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Universal Coverage: A Big Feast for Big Pharma

Posted on November 12, 2009, 9:34pm | Shikha Dalmia

Every special interest group knows that in Washington, "you are either at the table or on the menu." Big Pharma seems to have taken this motto to heart as Obama & Co. proceed to make mince meat out of the American health care system. And it is coming out a big winner.

Remember the $80 billion that President Obama said he had extracted from the drug industry over the next 10 years in order to fund his universal coverage plans? Well, The New Republic reports that it might have all been a giant sham. Far from eating into the profits of Big Pharma, health care reform is likely to prove a big boon to it.

As evidence, compare the March and the October profit forecast of IMS Health, a respected global research and consulting firm.

Back in March, according to TNR, IMS had projected no growth at all for the drug industry between 2008 and 2013. But in October, it projected average annual growth of 3.5%.

What changed? A major factor, according to IMS, was the emerging details of health care reform.

Health reform, as currently envisioned, wouldn't merely bring coverage to the uninsured. It would also fill in the "donut hole" in Medicare Part D--the gap in coverage that leaves beneficiaries with serious health problems paying for hundred if not thousands of dollars in out-of-pocket prescription costs.

In addition, because it will take several years to close the donut hole, reform relies on voluntary discounts from the pharmaceutical industry to make drugs more affordable in the intervening years. But those discounts would apply only to name-brand drugs, not generics.

Put it all together, and you have more demand for name-brand drugs. As a result, IMS believes, pharmaceutical companies would be able to raise their prices--enough to boost revenue significantly: "If this bill is implemented," the report concludes on page 138, "an increase in prices on new drugs can be expected."

Big Pharma has launched a major counter-offensive to the IMS report. It argues that:

"Projecting annual prescription drug sales is notoriously tricky, evident by the fact that IMS Health has released three different forecasts for 2009. Most troubling, the IMS report is based on incomplete information because it does not take into account discounts and rebates which can significantly lower the cost of drugs to payers.
 
"In some ways, it's like trying to project annual U.S. auto sales by adding up sticker prices.  That's not reality.  How many people actually pay full price for a car? Similarly, drug manufacturers often offer steep discounts and rebates through private negotiations. Medicare Part D is a good example. The Medicare Trustees, who unlike IMS have access to rebate data, report that rebates in the Medicare prescription drug program reach 20%-30% for many brand-name drugs and have increased over the past several years.
 
"The IMS forecast is incomplete in other ways, too. For one thing, it does not include key elements of health care reform legislation now pending before Congress, including a large increase of 8 percentage points in the base formula for the rebates that brand manufacturers pay in Medicaid. Nor does the report take into account the fact that Medicaid eligibility could be expanded to tens of millions of Americans who then would have access to lower-priced medicines.
 
"Most curious, however, is the notion that pharmaceutical sales will increase dramatically during the forecast period when major coverage expansions won't even kick in until 2013 or 2014, depending on what's in the final bill......"

It is entirely possible that Big Pharma is getting the short end of the bone in this dog fight. But it is also the case that it has spent $150 million in TV and radio ads to promote universal health care. Is it remotely possible that it is doing so purely out of the goodness of its heart even though it will lose money?

Call me difficult, but that's a line I find hard to swallow ....

Banner Year for State Budget Gimmicks

Posted on November 12, 2009, 7:51pm | Leonard Gilroy

In the November 2009 issue of Governing, Katherine Barrett and Richard Greene argue that this may be a banner year for state budget gimmicks:

Arizona is hardly alone in looking at "creative" ways to close its budget gap. This year may go down in the record books for the number of gimmicks used to balance state budgets—and the degree to which those gimmicks may come back to haunt the entities involved. We're not particularly aware of any new tricks out there. These are tried-and-true ways for governments to avoid confronting reality—at least for a while. They include deferring payments, accelerating revenues, changing accounting rules and, as in Arizona, borrowing from the future to pay for today.

California, as is often the case, takes the cake. In its efforts to resolve its nearly $60 billion budget imbalance over this year and last year, the state borrowed from local government property taxes and special fund accounts, added to payroll withholding, accelerated personal income tax and corporate tax estimated payments, and will be kicking the June payroll to July. That last one is particularly sneaky. Employees see virtually no difference. Their paychecks arrive a day late, maybe, and that's hardly cause for outrage. But for the state it moves those payments forward a full fiscal year.

"You can argue, ‘What's the big deal?'" says Mac Taylor, California's legislative analyst. "But our concern is that it's an expense we incurred this year, and we really should count it this year. We're getting out of sync on the reporting of what we're spending."

Read the whole thing for more examples of policymakers going to every extreme to avoid making the necessary budget cuts and reforms to address the pandemic of state fiscal crises.

NGA & NASBO: States Facing Fiscal "Lost Decade"

Posted on November 12, 2009, 6:23pm | Leonard Gilroy

States' fiscal crises are going to stay put for some time. That's the word from the National Governors Association and the National Association of State Budget Officers, who released two reports today forecasting continued fiscal woe for states over the next decade. From the press release (emphasis mine):

The weakening of state fiscal conditions is reflected in the $250 billion in budget gaps faced by states between fiscal 2009 and fiscal 2011. Of the $250 billion, states closed $72.7 billion in budget gaps during fiscal 2009 and $113.1 billion before the enactment of their fiscal 2010 budgets to bring them into balance with drastically declining revenues.

"These are the worst numbers we’ve ever seen in the decades of putting together this report," said NASBO Executive Director Scott D. Pattison. "States have been forced to lay off and furlough employees, raise taxes, drain rainy day funds and sharply cut state spending in ways that impact every part of state government."

