Topic: Finance, Banking & Monetary Policy

The Road to Cordray’s Removal Just Got Longer

The plot thickens in the ongoing battle for the Consumer Financial Protection Bureau, the controversial agency created in the wake of the 2008 financial crisis.  Yesterday, a federal appeals court decided it would grant rehearing of last year’s case, PHH v. CFPB, which held the agency’s structure to be unconstitutional.  The decision issued last year not only ruled the agency’s structure to be unconstitutional, but also placed the director under the president’s authority, giving the president the power to fire the director at will.  Now that the court will rehear the case, its earlier decision is no longer binding, meaning the president can no longer rely on it if he wishes fire Director Richard Cordray.

Why Do We Pay So Much More for No Progress?

That is the question asked by Scott Alexander and John Cochrane in discussing high school education, college and infrastructure spending. Despite rising funding, it is not clear outcomes are improving.

Scott highlights the example of K-through-12 public education where spending has increased substantially since 1970 but test scores have remained stagnant. He asks:

Which would you prefer? Sending your child to a 2016 school? Or sending your child to a 1975 school, and getting a check for $5,000 every year?

On college he presents a similar counterfactual:

Would you rather graduate from a modern college, or graduate from a college more like the one your parents went to, plus get a check for $72,000?  (or, more realistically, have $72,000 less in student loans to pay off)

He also highlights the rising cost of infrastructure spending through the example of a New York City subway:

1900…it’s about the inflation-adjusted equivalent of $100 million/kilometer today… In contrast…a new New York subway line being opened this year costs about $2.2 billion per kilometer

As Scott outlines, the underlying crisis here is made all the worse by the fact that new technologies and globalization should have put downward pressure on the costs of provision.

Two questions arise: why is this happening and what can be done about it?

This requires a huge amount of research. Certainly it cannot be answered in a blog post. But I want to suggest an analytical framework for thinking about these examples that can be applied in each case to work out what is going wrong. This is all the more necessary because the absence of meaningful prices in the public sector makes measuring productivity much more difficult than in the full market sector of the economy.

Rather than merely comparing money spent to outcomes, we can break things down as follows:

Taxpayer dollars -> Inputs -> Production process -> Outputs -> Outcomes (quality-adjusted outputs)

Take schooling. We pay money in through taxes.  These are used to fund the labor (teachers, administrators etc), to build schools, and to pay for the goods and services used within schools. The schools then operate. And those inputs work to produce measurable outputs in terms of number of children being taught, hours of teaching, exams prepared for etc. But what we really care about is outcomes, which are linked to but not quite the same thing (think test scores). This is best thought of as a measure of quality-adjusted output. Productivity (to the extent we can measure it) can be thought of as the ratio of outputs to inputs, whereas what we ultimately care about here is improving the effectiveness of money spent (outcomes over taxpayer dollars).

Are Payday Loans Harmful?

Payday loans are small, short-term, unsecured loans. The typical borrower can not easily borrow elsewhere, and the interest rates on payday loans are quite high. These factors generate enormous criticism of payday lenders for “exploiting” borrowers.

Economists Susan Payne Carter and William Skimmyhorn of the United States Military Academy provide evidence on this criticism:

We evaluate the effect that payday loan access has on credit and labor market outcomes of individuals in the U.S. Army. … We find few adverse effects of payday loan access on service members when using any of [our empirical] methods, even when we examine dozens of subsamples that explore potential differential treatment effects.

This should not be a surprise: for people with poor credit, payday loans can be better than the alternatives. These include going to a loan shark, which is even more expensive; or not borrowing, even to fund crucial medical care, or a rental payment that avoids eviction, or travel to secure a job.

The Treasury Should Revive the Snow Plan for Limiting GSE Debt Issuance

Despite both the recent release of a set of “GSE reform principles” by the Mortgage Bankers Association and Treasury Secretary Designee Steven Mnuchin’s promise to prioritize reform of Fannie Mae and Freddie Mac, as matters stand such reform seems likely to remain stalled for some time: while there may be a consensus to “do something,” there is far less agreement concerning what that something should be.

To jump start the debate, protect taxpayers, and encourage a more private mortgage market, Mr. Mnuchin, if confirmed, should strongly consider reviving a plan developed by his predecessor, John Snow. That plan would take advantage of the Treasury’s authority to place limits on Fannie and Freddie’s debt issuance to reduce those agencies’ indebtedness. The reduction can and should be done in a controlled manner that could be easily reversed if necessary; a 5 percent monthly reduction, for instance, should work smoothly.

