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Give the Oscar back: New study shows the financial crisis wasn’t an ‘Inside Job’

By James Pethokoukis

May 22, 2012, 2:58 pm

 

A new study from the Federal Reserve banks of Atlanta and Boston, “Why Did So Many People Make So Many Ex Post Bad Decisions? The Causes of the Foreclosure Crisis,” argues that the housing collapse and financial crisis wasn’t caused by the greatest grift of all time:

The dominant explanation claims that well-informed mortgage insiders used the securitization process to take advantage of uninformed outsiders. The typical narrative follows a loan from a mortgage broker through a series of Wall Street intermediaries to an ultimate investor.

1. According to this story, deceit starts with a mortgage broker, who convinces a borrower to take out a mortgage that initially appears affordable.

2. Unbeknownst to the borrower, the interest rate on the mortgage will reset to a higher level after a few years, and the higher monthly payment will force the borrower into default.

3. The broker knows that the mortgage is hard wired to explode but does not care, because the securitization process means that he will be passing this mortgage on to someone else.

4. An investment banker buys the loan for inclusion in a mortgage-backed security. In constructing this instrument, the banker intentionally uses newfangled, excessively complex financial engineering so that the investor cannot figure out the problematic nature of the loan. The investment banker knows that the investor is likely to lose money but he does not care, because it is not his money.

5. When the loan explodes, the borrower loses his home and the investor loses his money. But the intermediaries who collected substantial fees to set up the deal have no “skin in the game” and therefore suffer no losses.

This insider/outsider interpretation of the crisis motivated an Academy Award-winning documentary, appropriately titled Inside Job. It has also motivated policies designed to prevent a future crisis, including requirements that mortgage lenders retain some skin in the game for certain mortgages in the future. … We argue that the facts refute the popular story that the crisis resulted from finance industry insiders deceiving uninformed mortgage borrowers and investors.

Indeed, the study points out a dozen inconvenient facts for the “Inside Job” crowd:

Fact 1: Resets of adjustable-rate mortgages did not cause the foreclosure crisis.

Fact 2: No mortgage was “designed to fail.”

Fact 3: There was little innovation in mortgage markets in the 2000s.

Fact 4: Government policy toward the mortgage market did not change much from 1990 to 2005.

Fact 5: The originate-to-distribute model was not new.

Fact 6: MBSs, CDOs, and other “complex financial products” had been widely used for decades.

Fact 7: Mortgage investors had lots of information.

Fact 8: Investors understood the risks.

Fact 9: Investors were optimistic about house prices.

Fact 10: Mortgage market insiders were the biggest losers.

Fact 11: Mortgage market outsiders were the biggest winners.

Fact 12: Top-rated bonds backed by mortgages did not turn out to be “toxic.” Top-rated bonds in collateralized debt obligations (CDOs) did.

The authors have a far more boring explanation for the housing crisis than a group of insider sharpies taking advantage of ill-informed outsiders. It was simply the Mother of All Manias: “The bursting of a massive and unsustainable price bubble in the U.S. housing market caused the financial crisis. Both borrowers and lenders believed that house prices would continue rising. Borrowers were eager to purchase homes and investors wanted more exposure to the housing market. The securitization process merely facilitated these transactions.”

OK, then, what initially caused the bubble to inflate? The authors offer a number of possibilities:

– Too much cheap money from the Fed.

– A savings glut among developing countries pushed U.S. interest rates lower and thereby pushed U.S. housing prices higher.

– The bursting of the tech bubble made low-risk real estate a more attractive option for investors.

– Fannie Mae and Freddie Mac: They were major players in the lending boom of the 2000s, even if much of this lending occurred outside of their traditional guarantee business. Specifically, both Fannie Mae and Freddie Mac indirectly invested heavily in risky mortgages by buying AAA tranches of subprime and Alt-A mortgage-backed securities and holding these securities in their retained portfolios.

But in the end, the authors admit, economics doesn’t have a good understanding of why bubbles happen. So rather than try and prevent their occurrence, it is better to make the system more resilient to them. Here is what they advise:

1. Stress test financial institutions so at any given time they can withstand a 20 percent decline in house prices without any liquidity problems. It is important to consider such scenarios even when they appear remote. For example, just because house prices have already fallen 20 percent does not mean they cannot fall another 20 percent.

2. Stress test consumers. Financial experts recommend families practice a “financial fire drill,” which asks how they would get by if one income-earner lost a job, they should also game a situation in which falling house prices prevent the family from selling their house for more than they owe on their mortgage.

3. Mortgage disclosure forms need to “inform borrowers that there is a chance that the house they are buying will soon be worth substantially less than the outstanding balance on the mortgage.” But none of the new ones being proposed by the new consumer finance regulator do.

 

 

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Categories:  Financial Services, Regulation   |   Tags: ,

U.S. manufacturing output may boom, but not jobs

By James Pethokoukis

May 22, 2012, 1:52 pm

The WSJ:

After a 35% decline in the number of manufacturing jobs between 1998 and 2010, the tally has since risen by 489,000, or 4.3%, to 11.9 million. Most of that increase is due to the economic recovery rather than reshoring. But IHS Global Insight, an economic research firm, forecasts that the number of manufacturing jobs will climb 3.2% this year compared with a 1.6% increase in all jobs. ”We’re becoming more competitive,” says Daniel Meckstroth, chief economist at the Manufacturers Alliance for Productivity and Innovation, a research group in Arlington, Va. …

U.S. manufacturing has become attractive for some companies as Asian wages have surged over recent years and the wage gap between the U.S. and China has narrowed. The drop in the dollar over the past decade has also made U.S.-produced goods more competitive. And higher oil prices have increased the cost of shipping goods across oceans, making domestic manufacturing more appealing.

Still, as the piece goes on to say, the jobs being reshored are only coming back in dribs and drabs. And it may have less to do with rising U.S. competitiveness than companies embracing a “regional manufacturing” approach “where Asian plants serve Asian customers, North American ones serve Americans.”

The U.S. may well make more here at home and export more abroad, but that is not the  same thing as creating lots and lots of high-wage jobs. Tyler Cowen:

 The new export-based prosperity may not translate into higher wages for everyone, or even most people, in the United States. Skilled laborers who work with smart machines or even hold advanced managerial jobs will continue to make big gains, as the numbers have been showing for some time.  … As the number of American jobs in manufacturing has fallen dramatically, it is often forgotten that American manufacturing output has continued to rise, even during some slow times. In the past decade, the flow of goods coming from U.S. factories has gone up by a third as capital has increasingly become a greater share of input over labor.