Even after closing these gaps, an additional $14.5 billion in budget gaps remains in fiscal 2010, and states face at least $21.9 billion in budget gaps for fiscal 2011. To help close these gaps, 42 states cut their enacted fiscal 2009 budgets by $31.2 billion, and 33 states cut their fiscal 2010 expenditures by $53.5 billion. Additionally, states enacted tax and fee increases of $23.8 billion along with additional increases in other revenue measures of $7.7 billion for fiscal 2010.

According to an NGA analysis titled The State Fiscal Situation: The Lost Decade, the recent economic downturn, one of the deepest and longest since the Great Depression, began in December 2007. Although the recession likely ended in August or September 2009, states struggled in fiscal 2009 and will continue to struggle through most of the decade.

"States will continue to struggle over the next decade because of the combination of the length and depth of this economic downturn, the projected slow recovery and the overhang of unmet needs," said NGA Executive Director Raymond C. Scheppach. "The unmet needs are those postponed or deferred during the crisis including, replenishing retiree pension and health care trust funds and financing maintenance, technology and infrastructure investments. States will also need to rebuild contingency or rainy day funds. The bottom line is that states will not fully recover from this recession until late in the next decade."

More privatization has to be part of the solution here—it's unavoidable. Most state policymakers are extremely resistant to cutting existing spending and public jobs, but the severity of the problem makes these things necessary and inevitable. Banking on tax hikes and revenue enhancements to close the gap is a fantasy—even if there was the political and popular will to raise taxes in a tough economy (which there isn't), taxpayers would never stand for the level of tax increases it would take to close the massive budget deficits on the table for the next few years.

You can't avoid cutting the size and scope of government, regardless of what happens on the tax and fee side. Given that reality, privatization is a strong tool to deploy and will become a critical part of smart fiscal management in the near term. Done well, you can get more bang for fewer tax dollars while still ensuring the quality delivery of services. Win-win for the budget and taxpayers.

Louisiana has already figured this out. Hopefully other states will start to follow their lead.

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

Don't Believe the Hype on Federal "Insourcing"

Posted on November 12, 2009, 5:30pm | Leonard Gilroy

Get ready for some spin from the White House on the supposed cost savings of insourcing (or de-privatizing) federal work, writes Professional Services Council president Sam Soloway in an excellent column at Washington Technology. As Soloway notes, these claims will have been based on fuzzy math that utterly underestimates the government's true costs of doing business:

When President Barack Obama's budget goes to Congress next February, the Defense Department and other agencies will announce budget savings that have been achieved from insourcing. Unfortunately, most of those savings also will be largely illusory.

The military departments already have told their field activities that for every insourced position, a 30 to 40 percent savings is being included in the fiscal 2011 budget. Furthermore, each activity has been given an insourcing target to achieve. As a result, we are seeing more arbitrary insourcing of purely commercial activities, rather than a focus on the critical skills the government most needs.

However, the process of accounting for those savings simply does not capture the total costs of a federal employee, including salary, benefit, and all the attendant support systems required for each employee. Thus, the savings are based on fuzzy math at best. If an Air Force organization insources a support services contract, it might look like such action generates savings for the organization’s budget. But this tells little about the total costs that are paid out of other budgets to cover expenses such as construction and infrastructure, pay and personnel systems and offices, travel systems, training and development, and cell phones and laptops. Those expenses are essentially invisible and perceived as free to the unit commander.

Some argue that government agencies are factoring in those costs in their budgets. Although no one has been willing to disclose publicly the algorithms they are using — and we have asked for them — it is interesting that in a July letter to 11 members of Congress who raised questions on this topic, a senior Defense Department official said more detailed cost guidance would be issued this fall, long after the budget assumptions were made and the insourcing directives issued to the field.

Read the whole thing for a glimpse at bad public policy in the making. And this gaming of the numbers is in no way unique to the Obama administration. In fact, it's Tactics 101 from the anti-privatization playbook—use the labrynthine nature of the bureaucracy and budget to shuffle/obfuscate the all-in costs of public service delivery in an effort to justify an avoidance of competition. In short, assume away those costs (pensions, retiree health care obligations, overhead, facility maintenance, etc.) that are paid outside of an agency's direct budget. This creates an apples-to-oranges situation, as the private sector has to factor those all-in costs in its bids. I recently wrote on a similar example in Oklahoma corrections here and here.

This is why a sound privatization program must rely on evaluation systems and methodologies to get as close as possible to an apples-to-apples, public-vs-private comparison. Of course, this is based on the notion that policymakers actually have an obligation to taxpayers to get the best value possible for taxpayers' money.

Unfortunately, the federal government does not yet have a sound privatization program—nor does it seem to elevate value for taxpayer money to a central pursuit (or even a minor pursuit, for that matter). Hence politics, not sound policy, drive decisions that lead to arbitrary insourcing mandates and a massive expansion of the costly federal workforce. And of course, taxpayers will lose in the end, even as they're being told they've gotten a win through insourcing.

Taxpayers should read Soloway's column and ask themselves: is this the way you want your government to make decisions?

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

Reason's 2009 Webathon! Because Free Minds and Free Markets Aren't Free!

Posted on November 12, 2009, 11:25am | Nick Gillespie

Free Minds and Free Markets Don't Come Free!

For the next week, Reason magazine Editor in Chief Matt Welch and I will be asking you to please help us keep Reason.org, Reason.com, Reason.tv, and Reason magazine going stronger than ever by giving a tax-deductible donation to Reason Foundation, the nonprofit publisher of the leading libertarian website, video site, and print publication in this and all other known galaxies. (Click on the image above to hear Welch's eloquent spiel and catch—if you're lucky!—a post-video ad for Mucinex!)

