. Later this year, Kansas City Fed President Tom Hoenig is also scheduled to leave his current position.
Hoenig has actually gone beyond Bair in trying to address too-big-to-fail, having called for the largest banks to be broken up. While I don't believe that should be our first approach, having an advocate for both the taxpayer and the overall economy at the helm of the FDIC could make a significant difference.
Given that Section 2 of the Federal Deposit Insurance Act requires the FDIC to have a bipartisan board, President Obama is faced with the choice of either appointing a non-Democrat or asking Vice-Chair Marty Gruenberg to leave. While I have no idea as to Hoenig's politics, he'd likely be able to pass that test.
Hoenig has also been willing to publicly challenge Bernanke on a number of issues. Given the narrow group-think among regulators that contributed to the crisis, having a loud, credible, independent voice among bank regulators is solely needed. Hoenig again fits that bill. His appointment would also offer Obama a chance to show that he is not completely beholden to the Geithner "never seen a bailout I didn't like" worldview.
Perhaps with Hoenig at the helm, we can actually begin a debate about reducing the moral hazard created by the Federal Reserve. While Bair was all too willing to see both insurance coverage and regulatory powers of the FDIC expanded, Hoenig strikes me as open-minded to the very real excess bank risk-taking that is encouraged by the existence of the FDIC.
Price fixing is illegal in the private sector, but unfortunately there are no rules against schemes by politicians to create oligopolies in order to prop up bad government policy. The latest example comes from the bureaucrats at the International Monetary Fund, who are conspiring with national governments to impose higher taxes and regulations on the banking sector. The pampered bureaucrats at the IMF (who get tax-free salaries while advocating higher taxes on the rest of us) say these policies are needed because of bailouts, yet such an approach would institutionalize moral hazard by exacerbating the government-created problem of "too big to fail."
But what is particularly disturbing about the latest IMF scheme is that the international bureaucracy wants to coerce all nations into imposing high taxes and excessive regulation. The bureaucrats realize that if some nations are allowed to have free markets, jobs and investment would flow to those countries and expose the foolishness of the bad policy being advocated elsewhere by the IMF. Here's a brief excerpt from a report in the Wall Street Journal:
Mr. Strauss-Kahn said there was broad agreement on the need for consensus and coordination in the reform of the global financial sector. "Even if they don't follow exactly the same rule, they have to follow rules which will not be in conflict," he said. He said there were still major differences of opinion on how to proceed, saying that countries whose banking systems didn't need taxpayer bailouts weren't willing to impose extra taxation on their banks now, to create a cushion against further financial shocks. ...Mr. Strauss-Kahn said the overriding goal was to prevent "regulatory arbitrage"—the migration of banks to places where the burden of tax and regulation is lightest. He said countries with tighter regulation of banks might be able to justify not imposing new taxes.
I've been annoyingly repetitious on the importance of making governments compete with each other, largely because the evidence showing that jurisdictional rivalry is a very effective force for good policy around the world. I've done videos showing the benefits of tax competition, videos making the economic and moral case for tax havens, and videos exposing the myths and demagoguery of those who want to undermine tax competition. I've traveled around the world to fight the international bureaucracies, and even been threatened with arrest for helping low-tax nations resist being bullied by high-tax nations. Simply stated, we need jurisdictional competition so that politicians know that taxpayers can escape fiscal oppression. In the absence of external competition, politicians are like fiscal alcoholics who are unable to resist the temptation to over-tax and over-spend.
This is why the IMF's new scheme should be rejected. It is not the job of international bureaucracies to interfere with the sovereign right of nations to determine their own tax and regulatory policies. If France and Germany want to adopt statist policies, they should have that right. Heck, Obama wants America to make similar mistakes. But Hong Kong, Switzerland, the Cayman Islands, and other market-oriented jurisdictions should not be coerced into adopting the same misguided policies.
Kudos to Nicki Kurokawa, a former Cato employee, for this short but substantive video explaining "moral hazard." She notes that government-subsidized risk played a pernicious role in the housing bubble and financial crisis, and warns that "too big to fail" may create similar problems in the future.
John Kay’s column in yesterday’s Financial Times criticizes government guarantees to banks because they involve hidden but large costs. According to Kay:
- Such guarantees distort competition: sheltered banks outperform rivals not because of greater efficiency, but because capital becomes cheaper to obtain.
- Sheltered banks gain too-big-to-fail status, which creates barriers to entry for smaller, more efficient banks.
- Relief from business risk leads to more risk taking, AKA moral hazard.
- Cheaper private risk management incentives are reduced within and outside the bank.
Other kinds of government guarantees, such as social insurance, also involve large hidden costs. Social Security and Medicare’s guarantee of a paid holiday with medical care for the rest of retirees’ lives generates the same types of costs:
- Labor competition is reduced because the programs induce early worker retirements, which leads to higher wage costs, on average, and lower national output.
- Workers who believe they will receive Social Security and Medicare will engage in lower personal saving, which means less capital formation and lower economic efficiency.
- Retirement income guarantees induce riskier personal savings portfolios, AKA moral hazard.
- Guaranteed retirement income means poorer financial knowledge and poorer risk management.
And now, retiree political power is too big to fail as well!
How come when Kay writes about market distortions from government guarantees for banks, he gets published; but when I do the same about government guarantees for people, I get the cold shoulder from editorial page editors?
