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New FDIC Rule Proposals Would Restrict Private Equity Investment in Failed Banks

Posted on July 2, 2009, 7:14pm | Anthony Randazzo

Earlier today, the FDIC voted to move forward a proposal that would place restrictions on private equity groups seeking to participate in restoring failed banks. The WSJ reports:

The Federal Deposit Insurance Corp.'s board of directors on Thursday voted to seek comment on a proposal that would set new limits on allowing private equity firms to purchase failed banks. The staff proposal calls for investors to maintain certain capital levels at the acquired bank—a minimum 15% Tier 1 leverage ratio for at least three years—and would put other restrictions on ownership changes and where credit can be extended.

Beyond the capital requirements, the proposal would prevent certain types of investment structures from purchasing a failed FDIC-insured institution. Specifically, agency staff said it would not be appropriate to allow firms "involving complex and functionally opaque ownership structures" to buy a failed bank. Bair said the FDIC has already received bids from some firms whose legal structures raised red flags, which is one of the reasons they want to put the new rules in place.

This proposal is troubling, especially considering there have been 51 bank failures in the past 18 months. When private equity very interested in investing in these failed banks to bring them out of bankruptcy, such restrictions threaten to extend the amount of time failed banks feed off FDIC life support. The WSJ report continues:

But critics were quick to suggest the proposal in its current form would be too prohibitive and would discourage private equity investment.

"It may be well intentioned but I think it could guarantee that there will be no more private equity coming into banks," investor Wilbur Ross told Dow Jones Newswires. Ross' investment firm was part of the private-equity consortium that negotiated with the FDIC to acquire failed Florida bank BankUnited FSB in May. [...]

Comptroller of the Currency John Dugan said he was concerned that some of the restrictions are too onerous, and suggested they should be scaled back before a final rule is put in place.

Dugan was not alone in his concerns. The requirement to keep the bank "well capitalized" even after three years and other restrictions that could affect smaller shareholders could dissuade private equity firms from buying banks, said Lawrence Kaplan, an attorney at Paul, Hastings, Janofsky & Walker LLP.

"Even in proposed format, it's very frightening to entities that are not used to dealing with the government," Mr. Kaplan, a former attorney at the Office of Thrift Supervision, said of the proposal.

So the question becomes, why is the FDIC doing this?

"There is a significant need for capital and there's significant capital out there...We want to accommodate that, but accommodate it in a way that is prudent," FDIC Chairman Sheila Bair said in a statement. [...]

Regulators, however, are wary that private investors may not be committed to the long-term ownership of a healthy bank and that allowing some firms into the market could just result in future bank failures.

"We are particularly concerned with the owners' ability to support depository institutions with adequate capital and management expertise," Ms. Bair said.

Thus is the problem with market regulation, it too often restricts opportunities to create wealth. It is understandable that the FDIC be prudent in who is sells the banks it has receivership power over too. Afterall, they have to clean up the mess if the bank fails again. But it is also imprudent to require three year interest stakes in a bank when dozens of banks are sitting around looking for buyers.

Highlights from SF Fed President Yellen's Speech

Posted on July 2, 2009, 5:15pm | Anthony Randazzo

Federal Reserve Bank of San Francisco President Janet Yellen spoke at the Commonwealth Club of California on Tuesday about the progress of economic recovery. There has been some speculation that she might succeed Ben Bernanke as Fed Chairman when his term ends next year. She expects a slow recovery, but recovery nonetheless. Here are highlights from her speech:

I am not going to go into detail about the alphabet soup of Fed programs created during this period [fall of 2008]. But I want to stress that these policies—in some cases improvised in very short order—did succeed in averting a full-blown meltdown. The panic of 2008 subsided.  Increasingly, banks and corporations have been able to raise funds on reasonable terms. Confidence in the financial system is slowly returning...

The news during the past few months has been encouraging. Even though house prices are continuing to fall in most markets, housing sales and new construction appear to have stabilized. Consumers have recovered some spirit and their spending has also stabilized, thanks in part to government stimulus programs. Payrolls are still shrinking at an awful pace, but the momentum of job losses has slowed considerably in the past two months.

Financial markets are in much better shape today than we ever would have dreamed six months ago. Investors have gone from disregarding risk, to being paralyzed by it, to once again being willing to take on a reasonable bit. The stock market has rallied and investor appetite for corporate bonds and other assets has rebounded, restoring access to capital for healthy companies. Even so, I am concerned that mortgage rates, which have risen of late, could place a drag on a still very sick housing market, potentially driving home prices still lower and pushing more borrowers into foreclosure. The recent run-up in oil prices may also reflect greater confidence in the global outlook...

I expect the recession will end sometime later this year. That would make it the longest and probably deepest downturn since the Great Depression. Growth will come from a variety of sources. One is federal government spending resulting from the stimulus program passed by Congress earlier this year. This package provides tax cuts that leave more cash in consumers’ pockets, as well as direct government spending increases that add to payrolls and boost economic output. But it will take more than fiscal policy to really get the economy moving forward...

History also teaches us that it often takes a long time to recover from downturns caused by financial crises. In particular, financial institutions and markets won’t heal overnight.  Our major banks have made excellent progress in establishing the capital buffers needed to continue lending even through a downturn that is more serious than we anticipate. But they are still nursing their wounds and credit will remain tight for some time to come...

If the economy fails to recover soon, it is conceivable that this very low inflation could turn into outright deflation. Worse still, if deflation were to intensify, we could find ourselves in a devastating spiral in which prices fall at an ever-faster pace and economic activity sinks more and more.  But I don’t view this as likely. The vigorous policy actions of the Fed and other central banks, combined with sizable fiscal stimulus here and abroad, have sent a clear message that deflation won’t be tolerated. Based on measures of inflation expectations, the public appears confident that the Fed will adopt policies that will maintain a low, positive rate of inflation.

Public Option is an Economic Nightmare

Posted on July 2, 2009, 4:09pm | Anthony Randazzo

In a town hall speech yesterday, the President made a pitch for his health care plan, arguing it makes economic sense. I am not a health care expert, but I do think about things in economic terms. The President may make an argument about universal health care as just. He may say it would benefit the medical community. He could argue that a public option would save lives. On those arguments and more I would direct you to my colleague Shikha Dalmia, and her recent column in Forbes.

But the President can not argue that ObamaCare would be an economic boon. From an economics perspective, and as someone who wants affordable health coverage, this is my thought process:

Why would I want my employer to pay for health care, if I can get it cheaper from the government? Why not just get it from the government and have my employer pay me what would have gone to Blue Cross?

The answer is that the public option will probably be lower quality than private insurance. Otherwise it would make more economic sense to go with the government option. At the President's town hall yesterday, a woman named Debby Smith broke down crying that she has kidney cancer and no way to treat it. If the public option could help anyone with this problem, everyone would flock to it. But that's not how the public option is being designed, it is only intended to cover a percentage of those currently uninsured. So, ostensibly, the $1.6 trillion public option draft legislation (according to the CBO) and mandate—not $1 trillion as the President originally laid out—will create a lower quality service for some of those that don't have coverage now. How does that help all the Debby Smiths?

Now, the only way a lower quality insurance program will work is to ration services. Which means not helping everyone. It also means long waits and picking and choosing who gets help. But at least some people would be helped, right? The question becomes, is spending $1.6 trillion worth it for getting a handful of American's health coverage? From an economics perspective, no. Even if the public option could help everyone under its plan, it wouldn't be a good use money because we have no way to pay for it and the nation is already trillions in debt. 

Now lets say that the ObamaCare public option is successful. Suppose Uncle Sam can keep costs down and provide for people (the goal). If it is working then I will want to be a part of it. And so will everyone else. That's the prudent financial decision. Suddenly the public option starts pulling people away from private companies. Those companies will need to charge more for their decreased number of clients.