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Categories:  Economic Policy   |   Tags:

Kenneth P. Green

A novel approach to reducing traffic congestion

By Kenneth P. Green

May 22, 2012, 10:20 am

There are many ways to manage traffic congestion, from charging market pricing for the use of roadways, to putting a market price on parking, to expanding highways, computerizing traffic signalization, etc.

Of course, another alternative is just to wreck your economy:

Traffic congestion dropped 30% last year from 2010 in the USA’s 100 largest metropolitan areas, driven largely by higher gas prices and a spotty economic recovery, according to a new study by a Washington-state firm that tracks traffic flows.

That was the largest drop since the nation plunged into recession in December 2007.

Of the 100 most populous metro areas, 70 saw declines in traffic congestion while just 30 had increases, says Jim Bak, co-author of the 2011 U.S. Traffic Scorecard for Kirkland, Wash.-based INRIX.

The INRIX Traffic Scorecard explains the changes to mobility as being the result of a “stop-and-go” economy. In essence, if your economy is growing and your gas prices low, you get more congestion. If your economy isn’t growing, and your gas prices are high, you get less:

•    Cities outpacing the national average in employment growth (1.2%) like Miami (2.3%), Tampa (3.0%), Houston (3.2%) and Atlanta (1.6%) experienced some of the biggest increases in traffic congestion.

•    Cities with gas prices consistently equal to or less than 2011’s national average of $3.52 per gallon and moderate gains in employment like Atlanta (20 cents less, 1.2%), Austin (10 cents less, 2.1%) and Miami (same, 1.2%) also experienced the biggest increases in traffic.

•    Cities that experienced the biggest drops in traffic congestion also were consistent to those with fuel prices well above the national average ($3.96) at their April 2011 peak such as Los Angeles ($4.25), Seattle ($4.03), San Francisco ($4.25) and Honolulu ($4.48). San Francisco and Los Angeles present interesting cases where both cities experienced some of the highest gains in employment in the country (2.2%) yet experienced some of the biggest declines in traffic compared to the previous year signaling high fuel prices caused drivers to drive less.

Read a summary of findings here.

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Categories:  Energy and Environment   |   Tags: , ,

Thomas P. Miller

Entitlement reform for the highly educated

By Thomas P. Miller

May 22, 2012, 10:06 am

Former OMB factotum (let’s make that “health policy adviser without fixed portfolio”)  Zeke Emanuel has returned to academic life, but he opines periodically in a New York Times opinion column. On Sunday, the improbable happened. He proposed an idea for entitlement reform that should not be rejected out of hand—graduated eligibility based on lifetime income for Social Security and Medicare.

Bring out the usual clichés:

•    What was the wind chill factor today in Hell?

•    The lion and the lamb shall lay down together (Nope: it’s a co-tenancy with a wolf).

•    What were the other six warnings signs of the Apocalypse?

•    Even a stopped clock is right twice a day (and check out that blind squirrel’s acorn…)

•    There really is a pony inside that room piled high with manure.

•    C’mon. We kid because we love.

Suffice it to say, I’ve been a little critical of the other brother Emanuel’s advice on health policy reform in the past. But the desperate search for the road to bipartisan entitlement reform (it only takes two, if you’re filling up an ark for the great fiscal flood ahead) means any semi-plausible rationale for trimming back the outer bounds of our unfunded political lies (we call them “promises” in Washington) is worth a second look.

The shorthand description of the proposal is to replace a fixed “normal” age of eligibility for cashing in on the taxes of younger Americans with age of eligibility linked to one’s place in the lifetime earning distribution. The lower 50 percent of new retirees (I’m assuming the proposal would only operate prospectively) would be insulated from this change in policy, while the top quarter of seniors would have to wait the longest for their federal paydays to start (age 70 for Medicare, and age 71 for Social Security). The minimum age for social security retirement benefits would be adjusted similarly, but delayed retirement credits would remain in place.

The empirical argument for this change (aside from re-soaking the rich by narrowing the entitlement spending spigot, instead of extracting their dollars through the tax code—although I suspect the former would not replace the latter in the full Emanuel package) is that the lifespans of richer Americans have grown longer in recent decades than those of less affluent retirees. Perhaps those extra dollops of grey poupon are good for your health!

Is it time to close the dreaded longevity gap, and try to equalize the time in orbit for retirees on federal taxpayer support? Emanuel presents the proposal as not changing richer Americans’ state-given right to health and retirement benefits when they get older; it’s just a matter of adjusting WHEN they first get them.

The concept has some broader appeal on equity grounds, but more affluent, older Americans can do the math (or ask their financial adviser to check into it). Speculation over how the electoral math might change is premature, depending on which desperate options we might be choosing among when Congress finally approves a budget within our lengthening lifetimes.

However, several complicating aspects of the proposal remain.

•    Social security benefit formulas already are very progressive and favor workers with lower lifetime earnings.

•    Wasn’t progressive indexing of future social security benefits a better way to reduce the future growth rate of payments to higher earners?

•    The purported regressivity of the lifetime dollar amount of Medicare benefits has been diluted, if not fully reversed, over the last two decades.

•    The proposal overlooks the effects of lifetime wealth and other sources of non-wage income in making its adjustments.

•    Even relatively richer young retirees would face difficulties in relying more on current private markets for pre-Medicare health insurance coverage. Medicare buy-in options always sound better on paper than they unfold in practice.

•    Wary analysts should account for compensating behavior like increased rates of claims for disability benefits by younger retirees (and the Disability Insurance fund is headed toward insolvency well before Social Security or Medicare spring major fiscal leaks).

•    After recent rounds of Medicare income-related premiums, additional Medicare-dedicated taxes on the wages and capital income of higher-earning Americans, unindexed income taxes on social security benefits for growing numbers of retirees, and various caps on Medicare premium increases for different cohorts of retirees receiving small, if any, COLA hikes to their monthly retirement checks, the most “universal” characteristic of Social Security and Medicare is that both programs are running short of money and unable to fulfill all of their past promises.

Finally, the more powerful driver of growing differences among retirees in remaining life expectancy is more likely their relative levels of education; not their lifetime incomes.

