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The Secret Message of Stimulus Spending

vdereugy@gmu.edu (Veronique de Rugy) — Tue, 03 Nov 2009 12:42:00 EST

The idea behind the $787 billion stimulus bill is that government can create jobs by spending money. For now, let’s ignore fact, history, and economic theory and assume that government spending can actually create jobs.

In that case, we should expect the government to invest relatively more money in the states that have the highest unemployment rates and less money in the states with lower unemployment rates. So let’s check the data.

Using numbers from President Obama’s website Recovery.org and the Bureau of Labor Statistics, this chart plots the amount of stimulus funds spent per person in each state and the corresponding unemployment rate in that state. The solid blue line shows what the allocation of funds should look like if the administration was allocating relatively more money to the states with higher unemployment rates.

Yet, with a few exceptions, the data show that this is not the case. Many higher-unemployment states are getting far fewer stimulus dollars than lower-unemployment states.

Take Michigan, for instance. Michigan’s 15.2 percent unemployment rate is the highest in the country. So far, it has received $403 per person in stimulus funds. That’s above the average stimulus per person across all states ($326). However, it’s lower than the $409 per person that the state of Vermont, a state with relatively low unemployment (6.8 percent), has received so far. Michigan's per-person take is also much lower than the $707 per person the District of Columbia received. D.C.'s unemployment rate is 9.9 percent.

Now look at the state with the lowest unemployment rate in the country: North Dakota. It’s getting $253 per person with a 4.3 percent unemployment rate. Many other states are receiving roughly the same amount of stimulus funds per person despite much higher rates of unemployment.

Which suggests that stimulus funds are being allocated without thought to the level of unemployment within states. If government spending could in fact create jobs, then the problem of unemployment could be mitigated by distributing funds to states based on their relative unemployment levels.

But that's not being done at all. Instead, funds are being distributed randomly, as quickly as possible, among the states. That in turn suggests something else: Even the federal government doesn't believe the myth that government spending can actually create jobs.

Veronique de Rugy is an economist at The Mercatus Center at George Mason University and a columnist for Reason. This column first appeared at Reason.com.

A Hard Pill to Swallow

jsullum@reason.com (Jacob Sullum) — Thu, 29 Oct 2009 12:05:00 EDT

In August, Christina Romer, chairwoman of the White House Counsel of Economic Advisers, suggested that we think of the $787 billion American Recovery and Reinvestment Act as an extremely expensive course of antibiotics. “Suppose you go to your doctor for a strep throat,” Romer said in a speech to the Economic Club of Washington, “and he or she prescribes an antibiotic.” If your fever goes up after you take the first pill, just as unemployment rose after the stimulus bill was enacted, that doesn’t mean “the medicine is useless,” Romer noted. It could simply be that “the illness was more serious than you and the doctor thought.”

But it’s also possible that your sore throat and fever are caused by a virus, not a bacterium, in which case the antibiotic will not help. Eventually, though, you will recover on your own, and you may mistakenly conclude that your doctor’s prescription did the trick.

Such erroneous causal inferences are always a hazard when it comes to government spending aimed at alleviating a recession. Even if most or all of the money is disbursed after the recession has ended (which is typically the case), stimulus advocates can say the recovery would have been weaker without the spending. Since there’s no readily available parallel universe in which to test that counterfactual hypothesis, it can never be conclusively disproved.

Still, Romer seemed unreasonably sure that Dr. Obama’s medicine was already kicking in. Although she conceded that “the evidence from the path of the economy over time can’t settle the issue of what the effects of the Recovery Act have been,” her answer to the question posed in the title of her speech—“Is It Working?”—was “absolutely.”

I guess that depends on how you define “working.” No doubt spending billions of dollars in borrowed money has some impact on the economy. But the idea that the stimulus package had much to do with an incipient recovery that may have begun in June is belied by a couple of inconvenient facts.

First, since World War II the length of recessions has ranged from six to 16 months, with an average of 10. The current recession officially began in December 2007, so a recovery by the second half of 2009 is what you would expect.

Second, according to ProPublica, only $73 billion of the $580 billion in stimulus spending had been disbursed at the time of Romer’s speech. Another $37 billion or so had gone out in the form of tax cuts.

Romer conceded the latter portion of the stimulus did not seem to be very stimulating. She said “consumption fell slightly in the second quarter after rising slightly in the first quarter,” which “could be a sign that households are initially using the tax cut mainly to increase their saving and pay off debt.”

Is it plausible to suggest that $73 billion in stimulus spending over five months had a decisive impact on a $14 trillion economy? I say “decisive” because President Barack Obama, back in February, presented the stimulus package as the only alternative to a never-ending recession, and in August he claimed, “We’ve rescued our economy from catastrophe.”

Even if we accept the Obama administration’s numbers, taxpayers do not seem to be getting much employment bang for their buck. Romer estimated that “employment is now about 485,000 jobs above what it otherwise would have been.” That comes out to more than $200,000 per job, which seems pretty pricey, especially since many of these jobs are temporary.

Here is where the “reinvestment” part comes into play. Administration officials say the stimulus package is all about putting Americans back to work. When asked whether this is an efficient way to do that, they claim all the work needs to be done anyway. Conversely, when asked whether all the projects are really worth the money spent on them, they cite jobs “created or saved” as a backup justification. Stimulus means never having to admit you’re wasting money.

Senior Editor Jacob Sullum (jsullum@reason.com) is a syndicated columnist. This column first appeared at Reason.com.

Self-Governance Works

info@reason.org (John Stossel) — Thu, 29 Oct 2009 11:19:00 EDT

Much of what government does is based on the premise that people can't do things for themselves. So government must do it for them. More often than not, the result is a ham-handed, bumbling, one-size-fits-all approach that leaves the intended beneficiaries worse off. Of course, this resulting failure is never blamed on the political approach—on the contrary, failure is taken to mean the government solution was not extravagant enough.

We who have confidence in what free people can achieve have long believed that government should not venture beyond its narrow sphere of providing physical security. It should not attempt to cure every social ill. So it's good to learn that serious scholars have demonstrated that our intuitions are right. Free people, given the chance, solve what many "experts" think are problems that require state intervention.

For that reason, Elinor Ostrom's winning of the Nobel Memorial Prize in Economic Sciences ought to kindle a new interest in freedom. (See my earlier column here.)

Ostrom made her mark through field studies that show people solving one of the more vexing problems: efficient management of a common-pool resource (CPR), such as a pasture or fishery. With an unowned "commons," each individual has an incentive to get the most out of it without putting anything back.

If I take fish from a common fishing area, I benefit completely from those fish. But if I make an investment to increase the future number of fish, others benefit, too. So why should I risk making the investment? I'll wait for others to do it. But everyone else faces the same free-rider incentive. So we end up with a depleted resource and what Garrett Harden called "the tragedy of the commons."

Except, says Ostrom, we often don't. There is also an "opportunity of the commons." While most politicians conclude that, depending on the resource, efficient management requires either privatization or government ownership, Ostrom finds examples of a third way: "self-organizing forms of collective action," as she put it in an interview a few years ago. Her message is to be wary of government promises.

"Field studies in all parts of the world have found that local groups of resource users, sometimes by themselves and sometimes with the assistance of external actors, have created a wide diversity of institutional arrangements for cooperating with common-pool resources."

She has studied, for example, self-governing irrigation systems in Nepal and found successes never anticipated in the textbooks. "Irrigation systems built and governed by the farmers themselves are on average in better repair, deliver more water, and have higher agricultural productivity than those provided and managed by a government agency. ... (F)armers craft their own rules, which frequently offset the perverse incentives they face in their particular physical and cultural settings. These rules may be almost invisible to outsiders. ..."

In Governing the Commons, she writes about self-governed commons in Switzerland, Japan, the Philippines, and elsewhere that date back hundreds of years. For example, in the alpine village of Tobel, Switzerland, herdsmen "tend village cattle on communally owned alpine meadows" under rules of an association created in 1483. The rules govern who has access to the grazing lands and how many cows a herdsman can place there, preventing overgrazing. The cattle owners themselves run the association and handle the monitoring. Sanctions are imposed for violation of the rules, but compliance is high.

Don't mistake the association for government. Rather, it is a private co-op designed for a narrow purpose. "All of the Swiss institutions used to govern commonly owned alpine meadows have one obvious similarity—the appropriators themselves make all the major decisions about the use of the CPR."

She found something similar in Japanese villages, where residents use private property for some agricultural purposes and self-managed common forests for others.

Solutions imposed by external authority were not necessary—and usually self-defeating: "Academics, aid donors, international nongovernmental organizations, central governments, and local citizens need to learn and relearn that no government can develop the full array of knowledge, institutions and social capital needed to govern development efficiently and sustainably. ..."

How about that? Freedom works.

John Stossel will soon host Stossel on the Fox Business Network. He's the author of Give Me a Break and of Myth, Lies, and Downright Stupidity. This column first appeared at Reason.com.

Anti-Privatization Pacheco Law Continues to Hamstring Massachusetts Budget

adam.summers@reason.org (Adam Summers) — Wed, 28 Oct 2009 23:35:00 EDT

My colleague, Len Gilroy, did an excellent post the other day on efforts to repeal or amend the anti-privatization Pacheco Law in Massachusetts. Reason has been critical of the Pacheco Law for many years. Back in 2002, Reason VP for Research Adrian Moore, former Reasoner Geoffrey Segal, and I wrote a white paper for the Pioneer Institute for Public Policy Research on privatization and the effects of the Pacheco Law in Massachusetts. Here is an excerpt from that paper:

When faced with insufficient revenues, state governments typically have four options: increase taxes, scale back expenditures, spend down reserves, or seek ways to provide services more efficiently through contracting with private providers. Massachusetts, however, has only the first three options available; it is the only state in the nation that has virtually outlawed the privatization of public services.

The Pacheco Law was enacted by the Massachusetts legislature in 1993. The law, now M.G.L. ch. 7 sections 52-55, set up a series of tests that a state agency must pass before it can award a contract to a private company to perform services that had been previously performed by state employees. The law presents both statutory and political roadblocks to efficient government operations. Its provisions essentially slam the door on many opportunities that have been shown to improve services and save money in other places, as the law disregards all potential benefits other than lower costs.

Reducing costs is only one of many reasons agencies in other states choose to contract with private service providers. Well-designed contracts allow agencies to improve quality, accommodate peak demand, speed project delivery and meet deadlines, gain access to expertise, improve efficiency, spur innovation, and manage risk more effectively.

The Pacheco Law essentially prohibits Massachusetts agencies from contracting out to improve service quality, increase the number of people served, or reduce an existing backlog. A proposal to contract out cleaning and maintenance of bus shelters—which would have brought several million dollars annually to the state from new advertising revenues—was rejected because the contractor did not specifically calculate the difference in cleaning costs.

When a Massachusetts agency entertains bids for the right to deliver a service, public employees have the opportunity to submit bids to keep the work in-house. The Pacheco Law gives state workers significant advantages.

The cost and quality of service offered by private contractors must be compared not to existing cost and quality but to the hypothetical situation of public employees working in the most cost-effective manner and providing the highest quality possible. At no time are state employees held to these standards. If public employees win the contract, they are not held any concessions made as part of the bid.
The contractor must add lost tax revenues to the cost of the bid if any work is to be performed outside Massachusetts. No such adjustment is made to the public sector bid for the loss of tax revenues that would be realized if the work were to be performed by a private business subject to state taxes.
Private bids must also include estimated costs of monitoring contractor performance, while no such monitoring takes place in the public sector. The likely benefits of monitoring are not considered.

Even if a private contract scales these hurdles, the State Auditor may reject any proposal he deems not to be “in the public interest,” without providing a definition or reason. The rulings are final and may not be appealed.

Prior to the passage of the Pacheco Law, the Weld administration issued 36 privatization contracts, saving taxpayers an estimated $273 million. The procedure Massachusetts agencies must follow under the Pacheco Law is so onerous that only eight proposals have been submitted to the Auditor since its adoption in 1993. Only six were approved.

Over the last decade, federal, state, and local government agencies nationwide have contracted with private vendors to provide services from data processing to prison operations to adoption. According to the Government Contracting Institute, the value of federal, state, and local government contracts to private firms is up 65 percent since 1996 and exceeded $400 billion in 2001. Massachusetts law should not continue to prohibit agencies from taking advantage of this tool for reducing the cost and increasing the quality of state services.

Ideally, the Pacheco Law should be repealed. Short of repeal, it should be amended such that privatization can become a useful policy tool for legislators and agency managers.

Sadly, the Pacheco Law remains on the books seven years later. The silver lining of the state's current fiscal straits is that at least now there seems to be some momentum to weaken or eliminate the law and use the efficiency of the private sector to help balance the budget while providing high-quality services.

Other Resources:

» Pioneer Institute for Public Policy Research White Paper: Competition & Government Services: Can Massachusetts Still Afford the Pacheco Law?

» Reason Foundation's Annual Privatization Report 2009 (See page 19 for discussion of the Pacheco Law)

» Reason Foundation's Privatization Research and Commentary

'The Last Gasp of the Dinosaurs'

matt.welch@reason.com (Matt Welch) — Wed, 28 Oct 2009 11:11:00 EDT

In the April 1996 edition of reason, then-Editor Virginia Postrel wrote a column arguing that “Steve Forbes is a serious candidate” for president. “Not because he’s a rousing speaker,” Postrel observed, “but because he believes in the open-ended future, in the creativity of free people, and in the importance of clear, simple, limited rules within which individuals can shape their own decisions.”

Of those “clear, simple, limited rules,” the most famous was a flat and reduced personal and corporate income tax, an idea that, while never coming close to adoption at the federal level, nonetheless propelled a long-shot magazine publisher with no political experience into a third-place finish in the Republican primaries, including wins in Arizona and Delaware. In 2000 a flat tax song and social conservative dance helped Forbes whisk into second-place at the Iowa caucus, but he quickly dropped out after finishing third in New Hampshire and Delaware. In 2008 Forbes was a strong backer of the doomed Rudolph Giuliani.

Malcolm Stevenson Forbes Jr., 62, is the third Forbes to publish the successful business title of the same name. Founded in 1917, Forbes has gleefully billed itself as the “Capitalist Tool,” lionizing the entrepreneurs who make the world a richer place. In addition to producing its signature lists of the country’s (and globe’s) richest capitalists and companies, the 900,000-circulation magazine has been a staunch opponent of antitrust enforcement, an aggressive supporter of anti-totalitarian movements abroad, and a stubborn purveyor of a sunny, market-based optimism. Last November, at the height of political panic over the financial crisis, Forbes put Forbes himself on the cover, explaining “How Capitalism Will Save Us.”

In July, Editor in Chief Matt Welch interviewed Steve Forbes at the annual FreedomFest conference in Las Vegas.

reason: People know you as Steve Forbes, flat taxer and presidential candidate, but you’re also publisher of Forbes magazine in an era when magazines are struggling. How is Forbes responding to the economic crisis, the publishing crisis, and the transformation of the print industry?