Eventually, the private insurance companies will be charging very high premiums, putting a strain on businesses who are providing coverage, and the costs to individuals. In the mean time the public option will be over run, and be maxed beyond its capacity. Can we have a single payer system work in America? According to President Obama, no we can not. He said yesterday that the government is not capable of running all health care in this country, which is why his public option isn't trying to take people from the private system.

Ultimately, from an economic perspective, either the public option works and draws in a lots of people until it can't anymore, or it doesn't work and is an economic mess. Either way, it's not pretty.

Update: I originally misstated the CBO's scoring of universal health care spending. They said on June 16 that the universal health care draft bill being considered then would cost $1.6 trillion, but that did not include the cost of a public option. Which means the public option could increase the cost of the legislation if it is not completely paid for by premiums. Of course the final ObamaCare bill could be lower, but even if it is $500 billion, it doesn't change the broader financial status of the federal government—severely in debt.

Privatization Leader Sandy Springs, GA Continues to Innovate

Posted on July 2, 2009, 2:30pm | Leonard Gilroy

Regular readers of this blog are certainly familiar with the young city of Sandy Springs, Georgia, which seceded from Fulton County in late 2005 and, rather than creating a traditional city government, hired a contractor to manage all of the city's administrative functions and perform all of the hands-on, non-safety-related parts of the government. Sandy Springs' successes have even inspired four other nearby communities to incorporate since 2006 and follow its contract city model, as discussed in Reason Foundation's Annual Privatization Report 2008.

Last Saturday, an article by Atlanta Journal-Constitution reporter April Hunt shows that Sandy Springs continues to break ground, as evidenced by a new program to offer cash incentives for employee innovation. An excerpt (emphasis mine):

Sandy Springs, whose existence is a model of municipal privatization, has adopted a policy it hopes will keep it in the forefront of the movement to deliver local government services in new ways.

The city’s recently adopted innovation and visioning policy sets up a formal quarterly process for city workers to offer, and be rewarded for, new ideas and suggestions on how to best serve the 87,000 people in the northern Fulton County city.

That most of those workers are actually employees of a private firm the city contracts with for its basic functions is exactly the point. “We started with a blank sheet of paper starting this government, and I don’t ever want to throw that blank sheet away,” said Councilman Rusty Paul, who fashioned the policy. “We must continually look at how else we can do things.”

Voters carved the suburban city out of Fulton County nearly four years ago in large part out of a belief that the taxes they paid subsidized emergency services and infrastructure needs in the southern part of the county. Elected officials, all of whom actively pushed for cityhood, immediately recognized those needs as priorities when Sandy Springs incorporated on Dec. 1, 2005.

The city has since spent about $15 million to pave 63 miles of roads and $2 million to put sidewalks on all main roads and around schools. Another $4 million will be spent in the coming year for both programs and, for the first time, to begin rebuilding the city’s worst streets. [...]

The policy calls for more than just ideas, though. A review process will be set up, to test ideas and allow for feedback to perfect, for example, how the city will partner with nonprofits to further develop parks.

The employee who offers up the idea will receive a one-time merit bump of a few hundred dollars in his or her paycheck. That bonus program is already included in the budget. “This says a lot about us,” said Councilman Tibby DeJulio. “We have a vision for vision.”

Incentives like these are critical for facilitating dynamic government by offering a formal mechanism that effectively creates continual tension in the system. If other "traditional" cities were as fiscally responsible as Sandy Springs, they too might be in a position to appropriate funds for similar programs. Unfortunately, right now, many local governments are just trying to stop the fiscal bleeding.

More on Sandy Springs here, here, here and here.

VP Biden on Broadband "Information Overline"

Posted on July 1, 2009, 7:55pm | Steven Titch

You knew the White House was taking its chances sending out Vice President Joe Biden to talk up the broadband stimulus. And Old Joe was on form, as usual.

This afternoon outside Erie, Pa., the veep was on hand to announce the criteria the federal government will use to hand out $7.2 billion in stimulus funds aimed at developing the broadband infrastructure in underserved areas.

In his address to 200 people at Seneca High School near Erie, The Wall Street Journal reported Biden saying, “The bottom line is, you can't function -- a nation can't compete in the 21st century -- without an immediate, high-quality access for everything from streaming video to information overline.”

Commenters are invited to speculate exactly what “information overline” is. Yeah, it’s funny, until you realize the vice president in an administration that has called for an unprecedented level of aggressive and pre-emptive Internet regulation can’t even speak articulately about basic broadband connectivity.

For more Bidenisms, see this Reason.tv clip.

Pittsburgh to Privatize City Parking Garages

Posted on July 1, 2009, 4:27pm | Leonard Gilroy

The Pittsburgh Business Times reports that the Pittsburgh City Council has approved a five-year fiscal recovery plan that includes a section authorizing the privatization of the City's parking garages. Sounds like they're learning some lessons from Chicago, which privatized four downtown parking garages in a $563 million deal in 2006.

More details to come on Pittsburgh's plans as they're available.

Defending Complex Contracts from a Consumer Protection Agency

Posted on July 1, 2009, 4:10pm | Anthony Randazzo

The White House unveiled details on a key part of its regulatory reform plan yesterday, sending a 152-page draft bill to Congress to create a Consumer Financial Protection Agency. The Washington Post reports the bill suggests establishing a five-member board to run the new agency: four individuals nominated by the president and confirmed by the Senate, plus the new head of the National Bank Supervisor (another proposed, consolidation agency, by the administration).

One of the main policy objectives of the administration is to protect consumers. Part of that objective is the proposed creation of the Consumer Financial Protection Agency (CFPA). This new federal agency would be tasked with protecting consumers from "unfair, deceptive, and abusive practices" of credit card companies, mortgage lenders, commodities traders, mutual fund brokers, and other firms that originate products.

President Obama said that, if the bill becomes law, "Those ridiculous contracts with pages of fine print that no one can figure out—those things will be a thing of the past." I've seen a lot of this talk recently, about complicated contract terms. It is one of the leading issues driving reform efforts to make things easier for consumers. What I haven't seen much of is anyone standing up for the complicated contracts.

I'll grant that contracts are written with terms designed to maximise profit (that's just good business) and often have sneaky tricks. But that said, the push for simplification seems incredibly American—the lazy part of being an American. Is it too much to expect that someone buying a house or taking out a credit card should be able understand the deal they are making? If someone is responsible enough to own a home, they should be responsible enough to read a mortgage contract. This doesn't speak well to the education level in our country. Reading through a credit card contract should be a teenage rite of passage before getting your first card (I was nerdy enough at 15 to read several, trying to get my mind around the system). Or if you prefer, don't read the contract (it is your free right after all) and find out through the learning process called experience.

I guess I just don't understand how putting financial product contracts in simpler terms solves any problems. Fine print didn't cause the financial crisis, irresponsible lenders and borrowers did. It would seem that understanding a contract is a good threshold for whether someone is a good credit risk.

Ironically, another American tradition has been a key driver of complicated contracts: the frivolous lawsuit. Many financial product contracts are highly detailed to cover all potential legal scenarios. How ironic would it be if the McDonald's hot coffee lawsuit lady got confused about a mortgage contract and wound up defaulting? Sometimes, legal concepts just need to be put in legal terms... kind of like bills in Congress. Here is a challenge for lawmakers, if simplicity is important for protecting individuals, then write laws that the average American can understand. Put the CFPA bill in short, easy to understand terms. Why not?

To be clear: I understand the value of a simple contract. But I don't understand how increasing compliance and production costs for firms by forcing simple contracts solves any problems. It seems letting banks use the simplicity of forms as a competitive advantage would yield better results: "We're Wells Fargo: simple terms, simple prices" or "JP Morgan Chase: where the only complex choice you have to make is what to do with all the money you'll earn through our products."

More Legislative Roadblocks Over Private Toll Roads in Texas?

Posted on July 1, 2009, 3:14pm | Leonard Gilroy

Just hours into a special session called in part to address the need to extend and modify the state's authority to enter into private toll road contracts, the Austin American-Statesman reports that the prospects of resolution may be dimming as Texas legislators seemingly continue to be held politically hostage by solution-less opponents of road privatization.

