October 3, 2019 9:48AM

Virginia Is for Corruption

A recent corruption story in rural Virginia is rather stunning. The state is usually thought to have relatively clean government, but a Washington Post investigation by Antonio Olivo reveals something far different. The story—excerpted below—describes a wide-ranging scandal surrounding the Economic Development Authority (EDA) of Warren County, VA.

Local governments across the nation have EDAs, a key purpose of which is to hand out subsidies to favored businesses. EDAs are structured as quasi-independent from city and county governments to reduce transparency, and so they are ideal platforms for cronyism or corruption.

In a broad sense, subsidizing specific businesses is corruption in itself, even when local politicians and bureaucrats don’t line their own pockets. But they often do. This article regards an EDA official in Maryland stealing $6.7 million. In both the Virginia and Maryland scandals, it took years for the corruption to be uncovered. Why aren’t state governments auditing EDAs?

I have two solutions for this sort of local government corruption:

First, state legislatures should abolish EDAs and ban local governments from handing out narrow tax credits, loans, and other subsidies to companies. Having an in-government agency to help local businesses navigate tax and regulatory compliance might be a good idea, but having a secretive outside entity with little oversight handing out special favors is asking for trouble.

Second, Congress should repeal the tax exemption for municipal bond interest. These bonds create a strong incentive for businesses to lobby EDAs for loans rather than getting them in private markets. I understand that tax-exempt muni bonds are a core mechanism used by EDAs, and they create a bias favoring local government socialism over private enterprise.

Here are portions of the excellent Washington Post story:

Twenty-five years later, with the land cleaned up and Front Royal increasingly attractive to tourists and former city dwellers, officials announced plans for a data center and retail complex that would bring 600 jobs and act as a catalyst for other projects.

… The deal was brokered by Jennifer McDonald, a longtime Front Royal resident who directed the Warren County economic development authority. Washington-area developer Truc “Curt” Tran pledged to finance it with $40 million from wealthy immigrant investors and a $140 million federal contract his technology company had secured. As an added bonus, Tran would fund a police training academy overseen by longtime Sheriff Daniel T. McEathron.

But those were lies, documents in Warren County Circuit Court allege.

Tran never had the money to build the data center project on the 30 acres his company bought from McDonald’s agency for $1, a civil lawsuit alleges. And the training academy was one of several hoaxes that, prosecutors and civil lawsuits claim, allowed Tran, McDonald, McEathron and others to siphon away millions in public funds, which they allegedly used to buy properties, pay bills and gambling debts, and enrich relatives and friends.

… Now McEathron is dead, Tran is being sued by the economic development authority and there are state and federal investigations underway. McDonald faces 28 state counts of embezzlement, money laundering and obtaining money through false pretenses. She has denied the allegations and did not return interview requests, while Tran declined to comment through his attorney.

The claims against them, industry groups say, reflect the perils of weak oversight in economic development agencies — quasi-public entities that oversee large, complicated transactions, and whose boards often lack the financial savvy and investor scrutiny that protect their corporate counterparts. In Montgomery County, Md., an economic development official pleaded guilty this year to embezzling $6.7 million. The head of economic development in St. Louis pleaded guilty to steering lucrative contracts to the county executive’s political donors. In New Jersey, a grand jury is investigating how $500 million in tax incentives went to firms that, in part, allegedly lied on their applications.

… On Tuesday, the Virginia State Police announced that 14 current and former local officials — including all five county supervisors — were charged with misdemeanor misfeasance and nonfeasance “based on the individuals’ knowledge of and inaction [regarding] the EDA’s mismanagement of funds.”

… A soft-spoken resident of upscale Great Falls, Va., whose website boasts of contracts with the U.S. Office of Management and Budget, Tran wanted to turn part of the former Avtex Fibers manufacturing campus into a hub for cloud computing, with a three-building, $40 million complex that according to its business plan would include a restaurant, a coffee shop and a music store.

McDonald’s board approved a $10 million, 90-day loan. Tran promised funding from 80 foreign investors enrolled in the federal EB-5 visa program, which offers applicants and their families a path to citizenship in exchange for the jobs their money helps create. Officials and residents gushed over the plan.

“This is our first step into a new era,” then-Mayor Timothy Darr said at a 2015 groundbreaking, as McDonald, Tran and [Rep. Bob] Goodlatte smiled nearby.

The regional Criminal Justice Training Academy was announced the following year. McDonald said an anonymous donor would provide $8 million, and told her board the donor was Tran, the civil lawsuit says. McEathron, a fellow Rotarian, would be in charge.

… It all seemed in­cred­ibly fortunate. Until late 2016, when some town officials and residents looked up Tran’s company online.