Perhaps the biggest problem with the Obama plan to "reform" our financial system is the impact it would have on the market perception surrounding "too big to fail" institutions. In identifying some companies as "too big to fail" holders of debt in those companies would assume that they would be made whole if those companies failed. After all, that is what we did for the debt-holders in Fannie, Freddie, AIG, and Bear. Both former Secretary Paulson and Geithner appear under the impression that moral hazard only applies to equity, despite debt constituting more than 90% of the capital structure of the typical financial firm.
Geithner believes he's found a way to solve this problem - he'll just tell everyone that there isn't an implicit subsidy, and there won't be a list of "too big to fail" companies. Great, why didn't I think of that. After all, the constant refrain in Washington over the years that Fannie and Freddie weren't getting an implicit subsidy really prepared the markets for their demise.
Even more bizarre is Geithner's assertion that the government can force these institutions to hold higher capital, maintain more liquidity and be subjected to greater supervision, all without anyone knowing who exactly these companies are. Does the Secretary truly believe that these companies' securities disclosures won't include the amount of capital they are holding? Whether there is an official list or not is besides the question, market participants will be able to infer that list from publicly available information and the actions of regulators.
One has to wonder whether Geithner spent any of his time at the NY Fed actually watching how markets work. Before we continue down the path of financial reform, maybe it would be useful for our Treasury Secretary to take a few weeks off to study what got us into this mess. We've already been down this road of denying implicit subsidies and then providing them after the fact. Maybe it's time to try something different.
Just adding on to Glenn's post, much opposition to the government actually doing anything decent for people comes from the idea that the government is going to take my tax money and give it to people who don't deserve it. The problem is that for decades the Dems have tried to get around this by making sure policies and programs were relatively small and incremental, everything targeted and means tested. But doing that effectively confirmed the critics' point. The big (giant) government programs which are most popular are the ones which are universal - Social Security and Medicare - and other less controversial government programs, like highway spending, are also perceived to benefit people across the board.
There's a couple of interesting things going on here that seem worth unpacking. The first is actually a legitimate point about how valid arguments against various kinds of redistribution tend, with unsettling ease, to shade into unsavory demonization of the folks on the receiving end of the transfer. Suppose someone suggests that the government should, either by regulation or direct subsidy, ensure that the indigent are provided with health care or that insolvent homeowners are protected from foreclosure. Now, there are a few types of objections people might raise. There's an argument from efficiency and incentives: To the extent that the risks associated with individual financial or lifestyle choices are borne by the public, there's a familiar problem of "moral hazard" reducing incentives for prudence. And there's an argument from property and autonomy, to the effect that even if people ought to help others in need, each person is entitled to decide whether and how to do so without compulsion. Neither of these implies any blanket judgment about the folks who find themselves in need of aid. The first argument does suggest that redistributive policy will make it rational for people to take more risks at the margin, but it does not follow from either that people who are having trouble meeting their mortgage payments, or people who get sick and cannot afford care, are bad or foolish or irresponsible or otherwise deserving of their fate. And it is a good thing for these arguments that no such conclusion follows, because it's clearly not true.
Yet in popular political rhetoric, it's disturbingly easy to find just such a leap being made. Think of Rick Santelli's jeremiad against "losers" under foreclosure getting bailed out by government. Is it just that people are inherently spiteful or unkind? In fact, the tendency to assume that people who are badly off must deserve it may be a result of what social psychologists call the Just World Hypothesis. In brief, faced with evidence that the world is often arbitrary and unfair, and that bad things often happen to good people, many of us prefer to preserve our faith in a basically fair and benevolent universe by assuming that the badly off must somehow deserve their fates—which is a stronger and (I think) rather morally uglier proposition than the more plausible notion that people are often significantly responsible for their fates.
There are at least three reasons to take some care to avoid this implication, given how easily human beings fall into it. The first is just that it's an ugly and callous attitude to have toward people who will often deserve our compassion whether or not they ought to receive government aid. The second is that people will readily—and sometimes intentionally—misconstrue an argument about incentives as an argument about the moral worthiness or personal virtue of the proposed recipients, which does not make for a particularly fruitful conversation. Finally, there's a paradoxically quite authoritarian implicit premise lurking behind this sort of argument—to wit, that it's the job of the government to determine who is or is not morally deserving of its largess, and that the central question is whether this or that particular class of prospective recipients qualifies. That's a frame people across the spectrum ought to be uncomfortable with.
As Atrios points out, strategic response to this on the part of progressives has been to embed what are essentially welfare programs within an elaborate—and functionally, if not politically, superfluous—superstructure of universal social insurance. My colleague Will Wilkinson has pressed this point cogently in the context of Social Security. The rationale for the program is ultimately that we hope it will prevent people from being mired in poverty in old age. There is no sane reason, on this rationale, for cutting Bill Gates a check when he reaches the age of eligibility—but we do it this way because progressives believe, perhaps correctly, that a means-tested aid program for the indigent elderly would be more politically vulnerable to cuts. Which, I think, underscores the perverse effect of thinking in terms of the desert of the recipients, since there's no actually-valid argument on which a universal need-blind benefit makes more sense than a narrow means-tested one. So one more reason to eschew desert-centered political discourse: It gives rise to policy that's less intelligent whether your underlying commitments are progressive or libertarian.