Tag Archives: moral hazard

Government Market Intervention

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I’ve written before (here and here) about the damaging risks run by governments intervening in a free market.  I want to talk about a couple of additional examples of such intervention, and then I’ll leave the subject alone for a while.

The Daily Caller wrote today about the President’s attempt, by Executive fiat, to ease the debt burden on students.  The plan, according to early information, is to allow some of the (now graduated) students to ease their debt burdens by consolidating their loans into one loan.  Further, after the original loan contracts have been solemnly entered into, the President’s plan seems to be to allow borrowers to cap their loan payments at 10% of their after-tax income (with the signed contracts capping these payments at 15%).  Finally, unpaid balances can simply be walked away from—”forgiven”—after 20 years, instead of an originally contracted-for 25.  This plan is available, though, only to students whose loans were obtained through a Federal loan guaranty program or directly from the Federal government.  (Thus, not only is a select group being singled out for preferential treatment, only an especially favored subgroup is eligible for this particular intervention.  This, though, is beside the point of this post.)

Early word is that this will be “paid for” by “savings” claimed to occur from the 2010 nationalization of the student loan business which was included in Obamacare legislation.  There are a number of problems with this; I’ll confine myself to the market intervention problem.  With one party able unilaterally to alter the terms of a loan contract, costs will be imposed on the other party absent his agreement—even his discussion.

These costs will include lost interest income and principle repayment from the smaller payments of the loan’s repayment stream, and they will include outright loss of the principle loaned through that earlier forced “forgiveness.”  That five year chop, given the way loans are amortized, means that about 25% of the principle (assuming a 7% loan; the principle loss increases as the interest rate increases) can be written off.  Look at your home mortgages for an example: most of your payments are interest, with only a little principle being paid down until the last years of the loan.  These costs, as I’ve noted, are imposed solely on the borrower’s call.

Then there is the loss to the rest of us taxpayers by using the alleged savings from that nationalization to cover these costs rather than returning those savings to the Treasury to pay down the nation’s debt.  Of course some will point out that these savings, compared to our national debt, is just chump change.  This is disingenuous.  Ask any discount store about the importance of everyone’s nickels and dimes to the millions in profit those chain discounters make in the aggregate—on a slim margin compared to the millions in costs those chains experience, but a positive margin.  And as an Illinois Senator once said, “A billion here, a billion there, pretty soon, we’re talking about real money.”

Then there’s the cost of consolidating those loans—small, generally, compared to the loans themselves, but the fees add up across the six million, or so, prospective eligibles.  This is an unnecessary cost to the taxpayer, though, as anyone who ever has gotten into credit card debt trouble knows: loan consolidation is a standard means of containing, and ultimately paying down, excessive personal debt, and the mechanisms for this are already well established in banks and credit unions.

Some (others) might point out that students might have trouble getting a loan consolidation loan from a bank or credit union; their credit ratings will be too poor.  But wait: if they’re poor risks for a bank, aren’t they poor risks for the National Bank of Taxpayer?  And wasn’t freely lending to poor risks a major contributor to our present mess?

Finally, there’s the moral hazard being created here.  Given that the borrower from, or through, the government can simply change the terms at will, or take advantage of the myriad of loopholes in our current tax system (which I’ve heard no Democrat willing to change) to hold down the dollar size of that 15%10% cap, or simply to wait a now shorter while and then legally walk away from his loan contract, where is the incentive to take his loan obligation seriously in the first place?  Where is the incentive for private lenders to involve themselves in the student loan market?  Oh, wait—what student loan market…?

Another, brief, example is  the travesty of the Chevrolet Volt, built by a car company and union that were the individual, specifically targeted, beneficiaries of an historically huge market intervention.  I suppose, in the end, though, the Volt itself isn’t much of an intervention: even after a taxpayer-funded $7,500 rebate, the $40,000 (post-rebate) Volt isn’t selling, so the taxpayer’s funds aren’t being tapped too hard here.  There’s also no reason why it would be a large intervention.  This marvel of “green” technology gets around 40 miles per charge before it needs help from an on board internal combustion engine (in fairness to the Volt, this is pretty typical of other hybrids, too).  But so does the 1896 [sic] Roberts Electric Car; although the Roberts doesn’t have an internal combustion engine at all, and it’s missing some (unrelated to “green”) comfort features.