So, perhaps we should consider reducing promised benefits first for more highly educated Americans (we could start with the past and present Obama White House staff!). Except that they’d be more likely to find out about it ahead of time and lobby more articulately and extensively against the idea.

Okay, then let’s start with a future benefits reduction for all those under-age-26 slackers sucking up their parents’ group insurance coverage under ObamaCare’s regulatory cross-subsidy, without looking for a job and moving out of the basement. Don’t let them think they are legally entitled to other people’s money until they are at least a “subsidy-adjusted” age of 65, with at least 43 years of previous adult-like financial independence!

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Categories:  Economic Policy, Retirement and Social Security   |   Tags:

Peter J. Wallison

Elizabeth Warren gets Glass-Steagall wrong

By Peter J. Wallison

May 21, 2012, 10:32 am

Elizabeth Warren, as everybody knows, is a Harvard Law School professor. She was also the chair of the Congressional Oversight Panel, which oversaw the implementation of TARP, and she was tasked by the Obama administration to set up the Consumer Financial Protection Bureau, a powerful government agency established under the Dodd-Frank Act. Now she’s running for the Senate in Massachusetts, a seat held by Republican Scott Brown. One of the planks in her platform is the reinstatement of the Glass-Steagall Act, a depression-era law partially repealed under Bill Clinton in 1999. With the recent news about a $2 billion loss at JP Morgan Chase, she was on NPR over the weekend saying that Glass-Steagall should be reinstated in order to prevent losses like that.

If you heard that NPR broadcast—and you still can at www.npr.org—you’d have heard Warren say that “the thing about Glass-Steagall is that it makes banking boring… If you want to do all those exciting things like make $100 billion bets or lose $2 billion, or 3, you have to do that over in the Wall Street trading kind of business. Glass-Steagall says there needs to be a wall between those two kinds of activities.”

Well, Warren isn’t a senator yet, and that’s a good thing because she doesn’t have an understanding of Glass-Steagall that we might expect from a Harvard law professor. The first thing she has to understand is that Glass-Steagall still applies to banks. The only thing that changed in 1999 was that banks were allowed to affiliate with securities firms, but Glass-Steagall still forbids banks themselves to engage in underwriting or dealing in securities.

Well, if Glass-Steagall still applies to banks, how is it that JP Morgan Chase could make those trades that cost the bank $2 billion? They can do it because even under Glass-Steagall banks were able to buy and sell (that is, trade) loans and securities backed by loans. How could it be otherwise? Loans are banks’ stock in trade, and it would be as crazy to forbid them from buying and selling loans and securities backed by loans as it would be to prohibit Exxon Mobil from buying and selling oil.

What’s more, JP Morgan Chase’s CEO, Jamie Dimon, says the bank lost the $2 billion in hedging transactions, which means they were making trades to protect other assets against losses. Banks have always been allowed to hedge, not only under Glass-Steagall but also under the Volcker rule that is in the Dodd-Frank Act, which Warren said she supports.

$2 billion is a lot of money, of course, but it’s only 1/1000th of the assets of this $2 trillion bank. Warren fell for the media hype that this was a huge “bet,” and that doesn’t speak well for her ability, as a Harvard law professor, to distinguish between facts and what the media says. She’ll have to do that if she ever gets to be a senator, and maybe before.

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Categories:  Economic Policy, Financial Services, U.S. Politics   |   Tags: , ,

Just how bad for the economy would falling off the 2013 fiscal cliff be? Bad

By James Pethokoukis

May 18, 2012, 3:58 pm

 

Just how big and scary is the fiscal cliff American faces in 2013? Well, there are various estimates, and the folks at the Committee for a Responsible Federal Budget have compiled a bunch of them.

Anyway you cut it, it wouldn’t be a walk in the park.

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Categories:  Economic Policy, Fiscal Policy and Taxes   |   Tags: ,

Kenneth P. Green

Renewable energy stocks in decline

By Kenneth P. Green

May 18, 2012, 2:03 pm

For those tracking the ongoing pop-pop-popping of the renewabubble, The Hockey Schtick has a post worth printing out and putting on the wall:

The RENIXX Index of the 30 largest renewable energy companies in the world is trading at an all-time low today and has lost over 90% of its value since 2008. A partial listing of green energy companies that have already filed bankruptcy or are teetering on the brink is below. Many of these companies were financed by taxpayers.

Filed Bankruptcy:

o    Solyndra
o    Beacon Power
o    Ener1
o    Range Fuels
o    Solar Trust of America
o    Spectrawatt
o    Evergreen Solar
o    Eastern Energy
o    Unisolar
o    Bright Automotive
o    Olson’s Crop Service
o    Energy Conversion Devices
o    Sovello
o    Siag
o    Solon
o    Q-Cells
o    Mountain Plaza

Teetering on the Brink:

o    Abound Solar
o    A123 Systems
o    Brightsource Energy
o    Fisker Automotive
o    First Solar
o    Nevada Geothermal
o    SunPower
o    Nordex
o    The Bard Group
o    Amonix
o    NRG Energy
o    Alterra Power
o    Enel Green Power
o    Sunpower Corp

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Report: Move to break up big banks now gaining steam in Congress

By James Pethokoukis

May 17, 2012, 9:34 am

What hath JPMorgan’s billion-dollar hedging mistake—which may end up costing the bank $3 billion or more—wrought? Financial reform didn’t look like it was going to be much of political issue this year, especially with the Occupy Wall Street doing the Big Face.

But that has all changed in a heartbeat. Jaret Seiberg, the all-star banking analyst with Guggenheim Securities’ Washington Research Group, is out with an absolutely stunning research note today. This is what he lists as his top political issue for banks for the rest of the year:

1. Break Up the Big Banks. The Republican response to Dodd-Frank’s overkill is to break up the banks. The far left also wants to break up the big banks. The issue with the JP Morgan hedging mess is that it empowers the far left and the far right to pursue their agendas while the silent majority in the middle ducks for political cover. That is why we believe there are two serious threats here. First, Congress could enact the Hoenig plan which would require banks to divest their broker-dealer units. Alternatively, the regulators could raise capital requirements to the point where big banks voluntarily divest units to reduce the capital burden they face.

And what if the growing EU debt crisis results in one or more major blowups at U.S. banks this summer?

Who knows if anything will pass this year, but it will certainly weigh on the sector—and the 2012 elections.

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Here are 2 devastating debt charts Romney should show at every campaign stop

By James Pethokoukis

May 16, 2012, 3:06 pm

Mitt Romney hammered President Obama yesterday on the debt issue:

When you add up his policies, this president has increased the national debt by five trillion dollars.

