Reason Foundation

Private Sector's Increasing Role in Infrastructure Investment

Posted on May 17, 2012, 9:16pm | Harris Kenny

Today my colleague Leonard Gilroy and I published a piece on Real Clear Markets entitled, "States and Cities Going Private With Infrastructure Investment," which explains "...that new infrastructure financing models and sources of capital will be the only viable option to support and sustain growth." The challenge is simple: while governments at all levels are strapped for cash and continue to feel the effects of the Great Recession, they face pressing infrastructure needs.

Enter the private sector, where investors are demonstrating a willingness and capability to partner with governments to modernize and expand infrastructure, according to Reason Foundation's recent Annual Privatization Report 2011. The report finds that the amount of capital available in private infrastructure equity investment funds reached a new all-time high last year. And since 2006, the 30 largest global infrastructure investment funds have raised a total of $183.1 billion dedicated to financing infrastructure projects; the bulk coming from U.S., Australian and Canadian inventors. In fact, eight major privately financed transportation projects were under construction in the U.S. in 2011 totaling over $13 billion.

Historically, U.S. policymaker interest in public-private partnerships has been in surface transportation, however 2012 ushered in a wave of new social infrastructure considerations (along the lines of what is already seen across in the developed world.)

For a preview of the future, just look to Puerto Rico, where innovative infrastructure financing has been a priority of Governor Luis Fortuño's administration. Prior to his tenure, massive budget deficits and weak credit ratings left the territory with a limited ability to finance infrastructure. In fact, public infrastructure investment (as a share of GDP) had been on a steep decline in Puerto Rico since 2000.

Put simply, if Puerto Rico was going to maintain-much less expand and modernize-its infrastructure, it was going to need outside help. Policymakers proactively adopted a 2009 law authorizing government agencies to partner with private firms for the design, construction, financing, maintenance and/or operation of public facilities across a wide spectrum that includes transportation, ports, schools and other asset classes. The law also established a Public Private Partnership Authority (PPPA), a new unit of the Government Development Bank, to conduct due diligence on these infrastructure partnerships and take worthy projects to market in competitive procurements.

The piece goes on to highlight promising new efforts in Chicago, Texas, Connecticut and elsewhere, continuing:

Puerto Rico isn't alone though. For example, Chicago Mayor and former Obama chief of staff Rahm Emanuel stood with former President Bill Clinton last month to propose an ambitious $7.2 billion infrastructure program that will rely heavily on public-private partnerships and private financing for a broad spectrum of projects including roads, water, transit and more. To implement this program, city policymakers recently created a new Chicago Infrastructure Trust, a nonprofit infrastructure bank that can package deals and blend public and private financing to advance projects. Early pledges of up to $1 billion in private capital from several financial institutions, including Citibank, Macquarie and JPMorgan suggest the model may be viable.

Elsewhere, both Texas and Connecticut enacted broad-ranging laws to authorize private sector financing for state and local assets in 2011. In New York, The Yonkers Public Schools recently hired a team of financial, legal and technical consultants to evaluate the potential to tap private financing to help deliver a $2 billion K-12 school modernization program. Like Puerto Rico, Yonkers has a number of aging facilities over 70 years old that need reconstruction, yet lacks the ability to undertake large-scale renovation through traditional taxes and bonds given current fiscal and financial constraints.

We ultimately conclude that, "Infrastructure represents the arteries and capillaries of our economy, and if we let those deteriorate, the heart itself will soon follow." Read the full piece available online here. For more on this policy area, read my colleague Leonard Gilroy's previous post on Puerto Rico here.

Fannie Mae Breaks Its 14 Quarter Bailout Streak

Posted on May 11, 2012, 12:02pm | Anthony Randazzo

Fannie Mae performed a magic trick this past quarter: they made a net profit including their dividend payment to Treasury for the first time since the fall of 2008 when they were taken into conservatorship. This week, Fannie Mae's 1Q 2012 earnings statement was actually an earnings statement. They posted a $2.7 billion profit, and were able to make a $2.8 billion payment to Treasury, covering the balance of the payment with a few hundred million built up in positive net worth, according to The Wall Street Journal. 

Last year, Fannie Mae lost a net of $16.4 billion. With the $0 loss figure through the first quarter of 2012, that means the updated complete taxpayer bailout total (3Q2008 to 1Q2012) for Fannie Mae remains:

$116.2 billion

So while a few kudos are in order for not having to go hat in hand to taxpayers for a 14th straight quarter, Fannie Mae is far from being out of the woods. Of that $116.2 billion bailout given to Fannie Mae, $22.6 billion has been paid back, leaving a remaining balance of $93.6 billion.  

There were a few different reasons that Fannie was able to turn a profit. The WSJ reports:

Part of the profit is due to gains that resulted from an upswing in interest rates earlier in the year, according to Jim Vogel of FTN Financial. He pegs the contribution to profit at around $1 billion. With rates having retreated recently, this could reverse in the current quarter.

Another factor was an improvement in credit quality leading Fannie to set aside less money to cover souring mortgages. That the company needed $2 billion in provisions for credit losses, compared with $10.5 billion a year earlier, is positive. It shows Fannie's losses are growing at a slower rate, while profit from more recent, better-quality loans should bolster results going forward.

Fannie also said the serious delinquency rate for single-family mortgages declined to 3.67% in the first quarter from 5.47% a year earlier. A slower rate of home-price declines has helped on this front. 

The challenge for the future is that the Fed is promising continued low interest rates for the coming years, and there are million of homes that will be foreclosed on in the coming years as well. Losses will likely slow, but continue to mount in coming quarters. 

Freddie Mac also had a relatively good quarter, asking for "just" $19 million to cover losses from the first three months of the year. The combined total taxpayer bailout from 3Q2008 to 1Q2012 for Fannie and Freddie is now:

$71.365 billion (Freddie) + $116.2 billion (Fannie) = $187.565 billion

Here is an updated list of Fannie Mae's quarter bailout needs:

• 1Q 2012 — $0B
• 4Q 2011 — $4.6B
• 3Q 2011 — $7.8B
• 2Q 2011 — $5.1B
• 1Q 2011 — $8.5B
• 4Q 2010 — $2.6B
• 3Q 2010 — $2.5B
• 2Q 2010 — $1.5B
• 1Q 2010 — $8.4B
• 4Q 2009 — $15.3B
• 3Q 2009 — $15B
• 2Q 2009 — $10.7B
• 1Q 2009 — $19B
• 4Q 2008 — $15.2B
• 3Q 2008 — $0B

See last quarter's post on Fannie Mae's losses here.

See full coverage of Fannie Mae and Freddie Mac here. 

A Long Slog Ahead on Unemployment

Posted on May 10, 2012, 4:10pm | Anthony Randazzo

There have been a lot of stories lately about the challenges of college graduates finding a job. They aren't without merit. Here is a snapshot of the problem from The Wall Street Journal:

Graduating college students face a mixed job market at best this year, and most will leave school without an offer in hand, despite an uptick in hiring by on-campus recruiters... In a study to be released Thursday, the John J. Heldrich Center for Workforce Development at Rutgers University found that recent graduates are taking awhile to find work. Only 49% of graduates from the classes of 2009 to 2011 had found a full-time job within a year of finishing school, compared with 73% for students who graduated in the three years prior.

Daunting numbers. Here is how BLS April 2012 unemployment numbers look— 

• 20 to 24 year-olds: 13.2 percent 
• Men 20 to 24 years-old: 14.1 percent
• Women 20 to 24 years-old: 12.3 percent
• New entrants to labor force: 11 percent
• Overall unemployment: 8.1 percent

The links to those numbers will update each month so if you're reading this in June 2012 or later follow the link to see what the status is.

As bad as these numbers are, the unemployment problem is really worse than this. To start, the labor force participation numbers are artificially reducing the headline unemployment number, so there is more than 8.1 percent of the work force that is unemployed. Beyond that, there are several long-term demographic trends that are weighing on the labor force today. In a column over at Reason.com this afternoon I outline these trends and frame up a pretty negative outlook for the employment market.

(Video) Interview on Reason's New Mortgage Reform Study

Posted on May 10, 2012, 2:12pm | Anthony Randazzo

Earlier this week I appeared on Fox Business to discuss our recent Reason Foundation study "Restoring Trust in Mortgage Backed-Securities." We argue that to end the government housing monopoly and reduce the $5.8 trillion in mortgage debt liability taxpayers have as a result, that Congress should authorize MBS investors to have access to more information about the mortgages they are buying, and that the mortgage industry should create a group to create clear mortgage definitions that do not rely on federal regulations like the qualified residential mortgage.