If you give $100 (just $6.52 in 1935 dollars!), you'll get all kinds of swag, including a choice between a copy of Brian Doherty's great history of the libertarian movement, Radicals for Capitalism, and Peter Bagge's awesome collection of Reason comics, Everybody is Stupid Except For Me! And your name will appear (if you want) in a cool banner on this very site, thanking you for your help.

The fight for for freedom has never been more important than now. Here we are, a decade into the 21st century, fer chrissakes, and 20 years after the beginning of the end of communism, and the U.S. government owns a car company, has taken over the financial sector, is about to squeeze out the market from health care, is fighting two bum wars, and on and on. Who could have thought it could get worse apres Bush fils? (Plenty of Reason staffers, that's who!)

Reason in all of its iterations is your voice in the public debate, your source for news and commentary from a principled (and non-dogmatic!) libertarian perspective, and a virtual community of the forward-thinkers who can help lead us into a future so bright we'll all need genetically modified corneal implants.

Go here for details. And bring a friend!

Thanks,

Nick Gillespie

Under Federal Watch, Fannie Mae Has Now Lost $111 Billion

Posted on November 11, 2009, 6:44pm | Anthony Randazzo

The good news is that Fannie Mae lost $10 billion less than before. The bad news is that the GSE still lost nearly $20 billion and is asking for another $15 billion in "help us" money:

Last week, Fannie Mae posted a quarterly loss of $19.8 billion—which believe it or not was an improvement on the $29.4 billion that it lost a year earlier. Last quarter's results came with yet another request for government aid—$15 billion worth. That brings the total tab for Fannie and Freddie to $111 billion since they were put into conservatorship in September 2008.

Read the whole story here.

Questions For the Federal Reserve

Posted on November 11, 2009, 3:29pm | Anthony Randazzo

Henrey Kaufman presents a lot of questions that the Fed is dealing with right now:

Today, with interest rates near zero and the stock market booming, increased political pressure will be put on the Fed when it begins to shift away from its current posture of quantitative easing. What will most inspire a shift toward tightening? The inflation rate? Better employment numbers or a housing recovery? That's hard to say.

Even harder to say is how the Fed will deal with the speculative fervor now fomenting in the financial markets, i.e., the increase in the carry trade (borrowing dollars to buy assets) and the run-up of many stock and commodity prices. Will the Fed ignore these developments and wait until the economy gains full traction to raise rates?

The current economic situation suggests continued substantial monetary ease, but developments in the financial markets do not.

Closely related to the this conundrum is another one: How will the Fed reduce its bloated balance sheet—which has reached $2.2 trillion, compared with $919 billion in mid 2008? Fed holdings now include more than $1 trillion of obligations involving largely longer-dated mortgage-related securities.

Bernanke's job is not enviable. But long-term success would be more likely if we clear the decks sooner than later. Where's the light switch for that exit sign?

Read Kaufman's whole piece in WSJ here.

Renewed Interest in Midway Airport Lease?

Posted on November 11, 2009, 3:17pm | Leonard Gilroy

As Crain's Chicago Business reports, Midway Airport's strong economic performance of late is rekindling interest in a long-term lease:

Midway Airport is pulling out of the recession faster than O'Hare International Airport, as shifts in the air travel market boost Midway's fortunes and breathe new life into Mayor Richard M. Daley's plan to privatize the city's No. 2 airport.

Passenger traffic at Midway climbed 9% in September on a year-on-year basis, following smaller gains in July and August. O'Hare, meanwhile, saw monthly declines of 7% to 8% during the same period. [...]

Midway remains about one-fourth the size of O'Hare, the nation's second-busiest airport and a hub for United and American. That's not going to change significantly, but Midway's quick recovery will make it more attractive to private investors. "There is an active discussion around trying to get ready to do it (again)," says John Schmidt, a partner at Chicago-based Mayer Brown LLP who is advising the city on privatizing Midway.

A $2.5-billion privatization led by New York-based Citigroup Inc. and Vancouver-based YVR Airport Services collapsed in April. But a new deal could happen next year. "A combination of things has to happen for privatization: The airport has to come back, and credit has to be available," Mr. Schmidt says. "To be able to say 'Here's an airport that's doing well,' it's a great strength."

In a sign the privatization market is reopening, New York-based Global Infrastructure Partners paid $2.5 billion last month for Gatwick Airport, London's secondary airport. And in September, the Federal Aviation Administration gave preliminary approval to New Orleans to privatize Louis Armstrong International Airport.

Meanwhile, increased traffic at Midway will boost passenger facility charges — the $4.50 fee the airport collects from travelers — which are used to pay off bonds that financed an expansion five years ago. More passengers also means more revenue from parking, food and other concessions, a key component of any privatization.

This, plus the recent Gatwick purchase and the approval to move forward with a lease of New Orleans' Louis Armstrong International Airport, offer some encouraging signs on the U.S. airport privatization front.

For the latest on international airport privatization, check out colleague Robert Poole's comprehensive review in Reason Foundation's Annual Privatization Report 2009, as well as Reason's airports research and commentary here.

Milwaukee County Board Chooses Tax Hikes Over Privatization

Posted on November 11, 2009, 2:48pm | Leonard Gilroy

As I've written recently, the Milwaukee County Board is where good privatization ideas go to die—in particular those proposed by County Executive Scott Walker, who deserves credit for his tenacity in trying. It's happened yet again, as the Board has just opted for higher taxes to avoid privatization of public functions. Per the Milwaukee Journal-Sentinel:

The Milwaukee County Board adopted a precariously balanced 2010 budget early Tuesday that sets aside nearly all of County Executive Scott Walker's privatization efforts, ditches a proposed "wheel tax" and raises the property tax levy 3.8%, or nearly $10 million, to $267 million.

The budget approved by the board included a set of employee concessions with a much lower price tag than those Walker had wanted. Like Walker's, the ones the board approved have not yet been bargained with unions. [...]