Let me put that in a way we can understand. Your household’s share of government debt and unfunded liabilities has reached more than $520,000 under this president. Think about what that means. Your household will be taxed year after year with the interest cost of that debt and with the principal payments for those liabilities. Of course, it won’t be paid off by the adults in your household. It will be passed along to your children. They will struggle throughout their lives with the interest on our debts — and President Obama is adding to them every single day.

And that’s the best case scenario. The interest rate on that debt is bound to go up, like an adjustable mortgage. And there’s a good chance this debt could cause us to hit a Greece-like wall.

Subprime mortgages came close to bringing the economy to its knees. This debt is America’s Nightmare Mortgage. It is adjustable, no-money down, and assigned to our children. Politicians have been trying to hide the truth about this nightmare mortgage for years — just like liar-loans. This is not just bad economics; it is immoral.

Now, I’m no political pro, but I think these following two charts tell in pictures what Romney said in words. First, here’s a debt chart showing just the scenario Romney is outlining. It is the vicious-circle scenario where high debt levels boost interest rates and slow growth, resulting in even higher debt levels that put even Greece to shame:

This second chart is another personal favorite of mine. Prepared by the Obama White House, it shows the long-term fiscal impact of the president’s recent budget:

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Categories:  Fiscal Policy and Taxes   |   Tags:

Romney: Imagine if Uncle Sam designed a cell phone …

By James Pethokoukis

May 16, 2012, 2:14 pm

Liberal pundits like Jonathan Cohn are moaning and groaning about Mitt Romney’s economic speech in Iowa yesterday because a) he seemed to blame the sickly recovery on high debt levels, and b) he thinks the stimulus was a failure.

He are the two parts in question that liberals dislike:

President Obama is an old-school liberal whose first instinct is to see free enterprise as the villain and government as the hero. America counted on President Obama to rescue the economy, tame the deficit and help create jobs. Instead, he bailed out the public sector, gave billions of dollars to the companies of his friends and added almost as much debt as all the prior presidents combined. The consequence is that we are enduring the most tepid recovery in modern history. …

President Obama started out with a near trillion-dollar stimulus package – the biggest, most careless one-time expenditure by the federal government in history. And remember this: The stimulus wasn’t just wasted – it was borrowed and wasted. We still owe the money, we’re still paying interest on it and it’ll be that way long after this presidency ends.

A few thoughts:

1. Debt might well be retarding growth. Economists Carmen Reinhart, Vincent R. Reinhart, and Kenneth Rogoff just put out a new study looking at the economic impact of high debt levels: “We identify 26 episodes of public debt overhang–where debt to GDP ratios exceed 90% of GDP–since 1800. We find that in 23 of these 26 episodes, individual countries experienced lower growth than the average of other years. Across all 26 episodes, growth is lower by an average of 1.2%.” The economists also recommend not waiting until bond markets freak out before acting.

2.  Some models have the stimulus plan creating lots of jobs and growth, others do not. But here’s what’s for certain: The Obama administration, in the form of Vice President Joe Biden, said the stimulus would “literally drop kick us out of the recession.” But no one thinks we’ve returned to prosperity. Michael Grabell, a reporter for ProPublica, documents the many failings of the American Recovery and Reinvestment Act in Money Well Spent? The Truth Behind the Trillion-Dollar Stimulus, the Biggest Economic Recovery Plan in History. Rather than focus on the questionable Keynesian economics behind the stimulus, Grabell focuses on its execution and management. Grabell concludes that “the stimulus ultimately failed to do what America expected it to do — bring about a strong, sustainable recovery. The drop kick was shanked.”

3. There was an alternative to the Obama stimulus, such as a permanent cut in individual and corporate taxes. Worked pretty well for Sweden.

Romney also had a great bit on the difference between government and the private sector:

During my time in business and in state government, I came to see the economy as having three big players – the private sector, the states and localities and the federal government.

Of these three, the private sector is by far the most efficient and cost effective. That’s because scores of businesses and thousands of entrepreneurs are competing every day to find a way to deliver a product or a service that is better than anyone else’s. Think about smart phones. Blackberry got things going. Then Apple introduced the iPhone. Now the Android platform leads the market. In the world of free enterprise, competition brings us better and better products at lower and lower cost. Innovate and change or you go out of business. And the customer — us — benefits. …

Imagine if the federal government was the sole legal supplier of cell phones. First, they’d still be under review, with hearings in Congress. When finally approved, the contract to make them would go to an Obama donor. They’d be the size of a shoe, with a collapsible solar panel. And campaign donors would be competing to become the all-powerful app czar.

My point is this: As President Obama and old-school liberals absorb more and more of our economy into government, they make what we do more expensive, less efficient and less useful. They make America less competitive. They make government more expensive.

What President Obama is doing is not bold; it’s old.

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Categories:  Economic Policy, Fiscal Policy and Taxes   |   Tags: , ,

Where Obama has succeeded and failed on education reform

By James Pethokoukis

May 16, 2012, 1:41 pm

AEI’s Rick Hess on what Obama has done right and wrong on education:

First, the good:

The president and Secretary of Education Arne Duncan have broadened the Bush administration’s school reform agenda, bringing more attention to teacher evaluation, teacher pay, charter schooling, and higher education. They’ve used their bully pulpit to argue the need to spend school dollars more intelligently and challenge colleges to control their costs. And they’ve acknowledged the need for flexibility when it comes to some of the burdensome elements of the No Child Left Behind Act, while singing the praises of innovation more generally.

And now the bad:

First, his reform playbook has relied on a prescriptive, sprawling role for Washington bureaucrats. … Second, even when it comes to the putatively “state-led, voluntary” push for common math and reading standards, the president has been unable to resist the urge to get Uncle Sam involved. … Third, for all the administration’s handsome talk about the need to do more with less, the whole of the Obama school reform strategy has rested on pledges of huge new spending. … And while the Obama team deserves credit for supporting charter schools and “innovation,” it has also shown a troubling hostility to dynamic new problem-solvers in education. The administration has essentially declared war on for-profit educational providers, setting out draconian new regulations for colleges while restricting their participation in the K-12 “investing in innovation” fund.