In short, what are we getting for these government interventions into our market place?  Moral hazard, higher costs to the taxpayer—and the consumer—and loss of market participation.    This is a big price to pay for interventions that, by their nature, cannot work.

Bank Bailouts

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There are weighty discussions going in in Europe over the need to prop up/bail out the Greek economy by guaranteeing Greek sovereign debt.  The argument goes this way: Greek banks, which have a vast portion of their assets in the form of Greek sovereign debt instruments, need that debt made good, or the banks will fail.  If the banks fail, the Greek economy fails.  Further, major banks central to the economies of other nations of Europe, both private financial institutions and national central banks, are major holders of Greek sovereign debt; if that debt is defaulted, those banks will fail.  Other economies of the EU—Portugal, Italy, and Spain (the remaining PIGS)—will fail if their banks, holding all that Greek debt, fail.  The financial institutions of sounder economies are also major holders of those remaining PIGS’ debt; if those economies fail, so do these additional banks, and the cascade continues.  So it’s necessary to prop up the Greeks, to prevent bankruptcy and default there, in order to prevent the cascade from getting started.

The argument in Europe currently is from the perspective that since this cascade must be so widespread in its final outcome, it is legitimate for taxpayers to be forced to bail out the failing banks (the current mechanism for this is for the taxpayers’ money to be used to increase the capitalization—the cash on hand—of the exposed banks, so they’re better able to handle the losses in the even of a Greek default; however, the specific pathway of committing taxpayer funds is irrelevant to this discussion), even of other countries: the taxpayers are only protecting themselves by doing this.

Let’s look at this from another perspective, though.  Is a mandated bailout truly necessary, or appropriate?

To answer this, we must first understand whose money will be used to recapitalize (let us say) those banks.  If governments, individually or behind the veneer of an EU demand, mandate the recapitalization, it will be the taxpayers of the constituent nations whose money will be used, including taxpayers of nations different from the nationality of the banks being recapitalized.

If, on the other hand, the market is left to recapitalize the banks, it will be the market participants, the citizens* of the constituent nations whose money will be used, including the participants/citizens of nations different from the nationality of the banks being recapitalized.

We see, though, that these are the same people in both cases; it is the same money being used in both cases.  We also readily see that a critical difference between the government and the market solutions is that with the market solution, the decisions will be made by the people whose money is being committed—or withheld—but with the government solution, those decisions to commit (and not withhold) are made by government, committing other people’s money by diktat.  We also see the nature of that diktat in this paraphrase by Spiegel International Online of Luxembourg Prime Minister Jean-Claude Juncker’s remarks, revealing EU leadership disparaging attitude toward democracy and the crass citizenry having any input:

The German parliament’s right to co-decision on important matters pertaining to the euro bailout is one of the reasons that the summit has been stretched out over a period of several days.  And while some have demonstrated sympathy for Merkel’s problems, others have been irritated by the extra burden the co-decision has created.  Berlin isn’t the only place with a parliament….

In the nature of free markets, though, the decisions will be made far more quickly and far more transparently if they’re made by those citizens themselves.  Any damage done by a Greek default (for instance) will be far more limited in its cascade effects and far more quickly repaired.

On the other hand, government cannot keep up with the changing market conditions or with the rapidity of failure when failure is in the offing.  We’ve seen how the governments of the EU have been unable to understand the European economic problem, for instance.  The European nations have vastly and repeatedly underestimated of the amount of money needed to bail out Greece: an original estimate of some €120 billion was discovered to be insufficient last summer, and it ballooned to an additional €110, or so, billion; now those governments are finding that to be insufficient, and estimating another—in addition to that summer estimate—€252 billion.