Steve Forbes: When you have a severe recession and you have something transformational as we now see un-folding with the Web, you have to do two things. One, you have to address the immediate circumstances, which means belt tightening, which we did—and we did after 2001, when the economy also went temporarily off of the cliff. But at the same time, you have to invest for the future. And thankfully, 12 years ago, when we went online as did everyone else, we did not make the mistake that many print publishers made, and that was to think you take the printed page, throw it online, and have your electronic publishing. When Thomas Edison invented movies, some people thought you’d film a stage play and that was a feature film. No. It’s an entirely different medium.

We’ve always focused on entrepreneurs, on investors—on capitalist people who want to get ahead, people who want to do things in business. So we saw the website as another platform to reach the same constituency. Our value added is information, insights, and analyses, plus our profound belief in the moral basis of capitalism, which is meeting the needs and wants of other people. If you have that, you don’t get hung up on what the particular platform is.

reason: David Carr had a piece about you guys in The New York Times—a little snarky, but it was interesting. One thing he posited is that in 2009 this whole “Capitalist Tool” stuff is out of fashion; it’s out of step with the times. What’s your broad response to the notion that your stance or ethos is out of step and anachronistic?

Forbes: Well, capitalism—entrepreneurial capitalism, democratic capitalism—always goes through phases where it’s, quote, “out of fashion.” And it’s usually because of catastrophic mistakes made by government. The victim is blamed for it.

But you don’t abandon your mission or your core values because a crisis has put capitalism under a cloud. We went through it in the ’30s, we went through it in the ’70s, the greedy decade of the ’80s. These things do happen. But I think what’s happening in Wash-ington is the last gasp of the dinosaurs of the 1930s. It’s Jurassic Park statism. Oh! Franklin Roosevelt again! Wow! But it’s not working. It didn’t work in the ’30s.

So here we are today, and what’s the response? More spending, more taxes, and the economy is not responding the way it should. But while we’re getting assaulted now, it’s also a chance to regroup and hit these people back, because they are going against human nature, they are going against the impulses that come out of true entrepreneurial capitalism. While they seem to have the commanding heights at the moment, it’s only temporary.

reason: Do you see, to borrow a phrase, some green shoots, not necessarily in the economy, but in the citizen response to Washington economics right now?

Forbes: You see it with the tea parties, and you saw it in the state of Illinois, where the governor proposed tax increases, but the Democratic legislature ended up defeating them. The most amazing thing is now unfolding in California, where they’re seriously considering a flat tax because they’re beginning to realize—the Democrats!—that a highly progressive system doesn’t produce the revenue they need for their progressive programs.

reason: Have you seen an uptick in interest in the flat tax idea? Have people been knocking on your door and saying, “Oh yeah, about that thing.…”

Forbes: It’s not so much knocking on the door as people asking, when you face a severe crisis, what do you do? That’s one contrast between the political world and the commercial world. In the commercial world, failure happens all the time. It’s part and parcel of the system. You try something; it works or doesn’t work. In politics, you often have to go to the cliff before something is done. California’s at the edge of a cliff. They can’t print money. IOUs are not quite the same as legal tender. And so that’s why they’re considering something like the flat tax. Both [Gov. Arnold] Schwarzenegger and now Democrats in the legislature are starting to brood about the idea in sort of sheer desperation. It’s a version of what Ronald Reagan said: You don’t change minds on Capitol Hill through sweet reason; you do it through the heat of public opinion.

reason: Do you see a reawakening of those values, a reawakening in the Republican Party specifically, after eight years of a presidency when government was expanded hysterically, regulation was expanded hysterically? Do you see Republicans rediscovering their limited-government roots?

Forbes: I think it’s beginning to happen. Certainly among the newer, younger members. Or ones such as Paul Ryan from Wisconsin, who gets it on monetary policy, gets it on what’s happening with entitlements. Because, clearly, trying to be a Democrat Lite is not the way to perpetual power. Power does corrupt, and the GOP began to believe that pork will buy you happiness. It didn’t. And in fact, it demoralized the base of the party.

So now we have pork squared with the Obama administration, and it’s an opportunity for the Republicans to quickly regroup and find their voice again. The Obama administration is making a classic mistake of leadership: They feel they have to do it now, but they’re trying to do too much too quickly. It’s going to blow back on them.

reason: Looking at the 2012 Republican presidential hopefuls, especially after Mark Sanford started flying to Argentina a bit too much, do you see any individuals out there who look promising? Are you still considering yourself a candidate? Will you run again?

Forbes: I’m an agitator now, so I’ll leave the running to others. I’ll watch them exercise. But I think in 2010 we’ll get a very clear picture of the field. Right now there’s just too much going on. Too much ferment. If you look at a poll, probably Mitt Romney would be at the top, just because of name recognition. But whoever would have thought three years ago that Barack Obama would beat the Clintons at their own game and win the presidency? So it’s idle speculation.

But there are some names out there—[Louisiana Gov. Bobby] Jindal, Romney, who knows what [Mike] Huckabee might do, maybe [Minnesota Gov. Tim] Pawlenty will get a little more conservative and make a move for it. So who knows, maybe Paul Ryan might emerge, maybe somebody else from the House might emerge.

The key thing is don’t depend on one person. Have many Reagans out there, doing it on the state level, on the local level, and we’ll be OK.

reason: Talking of the “Democrat Lite” characters out there, [New York Mayor Michael] Bloomberg is a favorite of mine. He just announced an eight-point proposal to create or save media jobs on the island of Manhattan. You see a lot of proposals to have the government become involved with bailing out or somehow giving new assistance to legacy print media companies on the theory that they are fundamental to our democracy. What do you think about these initiatives and the ideas behind them?

Forbes: To really survive, newspapers, each one in each city, have to figure out what is their true value added. And it’s not going to be one blueprint for all. They’re each going to have to do it differently. You mentioned David Carr, who wrote a piece a couple months ago about this crazy paper in Boston that is doing very well focusing totally on local events in an iconoclastic way. People read it, whereas traditional newspapers are withering. So you’re going to see not one-size-fits-all but each one trying to pick out the particularities that can enable it to survive.

But nostalgia is a very strong human emotion. And so, you know, canals are preserved, and they’re wonderful tourist things now, even though they’re not real arteries for commerce the way that the railroads became and then highways became or air travel became. So it’s a natural reaction, but at the end of the day, it ain’t gonna get very far, because the world’s not going to stand still. Museums are very nice, but they’re not the way to a vibrant economy.

reason: Someone made the argument that the moment any industry becomes politically engaged, and starts lobbying a lot and starts getting targeted legislation, is not the moment that it becomes powerful but the signal that it’s stopped being powerful.

Forbes: Well it’s a peculiarity of the United States that it’s a sign that you’ve become successful that the government and the politicos go after you. And it does far more harm than any possible good.

You see it time and time again—G.M. in the ’50s and ’60s deliberately kept their market share below 50 percent for fear they’d get an antitrust suit and have to spin off Chevrolet. IBM got an antitrust suit in ’68 and 20 years later was on the verge of bankruptcy. Microsoft is not the feared Darth Vader that it was 10 years ago when the government went after them. One of the things that this administration doesn’t get is that the best antitrust policy is a vibrant marketplace. When profit gives you a message that something is lucrative, others will enter into it. They’re not just going to let you—“Oh, Matt’s doing very well, making a billion dollars on this thing. Good old Matt.” They’re going to say, “How do I get that?” And they’ll plunge in.

reason: What’s your assessment of Obama’s health care package?

Forbes: Well, let’s take the president’s word that health care should be universal and affordable. How is it best achieved? We know government achieves it by rationing. And the markets achieve it by creating more of it, and finding cheaper and better ways to deliver it. What people don’t fully grasp is we don’t have free enterprise in health care today in the United States. It is a hybrid system, because it’s third party. So you have a disconnect between providers and consumers. And what kind of market is it where the consumer doesn’t know what the thing costs? Anything else, you do. What is my hamburger going to cost? What is my car going to cost? But if you go to a hospital and ask what a procedure’s going to cost, they assume either you’re a lunatic or you must not have insurance. Why else would you want to know what the price is? How weird. How unusual. Why? Somebody else is paying.

So the system doesn’t work. And you don’t get the kind of productivity you get everywhere else. We use phones and emails for everything now. Do you do consultation with your physician or nurse by phone or email? Rarely. Or hospitals giving warranties, like you have everywhere else, where if they don’t scope your knee right, you go back and don’t have to pay for it again. Why wouldn’t that be their dime? Because it’s not real competition. They know you’re not writing the checks, so therefore they don’t have to please you; they just have to make sure they get a bureaucratic insurance company to approve it.

But we see from Lasik what happens when you get a real market. It costs a third less than it did 10 years ago. Cosmetic surgery hasn’t had inflation, like you have in the rest of health care, even though demand has increased sixfold in the last 15 years and even though there have been enormous technological innovations. Why? Because you pay for it.

reason: So what do you do? This is such a labyrinthine complexity that creates the sort of mixed market which you describe. Are there simple things that can be done to break the logjam?

Forbes: Yes. Equalize tax treatment. You’re going to give employers a tax deduction, why not individuals? And how about allowing you to shop across state lines for health insurance? Illegal now. If you live in California, want to buy a policy in Seattle, illegal. Interstate Commerce Clause, hello! You don’t need a government insurance company. Just get cross-state competition.

Allowing businesses to pull together. Why not remove barriers to that?

In terms of health savings accounts, if you want a higher deductible than X, you can’t get it. I forget what the number is now for a family plan; you can only go up so high. Remove those limits or substantially raise the caps on those.

If you want to set up a clinic or hospital, in a lot of states you have to get a certificate of need. Well, do you need a certificate of need to open up a grocery store if you want to go against Wal-Mart or Whole Foods? No. You just go and do it. See what happens. But because it’s all third-party paying, well, this is inefficient; it’s sort of a cartel system. Get rid of those kinds of things.

reason: Are you surprised by President Obama since he’s come into office? Anything about his comportment, his policy, the reaction to it?

Forbes: I was hoping he would defy my expectations and turn out to be what a lot of people thought—he’s smart, he’s moderate, he’ll do the right thing—instead of being what he has been so far, which is very much an ideologue. On the left, it’s all 1930s. You spend, you tax, you have government running things because we can do it more efficiently.

reason: I find it interesting that he still gives lip service—and gets away with giving lip service—to limited-government principles, saying things like, “Of course we don’t want the government running automobile companies.” And then in the same paragraph, he’ll say “but they need to consolidate their brands” and get very hyper-specific. He still says, “We don’t want to be in the banking sector; I’d rather be doing X, Y, and Z.” It’s as if he senses these things are unpopular out there.

Forbes: That’s why they have to do this by stealth, or semi-stealth. They know the American people are not in a mood for France North America or Germany North America. So they want to use the crisis to ram this stuff through before anybody realizes. Then you’re dependent and therefore, “Oh, they want to take this away from you”; it’s a fait accompli, it’s a coup. But thankfully the Founders devised a system where this stuff just bloody takes time. They didn’t confuse efficiency in the commercial sector with efficiency in government. We don’t want an efficient government in terms of making laws.

They feared passion. They saw what the wars of religion did to Europe and the bloodshed that engendered. They wanted a system where things could cool off before you did something.

reason: You have a new book out about historical figures and lessons that can be learned from them. What are some historical figures or moments of note that can apply to present-day circumstances?

Forbes: Take Alexander the Great. When Aristotle taught him as a young man, one of the things Aristotle tried to hammer home was you must learn to conquer yourself, i.e., control your passions. Alexander did not. He seemed to think that he was actually a living god, and he destroyed himself. He was immensely talented, but it all collapsed when he died. And that’s what I think may be happening with President Obama today. Putting aside what you think of his policies, he may end up getting very little.

For example, he didn’t realize with the stimulus package that Nancy Pelosi may have run up the limit on one of his credit cards. That $800 billion would have been very helpful from their point of view on trying to finance health care. But no, they spent that. It was overreach. No sense of what the real world is like.

reason: There’s been a lot of talk about the scattered state of the modern GOP, and a lot of discussion specifically about the big tent of Ronald Reagan with evangelical Christians and limited-government people. Is that a marriage that has run its course?

Forbes: No. There are two kinds of big tents. One is when you have mush, and so people come in because there’s nothing there. Another one is recognizing that one of the peculiarities of American politics is, because we are a heterogeneous nation, you have to put together coalitions of people who may not like each other much, and they have their own particular agendas and priorities, but you have to keep this thing together and maybe you can get some things done.

And so you’re always going to have tensions; it’s never going to be smooth. One tendency for parties is to just soften everything to oblivion. Another is where you have priorities, as Reagan did, and use a coalition where there are some basic shared values, but there are always going to be fights and tensions. That’s normal.

What helps keep the country together is that you’re not going to succeed by just being a narrow-based candidate, either geographically or ideologically. You’re always going to have to persuade. Like with a family. Families never agree on anything. Well, we’re like a family. And we have those kinds of disagreements. So be it.

Fed Up

bdoherty@reason.com (Brian Doherty) — Tue, 27 Oct 2009 15:17:00 EDT

Rep. Ron Paul (R-Texas), the libertarian-leaning congressman and failed 2008 GOP presidential candidate, has been suspicious of the Federal Reserve since before first entering Congress in 1976. In a 1981 article that mentioned the then-obscure legislator, United Press International reported that Paul “has proposed abolishing the Federal Reserve, repealing laws which make the dollar legal tender, and switching to currency issued by banks, 100 percent backed by gold.”

That was the year Paul first proposed a bill to audit America’s central bank. He recruited 44 cosponsors, but the bill never made it out of committee. The congressman introduced another bill to audit the Fed in 1983 and got less than half as many colleagues to sign on.

On another six occasions, Paul introduced bills that would have abolished the Fed entirely. Those acts of legislative defiance accomplished nothing much besides giving the congressman a reputation as an eccentric gold obsessive, hectoring an institution that was seen by almost everyone, critics and supporters alike, as foundational to the functioning of the modern world. Roll Call, a newspaper covering Capitol Hill, chided Paul after he won reelection to Congress in 1996 for his “idee fixe” of “a return to the gold standard,” which it described as a “rallying cry that hasn’t been a real issue since 1971.”

What a difference an economic crisis makes. In 2007 and 2008, as Paul ran for president, the candidate found to his own surprise that his young-skewing crowds reacted to trash talk about the Federal Reserve more than any other element of his small-government, anti-war agenda. So in 2009, with many economists blaming the Federal Reserve at least partly for inflating a housing bubble whose crash continues to inflict the most economic damage seen in the U.S. for a quarter century, Paul started pushing another version of his “audit the Fed” bill, this one numbered H.R. 1207. And as of press time, the bill has attracted a remarkable 282 co-sponsors, more than a majority, giving it a nontrivial shot at passing through the House of Representatives.