After nearly four hours of closed-door negotiations Monday night, supervisors reversed an earlier decision and agreed to accept the privatization of 15 county mainframe computer technicians, to tap into an unemployment compensation reserve fund and to reject a bus rapid transit plan that Walker wanted. [...]

The board voted to reject the outsourcing of housekeeping and security jobs at the courthouse complex and other county buildings. Supervisors also turned back Walker’s proposed outsourcing of 25 airport firefighter jobs.

Together, those moves would add about $5 million to Walker's budget, which counted on privatization to help freeze the property tax levy for 2010 at this year's $257 million.

There were some minor, potential bright spots, however. First, the Board agreed to study health savings accounts and a potential shift from a defined-benefit to a 401(k)-style defined-contribution pension system for new employees. If these policies were implemented, the County would at least stop digging the entitlement hole deeper. Second, the Board agreed to study Walker's proposal to privatize the operations and management of the County zoo.

On the zoo privatization front, hopefully County Board members will see this excellent piece by Detroit Free-Press columnist Tom Walsh on how the private sector rescued the Detroit Zoo under an arrangement similar to that which Walker is proposing (and which Dallas has just begun to implement):

For a telling Detroit example of how a public-private partnership can save and improve a regional asset that government can no longer afford, look no further than where the wild things are. [...]

The Detroit Zoo's record of growing attendance while controlling costs and boosting visitor satisfaction -- all during a horrible economic time -- is remarkable.

This didn't happen easily. When the city struck a deal in 2006 to turn operation of the zoo over to the Detroit Zoological Society, it came after the usual squeals of protest from some in Detroit who didn't want to surrender control of a so-called city-owned jewel. [...]

The city still owns the assets, but the nonprofit Zoological Society runs operations, and much of the budget comes from the regional tax.[...]

On the cost side, the biggest savings was switching employee retirement plans from defined-benefit pensions to contributory 401(k) plans, as many private companies have done. Kagan said benefit costs are now about 29% of salaries, down from 70% when the workers were City of Detroit employees.

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

Belize Privatizes Management of National Lottery

Posted on November 11, 2009, 1:02pm | Leonard Gilroy

Belize has privatized the management of its state-run lottery:

Following several months of rumored privatization, the Government formally announced today that it has awarded a 10-year contract to Brads Gaming Company Ltd. [...] to take over the management of the public lottery.

"Presently, collections from the sale of lottery books and license approvals net only about $0.9 million annually," the Government said via press release. "Therefore, the key conditions that Government decided to include in the outsourcing of the lotteries' management were the guaranteed collection of $2 million, annually, by way of a license fee; a profit sharing arrangement and business tax that the private company would be required to pay."

GOB claims that "to ensure transparency in the selection process," Cabinet had appointed a tender selection panel, chaired by Auditor General Edmund Zuniga, to recommend a company that would be able to administer the lottery for the next 10-year period, in the first instance, starting April 1, 2010. The arrangement should be assessed every two years. [...]

The release added that, "...in the first year of private management of the lotteries programs, nothing essentially will change as far as the purchase of lottery tickets is concerned. At the end of the first year, the transition to electronic sales will commence."

Meanwhile, lottery privatization remains largely stalled in the U.S., though Illinois is moving towards a lottery management contract that sounds similar in concept to Belize's approach. According to Reason Foundation's Annual Privatization Report 2009:

As recently as the summer of 2008, at least a dozen states were actively considering privatizing their state-run lotteries. But an October 2008 advisory opinion from the U.S. Department of Justice effectively stopped those efforts in their tracks.

In response to a request from Indiana Governor Mitch Daniels for a legal opinion on his proposal to lease the Hoosier Lottery and use the proceeds to fund a new state college tuition program, the department's Office of Legal Counsel determined that states would not be in compliance with federal law if they enter into long-term lottery-system leases with private consortia. The ruling found that while states may contract with firms to operate their lotteries, federal law requires that states maintain control over significant business decisions. The opinion also found that private management firms may not receive more than “a de minimus interest in the profits and losses of the business.” According to the opinion, the exemption state lotteries currently have from criminal prosecution under federal lottery laws would no longer apply if those lotteries were managed by private firms rather than the states. [...]

However, one state may have solved the question of how to monetize its lottery without running afoul of federal law. In July 2009, Illinois Governor Pat Quinn signed into law a $29 billion public works bill (House Bill 2424) that includes a partial privatization of the Illinois Lottery as part of the funding source. The bill calls for outsourcing the management of the lottery to a private firm that would be repaid with a five percent share of the lottery profits and the term of the contract would not exceed 10 years. Industry experts believe that since this deal would be structured more as an outsourcing contract—already common in many state lotteries—then a sale should pass federal muster. The bill sets March 1, 2010 as the deadline to ink a deal, so Illinois policymakers will need to move quickly on the procurement.

» Reason Foundation's Privatization Research and Commentary

Bob Poole (Quoted by Steve Forbes) Has It Right: Airline Deregulation is not to Blame

Posted on November 11, 2009, 11:00am | Shirley Ybarra

In a book by Steve Forbes and Elizabeth Ames, How Capitalism Will Save Us, Why Free Markets and Free People Are the Best Answer, the question was asked:  Didn’t deregulation wreck the airline industry?  The resounding answer is NO! It actually greatly benefitted consumers. As the a short version in an article concludes:  Airline deregulation actually has made service cheaper and more abundant. Adjusted for inflation, fares today are 25 percent to 44.9 percent lower than they were before deregulation three decades ago. Carriers offer far more service to more cities. And studies show travel is safer, too.