Ironically, these opponents have gotten a lot of mileage out of their disingenuous "tolls=taxes" rhetoric (toll roads are voluntary—i.e., you don't drive them if you don't want to pay; meanwhile, when was the last time you paid a "voluntary" tax?). Yet, when asked to present their solution for Texas' massive transportation funding gap, opponents' only proposed fix is to...(drumroll)...raise the gas tax. Last time I checked, fuel taxes are mandatory and tolls are not, but that seemingly intuitive point remains lost on many Texas legislators. 

So instead of recognizing that, for example, the recently completed private contract to develop the multi-billion dollar, congestion-busting North Tarrant Express project in the Metroplex area is the only realistic way that vital project would have ever been completed, many legislators seem content to ignore such evidence and remain fiddling on toll roads while Texas transportation burns. 

The status quo is failing to deliver the infrastructure Texas needs to remain economically competitive over the long-term, and the sooner legislators realize that they need all financing tools at their disposal—including private toll concessions—the better. For more on the Texas toll road situation, see here and here.

» Reason's Transportation Research and Commentary

(Un)Happy New Fiscal Year: Tax Hikes, Missed Budget Deadlines, State Shutdowns and Ongoing Fiscal Woes

Posted on July 1, 2009, 1:31pm | Leonard Gilroy

Today, forty-six states begin Fiscal Year 2010, but ongoing fiscal woes and the widespread rollout of economy-dampening tax and fee hikes promise to make this one of the more challenging budget years in some time for cash-strapped states. As Stephen Fehr at Stateline.org reports today, FY 2010 is already off to an inauspicious start:

Four states closed billions of dollars in budget shortfalls and approved spending plans in the last 24 hours, but legislatures and governors in six states were still far apart on their budgets as the fiscal year began Wednesday (July 1).

Indiana, Mississippi and Delaware averted disruptions in government services by approving budgets in time for the new fiscal year. It was not immediately clear whether Arizona would escape a shutdown, even though its Legislature sent Gov. Jan Brewer (R) a final-hour $8.4 billion budget plan. The budget did not contain a temporary sales tax proposal the governor had sought to put on the November ballot. If she vetoes the budget, the government could stop operating. [...]

States without budgets on the first day of the new fiscal year are Connecticut, Illinois, Pennsylvania, North Carolina and Ohio. California lawmakers approved a budget in February but falling revenue has knocked it out of balance by $24 billion.

California officials said they will be forced to issue IOUs because they will not have the money to pay all of the state's bills. Pennsylvania and Illinois officials say they will keep essential operations going, but a protracted stalemate could begin affecting day-to-day services in those states in a few weeks.

Shutdowns were not a threat in Connecticut, North Carolina and Ohio, even without a new budget plan in time, because those states have provisions to temporarily spend without a budget. [...]

The last time so many states blew the deadline was two years ago, when six states could not agree on a budget by July 1. The widening of the problem this year reflects a steady drop in tax revenue because of the recession, which has forced 48 states nationwide to close $166 billion of budget gaps.

Even in states that have approved budgets, July 1 is a day of reckoning because many of the budget cuts and tax and fee increases enacted by legislatures go into effect. In Nevada, for example, a record $1 billion in tax increases begin; Las Vegas now has an 8.1 percent sales tax. Twenty-five states boosted taxes this year, according to the Center on Budget and Policy Priorities, a Washington, D.C., think tank.

Hardly a week goes by without another state budget problem surfacing. On Tuesday, Kansas Gov. Mark Parkinson (D) said that since the Legislature approved a pared-down state budget earlier this year, tax revenue has fallen so sharply in May and June that another $135 million in cuts will be needed as the fiscal year begins.

Without the federal economic stimulus package, state budgets would be even more out of whack. Stimulus money has closed about 40 percent of state budget shortfalls, according to the Center on Budget and Policy Priorities.

In many ways, while we did see some modest state belt-tightening in FY 2009 and a lot of interest in privatization, streamlining government, and developing fiscally sustainable budget tools and processes, the influx of federal stimulus dollars papered over budget problems in many states and helped policymakers avoid making necessary and politically unpopular decisions.

Despite routine Chicken Little claims of "decimating vital programs" and "cutting needed spending to the bone" across the states (a guaranteed rhetorical response to cutting ANY spending), draconian cuts hardly occurred in most states. Spending cuts rarely exceeded 10 percent (hardly "decimating") for agencies, programs or categorical spending, by and large, in most places.

But the stimulus gravy train is going to run out, and policymakers are going to have to starting facing the inevitability of substantial reductions in the size, scope and price of government in earnest this fiscal year to close well in excess of $150 billion in budget deficits this year. That's why, for example, the Arizona House of Representatives' decision yesterday to let politics destroy a bill that would have created the strongest privatization and government efficiency board in the nation is so disheartening and puzzling (it obviously wasn't a statement on privatization, as there are several discrete privatization and asset sale/lease proposals embedded in the budget). Conversely, the looming intensification of the budget crunch also explains why the Louisiana legislature's passage of a bill codifying Gov. Bobby Jindal's Commission on Streamlining Government into statute is such a prescient and sensible action.

Solutions like these need to become part of the fiscal solution for states immediately, because if you think "Happy New Fiscal Year" sounds like a joke now, just wait until this time next year. The only thing standing between a "Year of Fiscal Responsibility" and a "Year of Budget Insanity" is the political will to take the necessary steps to reduce the cost of government.

» Reason's Privatization Research and Commentary

Public Pension Shortfall is Worse than You Think

Posted on July 1, 2009, 12:58pm | Adrian Moore

A new research paper, "Public Pension Promises: How Big are They and What are They Worth?," from the University of Chicago looks at nationwide public pension obligations and funding.  The author's summarize the paper as:

We calculate two present value measures of already-promised state pension liabilities using discount rates that reflect their risk. If benefits have the same priority in default as general obligation debt, aggregate underfunding is $1.21 trillion. If states cannot default on these benefits, underfunding is $3.12 trillion. The first measure is a lower bound on the value of the liability to taxpayers, and is more than the $0.94 trillion in state municipal debt. The second measure is a better benchmark for funding adequacy. We also estimate broader concepts of accrued liabilities that account for projected salary growth and future service.

You can download the paper here.

From their conclusion

[O]ur calculations focus only on liabilities accrued until now. Our summary numbers therefore assume that states will fully fund new liabilities accrued in the future, both from current and future workers. Munnell et al (2008) report that 57% of state and local governments paid their full Annual Required Contributions (ARCs) in 2006, with 16% contributing 80-99%, 13% contributing 60-79%, and 14% even less than 60%. Mitchell and Smith (1994) find wide variations in this funding behavior. Since there is no material penalty for not funding newly accrued benefits (i.e. for violating the ARCs implied in the funding standards), states do not always comply with funding to their own standards.

and

as shown by Lucas and Zeldes (2009), if taxation to correct pension underfunding has nonlinear distortionary costs, investing underfunded public pensions in risky assets with high expected returns and high volatility may impose a large expected cost of distortionary taxation on future generations.

The bottom line of this paper is that:

a) By the most realistic measure, public pensions in America are underfunded by more than $10 trillion.

b) Future taxes to pay for the benefits promised but not funded by current political leaders will be very burdensome and will distort the economy.

Future generations will curse us for this.

Obama's Not-So-Noble Health Care Lies

Posted on July 1, 2009, 12:51pm | Shikha Dalmia

Obama came to office, not as a mere mortal - but a near deity who was going to elevate the cesspool that is politics by always telling the truth, the whole truth and nothing but the truth, so help you god. But as I argue in my Forbes column this morning, when it comes to healthcare, Obama has only told lies, lies and more lies.

As I note:

"Lie One: No one will be compelled to buy coverage.