H.R. 1207 would lift existing restrictions on what auditors from the Government Accountability Office are allowed to look into when examining the Fed’s books. Specifically, the bill would allow investigators to report on the Fed’s dealings with foreign banks and nations, its “actions on monetary policy matters,” and the operations of its Federal Open Market Committee, the wing whose decisions most directly affect the U.S. money supply. The legislation is cosponsored by every single Republican in the House as well as 105 Democrats.

For the first time in Paul’s long career of tilting at Alan Greenspan’s windmills, popular sentiment against the Federal Reserve has its chairman, currently Ben Bernanke, running scared. Last summer Bernanke launched an unprecedented public relations campaign, explaining himself in venues from 60 Minutes to town-hall-style meetings broadcast on PBS. In July testimony to the House Committee on Financial Services, Bernanke warned that H.R. 1207 would damage global trust in the Fed’s political independence and “could raise fears about future inflation, leading to higher long-term interest rates and reduced economic and financial stability.”

Paul, after shepherding his idea from fringe to mainstream, is almost giddy. “Now the Federal Reserve is less popular than the IRS!” the congressman told a July gathering of Young Americans for Liberty in Washington, D.C. “This issue is never going to go away. Who would have thought a politician could talk about Austrian economics and get applause?”

The Austrian Opposition

With its power over interest rates and the supply of U.S. dollars, the Federal Reserve System is the most influential economic institution on the planet. That influence comes surrounded by an impenetrable aura of mystery. Hardly anyone, citizen or congressman, completely understands what the Fed does, how it operates, or what the effects of its actions will be.

Here is a highly simplified outline. The Fed is a set of 12 regional banks under the command of a seven-member board of governors appointed by the president and approved by the Senate. Its 12-member Federal Open Market Committee (FOMC)—the board of governors plus five regional bank chiefs—is responsible for adjusting the federal funds interest rate, which is the rate banks charge each other for loans. The FOMC does this through “open market operations,” buying and selling securities to affect the amount of money in the economy and thus the interest rate paid by banks to get more cash.

This process is hard enough to describe, let alone comprehend, and previous Fed chairmen have found it useful to keep their public pronouncements about the central bank’s operations maximally vague and obscure. A classic from Paul Volcker, chairman from 1979 to 1987: “We did what we did, we didn’t do what we didn’t do, and the result was what happened.” Volcker’s successor, Alan Greenspan, who enjoyed the longest stretch of low-inflation prosperity in Fed history (now widely seen as possibly laying the groundwork for the crash), helped reinforce both the central bank’s reputation for effectiveness and the expectation that its actions would remain inscrutable.

But these days the Federal Reserve faces challenges to both its power and its mystery, thanks to both hot public opinion and cold academic analysis. Politicians are demanding a peek behind the curtain, and holdovers from Paul’s 2008 presidential campaign have kick-started an “End the Fed” movement. Even within the central bank’s natural fanbase of economists and financiers, many are complaining about its appetite for regulatory power and its massive expansion of the money supply. During the last year the Fed has nearly doubled the monetary measure over which it has the most direct control, the “monetary base” (defined as circulating currency plus the reserves that commercial banks keep with Federal Reserve banks).

Signs abound that public sentiment is turning against the bank. Meltdown, an anti-Fed tract by the historian Thomas Woods, sat on the New York Times bestseller list for more than a month. Woods, like Paul, embraces the “Austrian” school of economic thought, which sees central banking as a recipe for endless inflation and constantly growing government. Paul has invited him to Capitol Hill to brief a growing unofficial caucus of Republicans attracted to Paul’s hardcore anti-statism. Fed bashing has been a prominent component of Tea Party gatherings nationwide. The largely Paulite movement Campaign for Liberty has organized “contact your congressman” campaigns to get H.R. 1207 on representatives’ radar screens, and the results are pouring in.

“The bill has received as many cosponsors as it has in part because Dr. Paul’s presidential campaign really brought the Fed into the spotlight, opened people’s eyes,” Paul Martin-Foss, a legislative aide for Paul, writes in an email. “There was also a lot of grassroots support, with numerous offices telling me that they had received a lot of mail about the bill and wanted more information.” Colorado Democrat Betsy Markey specifically credits Tea Party pressure for getting her interested in the bill, which she decided to cosponsor. “There’s a lot of anger from both sides of the aisle towards the Fed, not necessarily coming from the same position or working towards the same goals,” Martin-Ross writes. “But everyone wants to be seen as being in favor of transparency.”

Paul recognizes that the growing support for auditing the Fed does not indicate similar enthusiasm for his more radical goal of abolishing the central bank. He has introduced another bill to do just that, and it has yet to attract a single cosponsor. H.R. 1207 supporters, by contrast, “sign on because it doesn’t do” anything like that, Paul says. “It doesn’t direct policy changes. I did that on purpose.”

Paul’s beef with the central bank is a by-product of his longstanding interest in the works of Austrian school economists, most prominently Ludwig von Mises and Nobel laureate F.A. Hayek. Paul was a fan of Mises and Hayek before he entered politics in the mid-’70s, largely as a result of his reading the publications of the libertarian Foundation for Economic Education.

Paul, like the economists he admires, thought it a mistake to have a giant government-run institution trying to fix prices—in this case, interest rates, or the price of loaned money, which is the Fed’s main mechanism for pursuing its stated goals of economic growth, high employment, and relatively stable prices. As a critic of state power, Paul also worries that once a government has total control over paper money that it can create at will, it becomes too easy and too tempting for the state to spend at will. Cash unbacked by gold will flow to help the government out of its jams, pay for its wars, and appease its most powerful private constituents.

To Austrian-leaning libertarians like Paul, this danger makes the Federal Reserve, central banking, and “fiat” money the key libertarian issue. If the government can manufacture all the money it wants, the fight for limited government is over before it begins.

Central to this critique is the Austrian business cycle theory, which helped win Hayek his Nobel Prize for economics in 1974. Hayek, Mises, and contemporary economists such as Roger Garrison of Auburn University and Steve Horwitz of St. Lawrence University argue that low interest rates set by the Fed fool investors and builders into thinking that consumer demand for future goods is higher than it actually is. Cheap money makes producers more likely to launch long-term projects and take on long-term expenses. When low rates are a product of government intervention, rather than a market expression of people’s desire for long-term goods as reflected in their willingness to save now in order to consume more later, those long-term projects—for example, building and buying homes—will turn out to be unsustainable “malinvestments.” Prices in those areas will plunge. Everyone will start to realize that resources were funneled to unprofitable ends. An exaggerated boom will turn into a catastrophic bust.

Austrians believe increases in the money supply don’t always manifest in economy-wide rises in the consumer price index, the standard definition of inflation. The excess cash might instead flow into specific areas of the economy, depending on real-world factors that vary from case to case. In the housing boom and bust, those factors included mortgage lending standards, the actions of the government-created mortgage holders Fannie Mae and Freddie Mac, and reckless securitization of mortgages. In the Fed skeptics’ story about the last decade’s economic expansions and contractions, the housing bubble was a deliberate effort by the Fed to stave off economic troubles that began when the tech-stock bubble burst in 2000.

Who Else Is Afraid of the Federal Reserve?

A small but enthusiastic audience, largely connected with explicitly libertarian institutions, has kept the Austrian theory of Fed culpability alive in the decades since Mises and Hayek left the scene. (Mises died in 1973, Hayek in 1992.) But the Austrians aren’t the only opponents of the Fed’s practices. Although history tends to craft auras of inevitability around what exists, the Federal Reserve would have seemed an exotic and dangerous change in American monetary practice in the 19th century.

According to a popular Fed creation myth, the bank, established in 1913, brought an end to a chaotic, boom-and-bust environment of unregulated banking, replacing it with managed economic stability. This story is widely believed despite the fact that America’s most severe banking crisis and economic downturn, the Great Depression, occurred two decades after the Fed was created. As the popular historian (and no Austrian ideologue) Jack Weatherford wrote in his 1997 book The History of Money, “the final stripping of local banks of their power to control money came not because of financial failures but as a result of political movements to centralize power in Washington.”

Opposition to central banks and paper money runs strong through American history. Many of the Founding Fathers came to despise paper currency after their experience with the quickly worthless Revolutionary War “continental.” President Andrew Jackson crushed the Second Bank of the United States in 1832 in the name of the people. President James Buchanan noted after an 1857 bank panic that “our existing misfortunes have proceeded solely from our extravagant and vicious system of paper money.” The Civil War “greenback,” our first national government pure paper currency, was initially declared unconstitutional until a later Supreme Court bowed to political reality. And then there was the debate over establishing the Federal Reserve itself, in which opponents such as Sen. Elihu Root (R-N.Y.) noted the dangers of a potentially unlimited money supply.

In the postwar era of normality and economic centrism, noisy mistrust of the Fed was the province of gold fanatics, radical libertarians, and financial newsletter writers and readers who saw the bank as a machine the government used to debase the currency and steal from the thrifty. But the Fed also earned the ire of progressive leftists who saw it as the citadel of moneyed interests helping creditors at the expense of debtors by keeping inflation too low. The critique, which was especially audible from the Volcker era forward, is exemplified by the progressive journalist William Greider’s best-selling 1987 book on the Fed, Secrets of the Temple. It follows the grand tradition of the three-time Democratic presidential candidate William Jennings Bryan, who famously wanted to rescue indebted farmers through using cheaper and more abundant silver as money rather than crucifying them on a “cross of gold.”

During a time when the Fed actually lived up to its much-vaunted, often spurious “independence from political pressure”—when Paul Volcker was using the shock therapy of high interest rates and lower money supply growth to crush inflation in the early 1980s—the Fed came under political pressure from across the ideological spectrum. Its critics included Sen. Robert Byrd (D–W. Va.) and Rep. Jack Kemp (R-N.Y.) as well as many members of the Reagan administration. But for most of the tenure of Alan “Maestro” Greenspan, the Fed was broadly seen as doing little wrong.

Yet Paul discovered during his presidential bid that anti-Fed feeling had somehow morphed into a popular youth phenomenon. At an Iowa campus stop in 2007, the candidate and I expressed mutual wonder at the fact that his biggest applause line was not about ending the war but about reining in the Fed. At other Paul events, I’m told, kids burned Federal Reserve notes (dollar bills to you) to show their hostility toward the unrestricted and damaging flow of fiat currency.

As that flamboyant gesture indicates, anti-Fed feeling has long overlapped with powerful populist passions. Sometimes that attaches itself to misleading history and misaimed anger. Conspiracy theorists often cite the fact that the Fed is officially owned by its 12 private member banks as evidence that the whole system is a means for private bankers to mulct the public. But in its creation, purpose, and function, the Fed is a branch of government. Its board of governors is selected by the president and approved by the Senate, and most of its income ends up in the U.S. Treasury. And contrary to claims that the law creating the bank was pushed through Congress in the dead of night before Christmas 1913 solely as a result of a banker’s conspiracy forged on Jekyll Island, the Fed arose from long public and congressional debate.

Opposing something that has long been deemed as essential as air tends to attract eccentric people with eccentric beliefs. When I ask Ron Paul where this unexpected upsurge in youthful disdain for the Fed was coming from, he says the most important source was the website of the Mises Institute, an educational foundation for Austrian economics and libertarian political thought. But beyond the economic arguments against fiat currency, Paul says the biggest feeders of popular fear of the Fed are the conspiracy-minded documentary America: Freedom to Fascism and radio host Alex Jones, staunch opponent of the New World Order. In both cases Fed opposition is part of a general theory of sinister and subterranean forces struggling to keep Americans enslaved.

It certainly was no credit to the anti-Fed movement that Holocaust museum shooter James von Brunn had previously been arrested for attempting a “citizen’s arrest” of the Fed’s governors. And when the U.S. Army Reserve issued a “Force Projection Advisory” in November 2008 specifically targeting that month’s anti-Fed protests for “situational awareness and recommended mitigation measures,” it allowed those on the fringe to feel validation that they were not only right all along but a genuine threat to their enemies.

But the profound effects of the Fed’s avowed purpose—manipulating interest rates and making paper currency—are damaging enough, at least for those who see its fingerprints all over the current crisis, to make more baroque conspiracy theorizing superfluous. And when it comes to mistrusting the Fed, the Alex Jones crowd is not alone.

We’re All Austrians Now

Economists, pundits, and financial analysts are not exactly gathering by the hundreds in front of Federal Reserve buildings and chanting “End the Fed!” But it has become almost impossible to avoid respectable voices in respectable venues laying some of the blame for the economic crisis at the Fed’s discount window.

The Berkeley economist Brad DeLong, a popular blogger and former Clinton Treasury Department official who once dismissed Mises’ general monetary theory as “batshit insane,” still told this story in the October 2008 issue of the liberal American Prospect: “The current financial crisis has its roots in Greenspan’s decision to keep interest rates very low in 2002 and 2003 to head off the danger of a deflation-induced double-dip recession.…Six months ago, I would have said that his judgment was probably correct. Today… I can no longer state that Greenspan made the right calls with respect to the level of interest rates and the housing bubble in the 2000s.”

Fed bashing in a roughly Austrian style has gotten so popular that the theory’s opponents now feel embattled. Scott Sumner, a monetary economist at Bentley University who writes the much-cited blog The Money Illusion, thinks the Federal Reserve was and is too tight with interest rates and money for optimal economic performance. “As everyone knows by now,” Sumner complained in June, “the once kooky and discredited Austrian business cycle model has now become conventional wisdom.”

Blame-the-Fed sentiment now stretches across the spectrum of economic thought, from Keynesians such as DeLong to monetarists (who generally want the bank to maintain a fixed rate of money supply growth). In October 2008, the monetarist Anna Schwartz, co-author with Milton Friedman of one of the most important books of monetary economics, A Monetary History of the United States, told The Wall Street Journal: “If you investigate individually the manias that the market has so dubbed over the years, in every case, it was expansive monetary policy that generated the boom in an asset. The particular asset varied from one boom to another. But the basic underlying propagator was too-easy monetary policy and too-low interest rates that induced ordinary people to say, well, it’s so cheap to acquire whatever is the object of desire in an asset boom, and go ahead and acquire that object.”

In February 2009 the Stanford economist John Taylor, a monetary whiz so influential that there is a rule for setting interest rates named after him, told The Wall Street Journal: “The Fed held its target interest rate, especially in 2003–2005, well below known monetary guidelines that say what good policy should be based on historical experience. Keeping interest rates on the track that worked well in the past two decades, rather than keeping rates so low, would have prevented the boom and the bust.”

Even the Obama administration has gotten into the act. “Monetary policy around the world was too loose too long,” Treasury Secretary Tim Geithner told PBS interviewer Charlie Rose in March. “And that created this just huge boom in asset prices, money chasing risk. People trying to get a higher return. That was just overwhelmingly powerful.”

As with any issue in political economy, there’s disagreement. There are a variety of arguments to parry or blunt the Austrian theory. Former Federal Reserve Board economist Arnold Kling, for instance, argues that the modern world of money and credit is so convoluted, with so many avenues for the creation of money-like instruments outside of direct Fed control, that the Fed shouldn’t be seen as the main villain in any credit-driven collapse. At worst, Kling thinks, it’s a hapless bungler pretending to power it can never have. Bryan Caplan, a libertarian economist at George Mason University, thinks people are generally too smart to be fooled enough by false interest rate signals that they precipitate an economic crisis.

