Monthly Archives: October 2011

Government Market Intervention

Posted on by
Reply

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.

Spending Cuts: Austerity, or Thrift?

Posted on by
Reply

Europe’s search for a solution to its exploding debt crisis is couched in terms of austerity and citizen “sacrifice.”  Indeed, the Greeks riot over “austerity measures” which their government take that they consider to be going too far, and the Italian coalition government is threatened with collapse over the need to engage in further “austerity measures” to control its own long-standing national debt.  The arguments here at home over how deep to cut, if at all, are couched more and more in terms of “austerity measures.”  This raises other questions, though.

Is there no thrift involved in any of this?  Is thrift not a player at all, do the debaters tacitly assume that thrift is wholly subsumed into what is austerity?

When there are true austerity measures being contemplated or enacted, a nation is having to reduce expenditures on more than the highly useful or the nice to have features of its economy—a tax subsidy for this industry, for instance, pay raises for government employees, or expenditures on those national parks, and so on.  It’s also having to reduce or eliminate spending on the things actually necessary to the nation’s independence of action—national defense, roads and communications networks, other infrastructure items, and so on.  Austerity also cries out for tax increases to support its minimally required spending.

When the nation is being thrifty, instead, it’s managing its accounts and making the spending tradeoffs necessary to avoid overstretching is finances to the point where austerity is thrust upon it.  When the nation begins to overstretch—perhaps from a period of drift, perhaps deliberately to acquire a particularly expensive item or capability—it makes further tradeoffs, deferring spending here, eschewing purchasing altogether there—in order to bring its spending back into line.

Thrift, apart from being simply a wise management of the nation’s money, also is a powerful ward against the conditions that force austerity.  But to achieve control over our future, to avoid a need for austerity measures, in short to be thrifty, a government must achieve two things.  It must obtain a net positive income—that is, it must maintain its spending at a level at or below its revenue intake (and it must emphasize the “below” part where the national debt has gotten excessive).  The second thing it must do is commit that budget surplus to the following purposes.  First, government must pay down the national debt until that value is at a properly low level.  Then it must use the surplus to build the same sort of “rainy day” fund that many states accumulate and all responsible families accumulate, so that these accumulated savings can be tapped for unexpected needs, rather than routinely running up the national debt.  Finally, with the debt at a reasonable level and savings accumulated to a useful level, the surplus must be reduced by reducing the taxes collected from the citizens for whom the government works.

There are a couple of things that our government, in particular, can do to achieve that first requirement of achieving a net positive income and so to avoid the need for austerity measures.  One is to carefully and cold-bloodedly identify the things on which it spends that are truly necessary; the things that are useful, but not critical, to have; and the things that are, for lack of a better word, luxuries.  We have, as a nation over the last three generations (primarily spanned by the baby boomer generation after WWII), gotten so wealthy that we’ve simply lost track of the distinctions among these three categories.  Everything is necessary, because we’ve been able to afford it, or so it has seemed.

The other thing our government should do is determine where the responsibility for the spending should lie: with government, or with the individual.  Not everything on which our government spends should be a government expenditure.  One item, for instance, on which the government spent 20% of its 2010 budget, is Social Security.  A well-intended program, it was badly designed and has been badly managed by government to the point that this combination of failure will leave the program bankrupt in just a few short years.  Privatized retirement programs, where each citizen owns and manages his own retirement funding, will be a vast improvement in the government’s thrift.

This recognition of where spending responsibility lies, and an associated shift in who does the actual spending, is critical because this is the force behind thrift: the decisions made when it’s our money on the line vs. the decisions made when it’s votes and other people’s money on the line.  We’re much more likely to take care of our financial house when it’s our money, than is government, whose bureaucrats and politicians have no skin in that game.

Returning to government thrift has another beneficial pathway.  Reduced government spending, more disciplined government spending, reduces the flow of government money and of government debt into our economy.  This reduces crowding out of and competition against private enterprise, fostering their growth (and hiring).  In the end, almost any spending cut, to borrow a phrase from the present administration, is stimulative.  And so not austere.

Bank Bailouts

Posted on by
2

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.

Holidays and Insensitivity, Follow-up

Posted on by
Reply

A bit ago, I wrote about the apparent holiday insensitivity of a politically correct treatment of the fall holidays in a Massachusetts school.  In that post, I posed some questions to Dr Foley and Dr Pierantozzi concerning certain remarks they were quoted as having been made, in particular concerning Christopher Columbus, Thanksgiving, and Hallowe’en.  Dr Foley’s remarks were contained in an internal email to her school staff which had been obtained by Boston Herald columnist Jessica Heslam; Dr Pierantozzi’s remarks were made publicly in support of Dr Foley.   Separately, I emailed Ms Heslam, requesting access to that internal email from which she quotes.