During the campaign, Obama insisted that he would not resort to an individual mandate to achieve universal coverage. In fact, he repeatedly ripped Hillary Clinton's plan for proposing one. "To force people to buy coverage," he insisted, "you've got to have a very harsh penalty." What will this penalty be, he demanded? "Are you going to garnish their wages?" he asked Hillary in one debate.

Yet now, Obama is behaving as if he said never a hostile word about the mandate. Earlier this month, in a letter to Sens. Max Baucus, D-Mont., and Ted Kennedy, D-Mass., he blithely declared that he was all for "making every American responsible for having health insurance coverage, and making employers share in the cost."

But just like Hillary, he is refusing to say precisely what he will do to those who want to forgo insurance. There is a name for such a health care approach: It is called TonySporanoCare.

Lie Two: No new taxes on employer benefits.

Obama took his Republican rival, Sen. John McCain, to the mat for suggesting that it might be better to remove the existing health care tax break that individuals get on their employer-sponsored coverage, but return the vast bulk--if not all--of the resulting revenues in the form of health care tax credits. This would theoretically have made coverage both more affordable and portable for everyone. Obama, however, would have none of it, portraying this idea simply as the removal of a tax break. "For the first time in history, he wants to tax your health benefits," he thundered. "Apparently, Sen. McCain doesn't think it's enough that your health premiums have doubled. He thinks you should have to pay taxes on them too."

Yet now Obama is signaling his willingness to go along with a far worse scheme to tax employer-sponsored benefits to fund the $1.6 trillion or so it will cost to provide universal coverage. Contrary to Obama's allegations, McCain's plan did not ultimately entail a net tax increase because he intended to return to individuals whatever money was raised by scrapping the tax deduction. Not so with Obama. He apparently told Sen. Baucus that he would consider the senator's plan for rolling back the tax exclusion that expensive, Cadillac-style employer-sponsored plans enjoy, in order to pay for universal coverage. But, unlike McCain, he has said nothing about putting offsetting deductions or credits in the hands of individuals.

In other words, Obama might well end up doing what McCain never set out to do: Impose a net tax increase on health benefits for the first time in history.................."

For three more lies, go here.

More Casualties of Internet Tax Overreach

Posted on July 1, 2009, 12:29pm | Steven Titch

Overstock.com is ending its marketing affiliate program in four states that have passed dubious legislation declaring online affiliates the equivalent of a brick-and-mortar shops, thereby making Overstock.com and other online retailers subject to sales taxes. New York State attempted this last year but reversed course after Overstock threatened to end its affiliate program in the Empire State passed a similar law last year and Overstock dropped 3400 affiliates in the Empire State.

The Wall Street Journal reports:

Overstock.com Inc. informed its marketing affiliates in California, Hawaii, North Carolina and Rhode Island that it is ending its business with them to avoid collecting sales tax.

Lawmakers in the states have passed or are preparing to pass legislation that would require companies to collect sales tax if they have marketing affiliates in the state. Affiliate marketers run blogs or Web sites and get a sales commission by featuring links to outside e-commerce sites.

Rival Amazon.com Inc. has taken similar steps in the past few days, ending ties with affiliates in three of the same states and warning about California.

"It's painful to have to terminate these relationships with affiliates, simply because they live in states where counterproductive (and likely unconstitutional) laws are being passed," Overstock Chairman and Chief Executive Patrick Byrne said. "However, politicians have to remember that a tax is a price that government charges for a service, and when they raise their prices, we're going to buy less of their services."

Defining online affiliates as a physical "nexus" is a stretch to begin with. Affiliates are not merchants. In many cases they are Mom-and-Pop website set-ups that do not sell products online but earn a commission based on sales they generate through “clickthroughs” on advertising links they host. At the same time, such sales taxes, which rely solely on semantics to reach across state lines, arguably violate the Commerce Clause in the U.S. Constitution. In the meantime, the habit of many state governments have of turning to telecom and the Internet to feed their tax-and-spend ways continues to kill the very e-commerce development that has been boosting household incomes.

Arizona Privatization/Efficiency Board Bill Falls Victim to Toxic Budget Politics

Posted on July 1, 2009, 11:17am | Leonard Gilroy

Having passed the full Senate and the House Appropriations Committee in recent weeks, Arizona's SB 1466 (see here and here for details) came two votes shy of passage in the full House yesterday (29-30-1) amid the chaotic scramble to pass a budget to avoid a government shutdown.

It would be less frustrating if the vote was based on the policy merits, but by all accounts policy and logic had nothing to do with it. Rather, despite the support of the Arizona Chamber of Commerce and Industry, Americans for Tax Reform, Americans for Prosperity and a number of other influential groups, several House members decided to tank SB 1466 purely as a personal shot against the bill sponsor in retaliation for her positions on unrelated pieces of the budget package.

It's certainly not the first time good policy fell victim to stupid politics, and it won't be the last. But to let personal politics trump sound fiscal policy in a state facing among the worst budget problems in the country is downright immature and serves taxpayers appallingly poorly.

Way to utterly squander an opportunity, guys. Get ready to see this bill again, as the budget problems aren't going away anytime soon in Arizona.

Federal Highways Report on HOT Lanes

Posted on July 1, 2009, 11:14am | Shirley Ybarra

An excellent report about high occupancy toll (HOT) lanes has just been posted on the Federal Highway Administration website. 

 
HOT lanes operate beside existing highway lanes and offer users choice.  Carpools with three or more people in the car (HOV 3), van pools, buses and motorcycles travel for free on the HOT lanes. Drivers traveling alone or with only one other person have a choice: They can stay in the existing free lanes or pay a toll to travel faster in the HOT lanes. Tolls are based on real time traffic conditions. When traffic is heaviest the tolls are the highest. This variable toll pricing (also known as congestion pricing) limits the number of vehicles entering the HOT lanes, to keep them free flowing at the maximum speed allowed.   Most operators of HOT lanes have a toll system that allows drivers to pay tolls and enter the lanes without slowing down; there are no toll booths.
An excellent report and a serious guide for state transportation officials however the authors did not recognize the history of HOT lanes and congestion pricing as well they should have.

Hence the reasons for my post: 1) to highlight the report and 2) to give my colleague Bob Poole the credit he deserves.

Bob Poole, founder of Reason first wrote about congestion pricing in 1988 here and about HOT lanes in 1993 here. 

A long time in coming but the good news is we are seeing numerous projects around the country utilizing HOT lanes and congestion pricing in states including:  California, Washington, Minnesota, Virginia, Florida and Texas.

On the Very Idea of the Agricultural Committee

Posted on July 1, 2009, 9:00am | Carson Young

The Waxman-Markey cap and trade bill has turned into a feeding frenzy for special interests, as Reason’s Ron Bailey warned back in April.  Prominently elbowing its way to the public trough, as usual, is Big Agriculture:

Because they are the source of most carbon emissions, factories, power plants and oil refineries would all be covered by the caps and be required to buy the permits, or allowances, as they are called. The one major source that is not covered is the American farm….  But, for farmers, it wasn't enough to get a free pass on carbon emissions…. In the mind of the entitled American farmer, any increase in costs or reduction in revenue—whether from natural causes, market forces or government regulation—must be compensated for by the government.

This doesn’t come as a surprise, given the other boondoggles caused by the farm lobby’s disproportionate political influence (ethanol and the farm bill, to name a few).  One institutional reason for the farm lobby’s clout is Congress’s committee structure.  As Matt Yglesias explains,

One basic problem of democratic governance relates to concentrated interests versus diffuse ones. Organizing broad groups of people to advance the public interest in the face of entrenched opposition is difficult. And the committee structure is like it was designed to make this problem as bad as possible.

Ezra Klein proposes an obvious solution: get rid of agricultural committees.  Agriculture is the only industry that gets legislative committees all to itself (not to mention an entire executive department).  Maybe this made sense back in the 19th century, when the United States was still mostly an agrarian economy. But now that the agricultural sector employs only two percent of workers in the United States, agricultural committees have been reduced to serving as conduits between public funds and special interests, making already dreadful bills like Waxman-Markey even worse. Why do we need this problem?