Finally, for all those efforts these last 2 years, a Greek default now is being arranged anyway: the latest attempt is for a write-down of Greek debt of 60%.  In addition to this is the conversion of the European Financial Stability Facility (EFSF), the original pool of funds for the bailout, into an insurance scheme wherein the existing €440 billion of the EFSF will be leveraged, via insurance bets, into a €1 trillion backstop.  Both by government mandate.

But these decisions are properly those of the investors whose money it is in a free society, not a decision handed down from on high by government(s).  Let the taxpayers, in their free markets, make these decisions.  Greek default may well have the cascade of failing banks described above, especially if taxpayers decline to keep feeding the bad decision-makers, decline to continue funding bad debt issuers, against the wishes of their governments (though I doubt it’ll be so bad as the doomsayers wail).  However, without government’s involvement, the decisions and the outcomes, via the pricing mechanisms of a free market, or even a centrally-guided (if not so much, anymore, centrally managed in the EU) market, will move much faster.  Results will be known much more quickly without governments in the way as middlemen.

Thus, those taxpayers—citizens—will, as is entirely appropriate, decide for themselves, via their Invisible Hand, who the winners and losers will be; who will, or will not, receive bailouts; they need no assistance from governments.  The pace of the free market may deepen the downturn from a Greek default and any potential cascade, but with taxpayers in a free market making the decisions, the recovery will be much faster, too, and it will rise far beyond the condition preceding the onset of the Greek problem.  Indeed, had Greece been allowed to default two years ago when the problem became apparent, both the Greeks and the EU would be on the path to recovery, growth, and prosperity today.

Out of the creative destruction of a bankruptcy in a free market grows a refreshed, stronger, more vibrant economic entity than before the bankruptcy—even at the national economy level.  And the lessons learned from the bankruptcy and recovery are enormously valuable.  Out of the destruction of a propped up entity that is not allowed to go through bankruptcy grows more widespread bankruptcy and destruction and a far broader, longer lasting economic dislocation—especially at the national, and continental, levels.  And the lessons missed by that intervention and impeded recovery would have been enormously valuable.

 

*For exposition purposes, I hold that private enterprise, including private/commercial financial institutions, are agents of their individual, citizen, owners, and so in the context of this discussion, I make no distinction between citizens and the businesses they operate.

Update: Clarified Juncker’s paraphrase by indenting it.

Welfare and the General Welfare

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It has been argued that providing welfare for the least fortunate among us serves the common good—our “general Welfare.”  This is certainly true when that welfare flows from individual to individual or group, or from private group or the community to the individual or the group.

However, when that welfare flows, as a first resort, from government, it cannot be for the general Welfare—both by design and by logic.  That government welfare is not in the design of our government, not in our Constitution, is made plain by Representative James Madison in the 3rd Congress, on the matter of providing welfare to Haitian revolution victims:

Mr. Madison wished to relieve the sufferers, but was afraid of establishing a dangerous precedent, which might hereafter be perverted to the countenance of purposes very different from those of charity.  He acknowledged, for his own part, that he could not undertake to lay his finger on that article in the Federal Constitution which granted a right of Congress of expending, on objects of benevolence, the money of their constituents.

Rep Madison clearly recognized the dangers inherent in government-driven welfare: our Constitution has given our Federal government authority to pursue certain limited ends only.  These ends do not include authorization to provide the vast array of goods and services that today reduce so many of us to government dependency.  Instead, assistance is properly first the obligation of private individuals and private organizations, where dependency is not automatically created, and where it is accidentally, the scope of that dependency is far more limited.

Thomas Jefferson recognized, as well, the danger of ascribing a welfare component to the “general Welfare”—the national welfare—clause of our Constitution.  To interpret, wrote Jefferson, “general welfare” as granting the Federal government an independent power to “do any act they please, which might be for the good of the Union, would render all the preceding and subsequent enumerations of power completely useless.”  He wrote on another occasion, “Congress has not unlimited powers to provide for the general welfare, but were restrained to those specifically enumerated….”  Plainly, this includes a lack of Constitutional authority to provide welfare to individuals or to government-selected groups of individuals.