Dr Foley’s original email is available here, courtesy of the SomervillePatch, and I’m providing it below.

From: Foley, Anne
Sent: Wednesday, October 05, 2011 7:44 AM
To: Kennedy School
Subject: our next holiday

When we were young we might have been able to claim ignorance of the atrocities that Christopher Columbus committed against the indigenous peoples of the “new” world.  We can no longer do so.  For many of us and our students celebrating this particular person is an insult and a slight to the people he annihilated.

On the same lines – we need to be careful around the Thanksgiving Day time as well.  For many people this was just one big happy meal.  We can talk about this more during grade level meetings today if you choose.

Anne

From this email, it’s plain that there was no ban on holidays at the school; there was only an intent to “spark discussion.”

Since then (the following Monday, in fact) Dr Foley has delivered an explanation via email and autocalling an explanation of her remarks in that internal email.  That message is provided below, also courtesy of the SomervillePatch.

This message is to address the Herald article and its aftermath that occurred this past Friday. As we all know anything posted on the internet has the potential to become public. The email I sent was addressed to Kennedy School staff with the intent of sparking an educational discussion on how we can address the multi-cultural perspectives on our upcoming holidays. If this message had been intended for a broader audience, I would have chosen less inflammatory words and provided more of a context for the message. I apologize if my words offended anyone – that was not my intent.

Please know that nothing has changed regarding the instruction and events planned at the Kennedy School this year. As always, teachers and classrooms address holidays as part of their curriculum. I support the outstanding staff at the Kennedy School who will continue to provide the best education for our students. I want to thank all of those who have offered me kind words.

Thank you.

It’s plain that errors occurred in this affair.  Dr Foley has already addressed hers.  Ms Heslam, however, seems to have taken remarks out of context and created a story where none, in fact, existed.  The rest of us, yours truly included, were too quick to jump on the anti-PC bandwagon and start screaming bloody murder.

Taxes, or Whose Money Is It? III

Posted on by
Reply

This is the third 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 the second post, I looked at a second set of questions: the nature and purpose of government and the purpose of government spending.  In this post, I answer a question concerning the utility of revenue neutrality for tax program changes.

We established in those earlier posts that money continues to belong to us and not our government after it has been allocated to government in the form of taxes.  We  established subsequently that what our government is permitted to spend our money on is quite limited.  From these, we can now answer that third question: is revenue neutrality in changing (by a little or with a wholesale replacement, in the manner of a Cainian 9-9-9 replacement, for instance) our tax system useful or necessary?

The answer to this turns out to be quite straightforward; although, it depends on a couple of circumstances.  Even though the money is ours and not government’s, and even though permitted government spending is quite limited, enclosed by those bounds are these simple facts.   Government has a purpose clearly defined by us in our social compact, and within that purpose, government must spend in order to achieve that purpose.  There is a minimum level of government spending, defined by that purpose, which our government must do.

Separate from this, but no less important, is the simple fact that people and our markets adapt to a government spending régime.  We always seek the optimal allocation of our money within the bounds of the economic environment within which we must operate, and we tend to stabilize there and form habits of spending and acquisition appropriate to those parameters.  Free markets adapt very quickly to changing conditions, but they do not adapt instantaneously: habits are hard to change, and changes take time to ripple through an economy.

Thus, the straightforwardly dependent answer to our question is this.  Plainly, since the money is, and always will be, ours regardless of whether it sits in the coffers of free market participants or those of our government, revenue neutrality from tax system change is not necessary, per se, and so it has no inherent appropriateness.  However.  Were our government’s spending already at that minimum level needed for government to achieve our purposes for it, then revenue neutrality would be necessary to maintain that minimum level.

On the other hand, were our government’s spending significantly above that threshold level, then a degree of revenue neutrality would be needed in order to avoid unnecessary market disruption while the new tax system is put into place.  Neutrality should not be absolute, here, however; with government spending exceeding its necessary amounts, some degree of revenue reduction in the year of enactment, is not merely acceptable, but necessary—as a first step in a separately needed sequence for getting that spending back down to where it belongs.

Our current government’s spending is wholly out of control: it vastly exceeds revenues, it is allocated to wholly inappropriate matters (vis., loans to government-favored enterprises), its allocation to welfare far exceeds what is appropriate or necessary (vis., paying people for two (or more) years for not working), and its allocation to entitlement programs which are bankrupt, or nearly so, is inherently wasteful.  Thus, we find ourselves meeting the second criterion above: too much spending.  A degree of revenue reduction in the year of enactment of a tax system overhaul or replacement is entirely appropriate.  Revenue neutrality is not at all necessary or appropriate today.