Read the full study here

See our press release here.

Also, read our summary op-eds at RealClearMarkets and the DailyCaller.

Bair on U.S. Bond Bubble Possibility

Posted on May 9, 2012, 9:09am | Victor Nava

The United States government, the Fed and financial markets don't have a great track record when it comes to spotting bubbles. The financial markets missed the dot com bubble in the late 90's and, more recently, the Fed didn't pay close enough attention to the housing bubble, which peaked back in 2006. Is it possible that we could be in the midst of yet another bubble?

There are potentially multiple bubbles starting to inflate, but In a column published last week in Fortune, former FDIC chairwoman, Sheila Bair (whom we've highlighted opinions from in the past), focuses  on one potential bubble in which we may be in the middle of. She argues that the U.S. is currently experiencing a bond bubble that is being fueled by the Federal Reserve. Bair argues:

"The Fed has maintained interest rates at or near zero for four years running, even though the financial system has been relatively stable since 2009. The Fed's actions have kept Treasury bond prices high (while keeping the government's interest costs low), but the fundamentals do not support the high valuations, given the fiscal mess we are in."          

Her argument is dead on. The Fed has maintained a zero interest rate policy since late 2008 and actively pursued policies designed to further lower interest rates on bonds (ex. Operation Twist, though it didn't quite work). What has been the result? When you look at countries in terms of their debt-to-GDP ratios, the United States (estimated at 104.8%) is among the likes of Ireland (104.9%), Portugal (110%), and Italy (120%).  But unlike our undistinguished company, we have fairly low bond yields on  10-year treasury bonds compared with the yields on comparable 10 year (9 year for Ireland) government issued bonds from the previously mentioned countries  (1.88% compared to 6.82%, 11.06%, and 5.44% respectively). This translates to higher prices on U.S. bonds (hence the inflating bubble analogy) than we should theoretically have.

Bair acknowledges that defenders of the Fed's policies will point to Japan as an example of a country, which has run up huge debts without experiencing a bond bubble burst. And in some respects we are similar to Japan, which has an astronomically high debt to GDP ratio (at 233.1%), yet only a 0.92% yield on its 10-year bonds. But Bair points out some key differences.

"Japan enjoys a trade surplus, and its debt is held domestically. In contrast we run persistent trade deficits, and foreigners hold over half our public debt. To the extent foreigners keep buying Treasuries, it is because Europe's problems are worse. In short, we are the best-looking horse in the glue factory. "

You know the country is in bad shape and there is some economic danger when defenders of the Fed's policies have to justify themselves by pointing to Japan, a country which has been economically stagnate for decades, as an economic role model. Beware the bubble bond. 

Freddie Mac Takes $19 Million More from Taxpayers

Posted on May 8, 2012, 7:01pm | Anthony Randazzo

Freddie Mac reported last Thursday it needs $19 million from the U.S. taxpayers to remain solvent after making a dividend payment to the Treasury department following first quarter 2012 financial reporting. The government-sponsored enterprise made a net profit in the first quarter, but that was before factoring in the dividend payment they have to make to Treasury for the luxury of being bailed out of losses from previous quarters. Freddie asked for a total of $19 million from Treasury for for the first quarter of 2012. 

In total, Freddie Mac has received $71.365 billion in bailout money from the U.S. Treasury since FHFA took the GSE into conservatorship in late August 2008. Here is the most recent breakdown of taxpayer quarterly checks for Freddie Mac:

• 1Q 2012 — $0.019 billion
• 4Q 2011 — $0.146 billion
• 3Q 2011 — $6 billion
• 2Q 2011 — $1.5 billion
• 1Q 2011 — $0
• 4Q 2010 — $0.5 billion
• 3Q 2010 — $0.1 billion
• 2Q 2010 — $1.8 billion
• 1Q 2010 — $10.6 billion
• 4Q 2009 — $0
• 3Q 2009 — $0
• 2Q 2009 — $0
• 1Q 2009 — $6.1 billion
• 4Q 2008 — $30.8 billion
• 3Q 2008 — $13.8 billion

Last quarter Freddie asked for $146 million, so at least their asks have been declining since the third quarter of 2011. (See full details here.)

See our full coverage on Fannie Mae and Freddie Mac here.

Video: French and Greek Elections Were Not Proof Austerity Doesn't Work

Posted on May 8, 2012, 10:18am | Anthony Randazzo

Over the weekend France elected a new president, the Greeks shuffled their parliamentary make up, and Germany's leading party lost some local elections. The votes are viewed as a push back against the way European governments have handled the continent's sovereign debt crisis. Some analysts have been quick to argue that this proves austerity doesn't work. 

And that is the basis of the debate in the video below, a panel discussion from RT last night. However, I argue that this doesn't prove much of anything about austerity in general. Citizenry are not to be blamed for being upset with austerity measures. The whole point is that it doesn't feel good to get your fiscal house in order after a spending binge. The democratic reaction doesn't suggest the viability of the plan's capacity to achieve its goal of reducing government debt. 

While the elections don't say anything about the viability of the idea of austerity, at least the Greek election suggests that the form that austerity has taken in Greece is not the best approach. The big winners in the parliamentary elections were groups that despise outsiders and want to take back control of their country. Their win was the Greek people (at least the very low 65 percent of them that turned out to vote) saying it is unfair for Greece to take sharp budget cuts while still being saddled by the Euro so that the rest of Europe can avoid GDP losses that would occur if Greece left the European monetary union today. Eventually they will have to leave, but for now Europe gets to wall off that threat and plan for an orderly break.

In France, the election could also be seen as a nationalistic movement. All indications are that the vote was more anti-Sarkozy then pro-Hollande. There is a bit of populism that likes his tax the rich mentality. But Hollande seem to win over France with his Mr. Normal pitch vs. Sarkozy's flashy style that has worn out its welcome in France. Moreover, there could be some frustration in France that Sarkozy allowed Germany so much run of the house on the debt crisis negotiations. Germany will now have to deal with a more nationalistic government when sorting out coordinated actions to bail each other out.

(Side note on Greece: it is unlikely they will be able to form a government that lasts. The two parties receiving the most votes only form about 30 percent of the parliament, making it necessary for a big tent coalition to work out in order to avoid a new election. And even if that happens, such a coalition will be very susceptible to the need to make big decisions on budget cuts and handling negotiations with the rest of Europe. Further complicating the matter is the scatter shot approach that the Greek populace took in their choice of representatives this year. Not only did a far-right, neo-nazi group get 20 seats, but a far-left, old line communist group also got more votes then they'd seen in a long time. History does not need to be consulted that far back to suggest that the combination these two failed ideologies mixing as one is not likely to be the chemistry needed to get Greece on solid footing.) 

New Study: Restoring Trust in Mortgage-Backed Securities

Posted on May 3, 2012, 11:29am

In a new study, released today, former Moody's Analytics senior director Marc Joffe and Reason Foundation director of economic research Anthony Randazzo find that the profound lack of confidence in the models used by credit rating agencies to assess residential mortgage-backed securities (RMBS) and in the rating agencies themselves is a substantial roadblock to housing recovery in America.

The new study shows that the mortgage finance market has leaned heavily on government support over the past few years. More than 90 percent of mortgages originated in 2011 were securitized by government entities using taxpayer funds to guarantee investors against default risk. The result is that U.S. taxpayers are liable for more than $5.8 trillion in mortgage credit risk. 

The fact that there are still millions of homes in the foreclosure pipeline and significant household debt in the system suggests that a housing recovery is not close in the near-term. However, a conversation needs to begin now about how the private sector will regain marketshare when recovery does start to take hold. Joffe and Randazzo's paper contributes to that discussion by identifying four leading roadblocks to reform and providing several solutions to overcoming these hurdles. 

Randazzo says, "The only way we will see a robust housing market in the future is with the private sector taking the lead. But that can't happen with price competition that exists in the system now or with the legal complexities surrounding mortgage-backed securities. Once those challenges are met, the question becomes how to encourage private sector investment in housing through more transparency and better risk analysis tools then are provided now by the credit rating agencies."

The Reason Foundation study and its proposed solutions are available at http://reason.org/news/show/trust-in-mortgage-backed-securities. A one-page summary is available as well as the full study.

Please contact Chris Mitchell (chris.mitchell@reason.org) or Lainie Frost (lainie.frost@reason.org) for any media inquires. 

A Few Quick Thoughts On Mortgage Rates

Posted on April 30, 2012, 8:48am | Anthony Randazzo

The primary source of the pressure for banks and the GSE to refinance mortgages is so that those with rates around 7 percent and 8 percent can reduce their payments with the historic rates of around 4 percent that the Federal Reserve has helped artificially engineer. 