Nor can the government, as a first resort, provide welfare—under the guise of the general Welfare—as a matter of logic.  The general Welfare is the common good; it is the benefit of all of us as a national whole.  Thus, it cannot the benefit only some of us, and it cannot diminish any of us.  Yet, when government serves as the provider of the first instant of welfare, it can do so only by taking from some and giving it to others through a wealth redistribution mechanism—by taking from a disfavored group and giving the proceeds to a favored group.  Plainly, setting some groups above others cannot serve the common good: it can serve only a part of the whole, and it can do so only at the expense of the rest of the whole.

In the end, then, if there is to be welfare, and there needs to be, it must come from us directly.  Welfare is a matter of our personal obligations—from our Judea-Christian heritage and from those First Principles of our Declaration of Independence.  All men have an inalienable endowment, imbued in us by our Creator.  We have, then, a personal obligation to be the first source of welfare for those less fortunate than us, who actually need the hand up.  But it must come first from us to us, and not first through our government as intermediary.

A question was asked recently of the Estonian Economics Minister Juhan Parts.  “[D]oesn’t the government have to help those on the losing end of social change?”   “Of course,” he answered, “it’s important to help a society’s losers, the ones who are left behind. It would be wonderful to have a fantastic healthcare system and offer social guarantees for every emergency.  But you have to have the money.  We…have to reflect on what’s important for a society’s development….  If all you do is administer, nothing comes of it. The state must clear the way for those who want to achieve something. That’s the function of the state.”

We knew that once.  We would do well to relearn it.  Together with that uniquely American perspective (absent, you’ll notice, from Parts’ answer): we are first to help each other.

Taxes, or Whose Money Is It? II

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This is the second of a short series of posts that explores the nature of taxes.  In the first post, I looked at the property nature of taxes: whose money it was, both before and after, the taxation process.  In this post, I’ll look at a second and subsequent set of questions: the nature and purpose of government and the purpose of government spending.  In a third post, I’ll answer a question concerning the utility of revenue neutrality for tax program changes.

Having established in that earlier post that, under our social compact, the money collected by our government in the form of taxes remains our money and not government’s, we can address that next set of questions, beginning with: what is the purpose of our government?   With an answer to this, we can address the second question of our present set: on what should our government be spending our money?

Reviewing, briefly, we recall that men began in a state of lawless nature, even though each had certain rights and properties inherent in their very being, and in these rights and properties, each man was the equal of every other.  This so-called Natural Man’s existence, though, was quite Hobbesian: the stronger could—and would—prey on the weaker: might made right, and the Devil enjoyed the hindmost.  Out of this existence, groups of men agreed among each other to form social compacts and then to create governments in which they would vest some portion of their individual rights.  In this way, a government could act to protect all of the members of the compact, against both external marauders and fellow members of the compact.  Government, thus, would enforce each member’s inherent equality and his endowment of rights and consequent liberties.

I also mentioned, tangentially, in that earlier post that Locke, Rousseau, et al., held that the only legitimate government was one that governed with the consent of those being governed—the second two conditions I described in that post.  Take note, thus, of the means by which Natural Men form their government: it is via a wholly voluntary agreement among the members of a group—a social compact—to form themselves into a polity and then to form a government to lead that polity.  By being the outcome of an agreement among men, their government is necessarily subordinate to those men.  Indeed, our own principles statement takes both the need for consent and that inherent subordination of government to men as First Principles (our endowment is one of our First Principles, also, but that is beyond the scope of this post).  On consent, our Declaration of Independence says in so many words:

That to secure these rights, Governments are instituted among Men, deriving their just powers from the consent of the governed

The inherent subordinate role our government plays is clearly stated twice:

That whenever any Form of Government becomes destructive of these ends, it is the Right of the People to alter or to abolish it, and to institute new Government, laying its foundation on such principles and organizing its powers in such form, as to them shall seem most likely to effect their Safety and Happiness.

and

But when a long train of abuses and usurpations…evinces a design to reduce them…it is their right, it is their duty, to throw off such Government, and to provide new Guards for their future security.