In the course of describing the situation (accurately) the authors use an article in 'Regulation Magazine" by (Reason’s own) Bob Poole, Jr. and Viggo Butler where they explain:

• … government management of our airports and air-traffic-control systems has produced an antiquated, inefficient infrastructure unequipped to handle the explosion of air travel resulting from deregulation.
  Government-run airports, for example, are unable to use market-based methods to reduce airport congestion--such as using peak pricing to direct some usage by carriers into off-hours. This would not only cut down on overcrowded terminals, it would generate much-needed fees to finance expansion and technological improvements both in air traffic control and in airport facilities
• …the misery of today's air travel is largely caused by an air-traffic-control system that relies on outdated 1950s technology. Only recently did the FAA announce that it would phase in more sophisticated NextGen air-traffic-control systems that use the kind of GPS satellite navigation technology consumers have had for years in passenger cars. The new systems would enable airports to handle at least twice as much traffic.
• NextGen technology has existed for years. But the system has been bogged down in political debate. Not having to account to consumers, bureaucrats, as always, take their time at taxpayer expense. NextGen isn't expected to be fully in use until about 2025, at a total cost of some $35 billion.
• Other countries already have more efficient, up-to-date air-traffic-control systems than the United States because they have given the management of airports and air-traffic-control systems to nonprofit corporations under industry control--and out of the hands of politically interested government bureaucrats.

Hence the accurate concluding comment which Bob Poole has written about many times over:  "The real problem in the United States isn't our airline traffic jam. It's the bureaucratic bottleneck in Washington."

See other articles by Bob Poole, Jr. at http://reason.org/areas/topic/air-traffic-control

Amendment to Ron Paul's "Audit the Fed" Bill Isn't A Bad Compromise

Posted on November 10, 2009, 7:52pm | Anthony Randazzo

Rep. Ron Paul's "Audit the Fed" bill has been back in the national conversation the past week with news of an amendment offered by North Carolina Rep. Mel Watt (D). The Ron Paul amendment would have the GAO audit Fed monetary policy decisions, including the recent expansion of the Fed balance sheet in the wake of the financial crisis meltdown. Rep. Watt's amendment essentially would essentially have the GAO audit just the ways the Fed has been lending money over the past 18 months by claiming special circumstance.

In today's Journal, Anil Kashyap and Frederic Mishkin argue that Rep. Paul's bill would be dangerous because it would overexpose the Fed and hurt independence. This argument has been the major one from Paul's critics all along. But they support Rep. Watt's amendment as a positive thing Congress can do to hold the Fed accountable. And I agree that it is a good compromise. Kashyap and Mishkin write:

Congress is considering an amendment to the bill that would prevent the negative consequences of the original Paul legislation. This amendment, put forward by Rep. Mel Watt (D., N.C.) would change the focus of the bill by instructing the GAO to audit the new lending facilities at the Federal Reserve that were authorized under the 13(3) "unusual and exigent circumstances" clause of the Federal Reserve Act. The 13(3) lending authority, which had not been used by the Fed since the Great Depression, was the basis for many of the most controversial decisions made during the crisis, including the rescue of AIG and the establishment of new lending facilities.

This audit would involve oversight of the operational integrity of these facilities' accounting, internal controls, and protection against losses. It would also disclose the borrowers from these facilities one year after the facilities are closed. The audit would produce new, important information that is not otherwise available and would play to the strengths of the GAO. And the amendment would exempt the Fed's normal monetary policy actions from the audit.

Now, I wrote back in July that I more or less supported the Ron Paul bill:

...does the proposed GAO audit of the Fed constitute a threat of its independence. The audit is not an attempt to control interest rates. The audit would not make monetary policy recommendations the Fed would be forced to follow. The audit would simply provide an outside perspective. Congress doesn't need a tool to intimidate the Fed into changing rates since the Fed isn't completely independent. Now, I'm not sure what Congress plans to do after the GAO audits the Fed, but if there is any debate here, it should be over the value of transparency itself.

I still disagree with Kashyap and Mishkin that the GAO audit would destroy independence. As they point out in their editorial, most of the monetary policy information is already public. And it is unlikely that a GAO opinion on monetary policy will shift the market much. The more important part of the bill—which is why I supported the Paul bill—is a review of where all the money the Fed has been lending is going.

The Fed has lent billions as a way of controlling interest rates and providing liquidity to the marketplace. They have not been upfront with where the money went, and it should be public information to keep the Fed accountable. Even if it is just a Congressional committee that sees an "eyes only" report.

Rep. Paul claims that the Watt amendment guts his bill, as my colleague Adam Summers noted last week. But if the issue is keeping the Fed accountable, then the sensible approach would be a bill that requires an audit of the "exigent circumstances" lending facilities. The Watt amendment might not be everything Rep. Paul wants, and it might need to be tweaked to get it just right, but the compromise path here would lead to the fastest approval of some necessary accountability checks on the Fed.

Cioffi and Tannin Found Not Guilty

Posted on November 10, 2009, 5:42pm | Anthony Randazzo

In a somewhat surprising decision today, former Bear Stearns hedge fund managers Ralph Cioffi and Matt Tannin were found not guilty by a jury of their peers in federal court. Nearly a month to the day after their trial began, the jury ruled that Cioffi and Tannin did not mislead investors nor commit fraud. The AP reports:

A jury in federal court in Brooklyn deliberated about eight hours over two days before finding Ralph Cioffi and Matthew Tannin not guilty of conspiracy and other charges in an alleged scheme that cost 300 investors about $1.6 billion and nearly caused the demise of Bear Stearns itself. The firm avoided bankruptcy in a rescue buyout by JPMorgan Chase & Co.

Both men had been charged with three counts of securities fraud and two counts of wire fraud. Cioffi was also charged with insider trading.