• Some banks don't want to refinance mortgages because the loans are underwater.
• Other banks are just backed up on the paperwork.
• Still others are just bad at the job they are supposed to perform.

Whatever the case, there at least two things worth considering: even a 7 percent mortgage is a good thing in relative terms, and even without a massive, national refinance program, mortgage rates on outstanding debt have been falling.

Consider the below chart developed from recently released BEA data:

The average effective rate of interest on mortgage debt never fell below 8 percent from 1977 to 1996 (that is the farthest back the data goes). After the housing finance policy changes of the 1990s began to take effect in 1995 and 1996, we see the effective mortgage rate drop below that threshold. For the first quarter of 2012 the effective rate on all outstanding mortgage debt was 5.115 percent, and it has fallen every quarter for the last 24 quarters, or since the 2Q2006. 

There does not seem to be an immediate need for a massive refi program to push past the legal boundaries of mortgage law. Banks should become better at customer service, process decision faster, but still be allowed to make prudent calls on what would be the most profitable for their shareholders—many of whom are taxpaying Americans.

Considering Causes of Recessions vs. Rates of Recessions

Posted on April 27, 2012, 3:14pm | Anthony Randazzo

High school economics wunderkind Evan Soltas put an interesting chart (see below) on his blog yesterday that The Atlantic's Matt O'Brien pointed out to me, asking for a libertarian response. I lightly and respectfully undertake an attempt below.

Evan writes that he pulled the chart together from FRED and NERB data showing that recessions have slowed down considerably since the 1850s. This is not incredibly new information—it is widely understood that since the 1930s that volatility is much more subdued than in the 19th century—though I had not seen the information presented like this before, to Evan's credit. 

(The chart was an embedded interactive file so I had to take a screengrab to show it here, but check out the original on Evan's blog here.)

By itself this chart doesn't tell you much until you start putting pieces of information on it to extrapolate as to the cause. For instance, Evan argues: 

In libertarian circles, the late 19th-century is seen as the pinnacle of growth and of laissez-faire and treated with according reverence. That story is not really true. Statistics which show unprecedented growth during the Gilded Age, I worry, are either imprecise, inaccurate, or worse, gamed according to their start- and end-points... It would be very possible that [GDP] grew quickly in between the frequent recessions, but the data do not support such a case: from 1800 to 1840, real GDP per capita grew at 0.4 percent annually; from 1840 to 1880, 1.44; from 1880 to 1920, 1.78; from 1920 to 1960, 1.68; from 1960 to 1978, 2.47.

I don't want to put words in Evan's mouth, but it appears the underlying assumption is that it was the creation of the Federal Reserve, victory of new Keynesian economic policy, Glass-Steagall, deposit insurance, and a less laissez-faire system that enabled the faster growth in the 20th century. Furthermore, I take an assumption that our present state of fewer recessions and GDP average growth of 2 percent over a multi-decade period is preferable. (I'm happy to be corrected if I am in error on these judgments.)

While I have not dug into this specific data myself for any extended period of time (and it appears there was a detailed attempt here anyway), there are a few things to consider in performing such economic analysis. To start, recessions are not ubiquitous events. They are not created equal. Their causes matter more than their numbers. For example, we might prefer five recessions that are six-to-eight months long scattered between 2002 and 2012, all caused by over investment in tech firms like we saw in the wake of the dot-com bubble's burst, to the boom from 2002 to 2007, followed by the 19 month recession, and then three-plus years of tepid economic growth. 

In the former scenario we are less likely to see recessions substantially impact household debt or long-term consumption trends. Spending would tighten up for a few months, balance sheets would be cleansed a bit, but the level of toxicity would not be so dramatic as to cause the losses we've experienced in the wake of our most recent bubble's bursting.

In the later scenario we have only 19 months of recession to deal with as opposed to as many as 40 months of recession to wrestle with. And we achieve much higher living standards for at least half of the time period. However, there is no inherent, objective measure that suggests this is better than the alternative scenario that I set up.

Nor is my alternative objectively better either. If the causes of those frequent recessions were bank runs that caused liquidity tightening and wide-spread bankruptcies as businesses failed to get access to credit to finance their payrolls, then we might not see quick bounce backs and the effects of those regular recessions could bleed into each other creating the environment Evan's data suggests for the middle part of the 19th century (which did include a devastating Civil War, by the way). 

All of this merely points out that the frequency of recessions is a relatively unimportant data point. It is the sources of such recessions. 

So to the second assumption, on the causes of the decreased volatility. This is a complex question. I pointed out the declining savings rate of the 1980s, 1990s, and 2000s earlier today on this blog and how this contributed to the economic boom years following the end of Stagflation and the Reagan recession. Perhaps if there were no technical advances to give us credit cards or if we were a less trusting society we would have had slower economic growth. Would this change have then discredited Reaganomics or influenced the way we view tax rate impact on GDP growth? Probably. 

The point here is to merely suggest that GDP growth rates as higher in the 20th century on average relative to the 19th century don't suggest much about the realities of the Gilded Age. What would the 20th century have been without the technical evolutions that gave us cars, planes, global telecommunication, and computing power? Back in 2008, this country would have given up a lot to get a 1.5 percent GDP growth rate. 

Evan concludes that his chart and argument shows "a very different picture of America, when you think about it. Frequent recessions, slow growth, little improvement in living standards, profound inequality -- all of this against what we have (had?) in the postwar era: fewer recessions, faster growth, faster improvement of living standards, less inequality."

On its face this is an efficiency argument for the central bank era vs. a supposed lassiez-faire era. The problem is that this assumes the desirability of a recession rate, speed of economic growth, and level of equality all divorced from their causes. That's not a leap of logic we should lightly undertake. 

GDP Falling Back to 2.2% is Not Surprising

Posted on April 27, 2012, 9:25am | Anthony Randazzo

The BEA released first quarter of 2012 GDP data this morning, with the headline figure coming in at 2.2 percent growth. This was to be expected.

GDP growth for the last quarter of 2011 was primarily built on businesses spending money to add products to their inventories. It was further manipulated by a low adjustment for inflation. Even with BEA today reaffirming its 3.0 percent growth rate for 4Q2011, there is still a measure of cognitive dissonance and gaming of the figure to look stronger than growth on Main Street really was. 

Now we get a 2.2 percent for 1Q2012 figure. 

One positive is that personal consumption accounted for 2.04 of the 2.2 growth, compared to 1.47 of 3.0 at the end of 2011. In contrast inventory building was just 0.59 percentage points of the 2.2 percent growth figure, relative to 1.81 percentage points added to 4Q2012.

The major negative shift in bringing down GDP growth, however, was a combination of reduced inventory building and decline in non-residential fixed investments, like buildings, equipment, and software.

So at the end of 2011 businesses were spending a lot, likely to take advantage of depreciation rules that allowed many fixed investments to be written off of taxes at 100 percent, and consumers were a bit tepid in the holiday season. For the first three months of 2012, consumers are spending a bit more, and saving a bit less.

The reduced savings rate, from $466.0 billion in the first quarter compared with $530.8 billion in the fourth (or 3.9 percent in the first quarter compared with 4.5 percent in the fourth), means more contribution to GDP in this measurement period, but it also means less stability for the long term. One of the problems of the economic boom from the 1980s through the 2000s was that it was build in part on a declining savings rate. 

In the chart below you can see that personal savings as a percentage of GDP fell steadily from 1982 (the end of the Reagan recession) to 2006 (the height of the housing bubble). During the recession there was a sharp bounce back in savings, but since the recession ended in mid-2009, the savings rate has begun to decline again. 

Another way to look at savings is in fixed dollars. Here, data from the BEA shows that savings maintained a relatively stable line until the 2008-09 recession (spiking a bit in relative relation to its levels during the 2001 recession, but not much change measured against the 30 years measured here). But now the savings rate is falling. That could be interpreted as a positive thing for GDP growth in the coming quarters, or as signalling a return to imprudent spending behaviors by the American public and some new, unstable bubble. 

Other, somewhat neutral news was that consumption of automobiles and parts declined 27 percent from the last quarter of 2011 until now, though it was nearly double the rate from the first quarter of 2011. 

We've now had six straight quarters of negative change in consumption of gasoline and other energy goods. And transportation services remained at a less than 2 percent change from quarter to quarter for the sixth straight month as well. 