I guess I would like to get the U.S. education system as far away from Washington as possible. During the GOP presidential campaign, I liked Jon Huntsman’s idea of what to do with the Department of Education:

The Department of Education should be a clearinghouse of ideas, limited to normal market regulation and information gathering in order to provide objective measures so local actors can measure their performance. Jon Huntsman will transition the department toward this defined responsibility, transforming it into a more efficient Education Advisory Council, similar to the United States Trade Representative which maintains cabinet level status while being inside the White House. Other responsibilities not in line with these key objectives will be distributed to other appropriate agencies

In the WSJ today, Sen. Lamar Alexander resurrects his idea of a “grand swap”: “The federal government would take over 100% of Medicaid, the federal health-care program mainly for low-income Americans, and states would assume all responsibility for the nation’s 100,000 public schools.”

This, in theory, is not a bad idea at all. We really shouldn’t have three separate healthcare systems in America: Medicaid, Medicare, and—now—Obamacare. Workers should be able to spend their own pre-tax dollars on private health insurance, with the poor and elderly doing the same with subsidies. Under that system, it makes some sense to nationalize Medicaid.

As for education, pushing it back to the states completely would make it easier for states to function as 50 little policy labs where disruptive innovations can take place.

But before any of that can happen, a) Obamcare must be repealed or greatly modified and b) teachers unions must be further depowered.

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Categories:  Economic Policy, Education   |   Tags:

Kenneth P. Green

Is science in decline?

By Kenneth P. Green

May 15, 2012, 1:12 pm

There’s been a lot of talk lately about which political party is “more scientific,” which has obscured a much more important question, which is whether the institution of science itself is in decline.

Over at nature magazine, Daniel Sarewitz points out very troubling trends in the world of science:

Alarming cracks are starting to penetrate deep into the scientific edifice. They threaten the status of science and its value to society. And they cannot be blamed on the usual suspects — inadequate funding, misconduct, political interference, an illiterate public. Their cause is bias, and the threat they pose goes to the heart of research.

What Sarewitz is pointing to here isn’t political bias (though the overwhelming liberalness of scientists is well documented), but rather, to systematic biases that favor the constant production of “positive” findings with redeeming social value:

The belief is that progress in science means the continual production of positive findings. All involved benefit from positive results, and from the appearance of progress. Scientists are rewarded both intellectually and professionally, science administrators are empowered and the public desire for a better world is answered. The lack of incentives to report negative results, replicate experiments or recognize inconsistencies, ambiguities and uncertainties is widely appreciated — but the necessary cultural change is incredibly difficult to achieve.

And while most of the examples he gives are from biomedical research (where, ironically, it’s easiest to test hypotheses), Sarewitz suggests we view most scientific research with caution these days:

It would therefore be naive to believe that systematic error is a problem for biomedicine alone. It is likely to be prevalent in any field that seeks to predict the behaviour of complex systems — economics, ecology, environmental science, epidemiology and so on. The cracks will be there, they are just harder to spot because it is harder to test research results through direct technological applications (such as drugs) and straightforward indicators of desired outcomes (such as reduced morbidity and mortality).

As someone who routinely has to dispute crazy claims about climate science being “settled,” and about predictions of the climate 100 years from now as being “sound science,” I find it refreshing to see such a discussion in nature magazine. But as someone trained in the sciences, who believes that science is still our pre-eminent route to understanding the world around us, and that robust scientific institutions are necessary to human progress, I find the entire thing somewhat depressing.

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Categories:  Energy and Environment   |   Tags:

The fiscal cliff is like a nasty, double-diamond ski slope

By James Pethokoukis

May 15, 2012, 10:40 am

This is what the U.S. economy is facing (courtesy of a great chart from Strategas) come 2013 because of legislated tax increases and spending cuts. And here is the breakdown on those:

Fiscal cliff = recession—or an even worse recession if the EU debt crisis already has the economy shrinking by then.

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New study: It was technology that smashed private-sector unions

By James Pethokoukis

May 15, 2012, 10:23 am

From economists Emin M. Dinlersoz and Jeremy Greenwood, The Rise and Fall of Unions in the U.S.:

When the productivity of unskilled labor is (relatively) high it pays for the union to organize a lot of firms and demand generous wages. The shift from an artisan economy to an assembly line economy during the beginning of the 20th century was associated with an increase in the (relative) productivity of unskilled labor that led to an increase in unionization and a decrease in income inequality.

The decline of the assembly line economy and the rise of the information age during the second half of the century reversed this. This led to the ∩-shaped pattern of unionization and the ∪-shaped one for income inequality. … Statistical analysis suggests that skill-biased technological change is an important factor in de-unionization.

In 1900 seven percent of the American workforce were union members. The number of union members rose until the middle of the century, as shown in Figure 1, hitting its apex at 32%. It then began a slow decline. At the end of century 14% of American workers belonged to a union. At the beginning of the 20th century, the top 10% of workers earned 41% of income. This figure declined hitting a low of 31% around mid-century. It then steadily increased to 41% around 2000.1 What could have caused the ∩-shaped pattern of union membership and the ∪-shaped one for the distribution of income? Are they related? The hypothesis here is that skill-biased technological change underlies the rise and fall in union membership, along with the up and down in income inequality. The beginning of the 20th century witnessed a shift away from an artisan economy toward an assembly line one. This favored unskilled labor. The premium for skill declined.

Unskilled labor is homogenous, almost by definition. This makes it easier to unionize than skilled labor. When the demand for unskilled labor rises there is a larger payoff to unionizing it. Things changed at the midpoint of the century. The second industrial revolution was petering out and the information age was dawning. Transistors and silicon chips meant that automatons could replace the hoards of unskilled workers laboring on factory and office floors. This represented a reversal of the earlier trend.

Sorry, my left-liberal friends, there’s no going back to the 1950s and 1960s when unions were strong. And just as technology undercut unions, it has contributed to the rise of income inequality. That is what we call a trade-off, though as long as median incomes are rising and mobility remains high, I don’t much care about inequality driven by technology and globalization, as opposed to crony capitalism.

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Andrew P. Kelly

A college both left and right should be angry about

By Andrew P. Kelly

May 14, 2012, 5:09 pm

Democrats in Congress and the Obama administration have spent the past three years going after for-profit colleges in an effort to combat fraud and misuse of federal student aid monies. Some policymakers were careful to cast the onslaught as an attempt to root out bad actors. But most of the heated Democratic rhetoric went further, alleging that there is a fundamental contradiction between serving students and serving shareholders, and that for-profits simply can’t help but choose the latter (for my long take on the politics of this issue area, see here).