And pinning even partial blame for the current economy on the Fed is different from questioning its legitimacy. By limiting his bill to the narrow question of transparency, Paul is making it possible to create a broad political coalition that can agree the Fed needs to be kept in check without necessarily agreeing on why, or on what the Fed ought to be doing.

The Fed Forever?

Despite the palpable momentum behind H.R. 1207, the idea of inconveniencing the Fed with anything more severe than an audit still seems like a far-off fantasy. Meltdown author Woods notes that, although many mainstream analysts are jumping on the Austrian bandwagon to explain the causes of the crisis, none of them are really embracing the Austrian solution of ending the Fed’s power to manipulate interest rates at will. They just call for the power to be used more prudently next boomtime.

The Fed was an ideological and institutional response to a convincingly told story of crisis and solution—basically, that the 19th-century system of mostly private banks issuing their own mostly gold-backed paper was leading to too many small economic crises of the sort that used to be called “bank panics.” Milton Friedman, a critic of central banking practice, at the same time dismissed attempts to return to a commodity standard such as gold. One of his reasons was that it was “not feasible because the mythology and beliefs required to make it effective do not exist.” But with best-selling books, activists in the street, members of Congress, and economists across the ideological spectrum casting aspersions on Fed practice, we may see the crafting of a new set of myths and beliefs.

In this time of political ferment, Stephen Axilrod, a longtime Federal Reserve staff director and monetary policy guru, has issued a memoir from MIT Press titled Inside the Fed. Axilrod admits that Fed interest rate actions precipitated the crisis without letting that fact dent either his admiration for the institution or his belief in its necessity. Still, Axilrod notes something that should encourage Fed skeptics of all varieties: that “a country’s monetary policy is almost necessarily limited by conditions generated from the political, philosophic, and social ethos of the time.”

We are now seeing attempts to move the ethos in an anti-Fed direction. While it’s hard to imagine an America without an institution that has become so central, it’s interesting to contemplate something former Rep. Eldridge Spaulding (R-N.Y.) said in 1868, in the midst of the legal controversy over Civil War greenbacks: “No one would now think of passing a legal tender act making the promises of the Government…a legal tender in payment of ‘all debts public and private.’ Such a law could not be sustained for one moment.”

What anyone would think can change dramatically. Ron Paul, through his Fed audit bill, is trying to get his colleagues, and the American people, to change what and how they think about the central bank. Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee, told a Massachusetts town hall meeting in August that he believes the House will indeed pass H.R. 1207 in October.

All the anti-Fed agitation we’ve seen in the last couple of years may eventually feel like a footnote if the current binge of monetary expansion creates something Americans haven’t seen for a quarter century: substantial and painful inflation in the consumer price index. For now, Bernanke is trying to assure Congress and the public that the Fed governors are skilled and knowledgeable enough to know when they need to “neutralize” the new money by, for example, selling bonds to the market and essentially swallowing the money back up before prices spike.

But the Fed doesn’t have a stellar track record of timing monetary shifts with scientific precision, and any actions that rein in inflation, thereby cutting off the short-term stimulative effect that governments love, are bound to be politically dangerous both to the Fed and to the president who appoints its overseers. As Bernanke admitted at his televised town hall meeting in July, the Fed can maintain its independence only if it can “show that we are producing good results,” and while he added lip service to independence, the people he must show those results to are Congress and the administration. Though he was appointed to a new four-year term in August, if he flubs inflation, Bernanke will be facing a whole new wave of political attacks.

More generally, the Fed’s independence is threatened by a growing understanding that the Austrian interpretation of central banking’s risks might be correct: Keeping interest rates too low for too long can precipitate severe economic busts. “It’s hard to imagine the little spark that can make big change,” says Austrian business cycle theorist Steve Horwitz, “but it can happen if the drumbeat stays going. The Fed was created by Congress, so we won’t get major change until members of Congress perceive their constituents or people with political, cultural, and social power saying there’s something really seriously wrong here.”

Senior Editor Brian Doherty (bdoherty@reason.com) is the author of This is Burning Man (BenBella), Radicals for Capitalism (PublicAffairs), and Gun Control on Trial (Cato Institute). This column first appeared at Reason.com.

Time to Repeal Massachusetts' Pacheco Law

leonard.gilroy@reason.org (Leonard Gilroy) — Tue, 27 Oct 2009 12:56:00 EDT

Massachusetts State Senate Minority Leader Richard Tisei and State Rep. Jeffery Perry write in separate op-eds (in The Boston Globe and the Cape Cod Times, respectively) that the state's ongoing fiscal crisis demands real government reform, and they suggest that the state could save over $1 billion through a series of reforms that include repealing the state's anti-privatization Pacheco Law. As Perry writes:

Since this anti-privatization measure was approved during the Weld administration, the state has lost out on the opportunity to save hundreds of millions of dollars through the outsourcing of certain government programs and services. The law has effectively stifled state privatization efforts by keeping most work in-house, even when a private company could potentially deliver the same services more efficiently and at a lesser cost.

As I wrote in Reason Foundation's Annual Privatization Report 2009, the 2009 legislative session in Massachusetts saw increased interest in tweaking the Pacheco Law:

The state's "Pacheco Law"—a 1993 procurement statute that many observers say has created numerous procedural obstacles to the privatization of state services—came under scrutiny in May 2009 amid legislative negotiations over the state's FY 2010 budget, which will require closing a $1.5 billion deficit.

By an 11-28 vote, the Senate rejected a budget amendment that would have repealed the law. Amendment opponents argued that the strict law serves an important oversight function and that its repeal would threaten state jobs. Supporters countered with several arguments in favor of repeal:

•Repealing the law would help the state do more with less through privatization, potentially saving hundreds of millions of dollars that could support vital programs.

•The privatization of state services has effectively stopped as a result of the highly restrictive provisions of the law.

•One provision of the law requires state agencies to compare the cost of using private contractors to a hypothetical cost if state employees were to optimize the efficiency of current service delivery, ignoring the true costs of current service delivery.

•The state auditor already has the authority to unilaterally reject contracts he deems "not in the public interest."

But the Senate did approve, 24-15, a separate budget amendment that would exempt all contracts under $2 million in value from the provisions of the Pacheco Law, which currently applies to contracts over $200,000. According to amendment supporters, raising the cap would facilitate more privatization and help the state save millions of dollars.

Let's be honest about it—this law should have never existed in the first place and represents a cynical political attempt to appease public employee unions by stacking the deck against privatization from the get-go. At a time of record deficits, policymakers should be focused on removing unnecessary and counterproductive laws and rules that stand in the way of streamlining government. Ironically, with the law in place, the public employee unions that fought to pass and subsequently protect this law actually made their jobs a little less safe, which is precisely the opposite of what they intended. After all, if you're not outsourcing very many services (driving up costs) and government gets as bloated as it is in Massachusetts, then when it comes time to close a multi-billion budget deficit, by definition the public employees will automatically bear the brunt of the cuts.

Instead of fighting privatization, it might be more sensible to public employees to just embrace competition, as the costs savings generated by privatization will work to reduce the pressure on the state budget over time, which would be a win-win for both the public employees and contractor community.

» Reason Foundation's Privatization Research and Commentary

Financial Market Reform

miron@fas.harvard.edu (Jeffrey Miron) — Tue, 27 Oct 2009 10:57:00 EDT

In the coming weeks and months, Congress will be turning its attention to financial market reform, in hopes of avoiding future financial crises. According to perceived wisdom, the root cause of the 2008 financial crisis was excessive risk-taking, and proper regulation can detect and prevent such excess in the future.

This view is a pipe dream. Most new regulation will do nothing to limit crises because markets will innovate around it. Worse, some regulation being considered by Congress will guarantee bigger and more frequent crises.

Government-Induced Moral Hazard Caused the Crisis

The Financial Crisis of 2008 did not occur because of insufficient or ill-designed regulation. Rather, it resulted from two misguided government policies.

The first was the attempt to promote homeownership. Numerous policies have pursued this goal for decades, and over time they have focused mainly on homeownership for low-income households. These policies encouraged mortgage lending to borrowers with shaky credit characteristics, such as limited income or assets, and on terms that defied common sense, such as zero down payment.

The pressure to expand risky credit was especially problematic because of the second misguided policy, the long-standing practice of bailing out failures from private risk-taking. This practice meant that financial markets expected the government to cushion any losses from a crash in mortgage debt. Thus, the historical tendency to bail out creditors created an enormous moral hazard.

One crucial component of this moral hazard was the now infamous “Greenspan put,” the Fed’s practice under Chairman Alan Greenspan of lowering interest rates in response to financial disruptions that might otherwise cause a crash in asset prices. In the early to mid-2000s, in particular, the Fed made a conscious decision not to burst the housing bubble and instead to “fix things” if a crash occurred.

It was inevitable, however, that a crash would ensue; the expansion of mortgage credit made sense only so long as housing prices kept increasing, and at some point this had to stop. Once it did, the market had no option but to unwind the positions built on untenable assumptions about housing prices. Thus government pressure to take risk, combined with implicit insurance for this risk, were the crucial causes of the bubble and the crash. Inadequate financial regulation played no significant role.

New Regulation Must Avoid Moral Hazard

If government-induced moral hazard caused the crisis, then new regulation should avoid creating or exacerbating this perverse incentive. Yet two components of proposed regulation will increase, rather than decrease, the chances for moral hazard.

One proposed change in regulation would give the Federal Reserve increased power to supervise financial institutions, especially bank holding companies such as Citigroup or Bank of America. This approach is a triumph of hope over experience. Why should an expanded Fed role be beneficial when the Fed erred so badly in the previous instance?

Defenders of an expanded Fed role will claim that, in the lead up to the crisis, the Fed did not have explicit powers to supervise and monitor non-bank financial institutions, and that such powers could have avoided the crisis.

Yet during the years before the crisis, the Fed had more than ample power to recognize the unprecedented level of risk that was building in the economy and to issue stern warnings, whether or not it had explicit regulatory authority. In fact, far from cautioning the market to behave, the Fed promoted the notion that it could solve any problems that might result from a bursting of the housing bubble.

Regulators are fallible. Alan Greenspan, once thought to be the Maestro, got it fabulously wrong. Ben Bernanke, regardless of the merit’s of his stewardship, will not be Fed chairman forever. Centralized and expanded power to make things better is also centralized and expanded power to make things worse. In particular, any mistakes made by a powerful, centralized authority have a magnified impact because they distort the behavior of the entire market.

Just as problematic as granting the Fed additional powers is the proposal to allow the FDIC to resolve bank holding companies using taxpayer funds. Under the proposed arrangement, the FDIC rather than bankruptcy courts would be responsible for bank holding companies, and the FDIC would be authorized to make loans to failed institutions, to purchase their debts and other assets, to assume or guarantee their obligations, and to acquire equity interests. The funds would be borrowed from Treasury.

This means that FDIC resolution of bank holding companies would put taxpayer skin in the game, a radical departure from standard bankruptcy and an approach that mimics the actions of the U.S. Treasury under TARP. Thus, the new approach would institutionalize TARP.

The result will be that under the proposed system, bank holding companies would forever more regard themselves as explicitly, not just implicitly, backstopped by the full faith and credit of the U.S. Treasury. That is moral hazard in the extreme, and it will create an unprecedented incentive for excessive risk-taking by these institutions.

The Bankruptcy Approach

The only way to limit financial panics is to eliminate government-induced moral hazard, and that means letting failed institutions fail. Whether resolution is carried out by the FDIC or a bankruptcy court is not the crucial question; rather, it is whether that resolution process forces all the losses on the institution’s stakeholders rather than bailing them out with taxpayer funds.

The standard objection to allowing failures is that some financial institutions are allegedly so large or interconnected that their failure causes a breakdown of the credit mechanism, thereby harming the whole economy rather than just transmitting losses that have already occurred. According to this view, letting Lehman Brothers fail was a crucial mistake that initiated the meltdown, and bailing out other financial institutions was a necessary evil to prevent even further chaos. Nothing could be further from the truth.

Rather than being a cause, Lehman’s failure was merely the signal that time had come for the U.S. economy to pay the price for all the distortions caused by the misguided policies toward housing and risk. Given those distortions, a massive unwinding and restructuring was necessary to make the economy healthy again.

This restructuring required lower residential investment, declines in stock and housing prices, and shrinkage of the financial sector. All of this implied a recession, even without any impact of financial institution failures on the credit mechanism, and the recession meant that lending would contract, even without a credit crunch.

The bailout itself, moreover, caused much of the financial market turmoil. The announcement that the Treasury was considering a bailout scared markets and froze credit because bankers did not want to realize their losses if government was going to bail them out. The bailout introduced uncertainty because no one knew what the bailout meant. The bailout did little to make balance sheets transparent, yet the market’s inability to determine who was solvent was a key reason for the credit freeze.

Thus letting Lehman fail was the right decision; bailing out Bear Stearns, Fannie, and Freddie in advance of Lehman, and the rest of Wall Street afterwards, were the mistakes. For all its warts, bankruptcy rather than bailout is the right way to resolve non-bank financial institutions. Any regulation that formalizes bailouts creates an enormous moral hazard and a black hole for taxpayer funds.

The Future

To limit future financial crises, policy must first avoid the distortions inherent in the attempt to expand homeownership. This means eliminating the Federal Housing Administration, the Federal Home Loan Banks, Fannie Mae, Freddie Mac, the Community Reinvestment Act, the deductibility of mortgage interest, the homestead exclusion in the personal bankruptcy code, the tax-favored treatment of capital gains on housing, the HOPE for Homeowners Act, the Emergency Economic Stabilization Act (the bailout bill), and the Homeowners Affordability and Stability Plan. None of this is sensible policy.

In addition, policy must end its proclivity to bail out private risk-taking. This second task is difficult, since it requires policymakers to “tie their own hands.” Specific changes in policies and institutions can nevertheless support this goal. The first is avoiding new regulation that makes bailouts more likely. A second is repealing all existing financial regulation, since this would signal markets that they, and only they, can truly protect themselves from risk.

The third and perhaps most important way to reduce moral hazard is to eliminate the Federal Reserve. As long as the Fed exists, it will regard itself as, and be regarded as, the economic insurer of last resort. In a world with perfect information, appropriately humble central bankers, and an absence of political influence on monetary policy, such a protector might enhance the economy’s performance on average.

In the world we live in, none of these conditions will hold consistently, so the potential for policy-induced disasters is large. The U.S. economy prospered for its first 125 years without a central bank. It’s time to try that approach again.

Jeffrey A. Miron is Senior Lecturer and Director of Undergraduate Studies in the Department of Economics at Harvard University and a Senior Fellow at The Cato Institute. He blogs at http://jeffreymiron.blogspot.com. This column first appeared at Reason.com.