Our compact’s blueprint, our Constitution, puts this principle into practice:

This Constitution, and the Laws of the United States which shall be made in Pursuance thereof; and all Treaties made, or which shall be made, under the Authority of the United States, shall be the supreme Law of the Land….

Thus, our nation is a nation governed by law, not by government.  Further, Article I, Section 9, the 9th and 10th Amendments, and the Bill of Rights generally make clear the American Sovereign is We the People, not our government.

Having arrived at the subordination of our government to us, what is it we have instructed our government to do?  We have required it, in a concrete way, to act to preserve our endowment of rights, our liberties, and to do no other thing at all.  This is clear in our Constitution’s Preamble:

…to form a more perfect Union, establish Justice, insure domestic Tranquility, provide for the common defence, promote the general Welfare, and secure the Blessings of Liberty to ourselves and our Posterity….

Our government has, by design, that Lockean/Rousseauan purpose: to secure us from external threat, to protect us from each other, and in the process to enforce our rights and freedoms.  Absent from this is an obligation of government to protect us from ourselves.  That’s wholly our responsibility, as are the outcomes of our actions, where those affect us.

Within this mandate which we have levied on our government, then, on what have we authorized our government to spend our money?  Once again, we specified this in our blueprint, in the first clause of Article I, Section 8:

…Power To lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defence and general Welfare of the United States….

This clause explicitly identifies the purpose for which we have authorized our government to collect taxes, but since it makes no sense to collect taxes except in order to spend them on those purposes, this enumeration of taxing purpose is also is an enumeration of spending purpose.

However, Treasury Secretary Alexander Hamilton and today’s Progressives argue that this clause, in fact, authorizes spending for any purpose that Congress might decide is useful.  The clause’s position in Section 8, which enumerates the powers of Congress, both Hamilton and our Progressives consider irrelevant. James Madison’s argument, though, put forth in The Federalist Papers #41, remains valid today.

Had no other enumeration or definition of the powers of the Congress been found in the Constitution, than the general expressions just cited, the authors of the objection might have had some color for it; though it would have been difficult to find a reason for so awkward a form of describing an authority to legislate in all possible cases. …

But what color can the objection have, when a specification of the objects alluded to by these general terms immediately follows, and is not even separated by a longer pause than a semicolon?

Plainly, then, far from any purpose at all, the authorization to spend our money is limited to that Article I, Section 8.  This drives us to wonder about the first clause’s enumerated purposes: to pay the nation’s debts, to provide for our common defense, and to provide for our nation’s general welfare.  Our debts are self-explanatory, as is our national defense (indeed, several of those enumerated powers simply add up to “provid[ing] for the common Defence”).  Finally, in light of the spending authorization’s position as the first of a series of enumerated powers, of enumerated taxing purposes, of enumerated spending purposes, those other enumerating clauses clearly add up to our general welfare, our common (as opposed to individual) good.  Indeed, our common good is itself bound up in keeping our country safe physically (our common Defence) and fiscally (paying our national debts).

Spending by our government can have no other purpose than these.  There is no room in our authorizations, for instance, for bailouts of institutions that have histories of poor decisions and irresponsibility with their own resources.  In a free market, the common good is best served by letting failed enterprises fail and thereby letting newer, stronger enterprises replace them.  There is no room in our authorizations, for instance, for wealth distribution, since that can only reduce the welfare of some as it tries to increase the welfare of some others.  The most effective wealth redistribution, the most efficient wealth redistribution, occurs in a free market where we can make our own decisions concerning the exchange of our own wealth, in the form of our money or goods, for the wealth of another in the form of his goods or money.  There is no room in our authorizations, no matter how heart-wrenching, for our money being spent via government mechanisms as a first resort, even on hand-ups those who’ve merely had a run of bad fortune.  Our Judeo-Christian heritage enjoins us as individuals to see to the welfare of those less fortunate.  Only after we have done what we can, only after our charities and churches have done what they can, only then is it appropriate that government spend our money on hand-ups.