Reason's Anthony Randazzo has more on the travesty that is Waxman-Markey here.

The Sports Stadium and Arena Debacle

Posted on July 1, 2009, 8:20am | Samuel Staley

Anyone following the plight of America's sports stadia and arenas should take a look through this article in the New York Times chronicling the debacle we've created with public subsidies. We have more arenas then ever, and often pit private venues against public ones. They all lose.

"In Glendale, Ariz., the city-owned Jobing.com Arena — which is losing money and events to US Airways Center in nearby Phoenix and a third arena at Arizona State — may lose its National Hockey League franchise, the Phoenix Coyotes, which filed for bankruptcy last month.

"In the Minneapolis-St. Paul region, the Target Center, which is owned by the city of Minneapolis, vies with the publicly subsidized Xcel Energy Center in St. Paul. The Minnesota Timberwolves basketball team plays at the Target Center; the Minnesota Wild hockey team plays at Xcel Energy Center. Both sites are losing money, and they must also compete with the University of Minnesota, which has two arenas.

"In Columbus, Ohio, the Blue Jackets hockey team recently opened negotiations to sell its money-losing Nationwide Arena to the county, but the recession has made the sale somewhat unlikely. Nationwide Arena competes for concerts and other nonsporting events with Ohio State University’s Jerome Schottenstein Center, which barely breaks even, according to a report by The Columbus Dispatch."

Perhaps the only thing more stunning is the degree to which owners of these venues continue lobbying for public subsidies and favors to protect their own franchises.

"In New Jersey, the owner of the Devils hockey team, which abandoned the Izod Center in the Meadowlands to play at Prudential Center, wants Gov. Jon S. Corzine to tear down the Izod Center, in the hopes of eliminating a competing venue."

 For those interested in knowing whether these projects make economic sense even in good times, I recommend reading Holycross College economist Victor Matheson's working paper on the subject.

New South Wales (Australia) Parliament Report Supports Prison Privatization

Posted on June 30, 2009, 11:02pm | Leonard Gilroy

Prison privatization is not just a U.S. phenomenon, but rather a management tool used in numerous other countries, including Australia and the U.K. And while the location may vary, the public policy issues surrounding private prisons are very similar. Hence, there is an opportunity for U.S. policymakers to learn from their counterparts overseas, particularly given the growing interest in prison privatization in U.S. states as they grapple with major fiscal issues and work to rein in inflating corrections budgets.

In this context, a recently released New South Wales (Australia) Parliament report on prison privatization couldn't have come at a better time. Prepared by a general purpose Parliamentary committee, the report details the results of the committee's inquiry into the privatization of prisons and prison-related services in NSW, covering such topics as cost savings, public safety and escape rates, rehabilitation programs, staffing levels and the impact of privatization on publicly managed prisons.

The 228-page report (available here) is quite thorough and largely positive on prison privatization, well worth a read for anyone interested in the subject. Here are a few of the inquiry's more relevant findings:

• [W]e are confident that the private management of prisons will also likely produce greater cost savings and efficiencies than if they were to remain in the public system.
• [T]he Committee notes that the evidence received suggests that the privatisation of correctional facilities can assist in achieving the primary objectives of the operation of the prison system, which are: 1. fulfilling the principles of sentencing; 2. improving inmate welfare and; 3. lowering rates of recidivism in a cost effective manner.
• The Committee notes the concerns raised by prison officers and their families. It is clear that for many staff affected by the decision to privatise, none of the three options available to them are satisfactory, and many prison officers will be left with no choice other than to accept a disadvantageous option. Whilst this is not a desirable outcome, the Committee emphasizes that the primary goals of the operation of a prison system are to...(see list above).
• Based on the evidence provided during this Inquiry, the Committee is satisfied that there is no evidence to suggest that assaults on inmates and/or staff are likely to increase as a result of privatisation.
• The Committee notes that inmate allocation is a matter for government, and not a decision of the private contractor [...] [W]e are satisfied that there is no evidence that privatisation of prisons will result in overcrowding.
• The Committee notes that the Department determines inmate classifications, and makes its decisions independently of private operators. Therefore we do not believe that privatisation will impact upon classification levels.
• The Committee notes that government regulation has a primary role to play in ensuring appropriate staff training standards and qualifications exist in both publicly and privately run prisons. On the evidence presented, the Committee is satisfied that concerns raised regarding the level of training and professionalism of prison officers at private institutions in Australia are misconceived. [...] The Committee believes that training and qualification requirements must be applied consistently in all prisons, regardless of whether they are run by DCS or a private provider.
• [T]he majority of the Committee supports the introduction of competition into the public sector due to the innovations and efficiencies it brings. We note the range of innovations outlined in evidence, and the corresponding effect that they have had on the public system through cross-fertilisation.

These findings are generally consistent with Reason Foundation's corrections-related work, which is available here

.

Should Reducing Vehicle Miles Traveled Be a Federal Policy Goal?

Posted on June 30, 2009, 10:17pm | Robert Poole

National Journal's Transportation Experts blog is looking at the federal government's goal of reducing vehicle miles traveled. As I previously wrote, this is a very bad idea:

Vehicle miles traveled reduction targeting, along the lines desired by environmental groups and some members of Congress, is already the law in California, thanks to SB 375, enacted last year.

In the name of greenhouse gas reduction, this law sets greenhouse gas (GHG) reduction targets for each of the state’s 17 metro areas and requires them to draft smart-growth-oriented land use and transportation plans aimed at reducing vehicle miles traveled (VMT). Those that produce the “best” plans to do this will get priority in the allocation of about $20 billion per year in federal and state transportation funding.

The logic chain that underlies such efforts goes something like this: Transportation is a major source of GHGs, and the more people drive, the more GHGs they emit. If their jobs, schools, and shopping are close to where they live, they won’t drive as much. Therefore, government should promote compact, high-density development so as to reduce driving and therefore to reduce GHGs.

When you work through this logic chain with data and numbers, it starts falling apart.

First, all of transportation (including trucking, airlines, barges, etc.) contributes 27.9% of U.S. GHG emissions, according to the EPA. Personal vehicles (cars and light trucks) are 61% of that; hence, personal vehicles are the source of 17% of GHGs, not one-third, as you will often hear.

Second, GHG emissions from vehicles are a function of speed. Stop & go driving (as in congestion) produces much greater GHG emissions than steady-speed driving between 30 and 60 miles per hour (mph); above about 60 mph, GHGs increase fairly rapidly.

Third, there is no hard data showing that people who live in higher densities drive significantly less than those who live in typical suburbia.

Fourth, there is excellent data from the Australian Conservation Foundation showing that among housing types, townhouses have the lowest carbon footprint, single-family suburban houses the second-lowest, and high-rise condo-type dwellings the highest. This logic chain also ignores considerable evidence that traffic congestion increases with urban density—which of course increases GHG emissions.

If the attempts to reduce vehicle miles traveled in these ways succeed, the result will be even greater reductions in mobility than Americans already suffer through from today’s traffic congestion.

Contrary to What Congress Thinks, It's the 'Summer of Handsets'

Posted on June 30, 2009, 3:25pm | Steven Titch

As influential lawmakers such as Sen. Jay Rockefeller (D-WV) and Rep. Ed Markey (D-MA) seek to end to exclusive handset agreements in the name of protecting consumers from an erstwhile AT&T-Apple iPhone monopoly, Wireless Week has proclaimed it the "Summer of Handsets."

To see how out-of-touch Congress is regarding the wireless handset market, click here for a list of smartphones that rolled out in the two weeks between June 6 and June 19. FCC Chairman Julius Genachowski, who was confirmed Friday, promised an inquiry into whether AT&T and Apple are hurting consumers by unfairly crowding out competitors. Looks like he can start and end his investigation here.

California to Ship Inmates to Michigan Prisons?