New at Reason: Review of Federal Privatization Issues in 2011 and Today

Posted on April 23, 2012, 11:59pm | Leonard Gilroy and Harris Kenny

The rollout of Reason Foundation's Annual Privatization Report 2011 begins today with the release of the Federal Government Privatization section, authored by Reason's Adam Summers and Anthony Randazzo. This section of Reason Foundation's Annual Privatization Report 2011 provides an overview of the latest federal insourcing, housing finance, private spaceflight and other news on privatization and public-private partnerships in the federal government. Topics include:

• The ongoing dispute over what constitutes “inherently governmental” functions continued in 2011, and new Obama administration regulations could undermine federal outsourcing policy standards dating back to 1955.
• Regulators implementing the Dodd-Frank Act are creating significant risk for both mortgage investors and securitizers and appear likely to undercut the private mortgage industry while benefitting government mortgage providers. 
• In 2011, Fannie Mae, Freddie Mac and the Federal Housing Administration (FHA) combined to purchase or guarantee 95 percent of all new mortgages in America with some mortgages worth as much as $729,750. Every one of these mortgages is backed by taxpayer money.
• Federal agencies, under the encouragement of President Obama, are expected to generate nearly $13 billion in cost savings from asset divestiture, $9.8 billion of which comes form the Department of Defense’s Base Realignment and Closure (BRAC) efforts.
• The federal government owns approximately 1.2 million properties that cost $20 billion a year to maintain. Recent Congressional efforts to pass a Civil Property Realignment Act could save as much as $15 billion, according to the Office of Management and Budget.

» Annual Privatization Report 2011: Federal Government Privatization [pdf, 1.9 MB]

» Complete Annual Privatization Report 2011

The Fed As Source of Income Inequality

Posted on April 23, 2012, 2:24pm | Anthony Randazzo

We've noted before that income inequality is not inherently a bad thing—what matters is the source of the inequality. In last week's WSJ, hedge fund founder Mark Spitznagel points out one bad source creating artificial income disparagement... the Fed:

The Fed doesn't expand the money supply by uniformly dropping cash from helicopters over the hapless masses. Rather, it directs capital transfers to the largest banks (whether by overpaying them for their financial assets or by lending to them on the cheap), minimizes their borrowing costs, and lowers their reserve requirements. All of these actions result in immediate handouts to the financial elite first, with the hope that they will subsequently unleash this fresh capital onto the unsuspecting markets, raising demand and prices wherever they do.

The Fed, having gone on an unprecedented credit expansion spree, has benefited the recipients who were first in line at the trough: banks (imagine borrowing for free and then buying up assets that you know the Fed is aggressively buying with you) and those favored entities and individuals deemed most creditworthy. Flush with capital, these recipients have proceeded to bid up the prices of assets and resources, while everyone else has watched their purchasing power decline.

At some point, of course, the honey flow stops—but not before much malinvestment. Such malinvestment is precisely what we saw in the historic 1990s equity and subsequent real-estate bubbles (and what we're likely seeing again today in overheated credit and equity markets), culminating in painful liquidation.

The Fed is transferring immense wealth from the middle class to the most affluent, from the least privileged to the most privileged. This coercive redistribution has been a far more egregious source of disparity than the president's presumption of tax unfairness (if there is anything unfair about approximately half of a population paying zero income taxes) or deregulation.

See the full article here.

[Op-Ed] (Colorado SB 124) is a Misguided Attempt to Create Jobs

Posted on April 23, 2012, 1:27pm | Harris Kenny

Colorado recently lawmakers Senate Bill 124, which seeks to cut the strings on tax incentive programs for tourism projects. As I explain in my recent op-ed in The Colorado Springs Gazette entitled "Tax incentive program is a misguided attempt to create jobs": 

Nearly 8 percent of Coloradans are unemployed and seeking a job, and with numbers like that it’s normal for policymakers to focus on job creation. However a misguided attempt to create jobs through tourism projects might be made worse by the recently passed SB 124. The projects were originally approved with strings attached to limit taxpayer risk and lawmakers seeking to cut those strings aren’t considering the consequences.

The bill would modify the Regional Tourism Act passed in 2009, which approved tax increment financing for six total tourism projects. The Regional Tourism Act stipulated that only two projects could be chosen over the next three years and SB 124 would remove that stipulation until officials reach the six project cap. Despite passage through the legislature:

... (T)he bill faces bipartisan opposition in the Legislature and from the Governor’s office. Officials at the Colorado Office of Economic Development and International Trade have also questioned SB 124, citing uncertainty over whether the program will work. Gov. Hickenlooper’s critique centers around the need for oversight provisions and accountability measures that demonstrate projects will attract out-of-state visitors.

The piece later details how the Pew Center on the States determined Colorado belongs among the bottom half of states "trailing behind" in accountability for tax incentive programs. The piece concludes:

As long as the state is in the business of doling out special treatment through the tax code, taxpayers might as well know what they’re getting for their money. SB 124 is an excellent opportunity for Gov. Hickenlooper to flex his famed pragmatism and send a message that now is not the time to cut the strings and set loose Colorado’s flawed tax incentive programs, it’s time to rein them in.

Read the full piece available online here. For more, see my previous blog post on the aforementioned Pew study here. 

Durbin Swipe Fee Watch V: Gas Retailers

Posted on April 23, 2012, 12:20pm | Victor Nava and Anthony Randazzo

It is time for another edition of the Durbin Swipe Fee Watch. 

Recall that the Durbin Amendment was a last minute measure added to the Dodd-Frank Act. The provision, which directed regulators to cap bank interchange fees-the fees banks charge retailers in order for the retailers to use the banks debit card-was naturally lobbied for hard by retailers. Regulators later set the limit at 21 cents per transaction, less than half of the average 44 cents per transaction prior to the rule.

At the time, Senator Durbin hoped that the lowered fees would reduce prices and amount to savings for consumers. That hasn't been how the movie has played out though. 

The most recent evidence comes from new research showing that while the automobile gas retail industry has achieved $1 billion in annual savings from the lowered swipe fees, these are not savings being passed on to consumers. Of the 134 billion gallons of gasoline sold in 2011 approximately 48 billion gallons were purchased using debit cards, and with the average savings for gas retailers of about 3 cents/gallon on debit card purchases courtesy of the Durbin Amendment, you get the $1 billion figure. The reduced swipe fees mean less cost for the retailers, but what about the consumers?

With debit as the overwhelmingly most popular payment choice at the pump (comprising of 36 percent of all transactions), the reduced swipe fees have essentially given the gas retailers a subsidy windfall rather than any savings for consumers. 

It is well documented that gas price averages were 26 percent higher in 2011 compared to 2010. Much of this could be blamed on the Arab Spring or Federal Reserve's QE programs driving up commodities prices. The data shows that consumers should be seeing a 4-5 cent discount for an average 16 gallon pump when they pay with debit. But with prices ever climbing the ill conceived Durbin Amendment has just put that money into the pockets of the gas stations.

While it is not necessarily a bad thing that small businesses (gas retailers) have reduced costs, it is a problem that this has come at the expense of other businesses (banks), all because Washington decided to pick favorites. Disguising their rule as somehow for the betterment of consumers has simply become a joke.

We predicted this back in 2010. Since Durbin Amendment's directed regulation has started its film reel many banks have ended debit card reward programs and flirted with monthly debit card fees. Retailers such as Redbox have even had to increase prices as a direct result of the Durbin Amendment. All of this has caused measurable harm to consumers, with little evidence of an aggregate benefit for them, and all this while big box retailers stand to make millions and more. The notion that businesses would voluntarily pass along these savings to consumers and that the banks would not find other ways to make up for lost revenues is baffling, and very short-sighted by the U.S. Congress.

Now in its fifth edition, the Durbin Amendment Swipe Fee Watch has reached the level of both the Rocky and Planet of the Apes movie franchises in that, like both Rocky V and Battle for the Planet of the Apes, you are now wishing the Durbin Amendment never happened. We all fear the release of the next edition.

FHFA, DeMarco, and the Politics of Mortgage Modifications

Posted on April 16, 2012, 12:05pm | Anthony Randazzo

Mortgage principal write downs are not a Republican v. Democrat issue. At least they should not be. But just as global warming apologists and deniers split down party lines without much to connect the deep roots of conservative ideology or progressive tradition, so too have mortgage modifications become a partisan issue.

In this context, the recent comments from FHFA Acting-Director Ed DeMarco are interesting for the responses that he has gotten. He has not, despite his favorable tone given to modifications last week that has not been heard in years, changed is tune. Nor has he given blank approval to modifications. Rather, he has always relied on FHFA analysis to determine what would involve the lowest possible losses for the taxpayers and has until now come up with a "no modification" strategy. Now the analysis is providing some room for modifications.