Moral Hazards

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Earlier this month, President Obama claimed that “We created over two million jobs in the private sector — a million jobs this year alone in the private sector, but in the public sector, we keep on seeing these layoffs having an adverse effect….”  On the floor of the United States Senate earlier this week, Senate Majority Leader Harry Reid said that “It’s very clear that private-sector jobs have been doing just fine; it’s the public-sector jobs where we’ve lost huge numbers….”  And Vice President Joe Biden has been out on the stump assuring anyone who will listen that Republicans who vote against Obama’s Jobs Bill, or any part of it, are personally responsible for every rape, robbery, and cop killing that ensues after the bill fails.  Obama was plainly lying and Allysia Finley did a fine job of exposing him.  Reid also was plainly lying, and The Wall Street Journal‘s editorial staff did a fine job of exposing him.  Biden was plainly, well, Biden.

Rather than pursue the lies, though, I want to look at a different aspect of this “plan” of the Progressives.  This is in a throwaway line at the end of Finley’s column: “Paying governments to keep teachers and firemen on the rolls may sound good, but it actually creates a moral hazard.”  Let’s explore this moral hazard.

There are, actually, three hazards in the plan to transfer, ultimately, $130 billion dollars (the amount in the original Jobs Bill) to state and local governments, ostensibly to provide jobs for teachers, firefighters, and police.  The first hazard is that this creates a dependency in those state and local governments on continued Federal funding, and it inures those governments from the costs of the jobs they provide.  What happened with the nearly trillion dollar stimulus of 2009 that sent all those hundreds of billions of dollars to the states and cities for hiring teachers, firefighters, and police—or for “saving” all those jobs?  The Federal money ran out, and now there’s nothing left with which to continue paying those employees.  The state and local governments didn’t go through the belt tightening and efficiencies they needed to because, shielded from those costs, they had no incentive to do so.  Thus they still “need” Federal funds.  Continued Federal funding will only continue this dependency, though.  Further, continuing to have no stake in the costs, these governments will continue to have no incentive to take seriously their role in controlling them.

The second hazard concerns the individual recipients—those teachers, firefighters, and policemen—of this Federal jobs “welfare” that is washed through the state and local governments (what there is left of it after those government entities have skimmed off their cut).  They’re drawn into the same sort of dependency and shielding from costs.  They need this steady infusion of Federal largess—both in pay and in lucrative benefits—because, by using it for so long, they’ve lost their ability to work on their own—never mind that they might not be teaching, or fighting fires, or patrolling our streets.  Their dependency is just as complete as the governments through which their payments are washed.  And as with the state and local governments, these individuals have no skin in this game.  They just need their Federal hit.

The third hazard is this.  From where will the money for this “jobs” bill come?  There are three sources for this money: taxes, borrowing, and printing.  Yet, as Congressman Ron Paul points out repeatedly, borrowing and printing are just taxes.  Borrowing is a tax because the loan must be paid back, now and into the future, by us through our taxes.  Printing money is a tax because the increase in money in our economy drives up prices—it’s inflationary.  Ultimately, then, the money for all those dependency-creating transfers must come from the rest of us.  But this isn’t a private enterprise operation, where we as consumers get a choice in the product, its quality, and its price.  This is a government operation, in which we must participate without any choice or control at all: we must pay the tax price, and we must accept the product as it is delivered.  We’re denied a stake in the product; we just have to accept all the risk of which the state and local governments, and the individual recipients, are absolved.

None of this is to say we don’t need quality teachers, firefighters, or policemen; we certainly do, and in spades.  But we can’t continue feeding the expectation that the Federal government will pay for everything forever, that there is no such thing as failure.  That’s the path to national bankruptcy.