Privatization News Roundup, Oct. 23, 2009

leonard.gilroy@reason.org (Leonard Gilroy) — Fri, 23 Oct 2009 15:16:00 EDT

Some privatization news highlights from the last week that haven't been covered elsewhere on the blog:

FEDERAL

"GAO: Army shouldn't privatize West Point jobs," The Associated Press
"Panel Recommends Privatization of Fannie Mae And Freddie Mac," Talk Radio News Service
"Justice kicks off planning phase of $1.5B contract," Washington Technology

STATE & LOCAL:

"Puerto Rico to Use Private-Partnership Proceeds to Repay Bonds," Bloomberg
"Arresting Developments," Barron's
"Miami Tunnel Reaches Closure," The Bond Buyer
"Despite speed bumps, Port of Miami tunnels continued attracting lender interest," Miami Today
"Lawmakers eye using budget as a tool against Northrop Grumman in IT deal," Richmond Times Dispatch
"Montana Airport to Privatize Security Screening," Security Management
"Airport to privatize security," Daily Inter Lake
"Colorado prison cuts possible elsewhere," Denver Post
"Fire department should keep going to medical emergencies, committee says," Record-Searchlight
"Village gets bid by company to construct sewer system," The Reporter

INTERNATIONAL:

"Scottish Think-tank Propose PFI Replacement," PPPFocus.com
"Private firms model for projects," BBC News
"UK's Royal Mint Workers Protest Against Privatization Plans," Bloomberg
"Japan Post Goes in New Direction," Wall Street Journal
"Makeover of postal privatization," The Japan Times
"France: Voters Reject Postal Privatization," Toward Freedom blog
"Russia may privatize certain state corporations - Medvedev," RIA Novosti
"Poland Banks on Privatizations to Plug Budget," BusinessWeek
"Zambia Shortlists Eight In Privatization Of Zamtel," Wall Street Journal
"Public-private partnerships contribute to country's development," AngolaPress
"Zimbabwe: Privatization Opens Massive Infrastructure Opportunities," AllAfrica.com
"Government announces new wave of privatization," Daily Georgian Times
"More private finance initiatives to reduce budget deficit," Malaysia Star
"6 power plants to be privatized next year," Manila Bulletin

» Reason Foundation's Annual Privatization Report 2009
» Reason Foundation's Privatization Research and Commentary

Consumer Financial Protection Vagary

kmw@reason.com (Katherine Mangu-Ward) — Fri, 23 Oct 2009 12:43:00 EDT

Handing out small loans against future paychecks had absolutely nothing to do with last year's market meltdown, but federal regulators have been itching to get their hands on the the payday lending industry for years, and yesterday's committee vote on the creation of a new omnibus agency to control all financial products was the perfect opportunity.

The House Financial Services Committee voted 39 to 20 on Thursday to create a new Consumer Financial Protection Agency (CFPA). The stated goal of the proposed law, which will now move to a broader vote, is to consolidate regulation of financial products and use the resulting agency to monitor the use of sub-prime mortgages and other high-risk, complicated financial products.

In contrast to the complex instruments that helped bring about the financial crisis, payday loans are astonishingly low tech: Applicants bring in a stack of paper showing that they have a job and a bank account, write a paper check in a physical store for the amount they will owe when the loan comes due, and walk away with a handful of cash. These localized, low-key transactions are hardly the stuff of innovative high finance, but that hasn't stopped Congress and the president from purposefully conflating ordinary, everyday financial practices they deem unsavory with those that caused a global financial meltdown.

During his presidential campaign, Barack Obama promised to “work to empower more Americans in the fight against predatory lending” by capping “outlandish interest rates.” Obama also said he wants to extend the 2007 law imposing a 35 percent cap on interest rates for loans charged to members of the armed forces and their families to "all Americans." He's now well on his way, and if the CFPA becomes law, he'll be able to count it as a much-needed legislative victory. Payday lending has become a talking point for financial regulators, something that ordinary voters—who find derivatives confusing—can understand. The historical image of payday lenders as unsavory loan sharks and more recent stories of folks caught in debt spirals make the industry seem unsavory, ripe for regulation.

A press release on the committee's website is a study in the confused rhetoric of these new regulations, jumbling together several distinct types of financial products, crowing about "extend[ing] federal supervision to a host of financial industries, such as payday lenders and mortgage originators, which have long escaped oversight" and asserting that, "As last year’s crisis demonstrated, deceptive financial products—such as predatory mortgages and hidden credit card fees—not only damage the livelihoods of American families, but can destabilize the entire economy." The use and abuse of credit cards and payday loans may be indicators of the overall financial health of the country, bu they had nothing to do with the 2008 crash.

The press release also includes a quote from Rep. Brad Miller (D-NC): “The Committee vote today is a rifle shot at abusive financial practices, not a shotgun blast that would hit community banks making an honest living from fair lending practices. It’s no surprise that the lenders with the worst practices are still fighting tooth and nail against this bill. The last thing they want is to have to make an honest living.”

Small banks have managed to get out from under most of the harsh new regulations—probably because they call themselves "community banks." And who doesn't like community? Rep. Barney Frank (D-Mass.), the chairman of the House Financial Services Committee, told The Wall Street Journal last week that community banks "were not the cause of this" and agreed to an exception for small banks that would allow them to continue dealing with their current regulators rather than the new consolidated federal agency. The same might be said of payday lenders, and yet Frank had harsh words indeed for them, singling out payday lenders and promising to "adopt a system of regulating the non-bank, non-regulating competitors who are frankly worse for both the consumer and the economy."

Naturally, the payday lending industry is freaking out. And when Congress and the president join forces to regulate an industry, there's only one thing for it: lobbyists. When ordinary people go to payday lenders, they get $100 or $200 in cash as an advance on their paychecks. When payday lenders go to Congress, they get considerably more. The industry spent $4.2 million on lobbying during the 110th Congress (which ended in January 2009), and gave $1.5 million in the 2008 election cycle. In the past, payday lenders have mostly concentrated their lobbying efforts at the state level, to mixed success. But the threat at the federal level is real this time around and the lobbying dollars reflect that. Stay tuned for part two of the debate, when would-be regulators cite the massive amount of lobbying dollars as further evidence of the industry's corruption.

Katherine Mangu-Ward is a senior editor at Reason magazine. This column first appeared at Reason.com.

Milwaukee County Board Nixes Privatization, Again

leonard.gilroy@reason.org (Leonard Gilroy) — Thu, 22 Oct 2009 19:03:00 EDT

Generally speaking, the Milwaukee County Board of Supervisors has become a destination where good privatization ideas go to die. County Executive Scott Walker knows this well, having made numerous, sensible attempts to pursue outsourcing in several areas of government, only to see them mostly get squashed by the union-friendly County Board. As I wrote in Reason Foundation's Annual Privatization Report 2009,

In September 2008, Milwaukee County Executive Scott Walker released his 2009 budget, which included proposals to privatize several county services, including vehicle maintenance, operation of the county’s economic support call center and non-medical services at the county behavioral health hospital. The proposal also allocated $500,000 for a study assessing the potential privatization of General Mitchell International Airport. [...]

The privatization discussion quickly became politicized. In November 2008, the County Board cut the privatization measures from its version of the 2009 budget. Walker responded with a series of line-item vetoes that effectively restored nearly all of the privatization measures the County Board had cut. In turn, the County Board responded with a corresponding set of veto overrides that eliminated most of the privatization proposals from the budget. There was one notable exception, however. Walker and the County Board both agreed to proceed on a contract for food services at the behavioral health hospital, replacing 70 food service employees at the complex. This contract began in June 2009.

Walker's plans to privatize Mitchell International Airport failed to move forward after a County Board committee voted unanimously in October 2008 to reject his request for a $500,000 consultant study of a possible deal. Walker had pitched his airport privatization proposal as a way to generate $25 million a year for transit.

Walker indicated that he would likely resubmit separate legislation to recreate some of the privatization initiatives he had originally proposed. He brought the call center privatization proposal back to the County Board in January 2009 and was rejected a second time. The troubled call center has been under fire in recent years for severe staff shortages, prompting citizen complaints and a federal lawsuit. In addition, Walker's administration issued a request for proposals in July 2009 for an initiative to potentially outsource janitorial and security services currently provided by the county facilities division. If it decides to move forward, the administration would include the initiative in its 2010 budget proposal.

Though I suppose it must feel like beating one's head against the wall, I give Executive Walker tremendous credit for his persistence in pursuing these initiatives, because the County is on an unsustainable fiscal path. Apparently that message is still not getting through to some of the County Board:

The County Board's finance committee on Tuesday recommended rejection of privatizing security and housekeeping services at the courthouse complex.

County Executive Scott Walker's budget estimates the moves would save $1.7 million in property tax money next year. They are part of his solution to fill an $80 million hole in the 2010 budget.

The panel also called for rejecting a plan to substitute Air National Guard firefighters for county employees to provide crash and rescue service at Mitchell International Airport. That would save the airport, which is funded mainly through fees from airlines, an estimated $619,000.

Hiring private companies to do the work also would mean elimination of 92 county jobs - 25 airport firefighters, 31 security guards and 36 housekeepers. County workers would get first crack at applying for their old jobs with a private contractor, under Walker's budget. In all, Walker is proposing outsourcing 207 county jobs for 2010, for a first-year saving of $5.9 million.

Supervisors said hiring private firms for security and cleaning posed safety concerns, and private workers wouldn't do the job as well as county workers. [...]

[Walker] disagreed that hiring private firms for security or housekeeping would compromise safety at the courthouse. Major corporations use private security and housekeeping successfully, and the county should also be able to, Walker said.

Walker questioned whether there would be enough votes to kill the privatization moves. He also wants to privatize additional housekeepers, case managers for patients at the Mental Health Complex and mainframe computer technicians.

The courthouse security outsourcing was rejected on a 5-1 vote, and the housekeeping privatization was dumped on a 4-2 vote by the finance panel.

More to come on the continuing privatization saga in Milwaukee County.

Indianapolis Seeking Proposals for Convention Center, Sports Stadium Management

leonard.gilroy@reason.org (Leonard Gilroy) — Thu, 22 Oct 2009 15:32:00 EDT

Mary Beth Schneider and Bill Ruthhart at the Indianapolis Star report today that Indy Mayor Greg Ballard's administration has issued a Request for Information and Qualifications to gauge potential private sector interest in operating and managing the city's convention center and major sports stadia, which currently face large operating deficits:

Indianapolis is investigating hiring a private firm to handle the financial headache of operating Lucas Oil Stadium and the Indiana Convention Center, and potentially Conseco Fieldhouse.

The city has issued a "request for information and qualifications," shopping for a firm that thinks it can run the facilities cheaper and better than the Capital Improvement Board.

Paul Okeson, chief of staff to Mayor Greg Ballard, said the city doesn't know whether it will, in the end, privatize the management of the facilities. But, he said, there's only one way to find out: Ask.

"We issued the RFI for the sincere and honest purpose of maybe there's something out there we're not thinking of that someone could present to us that would save us a significant amount of money in operating these facilities."

The result, he said, could be private management of the facilities; private-management assistance to continued CIB management; or no change at all.

"It could be anything," he said. "We're obligated on behalf of the taxpayer to see if there's a way to do this and create some efficiencies or gain a significant amount of savings." [...]

Ballard and the CIB went to the General Assembly for help earlier this year when it projected a $47 million deficit for 2010.

The RFI is posted on the city's website here, and more details on the initiative are available in this Indianapolis Business Journal article.

As I told the Star, it's a smart move in a fiscal crunch for policymakers to look at innovative ways to get government out of the business of operating and managing non-core assets (especially when they're not even breaking even while doing it):

The city's request comes at a time when cities have increasingly turned to private firms to operate their large convention centers, arenas and stadiums.

"I'm hearing a lot more about this issue now," said Leonard Gilroy, who as director of government reform at Los Angeles-based Reason Foundation produces an annual report on privatization.

"There's been a renewal, a reinvigoration of privatizing these kinds of facilities because of the obvious fiscal crises going on at the state and local level throughout the country." [...]

Privatizing facilities like Lucas Oil and the convention center certainly isn't a new concept. But what is unusual about Indianapolis' request is that it includes multiple facilities.

"I have not seen the bundling of facilities like this request, but it is very smart because it adds value," said Gilroy, the privatization expert. "Blending them together like this creates more bang for the buck, because there are more savings, economies of scale and cost efficiencies an operator can find."

For more on other recent Indianapolis competition initiatives, see my earlier posts here and here. Mayor Ballard and his administration deserve recognition for really thinking outside the box and driving fundamental reforms in a variety of ways, both on the privatization front and on the larger front of revamping antiquated government systems and business processes. The end result is the same—delivering more efficient and streamlined government services to taxpayers.

» Reason Foundation's Annual Privatization Report 2009
» Reason Foundation's Privatization Research and Commentary

More Georgia Officials Considering Local Government Privatization

leonard.gilroy@reason.org (Leonard Gilroy) — Wed, 21 Oct 2009 17:04:00 EDT

From The Telegraph, more evidence that the "Sandy Springs effect" continues to spread throughout Georgia, this time in the context of a proposed merger of Macon and Bibb County:

A committee of community leaders has suggested privatizing many government functions and merging other city and county departments.

The initiative would be directed by a consolidation czar who would report directly to the mayor of Macon and the Bibb County Commission chairman to make sure plans are carried out.

The committee's report is still in draft form, and its members are seeking input from members of the Macon City Council and the Bibb County Commission. Many of the merger ideas are not new, but the report is one more sign that city-county consolidation, which has languished for years, has new momentum under Mayor Robert Reichert and Bibb County Commission Chairman Sam Hart. [...]

Some of the ideas are modeled after Gov. Sonny Perdue's Commission for a New Georgia, which sought to take a businesslike look at state government. Hatcher's father, Robert, co-chaired that commission. [...]

The report recommends:

–Merging the city and county engineering, technology, purchasing, billing, collection, human resources and risk management departments. The tax collector's office would oversee collections for a range of services, including court fines and permitting fees, in addition to taxes.

–Contracting out for many services now provided by government employees, including garbage pickup, vehicle maintenance and building upkeep. Existing departments could bid against private contractors for the work, and private companies could be required to retain existing government employees if they take over a service, the report says.

For more on managed competition—allowing public employees to bid against private firms to provide public services—see Reason Foundation's 2006 study here. Meanwhile, citizens in north Fulton County are still pushing to carve out a new Milton County from the unincorporated parts of north Fulton (the same area where Sandy Springs, Dunwoody and other contract cities reside), and if that were to pass, it's likely that the new county would explore a similar startup model as the new Georgia contract cities, relying on private firms to provide the bulk of services. It's amazing what some tension in the system can do to promote change in the system. In Georgia's case, the recent proliferation of newly incorporated cities contracting out for virtually all non-public-safety services forces policymakers and citizens to confront the reality that they're not thinking big enough on privatization.