They found it hadn’t yet been allowed to solicit investments under the EB-5 program. The $140 million federal contract appeared to be a mirage, with Tran receiving no payments from it. Skeptics asked increasingly pointed questions at public meetings, sparking warnings from Town Council members that the naysayers would blow Front Royal’s big chance.

… The Town Council authorized $1.7 million of infrastructure improvements for the Avtex site, and according to the lawsuit, McDonald allegedly paid Tran at least $1.5 million for construction costs without informing her board.

… In 2018, Front Royal’s finance director discovered a bigger red flag: The authority had overbilled Front Royal nearly $300,000 for its portion of debt service related to the Avtex site and a road improvement project. At a meeting about the discrepancy, McDonald nonchalantly said she had mistakenly falsified some invoices, Town Attorney Doug Napier recalled.

“She was not at all contrite,” Napier said. “It just shocked me.”

The revelation prompted a call to state police and an independent review of the authority’s books that uncovered a dizzying array of phony invoices, phantom projects, secret land deals and bank wire transfers to entities controlled by McDonald or her friends, according to a copy of the review completed in May by the Cherry Bekaert accounting firm. The probe was commissioned by the authority and is the basis of the criminal and civil proceedings.

McDonald allegedly billed the authority more than $50,000 to pay for renovating a vacant inn, then used those funds to pay credit card bills, according to the review. She is accused of doctoring invoices to secure $4.6 million for purchasing tax credits, then embezzling that money.

A plumbing company owned by her husband, Sammy North, allegedly collected at least $66,200 in secret payments, the review found. North has also been arrested, as was Donald F. Poe, a family friend accused of conspiring with McDonald to funnel $841,409 to his solar panel installation company for work the board didn’t authorize.

North did not return messages seeking comment. Ryan Huttar, an attorney for Poe’s company, said that his client performed the work it was hired to do and that it reimbursed the authority $335,000 when one job was canceled.

Attorneys in the civil lawsuit say McDonald allegedly convinced the authority to buy land from her aunt and uncle for a workforce housing project without disclosing that they were her relatives, and billed the authority an additional $130,000 in the transaction, most of which went to pay off what appeared to be her mortgage.

… McEathron wasn’t charged. But he may have felt the tide turning against him. He and McDonald had launched a real estate investment company called DaBoyz LLC in 2016, shortly after they announced the police academy. The firm used $3.5 million in authority funds to buy four properties, the independent review found. McDonald and McEathron also bought a three-bedroom home in Virginia Beach, which they rented to McEathron’s son and daughter-in-law, court records in the civil lawsuit show.

In one curious transaction, which lawyers for the authority say may have been an attempt to launder money, DaBoyz paid Rappawan, a construction company, $1.9 million for a large tract of land and then sold it back a month later for $1.3 million. Rappawan owner William T. Vaught Jr. declined to comment, citing the criminal investigations.

… McDonald was charged this summer with additional counts of money laundering and grand larceny. Her husband was arrested on counts of money laundering and obtaining money by false pretenses. The local grand jury, which was initially set to finish its work this month, requested another six months to investigate.

… Local activists, who had called for the state and federal investigations to be expanded, rejoiced at Tuesday’s announcement. “Somebody is finally listening,” said Salins, co-founder of the Warren County Coalition watchdog group. “It’s not every day that your entire government gets arrested. It’s so shameful.”

… And they had been demanding answers from Supervisor Tony Carter (R-Happy Creek), another of the people charged in the recent indictments. Carter works for his mother’s insurance company, Stoneburner-Carter, which holds insurance policies on four properties owned by the authority and has collected about $46,000 in premiums since 2015, according to records obtained through a Freedom of Information Act request.

For years, the local government “has been skewed [in favor] of the elite and the ‘good ol’ boys’ club,’ ” [Kristie Atwood] said. “With luck, and these indictments, our community is going to turn around for the good.”

I hope she is right. But to make sure the “good ol’ boys’ club” is gone for good, Warren County citizens should press to abolish their EDA and to rely on clean and efficient government with equal and low taxes for all businesses to encourage growth and development.

October 3, 2019 9:20AM

Reflections on the Repo‐​Market Imbroglio

While my fellow Fed-watchers have had their eyes firmly glued to the repo-market for several weeks now, I've been preoccupied with some other Fed monkey business: its plans to launch a new real-time retail payments service. Having recently testified before the Senate on that topic, I finally have some time to devote to add my two cents to what others have had to say about the Fed's repo-market tribulations.

A Broken Floor

By the "repo-market imbroglio," I mean, for those of you who haven't been watching the repo-market at all, the Fed's struggles of late to keep short-term private-market interest rates, including both the fed funds rate and rates on private repurchase agreements (or "repos"), from rising above—if not well above—the top of its fed funds rate target range.