Because of this tension, Democrats have argued, for-profits will skimp on education and spend their resources on the things that drive their stock price—marketing and recruiting. In order to avoid wasting federal student aid dollars on such useless expenses, Democrats have argued that the government should regulate access to student aid on the basis of an institution’s tax status. Non-profit? No problem. For-profit? Let me see your hands.

If this logic strikes you as dubious, just wait until read Businessweek’s latest story about High Point University, a private, non-profit college in North Carolina. In 2005, High Point hired Nido Qubein, a motivational speaker, to serve as its president. Qubein proceeded to invest nearly $700 million in the campus, constructing shiny new buildings, high-end dining halls, and a ridiculous array of amenities that would make the manager at a Four Seasons blush. As Businessweek points out, this is a very expensive way to grow the brand. Moody’s downgraded their bonds to junk status after the campus borrowed $165 million in just a few short years. Tuition at High Point has increased 60 percent, reaching $37,800 this past year. (High Point received about $400,000 in Pell Grants and $2.3 million in federal student loan dollars in 2009-2010).

Among the juiciest nuggets in the story:

In 2010, according to High Point’s annual IRS filing, [Qubein] received a deferred compensation package that boosted his pay to $1.38 million. IRS filings show the university pays almost $1 million annually to his family’s public-relations and consulting business, now headed by Qubein’s 28-year-old daughter, Deena Qubein Samuel.

So let’s get this straight: When for-profits spend public money on marketing instead of education, Senator Tom Harkin calls them to the carpet in the Senate. But when a nonprofit university feeds at the federal trough to the tune of $700 million in fountains, marble, and a certified “Director of WOW,” policymakers don’t bat an eye because they don’t pay out dividends to shareholders?

And we wonder why we have a college cost problem.

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Steven F. Hayward

Energy fact of the week: The shale whale

By Steven F. Hayward

May 14, 2012, 5:09 pm

One of the most tired talking points of the “hydrocarbon deniers” (as I am going to call them) is that the U.S. must move beyond oil because we have less than 2 percent of the world’s proved reserves, though we consume about 20 percent of global oil production. After last week’s testimony from Anu Mittal, the director of natural resources and environment for the Government Accountability Office, to the House Committee on Science, Space, and Technology, anyone who persists in using this talking point again (that would include the president) deserves to be labeled an anti-science ignoramus.

Mittal reviewed the geological survey data of oil shale in the western United States that show we have about 3 trillion barrels of oil equivalent. This represents about two-thirds or more of the total shale oil estimated to exist worldwide. About half of it, according to Mittal’s testimony, is thought by public and private analysts to be recoverable. With droll understatement, Mittal offered the following conclusion, which should be read slowly: “This is an amount about equal to the entire world’s proven oil reserves.”

So let’s look at what this means graphically. Figure 1 shows the estimated proven reserves of conventional oil. But add in “unconventional” shale oil (though this distinction is increasingly meaningless with the advance of extraction technology), and you get Figure 2, which shows that instead of having only 2 percent of global oil reserves, the U.S. actually has 82 percent as much oil as the rest of the world, and almost twice as much as the Middle East. Maybe we should start exporting oil to China and join OPEC?

Sources: EIA and IEA.

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Kenneth P. Green

Environmentalists to Canada: Drop dead

By Kenneth P. Green

May 14, 2012, 5:08 pm

In a recent editorial assault on Canada, oil-sands climate activist extraordinaire James Hansen (NASA) has basically declared war on Canada’s economy (not to mention our own). Hansen wrote:

Global warming isn’t a prediction. It is happening. That is why I was so troubled to read a recent interview with President Obama in Rolling Stone in which he said that Canada would exploit the oil in its vast tar sands reserves “regardless of what we do.”

He goes on to suggest that the U.S. actually take actions against the interests of our neighbors to the north:

President Obama has the power not only to deny tar sands oil additional access to Gulf Coast refining, which Canada desires in part for export markets, but also to encourage economic incentives to leave tar sands and other dirty fuels in the ground.

This is truly astonishing: A high ranking official at NASA has taken to the pages of the New York Times to lobby the president of the United States to physically embargo Canada’s oil and impose economic sanctions against Canada to force them to eschew tar-sand development and export.

As Bruce Carson, executive director of the Canada School of Energy and the Environment points out in the journal Policy Options, that would be unbearably painful for Canada:

The energy sector represents the largest single private investor of capital in Canada and continues to attract the single largest slice of foreign direct investment, and these investments are spread across the country. The energy sector is a major economic driver for Canada, accounting for 6.8 percent of Canada’s GDP in 2008 and directly employing 276,000 persons, or about 1.9 percent of total direct employment in Canada. In 2007, oil exports alone generated nearly $70 billion for the Canadian economy. The Canadian Energy Research Institute (CERI) estimates that the oil sands industry alone will add 3 percent to Canada’s GDP by 2020 and will create, during the period to 2020, 5.4 million person years of employment, 44 percent of which will be outside Alberta. Currently the oil sands industry contributes toward 112,000 jobs across Canada and, according to CERI, over the next 25 years it is expected to contribute over 11 million person years of employment to Canada and $1.7 trillion to the Canadian economy.

It would feel pretty bad on our end too:

•    Trade between the United States and Canada is huge and growing. Total trade between the two countries was worth $676 billion in 2008—more than one million dollars a minute.

•    Canada is the biggest export market for U.S. products. Moreover, Canada ranked number 1 in 35 states as the leading export market for goods in 2008, and number 2 in 11 others.

•    Trade creates jobs in the United States. More than 8 million U.S. jobs depend on trade with Canada. That’s 4.4% of total U.S. employment—1 in 23 American jobs depends on free and open trade with Canada.

Hansen’s most recent editorial has received sharp criticism for the over-reach of his claims about climate science, but what the media isn’t covering is an unprecedented call for environmental trade war with America’s largest trading partner. Let’s hope they catch up to that aspect of the story.

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Nick Schulz

Silent spring? Not so much

By Nick Schulz

May 14, 2012, 3:10 pm

I’ve mentioned before that I live in Rachel Carson‘s old neighborhood and often hike in the Montgomery County, MD parks, where she spent time ruminating about the natural world. Given that I’m a fossil-fuel loving, better-living-through-chemistry enthusiast, I am sure my presence there has her spinning in her grave.