» Reason Foundation's Annual Privatization Report 2009
» Reason Foundation's Privatization Research and Commentary

Privatization and State Laboratories of Democracy

leonard.gilroy@reason.org (Leonard Gilroy) — Wed, 21 Oct 2009 16:46:00 EDT

Following up on my post last week on the cancellation of Indiana's welfare modernization contract with IBM, there have been a mixed bag of opinions floating around in the state newspapers, some of which unfortunately paint the situation as a "failure of privatization," (which I argued earlier was a false interpretation). However, I found this sensible editorial in The News-Sentinel (Fort Wayne) to be spot on:

The failure of the plan should not be taken as proof that the effort never should have been tried in the first place. If we still believe in our republic's promise that states will be laboratories of democracy, we must accept experimentation. And some experiments fail.

The point is to learn from the failures. It could be argued that Indiana could have learned better from Texas, where a similar effort to privatize welfare failed spectacularly. And it should be argued that Texas and Indiana together provide a cautionary tale for other states planning such efforts.

But the focus should be on improving privatization efforts rather than eliminating them. Government can and must both serve its constituents and become more efficient.

Budget Woes Prompt Colorado State University to Consider Partial Privatization

leonard.gilroy@reason.org (Leonard Gilroy) — Tue, 20 Oct 2009 13:47:00 EDT

The Denver Post reports today that officials at the Colorado State University system are considering partial privatization as one potential response to significant budget cuts to higher education in the wake of the state's fiscal crisis and the expiration of federal stimulus dollars in 2011:

As state funding cuts loom in 2011, leaders of the Colorado State University system have started considering an option unheard of in all but a handful of states: converting to a part-public, part-private structure in which students pay more for costlier degrees.

If implemented, the change could mean CSU's $4,800 annual in-state tuition jumps to about $13,500 for liberal-arts programs and as much as $20,000 for engineering degrees at the Fort Collins campus. [...]

CSU executives earlier this month raised partial privatization as a possible answer to the state's defunding or severely reducing its support for higher-education institutions. Also under CSU's consideration are plans to cap the number of Coloradans who can receive reduced, in-state tuition rates.

CSU chief financial officer Rich Schweigert cautioned that the suggestions are the start of a last-resort contingency plan, and their implementation depends on how the state handles higher-education funding. All of the suggestions would require legislative approval. [...]

Colorado institutions are scrambling to cut costs and find new revenue ahead of a funding crunch that will leave them a collective $230 million-plus short in 2011, when federal stimulus money runs dry.

That shortfall represents more than a third of the state's support for colleges and universities, and the shortfall is only expected to worsen with the state's budget crisis. [...]

Schweigert said the CSU programs most ripe for privatization are those that cost the most to provide, such as veterinary medicine.

At the same time, CSU could limit the number of students admitted at lower, in-state rates to the amount that state funding will pay for. Both scenarios would mean tuition hikes for many students.

And both will be met with resistance from the legislature in 2010, when lawmakers expect CSU and other colleges to start pushing backup plans such as these.

And the political honesty award of the week goes to Colorado State Representative Jack Pommer:

[Pommer], incoming chair of the budgeting committee, said higher education's funding crisis has been a long time in the making as lawmakers for years have shied away from politically inexpedient proposals to allow tuition increases and other fixes.

"I'm very glad CSU is looking at these options. They really don't have a choice," said Pommer, D-Boulder. "If we're not going to plan ahead, at least the schools are."

» Reason Foundation's Annual Privatization Report 2009
» Reason Foundation's Privatization Research and Commentary

GAO: Federal Fiscal Outlook "Unsustainable" in Light of Historic Debt, Entitlement Program Deficits

leonard.gilroy@reason.org (Leonard Gilroy) — Tue, 20 Oct 2009 12:51:00 EDT

This isn't exactly surprising news, but a new GAO report finds that the long-term fiscal outlook for the nation remains unsustainable, with rising debt and enormous future deficits in our largest entitlement programs. BTW, GAO's estimates do not factor in the current proposals for health care reform. The main takeaways from the report:

"In little over 10 years, debt held by the public as a percent of GDP under our Alternative simulation is projected to exceed the historical high reached in the aftermath of World War II and grow at a steady rate thereafter."
Beginning in 2009, our Alternative simulation shows persistent annual budget deficits in excess of 7 percent of GDP—levels not seen since the aftermath of World War II.
"[A]ssuming revenue remains constant at 20.2 percent of GDP—higher than the historical average—by 2030 there will be little room for 'all other spending,' which consists of what many think of as 'government,' including national defense, homeland security, investment in highways and mass transit and alternative energy sources, plus smaller entitlement programs such as Supplemental Security Income, Temporary Assistance for Needy Families, and farm price supports.
"[R]oughly 92 cents of every dollar of federal revenue will be spent on the major entitlement programs and net interest costs by 2019. This is due largely to a substantial increase in interest on federal debt."
"[R]evenue would have to increase by about 47 percent or noninterest spending would have to be reduced by 33 percent on average over the next 75 years to keep debt at the end of the period from exceeding its level at the beginning of 2009 (40.8 percent of GDP)."
"[T]he longer action to deal with the nation’s long-term fiscal outlook is delayed, the greater the risk that the eventual changes will be disruptive and destabilizing."

Commenting on the GAO report, Jason Mercier at the Washington Policy Center suggests, "Perhaps it is time to bring back consideration of a federal balanced budget amendment to the Constitution." State governments have to balance their budgets—why shouldn't the feds? While it's true that balanced budget requirements in state Constitutions cannot prevent fiscal crises, nor can they prevent state policymakers from using accounting gimmicks and other questionable methods to close budget deficits, they at least provide some ongoing fiscal reality checks and trigger course corrections that keep things from spiralling too far out of control.

Meanwhile, in DC, the lack of significant fiscal restraints promotes obscene amounts of debt and perpetual deficit spending, creating a policy environment in which officials are seriously talking about digging the hole deeper by expanding entitlements through health care reform, rather than reforming the unsustainable entitlement programs we already have. When your boat springs a leak, wouldn't you focus on getting water out of the boat rather than pouring buckets of water into it? Option A helps you stay afloat, while Option B accelerates the eventual sinking.

In Praise of Doing Nothing

info@reason.org (David Harsanyi) — Tue, 20 Oct 2009 12:26:00 EDT

No. Normally used to express the negative of an alternative choice or possibility.

No. A super way to convey negation, dissent, denial, or refusal.

No. Republicans—the "Party of No"—should embrace the glory of the word.

It is always curious to hear irascible members of one political party accuse members of the opposing political party of "playing politics" as if it were a bad thing. Can you imagine? Politics. In Washington, no less.

As you know, Democrats claim to be above such petty, divisive and lowbrow behavior, especially on those days they are running both houses of Congress and the White House. What this country really needs, we are reminded incessantly, are more mavericks. Well, Republican mavericks. Folks who say "yes."

How starved is the White House to unearth some imaginary bipartisanship on the health care front?

Consider that for possibly the first time in American history, a vote in a Senate committee was the lead story for news organizations across the country, simply because the ideologically bewildered Sen. Olympia Snowe (R-Maine), used her inconsequential vote to move forward a government-run health care bill.

Judging from the coverage, you might have been under the impression that Snowe had nailed her 95 Theses to the door of the Republican National Committee's headquarters. In reality, she sits in a safe seat and habitually votes with Democrats.

"Forget Sarah Palin," remarked The Associated Press. "The female maverick of the Republican Party is Sen. Olympia Snowe." CNN's resident rational, reasonable, moderate Democrat, Paul Begala, called Snowe the "last rational, reasonable, moderate Republican."

Snowe even unleashed her own cringingly absurd self-congratulatory missive, claiming, "When history calls, history calls."

You know what? History always calls. You're in the United States Senate, for goodness' sake.

"The status quo approach has produced one glaring common denominator; that is that we have a problem that is growing worse, not better," Snowe added, in a glaringly obvious false dilemma. However ghastly the status quo might be, the alternative has the potential to be far worse. Saying "no" does not equate to a "yes" vote on the status quo.

In 2006, Snowe was listed by Time magazine as one of America's 10 best senators, in part for her ability to set aside partisanship. Which is funny because this year, Time magazine ran a hyper-adulatory story about the late Ted Kennedy, perhaps the most partisan force the Senate ever has known. Praise of bipartisanship, you see, is doled out selectively.

Now, as unlikely as it is, history also offers Republicans an unexpected opportunity to remake their party, to find an ideological center, to use politics to thwart a movement that is antithetical to every tenet they've been rhetorically peddling since Ronald Reagan.

Of course, Republicans will increasingly be accused of being ideologues. If only.

Is ideology something to be dismissed as a barrier to progress? Isn't ideology a framework of ideas that politicians should be using to inform their decisions?

Mavericks, well, they dismiss ideology because it would bind them to consistent and principled votes. John McCain often displays the muddled and mercurial thinking of a person with no political, intellectual, or economic philosophy guiding him.

There is plenty of room for dissent in political parties. But when it comes to health care reform, Republicans—powerless to stop meatloaf from being served in the Senate mess hall, much less a bill—do have a chance to embrace the ideals they've been pretending to champion for a decade with one straightforward, graceful and honorable word: "no."

They have no moral or civic or political obligation to embrace bipartisanship. History might even be telling them not to.

David Harsanyi is a columnist at The Denver Post and the author of Nanny State. Visit his Web site at www.DavidHarsanyi.com. This column first appeared at Reason.com.

Rising Pension Costs, Falling Revenues Lead to a $179 Million Budget Deficit in San Diego

adam.summers@reason.org (Adam Summers) — Mon, 19 Oct 2009 14:38:00 EDT

The City of San Diego has released its 5-year forecast—and the future is not pretty. The city is facing a record $179 million deficit this year, followed by additional projected annual deficits of at least $150 million for several years.
_

San Diego Mayor Jerry Sanders addressed the sobering news in a press release:

As we begin putting together a solution to close our budget gap, we will examine every responsible alternative to cutting services. But make no mistake about it, there will be cuts and the public will feel them.

As the San Diego Union-Tribune reported:

The city has generally closed recent budget gaps by eliminating vacant jobs, increasing fees and tapping reserves. Those decisions largely avoided controversial cuts such as laying off employees and closing libraries. That will no longer be possible, Sanders said.

A deficit this size is so significant that we can no longer shield the public from its impacts,” he said.

The city's budget deficits have been exacerbated by the economic recession but began when past leaders chose to increase employee pension benefits without identifying a way to pay for them.

While governments at all levels are experiencing falling revenues due to the recession, San Diego's outlook is particularly dire because of egregious missteps the city made regarding its pension system. San Diego's pension problems stem from pension deals reached in 1996 and again in 2002 which led to the city underfunding the system by increasing pension benefits without setting aside enough money to cover the additional costs. The city is still paying for its mistakes today. In addition to an extra $57 million that the city will have to pay from its general fund to cover pension investment losses—an increase in the city's pension contributions of approximately 34%—San Diego must pay $32 million as part of the McGuigan legal settlement to remedy its past pension underfunding.

If this picture is not bleak enough, consider that San Diego's fiscal situation is actually even worse than the 5-year projections because, as Councilman Carl DeMaio notes, the city did not include the costs of its retiree health-care benefits or deferred maintenance, such as street, sidewalk, and storm drain repairs that must be made, in its budget forecasts. The city is planning to pay $43 million next year for retiree health care—barely one-third of the estimated $120 million needed to adequately pay for the benefits. The city is already running a $1.3 billion unfunded liability for retiree health care.

In a speech given to the San Diego County Taxpayers Association last month, Sanders said, "We will make our full pension payment, to the penny. The Mayor and City Council do not determine the amount of the payment, nor should we. Nor should we repeat the mistakes of our predecessors and shortchange the retirement system so we can avoid making tough decisions." Yet, when it comes to San Diego's retiree health-care obligations, it appears that the city is set to repeat the same mistakes that got it into so much trouble with the pension system.

San Diego has implemented some pension reforms in recent years, but they were likely "too little, too late." In 2006, voters approved a measure to require voter approval of future city employee benefits increases. And beginning July 1, 2009, the city implemented a lower tier of benefits to new city employees. The new retirement plan is a hybrid plan that includes a 401(k)-style "defined-contribution" component to shift some of the risk of retirement investments from the city to the employees.

Nonetheless, lawsuits to undo the arguably illegal pension deals of 1996 and 2002 have proven unsuccessful, and the considerable debts that have already been racked up must be paid. The results will be severe negative impacts on city services, and only bold and significant reforms may prevent these service cuts from lingering for many years or keep the city from going bankrupt.

The city should switch to a pure defined-contribution retirement system for all new employees, with compensation levels comparable to those received in the private sector. Savings from this pension reform would be long-term, however, and the city needs some more immediate relief.

To that end, there are many government services that could be performed more cheaply and effectively by the private sector. Forcing the government to compete with the private sector to provide services could result in significant cost savings while maintaining or improving service quality. A 2007 study done by Reason Foundation and the San Diego Institute for Policy Research conservatively estimates that the city could save between $80 million and $200 million a year by implementing managed competition for services such as:

Water and wastewater treatment,
Trash and recycling collection,
Vehicle fleet maintenance,
Street maintenance,
Parks and recreation (including city-owned golf courses),
Library operations,
Permitting,
Facilities maintenance,
Information technology, and
Printing and copying.

Voters saw the wisdom in this "managed competition" approach, and overwhelmingly passed a measure in November 2006 to amend the city charter to allow the city to implement it. But city labor unions have tied up the process, and nearly three years after the voters passed Proposition C, the city is still without a managed competition program.

If labor unions continue to hold the city hostage, they will drive San Diego to the same fate as the City of Vallejo, California—into bankruptcy.

Other resources:

» Reason pension reform study: The Gathering Pension Storm: How Government Pension Plans Are Breaking the Bank and Strategies for Reform (see pages 33-40 for a case study on the City of San Diego)

» Reason-SDI study on managed competition in San Diego: Streamlining San Diego: Achieving Taxpayer Savings and Government Reforms Through Managed Competition

» Reason's privatization research and commentary

Adam Summers is a policy analyst at Reason Foundation.

The Myth of the Multiplier

vdereugy@gmu.edu (Veronique de Rugy) — Mon, 19 Oct 2009 12:19:00 EDT

Give us money, and we’ll give you jobs. That was the promise President Barack Obama made when he asked Congress for a $789 billion stimulus bill. The cash, he said, would create millions of jobs during the next two years. Without the stimulus, the administration warned in a January report by economic advisers Christina Romer and Jared Bernstein, unemployment by the end of 2010 would reach as high as 9 percent.

Well, Obama got his money. Since then, the economy has shed more than 2 million jobs and the unemployment rate has climbed to 9.4 percent. By May 2009, the Council of Economic Advisers (CEA) had changed its message. Now the stimulus would “save or create” 3.5 million jobs by the end of 2010.

Measuring total jobs “saved” by a piece of legislation is as difficult as measuring total crimes prevented by police patrols. That’s why no agency—not the Labor Department, not the Treasury, not the Bureau of Labor Statistics— actually calculates “jobs saved.” As the University of Chicago economist Steven J. Davis told the Associated Press, using saved jobs as a yardstick “was a clever political gimmick to make it even harder to determine whether this policy has any effect.”