If You’ve Got $650 Million, the Fiduciary Duty Rule Is Not Your Problem

Yesterday, the New York Times ran a column that claimed to illustrate the issues at the heart of the current debate over the so-called “fiduciary duty rule,” which is slated to affect retirement accounts in the coming months. Except the column completely avoided one of the most important issues—access to financial advice—and instead ruminated on the troubles afflicting movie star Johnny Depp. Mr. Depp may be profligate and his money managers may have been asleep at the wheel, but the fiduciary duty rule has nothing to do with the ultra rich or their expensive advisors. Quite the opposite. Its impact will be felt almost exclusively by moderate income Americans precisely because they have only moderate incomes.

The rule was proposed and implemented in 2015 and 2016; if left unchanged, it will become effective in April 2017. Its stated intent is to ensure that investors receive quality financial advice by requiring that brokers selling certain retirement savings products conform to a “fiduciary duty” standard. In legal terms, acting as a fiduciary means handling another person’s business with the care that a prudent person would take in handling his or her own affairs. Specifically, the rule is intended to address situations in which brokers act as advisors, providing information to investors about the pros and cons of different types of retirement accounts.

This sounds good. Why wouldn’t we want advisors to act in investors’ best interests? Isn’t that just good business? It may be, but there is a difference between deciding to act in your clients’ best interests and abiding by a regulation that imposes a legal standard. The first is essentially costless and may actually benefit the broker by promoting a reputation for customer service. The second is anything but costless. Aside from the expense of implementing necessary compliance procedures to ensure that everything adheres to the law, imposing a legal duty raises the specter of litigation. Litigation, even baseless litigation, is always extremely costly.

Second Doubts about a Border-Adjustable Corporate Tax (BACT)

First Doubts” dealt with predictions that a 25% rise in the dollar could make a 20% tax on imports disappear with only temporary effects on trade but a $1.2 trillion increase in tax revenues (which would supposedly be paid by foreigners, and without complaint).  

Second Doubts will focus on a key claim that border adjustability is needed because “exports from the United States implicitly bear the cost of the U.S. income tax while imports into the United States do not bear any U.S. income tax cost.”   And we’ll question whether border adjustability is justified because corporate “cash flow” taxes under the House GOP plan are more like value-added taxes than corporate income taxes in other countries.

A Better Way” (a House Republican discussion document of June 24, 2016) says, “In the absence of border adjustments, exports from the United States implicitly bear the cost of the U.S. income tax while imports into the United States do not bear any U.S. income tax cost. This amounts to a self-imposed unilateral penalty on U.S. exports and a self-imposed unilateral subsidy for U.S. imports [emphasis added].”  

That statement makes the case for “border adjustment” – which means the costs of imports (unlike equivalent domestic costs) would cease to be tax-deductible for business and rewards from selling exports would cease to be taxable.  

Since all countries have corporate income taxes, what could it possibly mean to say only our own corporate income tax is an “implicit” tax on exports?  Who pays this “implicit” tax?

What could it mean to say that failure to impose U.S. income tax on foreign factories is a “subsidy to imports?”  

Baptists and Bootleggers in the Organized Effort to Restrict the Use of Cash

In a classic account of why prohibitions and other economic restrictions harmful to consumers arise and persist, economist Bruce Yandle noted that such restrictions are often promoted by a coalition between two groups. The first group are morally motivated do-gooders (“Baptists”) who think that the restrictions will promote the public interest. The second group are profit-motivated business people (“bootleggers”) who may adopt the language of the first group but whose aim is to profit by legally quashing potential competition. In Yandle’s example, the prohibition of liquor in the United States during the 1920s was loudly promoted by Baptists and others who considered liquor consumption sinful, and quietly backed by bootleggers whose profits from rum-running depended on the absence of legal liquor.

In today’s organized effort to restrict or prohibit the use of cash we can see the same kind of coalition. The metaphorical Baptists include leading economic advisors like Kenneth Rogoff (recently labeled by one Indian writer “the high priest of demonetisation”) and Larry Summers. They argue that banning cash would fight crime and helpfully give additional power to monetary policy-makers (by enabling negative nominal interest rates). I have criticized these arguments for currency prohibitionism before. Other presumably disinterested advocates advance the implausible claim that reducing the payment options of the world’s poor by banning cash will benefit the poor by promoting “financial inclusion.” I scrutinize this claim below.

Pages