After the verdict, some jurors told reporters that they concluded that the evidence against Cioffi and Tannin was flimsy and contradictory. Other suggested the pair were being blamed for market forces beyond their control.

Having not been in the court room for any of the trial, it certainly would be unfair for me to completely disagree with the decision—especially since it is possible they are not guilty on technical grounds. Nevertheless, I am disappointed by the decision.

To begin with, I certainly don't believe Cioffi and Tannin should be held to account for what is technically not against the law. We should not judge people ex post facto in this country, not matter the distaste. Neither am I in favor of a Wall Street witch hunt, or of the opinion that the court system should be used to mediate cultural justice. But that said, for all practical purposes, Cioffi and Tannin did mislead investors. And that needs to be addressed.

First, Cioffi was not upfront about pulling his own money out of one account that was losing money. He should have told the other investors he did that, and why. If it's not against the law to disclose selling your own stock in a fund while it is losing money rapidly, we should consider something to that effect (provided such a rule didn't create unintended negative consequences).

Second, while Cioffi and Tannin were selling "AAA-rated" securities, the underlying assets of the securities were subprime crap. And it is pretty clear that the fund managers realized this well before communicating anything of the sort to investors. Why else was Tannin so torn up about their investment choices? (This was chronicled in emails from Tannin to Cioffi later published in William Cohan's House of Cards.) And why did Tannin and Cioffi use wives email accounts to discuss problems with the fund? They had knowledge which they did not share. This is a fiduciary responsibility issue.

It's not that they lost money. Sure, they pumped Bear Stearns money into the funds as they were going down, praying for a surge in the marketplace. That is just being bad at your job. But when you mislead investors who are trusting you with their money and you not only refrain from being upfront with them, but pull your own money out in fear of a loss, there is something wrong going on.

It might be that they didn't brake a technical law. In which case, the jury should be praised for not letting their emotions get in the way. But Wall Street shouldn't take this jury decision as permission to avoid transparency and disclosure. Wall Street should understand that, in exchange for a (relatively) relaxed and free market, they must obey the letter and spirit of the laws. Corruption, dishonesty, and the use of technicalities are crony capitalism, and do not help to make a prosperous society.

Financial Services Regulation Still in the Shadows of Health Care Reform

Posted on November 9, 2009, 5:07pm | Anthony Randazzo

With the health care bill passed out of the House this weekend, and the cap and trade bill approved by Representatives earlier this year, Speaker Pelosi has more breathing room to bring financial services reform to the House floor for debate. Well, debate might not be exactly what will happen. While Blue Dog democrats in the House of Representatives still have concerns, there is a bit more unfortunate consensus on how new Wall Street rules should be shaped than there was with health care. And with the White House breathing down Barney Frank's neck to get the last parts of the reform package out of committee, it's looking more likely that there will be a vote on the various pieces of financial services regulation restructuring (perhaps as a whole package if there are too many misgivings about consumer protection) before Christmas. Maybe even before Thanksgiving.

But in the Senate, financial services reform remains in the shadows. Senators Dodd has his hands full to be sure with the weight of health care shifted to the Senate, especially since he's committed to getting a vote on consumer protection by the end of December. The way to get that done, though, is to keep the regulation overhaul in the shadows. As long as it's just the lobbyists, analysts, and finance journalists (like me) that are paying attention, it should be easier to move forward. It helps Dodd and Co. that many limited government pundits have struggled to get their minds around the complexities of derivative reform and feel more comfortable blasting single-payer systems.

The reality is that a consumer financial protection agency (and similarly minded reforms) poses just as much of a problem to small businesses and banks as the health care bill coming out of the House poses to businesses and insurance companies. We are failing to take advantage of the moment; a moment when the regulatory structure can be untangled, clarified, and strengthened to prevent systemic risk, while protecting consumers and banks themselves.

Mary Peters on McDonnell's Transportation Agenda

Posted on November 9, 2009, 3:27pm | Leonard Gilroy

In a new National Review column, former U.S. Transportation Secretary Mary Peters reflects on the role that transportation policy played in Virginia Governor-Elect Bob McDonnell's election victory last week:

Much has been written about the "pragmatic" platform of Virginia governor-elect Bob McDonnell. The common wisdom is true as far as it goes — McDonnell ran on "kitchen table" issues that were of special concern to suburban voters — but the media has paid too little attention to one of the election's most important topics: transportation. [...]

McDonnell did this, in part, by explaining his policies to voters in one of the most comprehensive transportation documents ever compiled for a statewide race. Whereas most transportation discussions concentrate on the need for new revenues and the completion of specific projects, McDonnell's plan laid out a fundamental policy shift. McDonnell presented "four primary pillars": 1) making investments based on projects' value to taxpayers, not political influence; 2) reducing the time it takes to deliver projects without sacrificing environmental protection; 3) advancing a new strategy to operate and maintain existing infrastructure (and reduce congestion) that relies more extensively on technology and private-sector partnerships; and 4) transitioning toward a funding model that reduces congestion and establishes a stable revenue stream.

The dirty little secret behind transportation funding is that the best projects are not always those that get funded. Often, political influence, the need for geographical balance in road building, and the desire to bring economic development to disadvantaged areas trump more meritorious criteria such as congestion reduction and highway safety. McDonnell's plan advanced the notion that transportation funds should be allocated to projects on a cost-benefit basis, using consistent metrics and focusing on the most acute challenges.

Read the whole thing here.

Arizona Prison Privatization Proposal Doesn't Jive with Market

Posted on November 9, 2009, 12:55pm | Leonard Gilroy

Though it generated a lot of headlines in places like The New York Times, Arizona's ballyhooed proposal to turn over some or most of its prisons to private operators is revealing itself to be all smoke but no fire. According to the Arizona Daily Star:

Arizona's plan to turn over its prisons to private companies in exchange for a $100 million upfront payment is having trouble getting off the drawing board, with the plan behind schedule and prison operators showing little interest.