Posted on June 30, 2009, 2:35pm | Leonard Gilroy

Following up on my post yesterday, California officials are considering sending inmates from its overcrowded and overburdened prison system to Michigan facilities. Per the Sacramento Bee blog:

Recession-wracked Michigan is looking west to its poor sister – California – for a budget boost. Prison officials in California are headed east next month to explore a deal from Gov. Jennifer Granholm to lease prison beds to the Golden State. If it pencils out, Michigan could become the fifth state to take California inmates. Private prisons in Tennessee, Arizona, Mississippi and Oklahoma house about 7,600 California inmates.

Given California's exorbitant prison costs and budget woes, this seems like a sensible proposal to explore. In fact, Florida state policymakers recently gave themselves the same option to utilize out-of-state inmate management.

On the SacBee blog, one commenter offered some advice for California that may be worth taking:

Take the offer CA. Sign up now, and ship the criminals before the Prison Guard Union has their puppets pass a bill to make it illegal.

Indeed. Prison guards are California's largest personnel expense, and their unions lead the charge to prevent private competition for their jobs. They fight tooth-and-nail for taxpayer money in the form of higher salaries and gold-plated pension benefits that are far more lavish than most in the private sector receive. These inflated personnel costs are a major reason taxpayers pay roughly $45,000 a year to house each inmate (the highest among the 50 states).

When looking at the billions in California prison spending it is very easy to see why government prison guards earning $73,000 a year—plus tens of thousands in overtime, plus outstanding health benefits, plus amazing retirement benefits—wouldn't want to face competition from private prisons.

The guards and unions have a great gig going. Unfortunately that gig is appallingly expensive for taxpayers.

» Reason's Prison Privatization Research and Commentary

Performance-Based Maintenance Contracting: Another Tool

Posted on June 30, 2009, 11:28am | Shirley Ybarra

The Transportation Research Board released a report on June 12, 2009 about Performance-Based Maintenance Contracting (PBCM).  The report looks at the practice world wide, explores the potential to reduce costs, improve levels of service in the maintenance arena as well as those factors which appear to be limiting the use of PBCM.

Performance-Based Maintenance Contracting (PBMC) is a contracting method that provides incentives and/or disincentives to the contractor to achieve desired outcomes or results; in its purest form, PBMC does not detail how, when, or where to do the work. [There are many names for PBMC used around the world from Total Maintenance (Texas) to Asset Management (Virginia) to Managing Agent contract (UK)]

Performance-Based Maintenance Contracting (PBMC) was first implemented on a wide scale in British Columbia and since then has become a mainstay of maintenance contracting in Australia, New Zealand, England, and Finland, and to an increasing degree in other countries, including the United States.  As Deputy Secretary of Transportation for the Commonwealth of Virginia, we signed the first fixed-price, long-term contract in the US for performance-based turnkey Interstate highway maintenance.  Other states now include Florida and Texas.  I have written about it here as has my colleague Len Gilroy here.

Typically, maintenance contracts (with specifications)  are for individual contracts for everything from mowing, signs, guardrails, drainage, lighting, snow removal, pavement repair, painting stripes, picking up dead animals etc.   Thus, PBMC represents a departure from standard practice in that it contracts for a wide variety of services all in one contract rather than numerous contracts with specification such as mow the grass 4 times this summer, or paint signs 2 times.  The PBMC contract will typically provide outcomes desired from fence line to fence line.  In a performance based contract, it would say “keep the grass no more that 6 inches high” (and there is no specification that is needs to be mowed if some other method is available); for the signage, PBMC would be based on reflectivity measures, thus not specifying how many times the signs are painted (after all they may not need it). Guardrails:  replace when certain problems occur as opposed to “replace guard rails every other year” (Yes that is done whether needed or not)   And so on and so on.

The report contains a great amount of detail, but a few significant conclusions are in order:

The use of Performance-Based Maintenance Contracting (PBMC) is accelerating worldwide. By 2005, 35 countries had performance-based maintenance contracts. By early 2006, approximately 15 more were exploring this approach to maintenance.

• In the United States and Canada, there are already many examples of PBMC
•  PBMC reflects a long-term trend in changing the focus of upper management and maintenance managers to outcomes, especially those that are customer oriented.
• Evidence suggests that PBMC results in better outcomes at lower cost with less risk and more financial predictability for highway agencies.
•  The evidence on whether PBMC results in improved levels of service is not consistent. (Comment: Difficulties arise on how to measure and compare contract results with in -house staff results) 

A couple of telling conclusions: 

• A number of agencies are skeptical about the claims of cost savings, even though studies provide evidence that these cost savings exist. (Comment:  This is a  problem the “naysayers” raise and is a problem for the advocates to counter attack because the public sector numbers are always understated and never accurately recognize overhead or assets used in the running the "maintenance business”)

• PBMC, despite the success touted by its advocates, is controversial. There is a risk that a large part of the maintenance organization of a transportation agency will be privatized. As a result, a large number of public employees might have to seek employment with contractors if they wish to continue doing similar work. In-house maintenance staff becomes unsettled with the potential loss of worker protection and the possibility of reduced pay or benefits. (Comment:  This is not unusual particularly in unionized states, however typically we have seen better opportunities in the private sector for the employees who end up with higher wages.  This not an easy “sell” to the bureaucracy who feels secure in the state employment.)

Every state is facing a budget crunch on their highway program.  We know that there is no panacea for highway maintenance costs however the PBMC has distincct advantages and should be included in every state’s tool kit of contracting options.

The reasons are obvious but just to recap:

• Fixed long-term price (no change orders, beats inflation)
• Performance-based results
• Cost Savings 
• Reduction/transfer of risks
• Fewer contracts to administer
• Savings in administrative staff and resources
• Program stability

California Schools Could Save $750 Million by Outsourcing Janitorial, Transportation Services

Posted on June 30, 2009, 10:55am | Lisa Snell

My new column takes a look at the California budget deficit and why the state's school districts aren't able to save money by outsourcing non-instructional services:  

If California legislators are really serious about directing more scarce dollars to classrooms, they should help repeal California’s restrictive school outsourcing law.

In 2009, school districts across the nation are utilizing outsourcing to reduce costs. Troy Public Schools in Michigan is privatizing transportation services to save an estimated $2.5 million over the next three years. The Roanoke, Virginia, city school board voted to contract with a Pennsylvania-based bus company to provide transportation services at a cost reduction of approximately $250,000 annually.  In Columbus, Ohio, the school district is contracting out food operations to bring the indebted department back to solvency. In Leominster, Massachusetts, they are in the process of selecting a private company to take over the school lunch program.

Outsourcing non-instructional support services, such as transportation, food or janitorial and maintenance services, is a management tool used by school boards nationwide, because it allows them to sharpen their focus on providing core educational services while simultaneously right-sizing the academic bureaucracy. In Anchorage, Alaska, school board members recently voted to extend an outsourcing contract for custodians that saved the district $1.7 million a year. Board member Colleen Hamblen pointed out that "$1.7 million will buy us a lot of teachers in this budget, in any budget."

A 2008 survey of Michigan's 552 public school districts by the Mackinac Center for Public Policy found that 42 percent of the districts were contracting out food, janitorial and/or busing services. The research also identified one Michigan district that estimates a three-year savings of between $14.7 million to $21.5 million from privatizing all three services. A 2007 survey found that 78 percent of Michigan’s school districts contracting out services reported cost savings from privatization, and nearly 90 percent reported that they were satisfied with their privatization experience.

California could redirect a significant amount of resources to the classroom through outsourcing. According to the U.S. Department of Education, the National Center on Education Statistics, and the California Department of Education, California schools spend about 28 percent of their budgets on non-instructional services such as, operation and maintenance, transportation, and food service. This amounts to more than $15 billion each year spent on non-instructional school-site services.

School districts in other states have realized cost savings between 20 and 40 percent from outsourcing these services. If 25 percent of the more than $15 billion in California’s non-instructional services were outsourced at a savings of 20 percent, California would save approximately $750 million a year.