In the wake of the FHFA report, there has been a host of comments from both sides making political hay out of DeMarco's words. Few have argued that FHFA's analysis suggests reducing taxpayer losses at the GSEs by accessing a taxpayer funded incentive program called HAMP, in effect making a gimmicky accounting transfer (that is admitted in the FHFA report as a trade-off). Rather, the comments have been black and white views on principal write down as some kind of poison or healing potion, depending on the view. 

So lets clear a few things up: How do mortgage modifications, principal write-downs or refinances, fit into the democratic platform any different from a republican platform? Does one party prefer the housing market to suffer while the other not? No. Nothing inherent about modifications makes this a partisan issue.

To hear the democrats tell it, the republicans do want the housing market to suffer more for wanting to see housing prices bottom out. Ironically, while it would be a good thing for housing prices to bottom out, most republicans (at least in Congress) have shied away from the legislative options put in front of them that would actually have the housing market bottom (lowering the conforming loan limit, unwinding the GSEs, etc). And there have been few voices on the Hill crying out about the injustice of the mortgage settlement—at least in regards to the way it treats contracts and pension funds. 

To the the republicans tell it, the democrats want to just give free handouts to deadbeat borrowers who took on more than they can pay back. Ironically, while it is true that a wide spread principal write down program divorced from case-by-case economic consideration would involve free handouts to deadbeats, the GOP stands in favor of the mortgage interest deduction which gives free handouts to successful homeowners—and the point of the critic is the handout, not the deadbeat or the actual homeowner. More over principal write downs are not always bailouts.

The reality is that writing down the principal on a mortgage, which the investor or owner of the loan chooses to do so, can be the best way of recouping lent funds. Sometimes the losses will be higher without the write down. Sometimes the best guess at maximizing return is principal forbearance, rather than a straight up write off of the debt. And sometimes foreclosing on a home, fixing it up, and selling it, will yield the highest return.

Every case is different. Mortgages are individual products that, even if offered with the same dollar amount on the same terms, have different risk profiles based on the borrower (which has a wide number of variables) and the geographical location of the mortgage.

Even trying to estimate a mortgage's risk profile based on zip code can be inaccurate because the possibility of vastly different neighborhoods and development prospects with a sometimes wide geographical zone defined by zip code. (If investors had access to address level data due diligence would be much more reliable.)

So it is ridiculous to reject principal write downs universally—as the GOP has done. And it is ridiculous to accept them blindly—as the democrats have done.

What we have written time and again is that the evidence suggests that principal write downs are often times not the best way of getting money back for lenders. That means forced principal write down programs are a bad idea—no reason to force banks to take losses. It means that the GSEs should not start writing down mortgage principal in large chunks—no reason the taxpayers hould have to cover those losses too.

But all of that is in the abstract. I don't manage the GSE mortgage portfolio or the Wells Fargo portfolio of loans. Only those running the numbers can estimate on what the best option should be. I can point to the fact that more than half of the modifications under HAMP have failed. And we have done so in trying to push back on the idea that modifications are some how the panacea needed in the housing market. 

They are not. But they might be answer to some mortgages.

Enter Ed DeMarco last Tuesday, who noted that in "some circumstances" lowering the mortgage debt level of borrowers could reduce the possibility of default. Such a conclusion is not earth shattering. While a majority of the HAMP modified mortgages have failed, some have succeeded and theoretically staved off foreclosure. What has been missed in many stories about DeMarco's speech is that he was clear to point out that principal write downs are not a "magic bullet," and the benefits are "limited." 

He is right to say these things and the GOP is wrong to suggest that there should be no modifications (though modifying the principal on a mortgage the GSEs do not own would be a problem without authorization from the investor). Democrats are equally wrong to claim some sort of victory as if the debate over whether or not to go all in on principal write downs is won. This is ultimately a debate about servicing debt and managing the deleveraging process. It is a debate about what tools to use in preventing more taxpayer losses. DeMarco framed it this way:

"This is not about some huge difference-making program that will rescue the housing market. It is a debate about which tools, at the margin, better balance two goals: maximizing assistance to several hundred thousand homeowners while minimizing further cost to all other homeowners and taxpayers."

I will offer this critique of FHFA's analysis though. FHFA suggests it can reduce losses to the taxpayers by $1.7 billion by taking advantage of incentive payments made by HAMP to those who write down mortgage principal. The challenge is that in order to do this, the taxpayers have to pay out those HAMP fees. So in this particular case, the FHFA "savings" to the taxpayers is little less than an accounting gimmick. It is possible that principal write downs would save taxpayers from higher losses, but if it is only because the losses are otherwise subsidized by the taxpayers then there is no net gain and moral hazard from the write downs wins the day.

Sheila Bair on the Prowl, a Guide

Posted on April 16, 2012, 8:40am | Anthony Randazzo

My first thought when I read the soon-to-be infamous Sheila Bair op-ed in the Washington Post this weekend was to laugh out loud and share the $10 million-loan-for-everyone suggestion with the driver of the taxi I was traveling in through downtown D.C. My second thought was "damn, I wish I'd had written the case against ZIRP like that." 

In fact we have written similar arguments as the former FDIC chairwoman articulated her humorous and cutting commentary. But not in the tone that she was able to articulate, shining a light on what has truly become a farce: the Federal Reserve's free money passed out in bulk to Wall Street to "support" the financial system. The idea Bair proposes is completely crazy, but that is the point. She is just articulating what Fed policy is for the financial system, and it is no less crazy to be handing them billions in free loans. 

Here is a guide to understanding the Bair tongue-anchored-to-cheek op-ed. First she writes:

For several years now, the Fed has been making money available to the financial sector at near-zero interest rates. Big banks and hedge funds, among others, have taken this cheap money and invested it in securities with high yields. This type of profit-making, called the “carry trade,” has been enormously profitable for them.

So why not let everyone participate? Under my plan, each American household could borrow $10 million from the Fed at zero interest. [...] Think of what we can do with all that money. We can pay off our underwater mortgages and replenish our retirement accounts without spending one day schlepping into the office. With a few quick keystrokes, we’ll be golden for the next 10 years.

Such a suggestion is usually overheard at one of D.C. well attended liquor and beer distributing establishments. Well, except for the bond trading part. The difference between professional investors and Americans suddenly power-ball-lottery-winner rich is the disciple to "order up a few trades" as she puts it later in the piece. Theoretically, if everyone just bought sovereign debt and lived off the interest we could avoid an inflation problem of all that new money chasing far too few widgets made by a rapidly declining labor force. But it is much more likely that all that money would flow into the economy, ruining creditors who are paid back to complete the deleveraging cycle, but unable to buy much with the now worthless cash that has been paid back to them (via Fed helicopter).

Bair begins to expose her point when suggesting how the "carry trade" could be accomplished for America's new denizens of wealth: 

The more conservative among us can take that money and buy 10-year Treasury bonds. At the current 2 percent annual interest rate, we can pocket a nice $200,000 a year to live on. The more adventuresome can buy 10-year Greek debt at 21 percent, for an annual income of $2.1 million. Or if Greece is a little too risky for you, go with Portugal, at about 12 percent, or $1.2 million dollars a year. (No sense in getting greedy.)

This is actually what financial institutions have been doing with all that Fed money. The bailout was supposed to shore up bank balance sheets so the failed institutions could lend. Quantitative easing was supposed to free up capital from assets and let the fresh money boost the economy. Zero interest rate policy (ZIRP) has long been declared necessary to encourage borrowing and keep housing prices propped up.

But all this has done is contribute to a limping, recoveryless recovery. As we predicted in Reason magazine two years ago, we've been going "sideways" for a while. And that is Bair's beef with the Fed.

She also has a barb to throw at Congress:

Of course, we will have to persuade Congress to pass a law authorizing all this Fed lending, but that shouldn’t be hard. Congress is really good at spending money, so long as lawmakers don’t have to come up with a way to pay for it. Just look at the way the Democrats agreed to extend the Bush tax cuts if the Republicans agreed to cut Social Security taxes and extend unemployment benefits. Who says bipartisanship is dead?

Fair point. When it comes to actually helping the economy, Congress goes AWOL. When it is time to score some political points, compromise abounds (under the cover of something substantive happening). Bair doesn't hold back from going after social issues either in the piece:

Because we will be making money in basically the same way as hedge fund managers, we should have to pay only 15 percent in taxes, just like they do. And since we will be earning money through investments, not work, we won’t have to pay Social Security taxes or Medicare premiums. That means no more money will go into these programs, but so what? No one will need them anymore, with all the cash we’ll be raking in thanks to our cheap loans from the Fed.