The privatization effort is required under a law enacted last summer as lawmakers struggled to close a huge budget shortfall. It directs the state to award a contract to one or more private companies to run an unspecified number of prisons for $100 million.

It emerged as Republican lawmakers cast about for alternatives to Republican Gov. Jan Brewer's proposal to increase the sales tax to avoid deep cuts.

The prison-concession provision doesn't specify which or how many of the state's 10 prison complexes would be included, what would happen to current state employees or the length of a contract. State officials were supposed to provide an initial batch of information to potential bidders on Oct. 1, but missed the deadline.

Corrections Corp. of America, the nation's largest private prison company, "is not focused on that," said Louise Grant, a CCA vice president, adding "it's very questionable whether or not we would participate."

It's easy to see why it's not attracting interest—it was a hastily developed proposal that failed to jive with the reality of the market. Here's why.

After several iterations through the spring and summer, the FY2010 budget signed into law in September included provisions requiring the Arizona Department of Administration to issue a request for proposals for a concession agreement allowing private vendors to operate any Arizona state prison complex or combination thereof (aside from the state prison in Yuma). But on top of that, the state also wants to get a $100 million upfront payment, which is the source of the problem.

Despite using the term "concession"—which typically implies a transfer of most risks and responsibilities associated with facility ownership, except for the title itself—what policymakers crafted here is nothing of the sort. It's just a glorified operations contract without the facility ownership component that would be such a value driver, as it's on the facility end that private prison operators can really drive down costs that could potentially be capitalized in the form of a large upfront payment.

So Arizona policymakers dropped the ball by crafting a proposal that few, if any, companies are interested in bidding on. If I'm a private prison company and I can get contracts in a variety of states, why would I bother bidding on a less-than-attractive proposal to operate facilities I don't and won't own, all while making a $100 million loan to the state (taking a huge chunk of my capital reserves) on top of it!? I'll go out on a limb and say, "not gonna happen."

The kicker with all of this is that the language in House Bill 2010 authorizing the prison(s) concession is immediately preceeded by the also-reknowned statutory language authorizing the sale-leaseback of dozens of state buildings, including several Capitol complex buildings and...you guessed it...state prisons!

So apparently policymakers are OK with selling a prison facility to an investor for 20 years, but not "selling" them to private prison companies as part of a concession to generate upfront revenue and drive cost savings over time. As much as I hate to say it, I don't think any of this was purposeful, but rather sloppy drafting amid tremendous budget pressures.

Lest I leave the impression that Arizona policymakers have utterly mangled their attempts to rejuvenate prison privatization, I would like to point out that there are two other lesser known prison privatization components of the budget that I believe may have some legs. The first is a requirement that the Arizona Department of Corrections issue a request for proposals and contract for 5,000 new private prison beds at new or existing in-state private prisons. The state certainly needs new prison capacity, and a "greenfield" project like this should not generate significant opposition from the state correctional officers union since no existing jobs are at stake. The second initiative requires the ADOC to issue a request for information, followed by a request for proposals, for the privatization of all correctional health services (including medical and dental services) that are provided in a state owned prison (facility not specified).

Still though, it's unfortunate to see policymakers generally fumble the ball on prison privatization when the budget crisis demands quick action to cut costs. Privatization is a powerful way to do that, as I argued in a recent appearance on Arizona PBS's Horizon show.

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

Ayn Rand on the Economic Crisis

Posted on November 9, 2009, 12:51pm | Adam Summers

Since we at Reason have been celebrating the ideas of Ayn Rand lately (see here and the related articles and videos posted at reason.org and reason.tv), I thought I would share with you some of her thoughts on the economic crisis—in 1962. Unfortunately, it seems our national economic IQ has not improved much since then.

Since "economic growth" is today's great problem, and our present Administration is promising to "stimulate" it—to achieve general prosperity by ever wider government controls, while spending an unproduced wealth—I wonder how many people know the origin of the term laissez-faire?

France, in the seventeenth century, was an absolute monarchy. Her system has been described as "absolutism limited by chaos." The king held total power over everyone's life, work, and property—and only the corruption of government officials gave people an unofficial margin of freedom.

Louis XIV was an archetypical despot: a pretentious mediocrity with grandiose ambitions. His reign is regarded as one of the brilliant periods of French history: he provided the country with a "national goal," in the form of long and successful wars; he established France as the leading power and the cultural center of Europe. But "national goals" cost money. The fiscal policies of his government led to a chronic state of crisis, solved by the immemorial expedient of draining the country through ever-increasing taxation.

Colbert, chief adviser of Louis XIV, was one of the early modern statists. He believed that government regulations can create national prosperity and that higher tax revenues can be obtained only from the country's "economic growth"; so he devoted himself to seeking "a general increase in wealth by the encouragement of industry." The encouragement consisted of imposing countless government controls and minute regulations that choked business activity; the result was dismal failure.

Colbert was not an enemy of business; no more than is our present Administration. Colbert was eager to help fatten the sacrificial victims—and on one historic occasion, he asked a group of manufacturers what he could do for industry. A manufacturer named Legendre answered: "Laissez-nous faire!" ("Let us alone!")

Apparently, the French businessmen of the seventeeth century had more courage than their American counterparts of the twentieth, and a better understanding of economics. They knew that government "help" to business is just as disastrous as government persecution, and that the only way a government can be of service to national prosperity is by keeping its hands off.