While privatizing non-instructional school services will not solve the state’s budget crisis, it would empower local school leaders with maximum flexibility to manage their budgets. Unfortunately, a state law cripples the ability of local school officials to target spending cuts to non-instructional services and away from teachers and other instructional programs. The outsourcing law forbids the private firms from paying workers less than district counterparts and prohibits laying off or demoting any school employees as a result of the private contract. Limiting costs and controlling personnel decisions are crucial aspects of most outsourcing efforts so the state law is a huge roadblock to saving money.

Full Column Here
More Education Research and Commentary

Is It Your Right to Own an iPhone?

Posted on June 30, 2009, 10:30am | Steven Titch

My new column takes a look at the Senate calling on the FCC to investigate cell phone exclusivity deals like AT&T's iPhone arrangement. Excerpt:

The FCC will have a tough time proving that exclusive agreements are detrimental to the buying public.

For starters, the iPhone model that debuted 24 months ago at $599 now costs $99. Apple priced its latest, new and improved iPhone 3GS offerings at $199 and $299.  That's pricing from a company well-aware it is competing with others.

The iPhone certainly doesn't have a monopoly on the smartphone market. While it is exclusive to AT&T, it is just one of a number of smartphones that are available to consumers from other service providers. In addition to the new Palm Pre, there’s Research in Motion’s very popular BlackBerry line, and an assortment of highly functional devices from Samsung, LG, HTC, Motorola and Google, whose Android operating system, compatible with any wireless system, makes it something of an anti-iPhone.

Full Column

Reason's Telecom Research

Transit Lease-Back Deals Bite Metro

Posted on June 30, 2009, 10:00am | Samuel Staley

The recent Washington, D.C. Metro disaster that left nine people dead also brought back into the spotlght the role of lease-back agreements used by transit agencies to generate cash years ago. Apparently, the metro cars that collapsed like accordians were part of one of these deals. According to the Wall Street Journal, these deals discouraged Wasington Metro from retiring the rail cars and replace them with safer, upgraded models.

In essence, transit agencies sold their capital stock--metro rail cars, buses, etc.--to an investor (often a bank) who would then lease the cars back to the transit agency. The sale generated cash for the transit agency which it could use for maintence, capital improvements or, in many cases, operating costs during lean years. Investors benefited by being able to write off the depreciation on the capital asset (becoming a tax shelter). These deals were outlawed in 2004 because they effectively robbed Peter to pay Paul; they were short-sighted ways to raise cash for operating costs and often left transit agencies with few capital assets.

Metro was advised to phase out the metro cars several years ago because they were less safe than more modern cars. Metro didn't because the financial penalties for backing out of the deal were significant. Unfortunately, in a sign of the current times, Congress is now considering legislation that would effectively wipe the economic benefits of these contracts to the private investors.

"If the agency had wanted to break the leases, said Chief Financial Officer Carol Kissal, it would likely have had to pay penalties and fees on top of the cost of buying newer rail cars.

"Such shelters, known as "sale in lease out" or "lease in lease out" deals, were outlawed in 2004. But some deals made before that date remain in effect.

"Sen. Robert Menendez (D., N.J.) introduced legislation on Thursday that would apply a 100% excise tax on "windfall proceeds" banks reap from the transactions, giving them incentives to unwind the deals.

"And Sen. Charles Grassley (R., Iowa) said in a letter to House Majority Leader Steny Hoyer that any new funding for the Washington transit agency shouldn't go to tax-shelter counterparties. Mr. Hoyer is supporting legislation that would provide $1.5 billion in federal funding to the Metro system over 10 years."

While the frustraton with the way transit agencies have mismanaged their finances is understandable, the solution is not simply to abrogate contracts after the fact. These were contracts voluntarily entered into. They were (and are) legal. Simply nullifying the contract because they had unanticipated consequences, not matter how tragic, is bad public policy and could significantly undermine the ability of transit agencies to borrow from the private investor market in the future.

The lease-backs, it turns out, were bad deals. But trust and respect for contract is crucial to the functioning of any business enterprise, public or private. A knee-jerk, legislative backlash will only hamper their ability to function effectively in the future.  

Firework Sales Are... Booming

Posted on June 30, 2009, 8:09am | Anthony Randazzo

Yes, I said it. The Real Time Economics blog didn't want to go there, but I will (which is probably reflective of the reason I don't write for The Wall Street Journal). In any case, there are hints at a rise (a boom) in firework sales this year. In South Dakota, it appears that patriotism is still highly valued and not something Americans want to cut back on:

As the national economy slows, local fireworks sales are sparkling despite rising product costs, business owners say. "Our average sales have actually increased," said Kevin Lorenzen, the president of Pyro City Fireworks near Tea on Interstate 29. "It is up about 6 to 7 percent." Other Sioux Falls fireworks distributors witnessed similar increases. The rises reflect sales to residents of other states. State law restricts South Dakota citizens from purchasing fireworks until Saturday, a week before the July 4th holiday.

(There is certainly a blog post in there on the ridiculousness of allowing citizens from outside the state to come in an purchase something instate residents can not, but that will be for a later time.)

The owner of Lantis Fireworks, based in North Sioux City, said he thought the economic downturn would hurt sales. Don Lantis said current sales estimates prove otherwise. "I'd say they're up at least 10 percent," said Lantis, whose company operates a retail outlet between Sioux Falls and Brandon on Interstate 90. Dan Raderschadt, the president and owner of Lew's Fireworks in Watertown, said his company has observed a 5 percent to 10 percent growth in sales compared to this time in 2008.

So the question is, why are fireworks valued enough to be recession proof? Meanwhile, local governments are scaling back celebrations as the revenues to provide the public good are thin this year. More on the story from the Real Time Economics blog.

(There is also a post in there questioning the common wisdom of fireworks being a public good, since it seems people are still getting them. Perhaps the value in a firework is not the colorful explosion, but the act of setting up the artillery and celebrating with others as they are launched into the sky. But again, for a later time.)

Dan Walters on California Prison Privatization

Posted on June 29, 2009, 11:28pm | Leonard Gilroy

Columnist Dan Walters dismantles California's prison system in yesterday's Sacramento Bee piece, "Maybe it's time for prisons to go private." Here's an excerpt (emphasis mine):

California's cost of guarding, feeding, clothing, medicating and supposedly educating its nearly 170,000 prison inmates and supervising 110,000 parolees is about $10 billion a year. And it's very easily the fastest growing segment of the deficit-ridden state budget over the past decade.

It is, by a very wide margin, the costliest prison system among the largest states, with a per-inmate cost that prison officials tag at around $45,000 a year, roughly what it costs to send a youngster to one of the more prestigious private universities. [...]

It's a case study in political dysfunction, with penal policies being made in a highly charged atmosphere, with the union representing prison guards wielding way too much influence over those policies, as well as their own compensation, and with politicians' pandering to the union and public emotion rather than doing their jobs.

Gov. Arnold Schwarzenegger has not been immune to that syndrome, exploiting the public's fear of crime during campaigns, but he has stood up to the guards' union, the California Correctional Peace Officers Association, in sharp contrast to his predecessors, and with the state facing a fiscal meltdown has been willing to move toward reform.

Schwarzenegger says it's time for California government to adjust to a semipermanent shrinkage of resources, and get rid of wasteful, counterproductive spending. He's correct, and the first place to introduce rationality to a system gone mad would be in our overly expensive, underperforming prison system.

Interestingly, in a recent radio interview, Schwarzenegger suggested that privatization of prisons could save billions of dollars to offset other looming cuts in health and welfare services. If it's time to get serious about cutting our prison costs, private management could scarcely be worse than what we have now.