A look at the CEA’s job creation model undercuts its promises even more. The model’s calculation of saved or created jobs is based on a macroeconomic estimate, not on actual data. According to the authors, the estimate rests on a “rough correspondence over history” that indicates a 1 percent increase in gross domestic product (GDP) represents an increase of 1 million jobs. They might as well have said the estimate was picked at random.

How did they come up with the 1 percent figure? Since government spending is increasing, and since such spending is a component of GDP, they assumed GDP would grow whether or not the spending produced real growth in the economy. This is akin to assuming I will have a baby in nine months whether or not I am pregnant.

The May report concedes that while the CEA will attempt to measure job creation through data collected from stimulus recipients, the results will contain errors and inconsistencies. “Because of these limitations,” it warns, “the reported jobs numbers will need to [be] used with caution and as part of a more complex estimation strategy.”

Since then, Romer has told CNBC she couldn’t say for sure how many jobs would be created, since we can’t know what would have happened without the stimulus. But didn’t her report pro-ject what would happen if the stimulus wasn’t passed? Wasn’t the 3.5 million number supposed to be the difference between employment with the stimulus and employment without it?

The confusion flows from the faulty theory underlying the stimulus bill. In Keynesian thought, a decline in demand causes a decline in spending; since one person’s spending is someone else’s income, a fall in demand makes a nation poorer. As a poorer nation cuts back on spending, it sets off another wave of declining income. So any big shock to consumer spending or business confidence can set off waves of job losses and layoffs, as fewer goods are demanded and more workers become useless.

Under this logic, one possible remedy is for public spending to take the place of private spending. As government increases its spending, the money creates new employment. That, in turn, spurs those new workers to consume more and prompts businesses to buy more machines and equipment to meet the government-induced demand. Economists call this increase in aggregate income the “multiplier” effect. One dollar of government spending, the theory goes, ends up creating more than a dollar of new income. It’s a rare free lunch.

As appealing as the Keynesian story sounds, many economists have long doubted it. In 1991, looking across 100 countries, Robert Barro of Harvard presented historical evidence that high government spending actually hurts economies in the long run by crowding out private spending and shifting resources to the uses preferred by politicians rather than consumers. For a dollar of government spending, we end up seeing less than a dollar of growth. Can long-term poison be short-term medicine?

Even in the short run, if there’s a big decline in the demand for workers, why should that alone cause mass unemployment? If all those workers really want to work, why won’t wages just fall until all the workers have jobs? That’s how markets end a glut, whether it’s a glut of employees or a glut of blue jeans: with lower prices. If recessions really are caused by a fall in demand (and nothing else), why don’t wages fall enough to keep people from losing their jobs?

It’s because wages are sticky, Keynesians argue. Wages and salaries don’t change on a daily basis the way stock prices and gas prices do, so if a company hits a sales slump, salespeople might earn fewer commissions, but the vast majority of workers don’t get a pay cut. There’s something about the market for workers that keeps businesses from cutting wages in a slump. As long as wages are sticky, in the wake of a nationwide collapse in sales, entrepreneurs will start firing people.

If a decline in demand means mass firing, a rise in demand can mean mass hiring. Even if government spending is inefficient, pork-laden, and financed by future tax increases, the theory goes, it can still create some real jobs, some real output, in both the public and private sectors.

So what do the data say? There aren’t many studies of the issue. But two stand out: Robert Barro’s work and research by Valerie Ramey, an economist at the University of California–San Diego, on how military spending influences GDP. Both studies found that government spending crowds out the private sector, at least a little. And both found multipliers close to one: Barro’s estimate is 0.8, while Ramey’s estimate is 1.2. This means that every dollar of government spending produces either less than a dollar of economic growth or just a little over a dollar. That’s quite different from the administration’s favored multiplier of four. What’s more, Ramey also found evidence that consumer and business spending actually decline after an increase in government purchases.

Why this crowding out of private spending? Government spending comes from three sources: debt, new money, or taxes. In other words, the government can’t inject money into the economy without first taking money out of the economy.

Take taxation: Taxes simply transfer resources from consumers to government, displacing private spending and investment. Families whose taxes have increased will have less money to spend on themselves. They are poorer and will consume less. They also save less money, which in turn reduces the resources available for lending.

In addition, higher taxation encourages people to change their behavior to avoid taxes. They might switch their efforts to nontaxed activities, such as household production, or to the untaxed underground economy. Economists call this a deadweight loss, because people give up the taxed activity or good they prefer.

There are high costs to the other options as well. If the government borrows money, that leaves less capital for the private sector to borrow for its own consumption. If the government prints new money, it will create inflation, which reduces the value of the money we own and decreases everyone’s purchasing power.

Overall, government spending doesn’t boost national income or standard of living. It merely redistributes it—minus the share it spends on the bureaucracy that collects and spends our tax dollars. The pie is sliced differently, but it’s not any bigger. In fact, it’s smaller.

Contributing Editor Veronique de Rugy (vderugy@gmu.edu) is a senior research fellow at the Mercatus Center at George Mason University. This column first appeared at Reason.com.

Treating the Elderly Like Spoiled Brats

schapman@tribune.com (Steve Chapman) — Mon, 19 Oct 2009 11:02:00 EDT

When inflation hits, every dollar in your bank account is worth less each day. Deflation is just the opposite: You put your feet up and watch your money grow in value. The latter is what is happening now to America's seniors. And politicians think they should not have to stand for it.

The other day, the federal government announced that for the first time since cost-of-living adjustments were begun in 1975, Social Security recipients will not get an annual raise in their monthly checks. This decision is not the result of a fit of fiscal austerity or a sadistic desire to punish old people. There won't be a raise to offset inflation for the simple reason that there has been no inflation to offset.

Last year, seniors got a big raise because consumer prices had jumped 5.8 percent in one year. In the following 12 months, though, the Consumer Price Index has dropped by 2.1 percent. So in the coming year, Social Security payments will stay the same and be worth more than they used to be.

But so what? Groups representing the elderly, like AARP, have come to regard the annual raise as a sacred birthright in good times as well as bad, and few in Washington want to argue with them. President Obama has proposed giving every Social Security recipient a tax-free $250 bonus in lieu of a cost-of-living adjustment. Congressional Democrats are all for it, and the Republican leadership sounds agreeable.

A consensus like that happens only when someone comes up with a simple, appealing, and thoroughly horrendous idea. As it is, the cost-of-living rules are a great deal for seniors. Retirees get more money when prices rise, but they don't have to give any of it back when prices fall. The ratchet works only in their favor.

It's not easy to make a case for enriching seniors at a time when working-age Americans are suffering, but Obama and his allies are trying. The president insisted that "we must act on behalf of those hardest hit by this recession."

Who is he kidding? His policy would help those with the most protection. The people hit hardest by the recession are those who have seen their earnings vanish along with their jobs. Social Security recipients are assured of a stable stream of income even when companies are cutting payroll with a chainsaw.

Obama also claimed the help is essential because "countless seniors and others have seen their retirement accounts and home values decline as a result of this economic crisis." What's his excuse for singling out seniors? Most everyone with a house or a 401(k) has gotten whacked, and the government can't afford to help them all.

What no one mentions is that Social Security beneficiaries already got a bonus in the original $787 billion stimulus package, which provided them with payments of $250 apiece. That's the rough equivalent of a 2 percent COLA. If the president gets his way, they will get a total of 4 percent. That, in combination with the drop in the CPI, means they'll have about 6 percent more in inflation-adjusted dollars this year than last. Not many other Americans can say that.

The final pretext is that the payouts will provide "a boost to our economy," in the words of House Speaker Nancy Pelosi—presumably because they will spur spending. Trouble is, giving people money doesn't mean they will head to Walmart. When the Bush administration sent out rebates, most of the cash apparently went to pay off debt or bolster savings, neither of which spurs the production of goods and services.

"Because of the low spending propensity, the rebates in 2008 provided low ‘bang for the buck,’” concluded a study by University of Michigan economists Matthew Shapiro and Joel Slemrod. "Given the further decline of wealth since the 2008 rebates were implemented, the impetus to save a windfall might be even stronger now."

The cost of this stimulus would be $13 billion, according to the White House. But if the $787 billion stimulus served its purpose, why is the additional boost necessary? If $787 billion didn't do the trick, what is $13 billion going to accomplish?

My suspicion is that most old people, given the facts, would be mature enough to understand that there is no good excuse for this windfall. It's the politicians who need to grow up.

The Gathering Pension Storm: Now It Is Raining

adam.summers@reason.org (Adam Summers) — Mon, 19 Oct 2009 00:00:00 EDT

Louisiana has $12 billion in unfunded pension liability.

...

The New Deal Made Them "Right"

info@reason.org (Damon W. Root) — Fri, 16 Oct 2009 13:09:00 EDT

Toward the end of a mostly sympathetic profile of the great journalist and critic H. L. Mencken, Christopher Hitchens once claimed that Mencken’s only “brilliance and verve” occurred during “the period between 1910 and the end of Prohibition.” Which is to say, before Franklin Roosevelt’s New Deal came along. It’s an all too common refrain. Biographer Terry Teachout characterized Mencken as “blinded partly by his hatred of Roosevelt.” Mencken scholar Charles A. Fecher—whom you’d expect to know better—declared Mencken’s opinion of Roosevelt to be “maniacal—there is no other word to use.”

Although it’s true that Mencken ended the 1930s as an enemy of what he called FDR’s “More Abundant Life,” he hardly started out the decade that way. A self-described “lifelong Democrat,” Mencken voted for Roosevelt in 1932 and voiced cautious support for the New Deal’s first stirrings, writing in March 1933, “I have the utmost confidence in his good intentions, and I believe further that he has carried on his dictatorship so far with courage, sense and due restraint.”

It wasn’t until Mencken realized the vast size and intrusive scope of that “dictatorship” that he went on the attack, lambasting the New Deal as a “puerile amalgam of exploded imbecilities, many of them in flat contradiction of the rest.” Indeed, in a passage that could be recycled and reused in our own troubled times, Mencken denounced Roosevelt for proposing “to lift the burden of debt by encouraging fools to incur more debt, and to husband the depleted capital of the nation by outlawing what is left of it.”

“That the rebel of the twenties should now become a spokesman of the conservatives of the thirties,” observed Mencken scholar Malcom Moos, “came as a shock to many of Mencken’s admirers.” But was it really so shocking? As America’s most famous political journalist for several decades, Mencken routinely championed the individual against the collective, siding with the imprisoned antiwar socialist Eugene V. Debs, with the embattled high school science teacher John Scopes, and with the thankless American taxpayer, the sort “who feels that he is being mulcted in an excessive amount for services that, in the main, are useless to him, and that, in substantial part, are downright inimical to him.” To put it differently, Mencken didn’t turn right, the country lurched wildly to the left.

And he wasn’t the only one to feel the shift. By the late 1930s, a handful of prominent liberals suddenly found themselves on the wrong side of the New Deal consensus. Much like Mencken, they joined the “right” almost by default. For the sin of holding fast to certain fundamental beliefs, including the quaint notion that big business and big government should be kept as far apart as possible, they were dubbed heartless reactionaries and “economic royalists.” Yet thanks to their principled opposition, some of the New Deal’s worst excesses were brought to light or kept at least partially in check.

Branded as a Tory and a Reactionary

Foremost among the members of this new “right” was the muckraking journalist John T. Flynn. Unlike Mencken, whose radical views had always centered on a rugged brand of individualism, Flynn qualified as a progressive liberal until the New Deal drove him away. A graduate of Georgetown Law School, Flynn made his name in the 1920s and early 1930s as a left-leaning financial columnist and author whose books bore such titles as Graft in Business and Trusts Gone Wrong! He enjoyed identifying and exposing the dirty deeds of big business and, as biographer John Moser writes, “in particular he saw abuses in the banking system and the New York Stock Exchange, and as early as February 1929 he was predicting that the value of corporate securities was about to plummet.” Flynn’s work earned him a prominent perch at the New Republic, then as now one of the country’s leading left-liberal publications, where he wrote a weekly economics column from 1933 until he was dropped in 1940 for his increasingly harsh attacks on FDR’s policies.

But like Mencken, Flynn started out as a Roosevelt supporter, referring to the New Deal as a “promising experiment.” It took the National Recovery Administration to cure him of that. The centerpiece of FDR’s first 100 days, the NRA represented the nightmare of central planning made real. Enacted as part of the National Industrial Recovery Act of 1933, which FDR hailed as “the most important and far-reaching legislation ever enacted by the American Congress,” the NRA sought to micromanage the economy through more than 500 wage-, hour-, and price-fixing “codes of fair competition,” mandating everything from the price of food to the cost of having a shirt hemmed. The NRA’s stated purpose was to increase efficiency via military-style organization, yet as historian Arthur Ekirch has pointed out: “Little attention was paid to the fact that it was industry itself that had largely prepared the regulations governing prices and production. Also ignored was the fact that the NRA meant the suspension of antitrust laws along with the whole theory of free competition and free enterprise.”

Flynn was among the few who noticed. As a member of the progressive movement, he had long worried about the growing power and influence of the big corporations. Now FDR and his so-called brain trust were climbing into bed with them! As Flynn put it, “Curiously, every American liberal who had fought monopoly, who had demanded the enforcement of the anti-trust laws, who had denied the right of organized business groups, combinations and trade associations to rule our economic life, was branded as a Tory and a reactionary if he continued to believe these things.” Thus Flynn found himself on the right.

Using the same muckraking approach that had made him a darling of the left, Flynn denounced the NRA as “probably the gravest attack upon the whole principle of the democratic society in our political history.” As for Roosevelt, Flynn argued that although the president proclaimed “his devotion to democracy, he adopted a plan borrowed from the corporative state of Italy and sold it to all the liberals as a great liberal revolutionary triumph.”

Nor did these scathing attacks go unnoticed. After reading an article of Flynn’s published by the Yale Review, FDR wrote privately to the editor, denouncing Flynn as “a destructive rather than a constructive force” who “should be barred hereafter from the columns of any presentable daily paper, monthly magazine, or national quarterly.”

The Banner of Jefferson, Jackson, or Cleveland

While Flynn’s words certainly stung, the attacks from Democratic hero Al Smith shook the New Deal coalition to its core. A legend among the reform-minded, Smith had long championed leftist causes ranging from minimum wage laws for women to government-built housing for the poor. A child of Manhattan’s Lower East Side, Smith rose from Tammany Hall to the state capitol at Albany, where he served four terms as New York governor. In 1928, he received the Democratic Party’s presidential nomination, though he suffered a disastrous electoral defeat at the hands of Republican Herbert Hoover. At the 1932 party convention, Smith lost the nomination to FDR.