The basic problem is that the IOER rate has been steadily losing gravity, ("gravity" being its power to keep money market rates orbiting around it) for some time. The following chart illustrates the point with reference to the effective fed funds rate:

Fed, IOER, Liquidity, Repos, Standing Repo Facility

Here the blue line shows how the gap between the fed funds rate and the IOER rate, which was originally negative, has grown since mid-2018, while the red line shows the four five-point "technical adjustments" to which the Fed has resorted in order to keep the funds rate from creeping above the upper limit of its target range. On September 17th, those adjustments, at last, proved inadequate, with the effective funds rate briefly bursting through the target upper limit. More disturbing still was the even sharper rise in repo rates that day, which had some borrowers paying 10 percent for secured overnight funds. In response to those spikes, the Fed began injecting fresh reserves into the banking system through its own repo offers. So far, as the next chart shows, banks have borrowed several hundred billion dollars of fresh reserves; and they are likely to keep borrowing them for some time.

Fed, IOER, Liquidity, Repos, Standing Repo Facility

What all this means is that, for the time being at least, the Fed's "floor" operating system, which it decided to make permanent only this January, is broken. Under a proper floor system, temporary open-market operations shouldn't be necessary. Instead, banks earn enough interest on their excess reserves to be content to hoard such reserves, and are in turn supplied with so many reserves that they never have to borrow them on the private market, let alone directly from the Fed. Because reserves are no longer scarce in this setup, marginal changes to the stock of reserves no longer influence market interest rates. Instead, the central bank adjusts the stance of monetary policy by changing the interest rate it pays on bank reserves, triggering an arbitrage process that results in corresponding changes to money market rates.

Simplicity is supposed to be the hallmark of this arrangement. As New York Fed Vice President and acting System Open Market Account (SOMA) manager Lorie Logan put it before things went sour, compared to arrangements that depend on routing open-market operations, a floor system is simple and efficient to operate. The interest rate the Fed pays on excess reserves serves as the primary policy implementation tool, with support from a standing facility that offers overnight reverse repos (ON RRPs) at an administered rate. There is no need to forecast specific factors affecting reserves or to conduct discretionary open market operations each day… Market forces keep the federal funds rate in the FOMC’s target range by allowing a wide range of counterparties to price trades against the alternative option of investing with the Federal Reserve.

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October 3, 2019 9:15AM

Poll: 58% of Americans Favor Vouchers for K – 12 Private School

The Cato 2019 Welfare, Work, and Wealth National Survey finds a solid majority (58%) of Americans favor a proposal that would allow parents to use a “voucher to enroll their children in a private school” with “government helping to pay the tuition” while 40% oppose.

Majority of Americans favor school vouchers

Full survey results and report found here.

African Americans, lower-income Americans, high school graduates, and Republicans are most likely to favor letting parents use vouchers to send their kids to private school.

More than two-thirds (69%) of African Americans support school vouchers, compared to 56% of White and Latino Americans.

Nearly three-fourths (73%) of people with annual incomes below $20,000 and 64% of high school graduates support school vouchers. But support drops among those with incomes above $20,000 and college graduates to 55% and 52%, respectively. Nevertheless, slim majorities continue to favor the proposal.

Republicans (68%) and independents (61%) are more supportive of school vouchers than are Democrats (47%). Instead, 50% of Democrats oppose such a proposal.

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October 2, 2019 3:06PM

New Cato Journal Addresses Urgent Questions about Power and Policy

The Fall 2019 edition of the Cato Journal, the Cato Institute’s interdisciplinary journal of public policy, is now available online. This latest issue’s contributors tackle a range of timely topics—from Modern Monetary Theory, to the Supreme Court’s shifting stance on executive authority, to the politicization of the Federal Reserve, to the myths surrounding the meaning of an “optimal” top tax rate. You’ll find summaries of the articles on monetary matters—and links to their full text—here. Below is a run-down of two of this issue’s other highlights, with links to their full articles as well.

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October 2, 2019 10:30AM

Today’s Tariff Headlines: Trump Administration To Impose Some “Legal” Tariffs

There are so many tariff threats, tariff announcements, and tariff impositions being tossed around these days that it can be hard to keep them all straight. With that in mind, I thought it was worth explaining the headlines today about some new U.S. tariffs relating to World Trade Organization (WTO) litigation over aircraft subsidies. These tariffs have the same negative economic impact as all the other recent tariffs imposed by the Trump administration, but it is worth noting that they aren't quite as bad as many of those other tariffs because they are -- so far, anyway -- being pursued in accordance with international law. So while they are not good, they are less bad (if that's any consolation).