[...]

We can stop worrying about education, too. Who needs to understand the value of pi or the history of civilization when all you have to do to make a living is order up a few trades? Let the kids stay home with us. They can play video games while we pop bonbons and watch the soaps and talk shows. The liberals will love this plan because it reduces income inequality; the conservatives will love it because it promotes family time.

The frightening thing is that many of these attitudes are prevalent in American society even without the $10 million loans. 

The tax code is skewed. The answer is not to raise tax rates—the income tax system is a terrible way to tax a society and just slows down the economy—but that doesn't make the lower tax rates paid by wealthier segments of society any less damning. At the very least, the incentive structure of the tax code is set up to drive assets into many unsustainable things (like housing) and away from funding public liabilities (as Bair notes). 

Education is screwed up in America as well. Test scores are stagnant. High school graduation rates are sliding. Labor force mismatch issues are becoming an increasing concern. And it hasn't taken $10 million loans to end interest in math and history in many corners of America. 

So is Bair's solution viable? According to her, "This is the best American financial innovation since liar loans and pick-a-payment mortgages... Some may worry about inflation and long-term stability under my proposal. I say they lack faith in our country. So what if it cost 50 billion marks to mail a letter when the German central bank tried printing money to pay idle workers in 1923? That couldn't happen here. This is America." 

Touche. 

There will probably be more than a few out there who don't get the joke. But building on a pattern of loans without paper work to make everyone indebted to the Fed is not a serious policy proposal. Rather, her point is to channel the incredulous feelings of the readers into a criticism of the fact that the Fed does exactly this proposed idea, just with financial institutions instead of households. 

It is crazy and it has to stop. 

State Tax Collections Rise $62 Billion in 2011

Posted on April 14, 2012, 6:07pm | Harris Kenny

State tax collections increased $62.1 billion—or 8.9 percent—up to $763.7 billion in 2011, according to the U.S. Census Bureau’s recently released 2011 Annual Survey of State Government Tax Collections. See the following figure for a breakdown of the $763.7 billion in state tax collections by category in 2011:

All 50 states experienced a positive increase in total tax collections; whereas in 2010 only 11 states experienced a positive increase. There are nine states where tax collection increased by 10 percent or greater in 2011, including:

• North Dakota (+44.5%)
• Alaska (+22.4%)
• California (+17.4%)
• Illinois (+15.3%)
• New Mexico (+15.1%)
• Wyoming (+14.1%)
• Idaho (+10.5%)
• Colorado (+10.4%)
• Minnesota (+10.1%)

In an accompanying press release, the U.S. Census Bureau highlights the following findings from the report:

States with the largest percent increase in motor fuels tax revenue were California (+80.3 percent), Alaska (+37.4 percent), North Dakota (+13.1 percent) and Kentucky (+10.6 percent).

Severance taxes—collection for removal or harvesting of natural resources (e.g., oil, gas, coal, timber, fish, etc.)—were up $3.5 billion, a 31.2 percent increase. This followed a 16.4 percent decrease in fiscal year 2010. The largest increases in severance tax revenue were seen in the West.

Revenue on taxes imposed distinctively on insurance companies and measured by gross or adjusted gross premiums (insurance premium sales tax) increased $593.8 million, up 3.8 percent. This followed a 5.3 percent increase in fiscal year 2010. The largest increases in insurance premium sales tax revenue were seen in the Northeast and South.

It’s important to note that state tax collection data does not include: employer and employee assessments for retirement and social insurance purposes; collections for the unemployment compensation taxes imposed by each of the state governments; or tax collections from local governments.

This data is only one piece of the state revenue puzzle. For context, in 2010 state tax collection accounted for approximately one third of total state government revenue. That being said, growing state tax collections suggest an ease to state budget woes. For related research on this topic, see Reason Foundation’s Tax and Budget Policy Research Archive.

Pew Finds States Barely Evaluate Tax Incentive Programs

Posted on April 12, 2012, 9:50pm | Harris Kenny

Today The Pew Center on the States published an eye opening report entitled Evidence Counts: Evaluating State Tax Incentives for Jobs and Growth. First, kudos to Pew for conducting this report and asking important questions about state tax policy. The report starts with a refrain commonly seen here on Reason Foundation’s Out of Control policy blog, which is that state governments are strapped for cash and need to both get their fiscal houses in order and foster economic growth.

Many policymakers feel the way to foster economic growth is by supporting politically favored businesses—as opposed to promoting economic freedom—so they pass lavish tax incentive programs totaling billions of dollars across the country in hopes of turning things around. Today’s Pew report addresses a critical follow up question: Do states measure to see if their tax incentives are having an impact? Their answer? Barely.

No state was spared in this analysis because every state has at least one tax incentive program, and most have several. Tax incentives come in the form of tax credits, exemptions and deductions; financial assistance for relocation or workforce expansion; and a variety of other mechanisms. Pew reviewed almost 600 documents and interviewed over 175 government officials and policy experts to evaluate whether or not states gauge the effectiveness of their tax incentives, and if they do, Pew examined how well they do it.

Ultimately, the report finds:

... (N)o state regularly and rigorously tests whether (its tax incentives) are working and ensures lawmakers considers this information when deciding whether to use them, how much to spend, and who should get them. Often, states that have conducted rigorous evaluations of some incentives virtually ignore others or assess them infrequently. Other states regularly examine these investments, but not thoroughly enough.

Since no state met Pew’s expectations for the study, it became a battle to avoid last place. States are evaluated under two criteria, scope and/or quality of evaluation, and are split into three categories listed below.

• 13 states are “leading the way,” which means they're “meeting both criteria for scope of evaluation and/or both criteria for quality of evaluation.”
• 12 states are achieving “mixed results,” which means they're “meeting only one of the criteria for scope and/or quality of evaluation.”
• 26 states (including the District of Columbia) are “trailing behind,” which means they're “not meeting any of the criteria for scope or quality of evaluation.”

Below is an infographic provided with the report detailing where states rank and highlighting four recommended steps for state policymakers:

For a detailed evaluation of state performance, see page 32 of the report available online here. Stay tuned because I will be exploring the report’s specific findings—by policy area and by state—over the next week. In the meantime, check out Reason Foundation’s Government Reform Tax and Budget Policy Research Archive and State Government Privatization Research Archive for more ideas on ways that policymakers can turn things around in their states.

Discord in the Fed

Posted on April 12, 2012, 5:07pm | Anthony Randazzo

There is a bit of discord at the Fed. After Minneapolis Fed President Narayana Kocherlakota said earlier this week that the FOMC should consider raising interest rates later this year rather than maintain zero interest rate policy through 2014 (as is the current position of the Fed), vice chairwoman Janet Yellen remarked that ZIRP might actually need to be extended as far as 2015. The former San Francisco Fed President further commented in her speech at the Money Marketeers club of New York University that there has been "a significant shortfall in the overall amount of monetary policy stimulus since early 2009."

Then, at a meeting of the National Economics Club I was attending this afternoon, Philadelphia Fed President Charles Plosser note that when QE2 was launched in 2010 that unemployment was soaring and inflation was nill, and that because unemployment is falling and inflation is picking up that rather than talk about the need for QE3 we should be looking to tighten monetary policy.

After making this remark he backed off a bit and said he wasn't suggesting we should actually tighten monetary policy but rather just take it as a hypothetical response relative to the perceived need for QE3. 

Discord indeed.

At least the Federal Reserve appears to be about as conflicted as the blogosphere is on what to do and when to do it.

Washington's Road to Economic Decline

Posted on April 12, 2012, 4:55pm | Adrian Moore

I have a column up at Real Clear Markets today about the "long history of bi-partisan bonehead thinking on Capitol Hill about transportation, jobs and the economy."

It is no surprise that in an economic slump, or any other time really, politicians would focus on the jobs "created" by transportation spending. Leaving aside the flawed logic that taking money from one group of people to fund work by others in any real way "creates" jobs. The stopgap transportation bill is a poster child for how Washington has long been thinking about transportation, which explains the decisions it has made that have undermined economic growth in the United States.

I go on to explain how transportation infrastructure really effects the economy, with some emphasis on how disastrous is our federal, state and local government's decisions to allow congestion to continue growing. I conclude:

Our economy needs an oil change in the form of revamping transportation policy to focus on providing an effective transportation system that fuels economic growth rather than political ambitions and the creation of jobs "immediately," as Rep. Pelosi put it. Two years ago, a colleague and I sketched out in some detail what a more effective highway trust fund reform would look like. The most important things we focused on were transportation investments that maximize transportation benefits and mobility, and funding transportation with user fees, not taxes. Our economy depends too much on effective transportation for it to be a political pony to ride.