We should remember this when we hear claims that a "public option" for health insurance will somehow improve private-sector competition, improve services, or lower costs. Rand continues:

Regardless of the purpose for which one intends to use it, wealth must first be produced. As far as economics is concerned, there is no difference between the motives of Colbert and of President Johnson. Both wanted to achieve national prosperity. Whether the wealth extorted by taxation is drained for the unearned benefit of Louis XIV or for the unearned benefit of the "underprivileged" makes no difference to the economic productivity of a nation. Whether one is chained for a "noble" purpose or an ignoble one, for the benefit of the poor or the rich, for the sake of somebody's "need" or somebody's "greed"—when one is chained, one cannot produce.

There is no difference in the ultimate fate of all chained economies, regardless of any alleged justifications for the chains.

[The above excerpts are taken from Rand's essay "Let Us Alone!" based on a column in the Los Angeles Times, August 1962, and included in her book Capitalism: The Unknown Ideal.)

Sadly, nearly 50 years since Rand wrote this, the United States is still pursuing the failed policies of "economic stimulus," bailouts, and ever-increasing government control of numerous industries. The sooner we learn the economic lessons of Rand, the sooner we may return to a state of greater prosperity and freedom for ourselves and future generations.

P.S. For those interested in learning a bit more about Ayn Rand, the Cato Institute recently held an interesting book forum with the authors of two new books about the life and impact of Rand. The participants included Jennifer Burns, author of Goddess of the Market: Ayn Rand and the American Right, and Anne C. Heller, author of Ayn Rand and the World She Made. The video and podcast of the event are available here. See also the interview Ms. Burns did with Reason magazine Senior Editor Katherine Mangu-Ward here.

Airport Security (Lack Thereof) or the Right Methods?

Posted on November 9, 2009, 10:46am | Shirley Ybarra

My colleague Bob Poole, in his most recent Airport Policy and Security Newsletter( # 51) highlighted the General Accounting Office report looking at airport security (or lack there of).

About the same day, the Washington Times also had a critical editorial citing many of the same problems.

As the Times pointed out “Despite this massive expenditure and the passage of seven years, the agency has not deployed the technology and isn't even sure any of the 10 new systems can address the greatest threats. According to a recent investigation by the Government Accountability Office (GAO), there may not be any benefit from any of this any time soon.”

Bob said:  "One key finding is that after years and years of rhetoric about risk-based policy from both TSA (Transportation Security Agency) and its parent agency, the Department of Homeland Security (DHS), "TSA's strategy does not incorporate some key risk management principles-a risk assessment, cost-benefit analysis, and performance measures." 

The Times echoed a similar thought with “GAO auditors found that TSA has not applied any risk analysis or cost-benefit analysis to ensure the effectiveness or need of the new technologies. GAO said that TSA doesn't even have "reasonable assurance that technologies will perform as intended."

One of Bob’s final comments “A section toward the end of the report also makes dismaying reading. It summarizes DHS's response to the report's eight recommendations, all of which the agency said it agrees with. In most cases, however, the GAO states its concerns that the agency either doesn't really mean it or that the actions it says it will take will not (or not fully) address the intent of the recommendation. In two cases, GAO cannot provide a detailed explanation of its concerns, because "TSA determined our evaluation to be sensitive security information."

Now comes an article today in the Washington Post entitled “TSA screening more than just carry-on bags” with subhead 'Behavior detection' officers covertly watch travelers' conduct”

The article tells us that the TSA has stationed specially trained behavior-detection officers at 161 U.S airports to identify potentially dangerous individuals.  The officers may be positioned anywhere, from the parking garage to the gate. 

• "We're not looking for a type of person, but at behaviors."  We are trying to spot passengers that show an unusual level of nervousness or stress.  It is not easy to identify these offices as they “blend in” with other TSA screeners.  The behavioral officer is specially selected for their intelligence, maturity and ability to work with people.  These jobs do not require a background in behavior analysis
• Koshetz said the TSA has established specific criteria for what is considered normal behavior "in an airport environment." She said officers react only if a passenger strays from those guidelines, which the TSA declines to reveal for security purposes.
• The observation of passengers does not end at the airport.
  On an undisclosed number of domestic and international flights, federal air marshals pick up where the behavior detection officers leave off. 
• The article cites many successes most of which are drug related however at least is one is threat of a bomb in the back pack.  The statistics for last year indicate that officers nationwide required 98,805 passengers to undergo additional screenings. Police questioned 9,854 of them and arrested 813.

It is not an easy job to ensure the public safety but is TSA using the right methods?

Mises Predicted the Crisis

Posted on November 7, 2009, 10:21pm | Anthony Randazzo

In this weekend's WSJ, Mark Spitznagel, founder and chief investment officer of the hedge fund Universa Investments LP, writes that, in the 1920s, German economist Ludwig von Mises predicted how our crisis would evolve:

Taking his cue from David Hume and David Ricardo, Mises explained how the banking system was endowed with the singular ability to expand credit and with it the money supply, and how this was magnified by government intervention. Left alone, interest rates would adjust such that only the amount of credit would be used as is voluntarily supplied and demanded. But when credit is force-fed beyond that (call it a credit gavage), grotesque things start to happen.

Government-imposed expansion of bank credit distorts our "time preferences," or our desire for saving versus consumption. Government-imposed interest rates artificially below rates demanded by savers leads to increased borrowing and capital investment beyond what savers will provide. This causes temporarily higher employment, wages and consumption.

Ordinarily, any random spikes in credit would be quickly absorbed by the system—the pricing errors corrected, the half-baked investments liquidated, like a supple tree yielding to the wind and then returning. But when the government holds rates artificially low in order to feed ever higher capital investment in otherwise unsound, unsustainable businesses, it creates the conditions for a crash. Everyone looks smart for a while, but eventually the whole monstrosity collapses under its own weight through a credit contraction or, worse, a banking collapse.

Read the whole piece here.