Carson is, of course, most famous for Silent Spring, her polemic against industrial chemicals, including DDT. The book was serialized by the New Yorker 50 years ago this June and is credited with launching modern environmentalism.

The anti-DDT forces inspired by Carson went too far (something Roger Bate and his friends demonstrate conclusively in this fine book). Many millions of people in developing countries have suffered needless disease and death due to anti-DDT zeal and rejection of science.

In any event, despite my love of modern industrial society, I’m as much a sucker for cute, helpless animals as the next mammal with opposable thumbs. So I’m happy to note that, as the picture below shows, there’s a noisy spring in my neighborhood this year.

That’s a nest in my backyard, adjacent to Carson’s old haunts.

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Greece euro exit a time bomb under Obama reelection

By James Pethokoukis

May 14, 2012, 2:40 pm

It wasn’t a meltdown in the mortgage-backed securities market that handed Barack Obama a near-landslide victory in 2008. No, it was fear. Or to put things in Wall Street lingo, it was “a lack of confidence.”

As in “a lack of confidence that ATMs would keep dispensing cash.”

As in “a lack of confidence that millions of unemployed wouldn’t soon be selling their Apples (iPod, iMacs, iPhones) on street corners.”

As in “a lack of confidence that your doomsday prepper neighbor wasn’t right all along.”

And it might be a shattering lack of confidence that sinks the fragile U.S. recovery and makes President Obama a one-term president. As the European Commission puts it, “No other economic relationship in the world is as integrated” as the U.S.-EU economies. Keep that in mind as you ponder how a Greek exit from the euro would almost certainly send the eurozone region headed back to where it was in 2008 and 2009. Confidence, investment, and spending would plunge. (A new poll of Societe Generale clients finds three-fourths think Greece is leaving, by the way. And more and more, the markets do too.)

Great Recession 2.0, EU-style. “This type of shock could produce instability at least as extensive as the aftermath of the collapse of Lehman Brothers in September 2008,” says Simon Johnson, former chief economist at the IMF. “It would lead to massive redistribution of capital and wealth, forcing some leveraged institutions into instant insolvency.”

And don’t think for a minute that big problems over there wouldn’t affect us over here. “A banking crisis in the euro area and in the EU would most likely result from an exit by Greece from the euro area. The fundamental financial and real economy linkages from the rest of the world to the euro area and the rest of the EU are strong enough to make this a global concern,” Citigroup Chief Economist Willem Buiter said in a report late last year.

Forget for a moment about the impact on U.S. exports to Europe or the impact on U.S. banks. The contagion of fear alone might be enough to push America—its economy just above sputter speed right now—back into recession. The top thing wealthy investors talk about with their reps at Schwab these days: Europe’s debt problems. And with good reason. Unemployment would head right back to 10%, and incomes would fall. We’d be right back in the ditch, and the last four years would seem like a colossal waste of time, money, and political opportunity.

The last time the U.S. suffered a recession during a presidential election with an incumbent president on the ballot was 1980. Jimmy Carter lost 44 states and won just 41% of the popular vote. Obama might not do a whole lot better.

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Tax-hike austerity failing in California, just like Europe

By James Pethokoukis

May 14, 2012, 11:01 am

I am having problems comprehending this Bloomberg headline: “Brown Tax Increase Gains Urgency as Deficit Rises to $16 Billion.” The story is even more puzzling:

California Governor Jerry Brown bet that a nascent financial recovery would lift the world’s ninth-largest economy enough to whittle down a $9.2 billion deficit. Instead, the gap has widened to $16 billion.

Today the 74-year-old Democrat will unveil his revised budget and explain what additional spending must be cut. Tax collections have run $3.5 billion below what he calculated four months ago. Spending has grown $2 billion above projections. The federal government and court ruling blocked some savings he expected, while his fellow Democrats in the Legislature balked at others.

California, with an economy bigger than Russia’s, lost more than a million jobs in the recession that struck in 2007, costing the most populous U.S. state 24 percent of its revenue. The new deficit estimate increases the urgency of the governor’s plans to increase income taxes on some earners to the highest in the nation, and boost sales levies that are now more than any other state.

The plan would temporarily raise the statewide sales tax, already the highest in the U.S., to 7.5 percent from 7.25 percent. It would also boost rates on income starting at $250,000. Those making $1 million or more, now taxed at 10.3 percent, would pay 13.3 percent, the most of any state.

Wait, taxes are rising and revenues are falling. So obviously the solution is even more taxes? Who’s running the show over there, the IMF? So the state with highest sales tax in America would also have the highest income tax in America? As it is, California ranks 48th in the Tax Foundation’s State Business Tax Climate Index. The California Dream has become the Golden State Nightmare …

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Charlie Gasparino on breaking up the big banks

By James Pethokoukis

May 14, 2012, 10:23 am

Charlie is no socialist or friend of Big Government or Occupy radical. But he’s had enough:

No amount of rules, regulation and smarts (Dimon is the smartest guy in banking today) can prevent banks from sometimes losing money. And the bigger these banks are, the more likely they are to have losses with severe economic consequences for the markets and the whole US economy.

See, for all Dodd-Frank’s mind-numbing rules, it fails to address the fact that regulators can’t catch every screwup. If they could, then the Federal Reserve officials who regularly camp out in JPMorgan’s offices would’ve caught the London Whale’s bad trades before they snowballed into these huge losses. …

Plus, Dodd-Frank allows these banks to remain large, unmanageable and (in the end) “too big to fail,” which could leave the taxpayers on the line for a bailout that could easily dwarf TARP and the Obama stimulus. …

In many ways, Dodd-Frank was a Faustian bargain between the big banks and the Democrats who ran Washington in the crisis’ wake. The surviving banks got to stay intact as long as they agreed to the rules that the Obama administration, Rep. Barney Frank and Sen. Chris Dodd offered up.

Sure, Dimon and others opposed much of the fine print, but they publicly supported the overall law — which, in the end, let them keep their mega-institutions, risk and all.

Force JPMorgan, Citigroup and Bank of America to become less systemically important, and they’d then have to sit on a hell of a lot less capital — freeing it up for small-business loans.

Separate JPMorgan’s federally insured commercial bank (where the “Whale” loss came from) from its investment-banking division, and Dimon would have fewer risks to manage — and when he (or some successor) fails, the damage wouldn’t be systemic.