Read the whole thing here.

Barry Ritholtz On Housing Pessimism

Posted on April 10, 2012, 2:15pm | Anthony Randazzo

Last Friday, Washington Post columnist Barry Ritholtz broke down the pessimist's view on the housing market. With spring comes a traditional uptick in housing data, inspiring memory challenged journalists to wax philosophical about the bottom of the housing market finally being upon us and blue skys forever to come. But here are some reasons why that view is misinformed (regular readers will note these are not new concepts to this blog).

First, the shadow inventory:

"What is shadow inventory? This is important, as lowering the total inventory of houses for sale is how prices stabilize and sales volume moves higher... It includes bank-owned real estate, distressed houses not yet for sale, short sales and delinquencies that have not yet defaulted. Foreclosure properties are also in the shadow inventory. These houses will eventually become part of the total supply for sale. Although there is no official count, estimates of potential shadow inventory run as high as 10 million.

"That’s not all. There’s also a huge overhang of underwater homeowners — whose houses are worth as much as 25 percent less than what is owed. The owners don’t qualify for a mortgage modification. They may be delinquent but aren’t in default. Two-thirds of all U.S. houses have mortgages. Of those, an estimated 21 to 29 percent of the mortgages are underwater, or up to 16 million houses. When prices finally do rise, we can expect many of these no-longer-underwater owners to put their houses up for sale. If only one in three do, that is another 5 million homes in inventory."

Second, home affordability:

"Are houses affordable? Here’s where every discussion of affordability seems to start: the National Association of Realtors Home Affordability Index. In my view, it’s worthless. Why did I come to such a harsh conclusion? The index offers little insight into how affordable housing actually is. In the biggest run up in housing prices in American history, the index never dipped into the level of unaffordable. Imagine that.

"As ridiculous as that sounds, it’s even more absurd when we look at the NAR methodology, which ignores factors such as family savings rates, cash assets, consumer credit, indebtedness, credit servicing obligations, inflation and income gains. The affordability index looks at the wrong things and ignores the important ones. The correct question is not whether the houses are affordable in theory. Rather, it’s whether potential buyers can afford to buy them."

Third, how cheap house prices are:

"Are the prices cheap? Few had forecast the steep drop in median house prices. Some regions that were excessively frothy during the boom — California, Las Vegas, South Florida and Arizona — have seen much greater price drops. Other areas had laws (Texas) or financial conventions (New York City) that mandated significant down payments and other prudent requirements and avoided much of the bloodshed. The conventional wisdom seems to be that prices have stabilized and are overdue to start rising. The data, however, suggest something else. The most recent Standard & Poor’s / Case-Shiller index of national prices (January) shows prices are still falling, about 4 percent year-over-year."

Fourth, asset prices follwing a bubble:

"How do asset prices behave following a bubble? Regardless of the asset class — stocks, bonds, commodities, houses, etc. — assets do not merely stabilize. We have never seen a stock market run up into bubble territory and then revert to fair value. Instead, we careen wildly past that level, to deeply undersold and exceedingly cheap. That is the marvelous mechanism of markets. It is how assets are repriced, distressed holdings liquidated, capital markets stabilized, fools revealed, speculators punished — and money returned to its rightful owner, the prudent investor.

For a lasting recovery, we need to see houses cheap enough that they fall into “good hands” — long-term owners who can afford their mortgage payments. Until that happens, houses will stumble along the bottom of the price range. The nation could easily see another 10 percent to the downside — assuming nothing else goes wrong. This would actually be good news. The government interventions (first-time buyer tax credit, mortgage modifications and foreclosure abatements) have prevented prices from finding their own levels. If they did, houses would be much more affordable, and buyers would come out in droves.

That is how a true housing recovery begins.

Read the rest of the piece at Washington Post here.

The Federal Reserve Signals No Further Easing…Until the Next Easing

Posted on April 4, 2012, 12:12pm | James Groth

Minutes for the latest Federal Open Market Committee (FOMC) meeting were released yesterday afternoon sending the stock market down and Treasury yields up largely due to the hawkish tone of the release. Committee participants noted stronger signs in labor markets and improvements to output as lacking necessity for further easing. Outspoken hawks, President Lacker being the only one, stated that the current degree of policy accommodation beyond this year would be “inappropriate.”

Yet despite the meeting’s tone, members’ hawkish comments and the securities markets’ reactions, we will most certainly be seeing continued accommodation and likely further easing before the year’s end.

Why?

The following two charts:

The first is a 5-year chart of Treasury Bonds:

The second is a 25-year chart of commodities prices:

Selling in long-dated Treasuries has pushed yields up to uncomfortable levels. Despite Bernanke purchasing more than $40 billion per month under Operation Twist, yields on the 30-year Treasury Bond have gone from 2.7 percent when Bernanke first commenced the unprecedented buying program to just over 3.4 percent in yesterday’s trade. They are expected to go much higher. As selling pressure persists, the Fed will likely purchase more to offset the rise in yields that has been persistent since last October either through extending Operation Twist or by announcing another round of bond purchases.

The one thing that would stop the Fed from such a move is inflation pressures. This is where the second chart comes into play.

Bernanke has remained consistent pointing to a slack labor market keeping wages down and so holding off inflation. Recently he has also been pointing to declines in commodity prices (highlighted) as a sign that the initial rise in commodity prices was indeed transitory as he predicted throughout its rise.

The combination of dangerously high Treasury yields (yes, when the Federal Debt is nearing $16 trillion, even 4.5 percent on a 30-year is unmanageable), a slack labor market, and “declining” commodity prices is reason enough to continue debasing our currency.

But take a look at the charts again. Much of the weakness in commodities, or rather the slight pullback in prices, can be attributed to lower demand from the Eurozone. Similarly, some of the money pumped into Treasuries over the last nine months has come from sales of Euro area debt and other Euro securities. Recent trends point to this continuing.

Despite nearly $1.5 trillion in loans from the European Central Bank (ECB) pumped into banks and institutions since December and more than $100 billion of additional direct purchases of sovereign debt over the year, European periphery debt is still pricing in downside risk. The ECB’s efforts have attracted significant interest from domestic buyers, but institutions abroad in the US and elsewhere have not participated, and many have sold into the backstopped Euro buyers. Without further accommodation from the ECB, bond auctions in Spain, Italy, and Portugal will continue to disappoint and push up yields (as can be seen following today’s Spanish auction). Couple this with negative growth over all of 2012 and most of 2013 in the Euro periphery, as projected by the IMF (more severe projections by most economists), and one has to conclude that commodity pressures will continue to ease.

That gives Bernanke the green light.

Unless US employers start kicking up wages, inflation will be kept in check. This is regardless of the trillions printed by the Fed and the trillions more in the pipeline. Wage increases won’t broadly occur until unemployment hits closer to 6 percent, and that isn’t in the cards for……..? So, as long as the current US and Euro picture persist, Bernanke will soon once again hit the gas. Both the Fed and the Treasury can ill-afford any rise in Treasury yields.

And they are rising.

Banks and institutional investors are exiting long-dated Treasuries in droves. Yields on the 30-year and 10-year Ts are 3.4 percent and 2.3 percent respectively. That is up from 2.7 percent and 1.7 percent last fall. European buyers are parking funds that would otherwise be allocated to Ts into German Bunds which have decoupled from US Ts following the massive injection from the ECB. German 30-year and 10-year paper trades at 2.5 percent and 1.8 percent respectively. This is a significant spread from Ts, which before the ECB easing used to trade with similar yields.

Bernanke knows that without buyers from European institutions, and with domestic institutional selling, current Treasury yields cannot be supported. The Eurozone weakness and the US slack labor market is a godsend to further accommodation.

Signaling aside, the Fed is not finished. They won’t be until either Congress forces their hand, or for some reason American employers decide to bump wages and share the wealth. At present, a larger percentage of corporate earnings are going towards profits than to wages than at any other period since 1947. That may help shareholders, and the wealthy, but it is short-term and does not improve the economy as a whole. Expect more easing, expect more wealth divide, and expect more central bank control of the “free market.”

A Financial Products Agency is a Bad Idea

Posted on April 3, 2012, 10:21am | Anthony Randazzo

Back in February Eric Posner and Glen Weyl, both of the University of Chicago and deservedly respected economic and legal minds, wrote a paper proposing a Financial Products Agency. The idea is relatively simple—just as the FDA must approve new food and drug products for consumption, an FPA should approve all new financial products with a test measuring for social benefit. 