» Reason's Prison Privatization Research and Commentary

Socialist Hungary Cuts Spending, Plans to Cut Taxes

Posted on June 29, 2009, 4:08pm | Anthony Randazzo

Here is a story a bit out of the twilight zone. Hungary is taking bold actions to combat its recession. Today, the parliament passed a tax law that will cut personal income tax rates to 17 percent rate and reduce the "social contributions" paid by employers to the government "to encourage employers to save and create jobs."

Yes, the socialist Hungarian government realizes that letting business have more of their own money from production will allow them to hire more people. That is a jobs program. At least relative to eastern Europe.

Of course, cutting taxes is only beneficial when accompanied by spending cuts. The run-of-the-mill Marx loving, Lenin worshiping, French emulating socialist government generally doesn't cut spending. By very nature of what a socialist government believes, it should be trying to maximise distributing government revenues through social programs. That's why this, reported by Reuters, is such a stunner:

[Prime Minister Gordon] Bajnai's government, which took office in April, has cut spending and kept the budget deficit in check. This has helped the forint [currency] to firm from all-time lows hit versus the euro in March, and helped rebuild some investor trust in Hungary.

This story reminds me of South Korea's tax cuts back in January, which I blogged here.

Dimon Almost Pandering to America

Posted on June 29, 2009, 10:28am | Anthony Randazzo

JP Morgan Chase CEO Jamie Dimon has an op-ed in The Wall Street Journal that does an impressive tightrope walk of spin and pandering. The language of the article is apologetic, though sometimes unnecessarily so. He writes:

Above all, no matter what the regulatory framework is, it means recognizing that our accountability is not only to our shareholders, customers and employees, but also to the broader public. The gulf that grew between Wall Street and Main Street has hurt everyone. Americans must see that the work we are doing is not just about earning a profit, but also about creating value that helps consumers, small businesses, government agencies, nonprofits and the whole economy.

I disagree that Wall Street must be held accountable to Main Street, that kind of thinking skews investment decision making processes as much as government regulations, but I do agree that Americans should realize that the profit Wall Street earns is a good thing, a sign that the nation is moving forward, growing, prospering. Profit isn't bad. And a rising tide lifts all ships.

On the spin side, as Noam Scheiber also points out, he somehow manages to support tougher regulations for financial products that drive his competitors, while favoring a lighter touch for his bread and butter. On derivatives, a $5 billion cash cow for JPMC in 2008, Dimon writes:

We applaud the administration's plans to expand the use of the central clearing house for standardized "over-the-counter" derivatives traded between significant financial institutions. However, let's not forget that businesses large and small still need customized derivative products to hedge risk. These products are not easily traded on an exchange, and there are serious economic, competitive and systemic consequences for doing so.

I do agree with Dimon on this point. An open exchange for derivatives would allow for anyone in the market to see what the value of certain insurance contracts was at any given moment. Significantly, it would also standardize the types of contracts (as part of the private sector changes plan to do). While the transparency is helpful for bringing more knowledge into the market, the limitations of standardization destroy much of the value derivatives offer in the first place, decreasing the number of investors. Allowing a financier to craft a unique contract based on the needs of the consumer is an important part of the success of these types of financial products.

In the late 1990s, Jersey City created a unique security from pools of collateralized residential tax liens. Investors, buying up millions of this special derivative wound up keeping the city from going into bankruptcy (because the city was struggling under the weight of unpaid liens). Under current proposals for standardizing the trade of derivatives, this type of contract would not have been allowed.

The flexibility of financial products, matching financier with consumer, is a key part of the wealth creation process. If derivative regulation moves forward, lawmakers should consider how to best structure standardized derivatives on an exchange while allowing for product innovation, maximizing the creation of wealth. As the private sector changes to processing OTC derivatives suggest, it is possible to standardize some of these financial products while leaving others open to meeting consumer demand with provider services and vehicle structure.

Consider the Dimon op-ed another salvo fired into treaturous territory of regulation overhaul. A battle that is being overshadowed by health care and environment debates, but is just as hot and complicated.

Will the Climate Change Bill Cost Just a Postage Stamp?

Posted on June 29, 2009, 10:12am | Shikha Dalmia

The advocates of the climate change monstrosity that just passed the House - and is now headed to the Senate -- allege that the bill won't break the bank of Americans.  To back their claims they point to a Congressional Budget Office study that estimated that in 2020 the bill's cost works out to about $175 a year for an average household. This translates into an extra postage stamp every day, the bill's author, Edward Markey (D-Mass), has been crowing. (My colleague, Anthony Randazoo, blogged the state-by-state breakdown of this estimate here.)

The CBO is a non-partisan entity that is held in high regard so its analysis has to be taken seriously. But Markey's sound-bite - that is being repeated ad nauseam by global warming alarmists - ignores this VERY important caveat: The $175 figure is based on the year 2020 - a year that the CBO itself acknowledges is not representative of the true costs of the program. Why? Because that year the government will still be handing a bulk of the carbon credits for free to power plants, utilities and other big emitters. Energy consumers won't feel the true pinch till about 2035 when these free allowances are phased out and the program starts forcing utilities etc. to buy about 70% of their credits. That's 16 years from now when President Obama (and Congressional backers of the bill) will be safely out of office, making millions of dollars giving speeches, and, in his spare time, basking in the sun room of his taxpayer-subsidized solar powered home.

Be that as it may, here is what CBO really says on page 3 of its report:

"This analysis focuses on the effect of the legislation in the year 2020, a point at which the cap would have been in effect for eight years (giving the economy time to adjust) and at which point the allocation of allowances would be representative of the situation prior to the phase-down of free allowances. The incidence of gains and losses would be considerably different once the free allocation of allowances has mostly ended. (Emphasis added)."

The true impact of the bill is a subject of fierce debate with: the Heritage Foundation estimating that it will cost a household about $4,300 annually; an MIT study putting this number at $3,100; and a previous CBO study of a similar bill at $1,600.

My own hunch?

The actual costs are likely unknowable because it is impossible to quantify opportunity costs of what could have! should have! would have! been had the resources being expended to appease the climate avatars been deployed in more productive segments of the economy.

The only thing certain is that they will be much higher than what meets the naked eye.

Oil Financial Transactions Tax Proposed to Fund Transportation

Posted on June 29, 2009, 9:46am | Samuel Staley

Oregon Congressman Peter DeFazio has introduced legislation to impose a financial transactions tax on oil futures trades as a way to raise money for U.S. transportation projects. DeFazio claims the tax is a "win-win" because it will reduce the price of oil, fill a large transportation funding gap, and "not cost consumers one cent." Has DeFazio found a tax that really improves the economy? Hardly, despite the rhetoric. In fact, this tax would likely reinforce the inefficiencies embedded in our current transportation funding process.

According to a press release from Congressman DeFazio's office:

"The proposed transaction tax on crude oil is 0.02% on futures contracts (a contract to buy crude oil at a previously set price on a future date) and 0.5% on the option for a futures contract (the premium paid to have the option to buy a futures contract).  Taxing these derivatives of crude oil will reduce the price and volatility of the market.  It is the only revenue source that lowers the price of oil while raising revenue for the Highway Trust Fund.  The tax is simple; it imposes a small burden that penalizes short-term traders for speculating on the price of oil. The CFTC distinguishes between end users and legitimate hedgers, like airlines and railroads, and short-term speculators.  This proposal would rebate all transaction taxes paid by legitimate hedgers. Since the tax is on speculation only, it deters speculation and undermines much of the crude oil price bubble."

Leaving aside the issue of whether this tax would actually raise enough money, the concept relies on an old Keynesian idea that says, in essence, speculation has no economic value. Indeed, in a 1989 academic article, current White House economist Lawrence Summers said as much. Short-term futures trading is little more than gambling, he wrote, and added needless volatility to financial markets. Taxing short-term futures trades would effectively chase away speculators, leaving the stock market to the big boys who were (in theory) more in tune with making stock market decisions based on long-term value.

Of couse, speculation has economic value and is used to hedge the risk that prices might go up (or down) in unexpected ways. What DeFaxio (and other born again Keynesians) don't like