And let me add a study that backs Charlie up, via the Cleveland Fed:

While the Too Big To Fail issue has received wide attention in the academic literature and popular press, there is little agreement regarding economies of scale for financial firms. We take the stand that systemic risk increases when the larger players in the financial sector have a larger share of the output. Our calculations indicate that the cost to the economy as a whole due to increased systemic risk is of an order of magnitude larger than the potential benefits due to any economies of scale when banks are allowed to be large. When distributional and inter generational transfer issues are taken into account, the potential benefits to economies of scale are unlikely to ever exceed the potential costs due to increased risk of financial crisis.

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Washington breaking up big banks now ‘possible’—Wall Street research firm

By James Pethokoukis

May 11, 2012, 3:42 pm

Wow. This, from the highly influential Washington Research Group of Guggenheim Securities:

The JP Morgan announcement has brought new attention to FDIC Director Hoenig’s plan to force commercial banks to sell their broker-dealers.

Our View

·         We believe the Hoenig plan is getting considerable attention on Capitol Hill and it could form the backbone for an eventual legislative response to J.P. Morgan’s losses.

·         The odds are still in favor of the status quo, but a break-up-the-bank outcome has now moved from the improbable to the possible. As we wrote this morning, the odds are now 35% for adoption of a break-up-the-bank plan.

All-star analyst Jaret Seiberg goes on to say that Republicans like the idea because it would give them a way of repealing Dodd-Frank, while Democrats fear that banks are becoming so large that they can exercise too much political and economic power. “That said, we believe there needs to be another scandal in order to move this from the realm of possible into the realm of probable. This is because the moderates from both parties remain uncomfortable with restructuring industries,” Seiberg says.

So one more blowup and the train really gets rolling. Maybe a worsening this summer of the EU debt crisis will provide just such a catalyst.

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Peter J. Wallison

JP Morgan’s losses prove that the Volcker rule is unworkable

By Peter J. Wallison

May 11, 2012, 2:53 pm

Much of the commentary about the JP Morgan Chase losses suggests that either this is proof of the need for the Volcker rule, or is a reason to get the Volcker rule in place promptly. Neither is true. In fact, as thus far reported, what happened at JPMC is proof that the Volcker rule is unworkable and should be abandoned.

The rule bans proprietary trading by banks, but specifically authorizes hedging transactions. It appears from news reports that JPMC has suffered the losses while pursuing a hedging strategy. If so, the losses would not have been prevented by the Volcker rule.

More broadly, it is virtually impossible to determine whether a specific trade or a series of trades is a hedging transaction—an effort to reduce risk that the bank has already taken on—or speculation, a risk that the bank is taking. That is the fundamental flaw in the Volcker rule, and the reason why it should be repealed.

If the answer cannot be determined except by knowing all the circumstances surrounding a trade, and what was in the mind of the trader when the trade was put on, it is not suitable for a regulation—i.e., for a written rule like the Volcker rule. Instead, it is suitable for a subsequent supervisory action; an investigation by a bank supervisor to determine the facts after the event, which may then result in a penalty for the bank if it has failed to comply with the distinction between speculation and hedging.

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Facebook co-founder flees America’s coming tax deluge

By James Pethokoukis

May 11, 2012, 2:52 pm

From Bloomberg:

Eduardo Saverin, the billionaire co-founder of Facebook Inc. (FB), renounced his U.S. citizenship before an initial public offering that values the social network at as much as $96 billion, a move that may reduce his tax bill. Facebook plans to raise as much as $11.8 billion through the IPO, the biggest in history for an Internet company. Saverin’s stake is about 4 percent, according to the website Who Owns Facebook. At the high end of the IPO valuation, that would be worth about $3.84 billion. His holdings aren’t listed in Facebook’s regulatory filings. Saverin, 30, joins a growing number of people giving up U.S. citizenship, a move that can trim their tax liabilities in that country. The Brazilian-born resident of

Singapore is one of several people who helped Mark Zuckerberg start Facebook in a Harvard University dorm and stand to reap billions of dollars after the world’s largest social network holds its IPO. Singapore doesn’t have a capital gains tax. It does tax income earned in that nation, as well as “certain foreign-sourced income,” according to a government website on tax policies there.

Saverin won’t escape all U.S. taxes. Americans who give up their citizenship owe what is effectively an exit tax on the capital gains from their stock holdings, even if they don’t sell the shares, said Reuven S. Avi-Yonah, director of the international tax program at the University of Michigan’s law school. For tax purposes, the IRS treats the stock as if it has been sold. Renouncing your citizenship well in advance of an IPO is “a very smart idea,” from a tax standpoint, said Avi-Yonah. “Once it’s public you can’t fool around with the value.”

Singapore doesn’t have a capital gains tax? The U.S. does, and it is about to rise by 60% due to the expiration of the Bush tax cuts and the implementation of the Obamacare investment tax—even higher if the Buffett Rule tax should ever pass—a factoid I bet Saverin is well aware of.

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Government jobs and the black middle class

By James Pethokoukis

May 11, 2012, 2:11 pm

From NPR:

Blacks are 30 percent more likely than nonblacks to work in the public sector, according to the University of California, Berkeley’s Center for Labor Research and Education. And roughly 21 percent of black workers are public employees, compared with 16.3 percent of nonblacks.

But government jobs, long considered the most secure form of employment in America, have rapidly disappeared since the start of the last recession in December 2007 — particularly at the state and local levels, where officials have cut budgets to cope with declining tax revenues and the rising costs of unemployment benefits, employee pensions and Medicare.

After the civil rights gains of the 1960s opened opportunities in government, blacks began a steady move into local, state and federal government, particularly in civil servant and teaching positions. And since the collapse of U.S. manufacturing, the public sector has been the biggest employer for African-Americans.

Beyond the jobs themselves, their relatively competitive pay scales have lifted generations of blacks into the middle class. Berkeley’s labor center found that among industries that pay blacks the highest wages, the biggest proportion of those blacks work in the public sector.

Let me quote something I quote in my previous blog post: “Real jobs emerge in the context of patterns of sustainable specialization and trade. Unfortunately, the patterns of specialization and trade that had emerged five years ago were not sustainable. Many jobs in home construction, durable-goods manufacturing and distribution, and mortgage finance were dependent on housing markets with ever-rising prices.”

Turns out those jobs were not so sustainable given both rising budget deficits and their lack of productivity in a more competitive, more technological economy. U.S. Postal Service, meet email and FedEx.

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