So it came as a surprise when Smith began criticizing the New Deal. After all, hadn’t he supported the same sort of policies in New York? But like Flynn, Smith saw himself as a constructive critic, not as a partisan foe. As one of the country’s most famous opponents of alcohol prohibition, a group popularly known as the “wets,” Smith had been deeply troubled by the lessons of the Eighteenth Amendment. Prohibition, he wrote in 1933, “gave functions to the Federal government which that government could not possibly discharge, and the evils which came from the attempts at enforcement were infinitely worse than those which honest reformers attempted to abolish.” As biographer Christopher Finan put it, Smith “began to believe that the danger of giving new power to the federal government outweighed any good it might do. . . . He was putting himself on a collision course with the New Deal.”

That collision came on January 25, 1936, when Smith delivered a fiery anti–New Deal speech before the Liberty League, a mostly conservative group organized in opposition to Roosevelt’s policies. As Smith told the capacity crowd gathered at Washington’s Mayflower hotel, “this country was organized on the principles of representative democracy, and you can’t mix Socialism or Communism with that.” Deriding FDR and his brain trust for their “betrayal” of the Democratic party’s principles, Smith declared: “It is all right with me if they want to disguise themselves as Norman Thomas or Karl Marx, or Lenin, or any of the rest of that bunch, but what I won’t stand for is to let them march under the banner of Jefferson, Jackson, or Cleveland.”

Unfortunately for Smith, most Democrats saw things differently. Joseph Robinson, who had been Smith’s running mate on the 1928 presidential ticket, derided Smith for addressing the Liberty League’s “billion-dollar audience.” He “has turned away from the East Side with those little shops and fish markets,” Robinson sneered, “and now his gaze rests fondly upon the gilded towers and palaces of Park Avenue.”

Though Smith continued to enjoy hometown popularity in New York, he was basically excommunicated from the party. In 1936 he crossed the aisle to support Republican presidential candidate Alfred Landon, declaring, “I am an American before I am a Democrat.” Four years later he campaigned on behalf of Republican Wendell Wilkie. FDR trounced them both.

As Smith remarked of his harsh treatment at the hands of one-time friends and allies, “Unless you’re ready to subscribe to the New Deal 100 per cent and sign your life name on the dotted line, you’re a Tory, you’re a prince of privilege, you’re a reactionary, you’re an economic royalist.” It took his support for FDR during World War II to repair the damage.

The Switch in Time

A similar impatience with the New Deal’s critics would famously reappear in FDR’s war on the Supreme Court, culminating in his failed court-packing bill of 1937, which would have allowed Roosevelt to appoint as many as six new Supreme Court justices. Among other things, that conflict transformed the fiery progressive Sen. Burton K. Wheeler (D-MT) from a longtime friend into a deadly foe.

On February 5, 1937, FDR submitted his plan to reorganize the federal judiciary by allowing the president to appoint one new federal judge to match every sitting judge who had served at least 10 years and hadn’t retired or resigned within six months of turning 70. “A lower mental or physical vigor leads men to avoid an examination of complicated and changed conditions,” FDR argued. “Little by little, new facts become blurred through old glasses fitted, as it were, for the needs of another generation.” In other words, the Court’s commitment to such “horse and buggy” notions as property rights and limited constitutional government kept getting in the New Deal’s way. Most ominously, in Schechter Poultry Corp. v. United States (1935), the Court unanimously struck down FDR’s beloved NRA.

So Roosevelt bided his time, waiting until after his sweeping reelection in 1936 to strike against the “nine old men.” As historian William E. Leuchtenburg put it, the court-packing scheme “bore the mark of a sovereign who after suffering many provocations had just received a new confirmation of power.” Senator Wheeler would have agreed with that description, particularly the sovereign part. Wheeler thought the whole thing reeked of unbridled executive power.

And Wheeler, much more than Flynn or Smith, was a true-believing New Dealer with impeccable credentials. In 1924, he served as the running mate of Progressive Party presidential candidate Robert M. La Follette. As chairman of the Senate Interstate Commerce Committee, Wheeler played an indispensable role in the 1935 passage of FDR’s bill to regulate utility holding companies. And on a personal note, when the Supreme Court nullified the Agricultural Adjustment Act of 1933 in United States v. Butler (1936). Wheeler’s son-in-law, an economist at the Agricultural Adjustment Administration, was tossed out of work.

But none of that changed Wheeler’s low opinion of FDR’s court-packing plan. As Wheeler wrote in a letter to the socialist leader Norman Thomas, “It is an easy step from the control of a subservient Congress and the control of the Supreme Court to a modern democracy of a Hitler or a Mussolini.” Addressing a national radio audience less than two weeks after FDR introduced the plan in Congress, Wheeler moved in for the kill: “Every despot has usurped the power of the legislative and judicial branches in the name of the necessity for haste to promote the general welfare of the masses—and then proceeded to reduce them to servitude. I do not believe that President Roosevelt has any such thing in mind, but such has been the course of events throughout the world.”

Against Wheeler’s incendiary rhetoric and crafty legislative maneuverings, the court-packing bill failed to garner the necessary votes and died in the Senate by a final tally of 70-20. Wheeler’s “conservative” stand thus helped preserve some degree of judicial independence. (Though FDR did eventually get what he wanted. By the time of his death in 1945, he had “packed” the Court with eight New Deal–friendly justices. And the plan itself is widely credited with influencing swing vote Justice Owen Roberts, whose newfound support was called “the switch in time that saved nine.”) Today’s pro-Roosevelt liberals might take a moment to contemplate what George W. Bush would have done with those courtpacking powers.

Superfluous Men

But outside of the court-packing battle, did the fight against the New Deal really matter? As Smith discovered, the voters didn’t seem to have any problem with Roosevelt, and most historians still praise him today for ending the Depression and “saving capitalism.” Is there anything to learn from the principled liberals who stood athwart the New Deal yelling stop?

Albert Jay Nock thought there was. An acclaimed journalist, editor, and biographer, Nock remains one of FDR’s most intriguing opponents. Though he’s normally remembered as a founding father of the modern libertarian and conservative movements, Nock actually championed a unique brand of Jeffersonian anti-statism that has never fit comfortably on the political right. An advocate of free trade and minimal government, he also opposed the private ownership of land, taking his cue from Henry George’s 1879 bestseller Progress and Poverty, which argued that the government should be funded exclusively via a “single tax” on collectively owned land.

Indeed, Nock’s political and economic views owed as much to the progressive historian Charles A. Beard as they did to the libertarian theorist Herbert Spencer. In his best remembered book, Our Enemy, The State, Nock combined Spencer’s emphasis on free trade and social cooperation with Beard’s thesis that the U.S. Constitution represented an “unscrupulous and dishonourable” coup d’etat waged explicitly by “the speculating, industrial-commercial and creditor interests.” As historian Charles Hamilton observed about the Freeman, the political magazine Nock edited for its entire 1920–1924 run, readers “couldn’t decide if it was liberal, conservative, Bolshevik, revolutionary, anarchist, or Georgist.” Hamilton might as well have been writing about Nock himself.

And although Nock was never a New Deal supporter, he was nonetheless shoved to the right by the Rooseveltian juggernaut. As Brian Doherty observed in his definitive libertarian history, Radicals for Capitalism, “Nock had never stopped thinking of himself as a radical. He found it bitterly ironic that in the post-New Deal era, conservative businessmen became his primary audience.”

As far as Nock was concerned, it was the New Dealers who had forfeited their liberal status. He was the one keeping true liberalism alive so that future generations might bring it back into vogue. “Considering their professions of Liberalism,” Nock wrote in a 1934 introduction to Herbert Spencer’s The Man Versus the State, “it would be quite appropriate and by no means inurbane, to ask Mr. Roosevelt and his entourage whether they believe that the citizen has any rights which the State is bound to respect. Would they be willing . . . to subscribe to the fundamental doctrine of the Declaration? One would be unfeignedly surprised if they were.”

Today, a chorus of distinguished economists and legal scholars has joined Nock’s lonely voice of New Deal opposition, suggesting that his efforts to preserve classical liberalism paid off in the end—as did the efforts of Mencken, Flynn, Smith, and Wheeler. Though they didn’t defeat FDR or even inspire a particularly effective opposition movement at the time, their positions have since been rediscovered by generations of libertarians and conservatives seeking to rein in the post-New Deal state. With President Barack Obama now wielding a similar array of sweeping executive powers in the face of a growing economic crisis, their principled examples have become more important than ever.

Damon W. Root is an associate editor at Reason magazine. This article originally appeared in the September/October 2009 edition of Cato Policy Report. This column first appeared at Reason.com.

State Tax Receipts Tumble

leonard.gilroy@reason.org (Leonard Gilroy) — Thu, 15 Oct 2009 15:41:00 EDT

Michael Cooper at The New York Times reports on a new study from SUNY's Rockefeller Institute finding that state tax collections have declined at a greater rate than any period over the last several decades. Cooper writes:

Total state tax collections from April through June dropped by a record 16.6 percent compared with the same period a year earlier, according to a report released today by the Nelson A. Rockefeller Institute of Government, the public policy research arm of the State University of New York. The report found that total state tax collections were down by $63 billion for the year ended in June, which is roughly twice the amount of money that the states had received in fiscal relief through the stimulus program up to that point.

The stark numbers in the report tell the story of the recession. People were out of work or earning less, and income tax collections were down 27.5 percent in the quarter. They spent less, and sales tax collections were off by 9.5 percent.

The dismal data highlighted a hard truth: there can be a long delay between the time the economy begins to improve, as some economists believe is happening now, and the time that the change is reflected in state finances. [...]

Some state officials fear that by the time tax collections rebound, the stimulus money will have run out, continuing a cycle of budget gaps that will have to be filled with cuts or tax increases or expensive borrowing.

...or how about streamlining government? Louisiana's extensive government streamlining efforts are driving some fundamental rethinking in service delivery and just earned the state a credit rating upgrade. Other states should give it a try before resorting to pouring more money into the same government bureaucracy, expecting different results. It's time to do more with less, not the other way around.

» Reason Foundation's Annual Privatization Report 2009
» Reason Foundation's Privatization Research and Commentary

Mortgage Madness, Again

schapman@tribune.com (Steve Chapman) — Thu, 15 Oct 2009 13:04:00 EDT

Watching Washington policymakers in action, I sometimes think they make mistakes because of unrealistic goals, flawed thinking, blind obedience to party, or dubious information. And sometimes I think they make mistakes because they are—how to put this?—clinically insane.

There is no other way to explain what is going on at the Federal Housing Administration, which provides federal guarantees for home mortgages. Given the collapse in real estate prices, the weak economy, and the epidemic of foreclosures, banks are acting with more caution than before. They now commonly require home buyers to make down payments of 20 percent to qualify for a loan. But the FHA often requires only 3.5 percent.

That's the equivalent of playing pool with a guy named Snake, and it's had two predictable effects. The first is that the agency is insuring about four times as many home loans as it did just three years ago. The other is that the number of FHA-approved borrowers who are not repaying their loans is climbing. Since last year, the default rate has jumped by 76 percent.

Another likely consequence looms: you and I eating the losses. A former executive of mortgage giant Fannie Mae told a congressional subcommittee that the FHA "appears destined for a taxpayer bailout in the next 24 to 36 months." Commissioner David Stevens had to assure the subcommittee that it would not need help—well, unless there is a "catastrophic home price decline."

But who says there won't be? It's not as though anyone at the FHA foresaw the housing bubble or the housing bust. Yet now it feels confident betting its $30 billion cash reserve that prices won't fall.

Just a few years ago, after all, everyone assumed that U.S. home values were bound to keep rising. In fact, on average, they have dropped by a third since the peak of the market. If prices can drop by a third, they could certainly drop some more.

That's why many private lenders wouldn't touch a 96.5 percent loan with a 96-foot pole. One dip in the economy, and the house is worth less than the mortgage. That's an invitation for the owner to stop paying, drop the keys in the mailbox, and find a place to rent—an invitation hordes of people have already accepted.

What most foreclosures have in common is that the mortgage holder owes more than the property could sell for. "Not everybody who has negative equity goes into foreclosure, but nearly everybody who goes into foreclosure has negative equity," says Paul Willen, an economist at the Federal Reserve Bank of Boston.

But Stevens sees no reason the agency should raise its down payment requirement to 5 percent. "All that's going to do is retard recovery," he says, by making it harder for people to buy homes.

But guess what? It should be harder for people to buy homes. Making it too easy to buy homes is what caused the foreclosure epidemic, which led to the financial crisis, which helped crater the economy.

Right now, the real estate market is adjusting to the new environment, where Americans are not willing to pay as much because they perceive that when you buy a house, you cannot be certain of making money on the investment and, in fact, may lose your shirt. The FHA's easy-money policy is supposed to prevent that adjustment, and push up prices, by assuring that people who cannot afford the risks of home ownership will be able to buy.

If many of the loans turn into pumpkins, that's OK. House Financial Services Committee Chairman Barney Frank (D-Mass.), actually told The New York Times, "I don't think it's a bad thing that the bad loans occurred. It was an effort to keep prices from falling too fast." In other words, soaring defaults are not a bug. They're a feature.

But as Willen points out, prices didn't rise during the boom because there was reckless lending. There was reckless lending because everyone thought prices would rise. But the FHA imagines that it can cure the problems created by easy credit by promoting more easy credit.

Is it fair to call that approach shortsighted? Imprudent? Economically fallacious? Sure. But mainly, it's just plain crazy.

COPYRIGHT 2009 CREATORS.COM

Breaking Down State Tax Revenues

leonard.gilroy@reason.org (Leonard Gilroy) — Tue, 13 Oct 2009 16:17:00 EDT

A new Tax Foundation report by economist Gerald Prante offers a handy snapshot of state fiscal systems and their relative reliance on various sources of tax revenue.

To accompany its coverage of the report, Stateline.org used the data from the Tax Foundation report to create a useful graphic (see right) illustrating the variation in revenue sources. According to Stateline writer John Gramlich:

States that rely too heavily on one tax are vulnerable to revenue fluctuations that can be especially harmful during recessions. In Oregon, for instance, where individual income taxes account for 44.1 percent of total government tax revenue, lawmakers this year were slammed by a huge revenue decline as employment — and personal income — decreased. That has resulted in major spending cuts and is forcing some school districts to resort to four-day weeks.

Alaska, which has no statewide sales or income tax but relies heavily on natural resource taxes, also has seen a sharp revenue decline as oil prices have fallen. According to the Tax Foundation, Alaska draws a nation-high 52.6 percent of its state and local revenue from a group of taxes that includes severance taxes on natural resources, stock transfer taxes, estate taxes and fees for hunting, fishing and driver’s licenses. Other states that rely heavily on this category of taxes include Delaware (34.1 percent), Wyoming (30.1 percent), North Dakota (20.7 percent) and Montana (18.8 percent).[...]

Nationally, sales taxes account for 34.4 percent of state and local tax revenue — 23.5 percent from taxes on gasoline, cigarettes and other targeted products and services, and 10.9 percent from general sales taxes. Property taxes account for 30.1 percent, and individual income taxes account for 22.6 percent.