Before I get to these particular tariffs, let me start off with some general background. Despite centuries of evidence to the contrary, President Trump, the self-declared "tariff man," seems to think the protection tariffs give to domestic producers, combined with the revenue tariffs bring in, makes the economy stronger. He also seems to think tariffs are helpful as a negotiating tool, as we can threaten our trading partners with tariffs in order to extract concessions from them. (So far, there isn't much evidence that this is very effective.) In addition, the Trump administration has been using tariffs as an enforcement tool: Having made the unilateral determination that China is behaving unfairly on trade, the administration is trying to use tariffs to get China to change its behavior. No luck there yet either.

These are all particularly bad uses of tariffs. But there is another use of tariffs that, while it is far from ideal, is at least designed to support the rule of law and reduce trade barriers. At the WTO, if a government believes that another government is violating the rules, the first government can file a complaint and have a neutral adjudicator decide whether there is, in fact, a violation. If that adjudicator finds a violation, and the guilty party does not come into compliance, the complainant can then get authorization to impose tariffs, in order to induce the guilty party to come into compliance. These tariffs certainly aren't great, but their objective is to help us get to a world of lower trade barriers through a neutral arbitration process governed by the rule of law.

It is this rule of law process that has been followed for the tariffs in the news today. As CNBC reports:

The World Trade Organization (WTO) has backed a U.S. request to impose tariffs on $7.5 billion of European goods, potentially sparking a new trade war across the Atlantic.

Arbitrators from the WTO have granted President Donald Trump’s administration the right to levy billions against imports of European goods for what they say are illegal subsidies granted to the planemaker Airbus by European governments.

It may take a week or two to go through one more formal WTO step before the tariffs can be imposed.

The ideal outcome here is that the EU removes those subsidies, with pressure from these tariffs acting as an incentive. In the meantime, though, American consumers and businesses will feel the costs of the tariffs, with a wide range of products, including cheese, wine, and aircraft parts, to be affected.

At the same time, keep in mind that the EU has also challenged U.S. government subsidies to Boeing, and some time in the coming months the EU will get authorization to impose its own retaliatory tariffs. (The EU may also make an argument that it can impose retaliatory tariffs sooner, based on an old U.S. violation of WTO rules).

The ideal outcome would be that both sides will remove, or at least rein in, their aircraft subsidies, and I hope that these tariff authorizations move us in that direction. But it will be a challenge. These cases (and their earlier iterations) have gone on for decades. The WTO has generally been helpful with resolving trade disputes, but some issues are very difficult to resolve. Nevertheless, with the threat of tariffs now becoming real here, it would be great if both sides would start taking seriously the task of working out how to limit subsidies to the aircraft industry.

October 2, 2019 9:20AM

New Cato Journal Features an Array of Articles on Urgent Monetary Matters

The Fall 2019 edition of the Cato Journal, the Cato Institute’s interdisciplinary journal of public policy, is now available online. Readers of Alt-M will find the articles on monetary and financial topics of special interest. Their topics range from financial inclusion, to macroprudential policy, to Modern Monetary Theory, to the politicization of the Federal Reserve, to European monetary policy. Here are links to the full-text articles–followed by a summary of each.

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October 2, 2019 9:15AM

Poll: 55% of Americans Favor Decriminalizing Drugs

Americans favor decriminalizing drug offenses

The Cato 2019 Welfare, Work, and Wealth National Survey finds that a majority, 55%, of Americans favor “recategorizing drug offenses from felonies to civil offenses” such that they “would be treated like minor traffic violations rather than crimes.” Forty-four percent (44%) oppose treating drug offenses like traffic tickets.

Full survey results and report found here.

Majorities of Democrats (69%) and independents (54%) support decriminalizing drug offenses. However, most Republicans (59%) oppose this change while 40% favor.

This partisan gap is consistent with Gallup polling that has found Democrats and independents are more supportive than Republicans of legalizing certain types of drugs. For instance, Gallup found Democrats (75%) and independents (71%) are about 20 points more likely than Republicans (53%) to support legalizing marijuana.

Democrats and Independents Support Decriminalizing Drug Offenses; Republicans Oppose

Read more of the survey report here.

The Cato Institute 2019 Welfare, Work, and Wealth Survey was designed and conducted by the Cato Institute in collaboration with YouGov. YouGov collected responses online March 7 to 13, 2019 from a representative national sample of 1,700 Americans 18 years of age and older. The margin of error for the survey is +/- 2.2 percentage points at the 95% level of confidence.

Sign up here to receive forthcoming Cato Institute survey reports.