This is a terrible idea for at least three reasons:

First, an FPA would not have stopped the financial crisis. Let us assume for a moment that this FPA existed in 1998. Back then, when subprime debt began to pick up its pace, there was little understanding of the risk that was building up in the system. We can't just assume that having an FPA would mean regulators have somehow gained hindsight. Regulators were aware of what was going on to the degree that they had the resources to manage and the expertise to understand and didn't do anything then. Let's assume again that the FPA existed in 2004. Around that time regulators like Greenspan and Bernanke were well aware of the housing bubble but either did not think the risks were that big or did not think it was appropriate to step in. With rising housing prices (that all the regulators never thought would go down) masking the risks of subprime debt by preventing defaults, it is very hard to believe that regulators at this FPA would have done much to stop the risky financial products Posner and Weyl blame for contributing to the financial crisis.

Second, the model of the FDA is not a great idea unless you want to stunt markets. While the public has come to depend on the FDA to keep them safe there are regular outbreaks of diseases and complications with medicine. Even approved products can be misused. Beyond this, there are numerous cases where the FDA has prevented positive health outcomes, such as slowing down cancer prevention drugs for political reasons or sheer incompetence. And given the bureaucratic nightmare that is the FDA, it is impossible to know what drugs have not been pursued simply to avoid the compliance and approval costs and headaches. What we do know is that there is a growing problem of drug shortages in the U.S. and it is in part because of the FDA.

Finally, the whole argument for an FPA is based on the premise that derivatives contracts were significant contributors to the financial crisis. But derivatives—even the most risky contracts—are innocuous vessels. Blaming them is like blaming money for the crisis or computers. Though an argument can be made that there was too much money via central banks and too much computing power pushing high frequency trades, it is not the money or the computers but how they are used in connection with the other factors that caused the crisis. Derivatives contracts became a problem because the underlying assets they were being created with were misunderstood and financial institutions did not properly hedge their risk. If AIG had set aside the necessary amount of capital relative to its risk exposure, there wouldn't be as much carping about derivatives. If lending standards had not fallen so low, the subprime debt levels that did exist would not have been there to generate such a massive amount of unhedged, misunderstood, risky derivatives for subprime debt in the first place.

Unfortunately, despite these problems, the FPA finds the approval of NY Times business columnist Gretchen Morgenson, who wrote over the weekend regarding this proposed idea:

It is a refreshing rejoinder to the mantra on Wall Street — and in some circles in Washington — that financial innovation is always good and regulation is always bad. Bankers often argue that complex financial products are among America’s great inventions. But given that exotic instruments played a central role in the credit crisis, it is worth questioning the costs and benefits of such financial innovations. 

I agree that it is always worth questioning and debating and wrestling with ideas. That is the best way to avoid getting tunnel vision on something. But in this case, the idea under consideration is not a very good one.

Ms. Morgenson makes the problematic assumption at the start of her column that regulators would somehow have behaved differently if there were an FPA before the crisis. "Imagine if there were a Wall Street version of the F.D.A.," she says, "How different our economy might look today, given the damage done by complex instruments during the financial crisis." But as we were just pointing out, there was lot of authority to limit Wall Street. Financial markets are and have been one of the most heavily regulated industries in the U.S. But the only thing that I can think of that would have actually changed regulator behavior prior to the crisis would be something that eliminated regulatory capture. An FPA, just like the SEC, would have been filled with bureaucrats more than willing to use a light hand on approval procedures to ensure they had a job with some firm after their civil minded spirit got drilled into the pavement of Manhattan with one to many luxury cars. 

Then, Ms. Morgenson begins to lay out the case for the FPA, noting that the Posner/Weyl paper argues we should be able to regulate financial markets because they are different from the real economy, where a more laissez faire approach is good. The two leading problems with this argument are that:

1. Financial markets are so interwoven with the real economy that you can't truly separate the two. Financial markets are the lifeblood of new businesses, which in turn are the lifeblood of the U.S. economy. So anything regulations that unnecessary restrict credit are actually hitting the real economy; and
2. The problem is not a lack of rules but the absence of the right rules. If we learned anything from the crisis shouldn't a key lesson be that a lot of rules without regulators smart enough or inspired enough to enforce them winds up with meaningless protections and a false sense of security. It is foolish to depend on this regulatory crutch again and again. It is literally insane.

The next piece of the Posner/Weyl argument is that derivatives that are risky bear limited social utility and can cause system risk. I counter by arguing that: 

1. Just because something has limited social utility does not mean it should be restricted. Fantasy baseball may actually reduce productivity at work places across America, for instance, and may not get past a social utility censor. But I'll join up with an Upper Peninsula anti-government militia if the government tries to stop me from competing for glory; and
2. Derivatives in a market that has too-big-to-fail banks may cause systemic risk—but the problem there is the bloated banks and the lack of handling failed institutions. If every bank had 75 percent capital requirements there would probably be very little derivative risk. Of course we'd also have a nonexistent banking system. The key here is to solve for moral hazard and improper incentives in the system, not try to limit financial activity on the other side of the equation.

Ms. Morgenson further carries the Posner/Weyl case forward by noting they also want the proposed FPA to measure financial instruments for "how they affect capital allocation, and whether they might add useful information to the marketplace." Again, a couple of points:

1. How could an FPA really understand where capital should be allocated? Every regulator under the sun thought that capital flowing to the housing industry was a good idea during the bubble era. Imagine the FPA arguing in 2002 that there was too much capital flowing to the housing industry. It never would have happened, and on the off chance that our revisionist history unearths a Mike Burry to have influence in this FPA, the counter political pressure would have been too strong to let them do anything. Everything politically during the bubble was pushing capital towards housing. The Bush "Ownership Society" mantra. The previous decade's changes at Fannie and Freddie and FHA. Basel rules favoring housing. Even a massive accounting scandal at the GSEs failed to really derail their political or financial activities, so strong were the pressures to increase home ownership rates.
2. And why should a financial product be disallowed if it doesn't provide useful information to the marketplace? If I want to structure a deal with my neighbor where we place a complicated bet on the outcomes of real estate values from the properties of people two streets over, with a few voluntary counter-parties financing the bet... why should anyone else care? Posner and Weyl may respond they would care if my personal failure on coming up short in the bet posed a risk to the financial markets. But I would again push back that the problem then would not be the derivative contract but the fact that the system was so poorly incentivized that I could become a systemic risk.

The Posner/Weyl paper says in the introduction that Dodd-Frank is an empty vessel and on this point we agree. My remarkes are not a defense of Wall Street today or the regulatory system. This FPA idea is just not the right response mechanism to that problem. 

Regulators Making Moves to Force More Banks Into Mortgage Settlement

Posted on April 2, 2012, 10:49pm | Anthony Randazzo

A few weeks ago we warned that the mortgage settlement might not be limited to just the five banks that signed on, but that regulators would find a way to force others into the agreement, like PNC and US Bancorp. Well, today the NY Times reports:

Federal regulators are poised to crack down on eight financial firms that are not part of the recent government settlement over home foreclosure practices involving sloppy, inaccurate or forged documents. Last week, a senior Federal Reserve official recommended fines for these additional firms, raising questions about how deep foreclosure problems run through the banking industry.

The firms cited include, non surprisingly, SunTrust Bank, U.S. Bancorp, PNC Financial Services, plus five more: MetLife, EverBank, OneWest, Goldman Sachs, and HSBC’s United States bank division. The Times story continues:

The recommendation is the culmination of an investigation begun nearly two years ago over accusations that bank representatives had been churning through hundreds of documents a day in foreclosure proceedings without reviewing them for accuracy, a practice known as robo-signing. Some see the Fed’s recommendation as an attempt to push these firms to agree to the terms of the broader mortgage settlement involving the state attorneys general and federal officials. 

Count me as one of those seeing a push. More of a shove really. PNC, for example, believes that it is going to be required to sign on to the new national mortgage servicing standards and modify mortgages. But where Bank of America and JP Morgan Chase have plenty of investor mortgages to write down principal on—essentially using other people's money for their own fines—PNC does not. From their perspective this is unfair punishment, since they'll actually have to pay the fine.

In one sense, they are right. It isn't fair. But there really shouldn't be any write downs. There is a $1.5 billion settlement pool set up for the roboforeclosed and anyone whose home was wrongly seized can still bring legal suit. And if PNC and others committed the same failures they should pay into the settlement pool too. But modifying the mortgages of borrowers now, borrowers unrelated to the robosigning, is bad housing policy but extortion and not justice being served.