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Austerity By the Numbers

Veronique de Rugy — Thu, 24 May 2012 16:57:52 -0400

Publication

We are told that austerity in Europe has failed. The elections in France and Greece, for instance, are supposedly evidence of people’s opposition to severe cuts in spending. However, the growing anti-austerity backlash in Europe ignores one fundamental point: If there is austerity in Europe, in most cases it hasn’t taken the form of massive spending cuts.

The following collection of charts shows the extent to which certain countries in Europe have participated in “austerity” measures. Using different measures of government spending from the European Commission’s Eurostat and the Organization for Economic Cooperation and Development (OECD), the data show a reoccurring trend: While a few countries have reduced spending by slight amounts, most have not. Furthermore, the unseen (and less talked about) tax hikes and increased regulatory burdens continue to augment the façade of austerity in the Eurozone.

No "Savage" Spending Cuts in Sight

The chart above shows government spending for various Eurozone countries from 2000 to 2011. Following years of large spending expansion, Spain, France, the United Kingdom, and Greece—countries widely cited for adopting austerity measures—haven’t significantly reduced spending since “austerity” supposedly started in 2008.

France and the United Kingdom have not cut spending. When spending was actually reduced—between 2009 and 2011 in Greece, Italy, and Spain—the cuts were relatively small compared to the size of their bloated European budgets.

While Italy reduced spending between 2009 and 2010, it also increased spending in the following year by an amount larger than the previous reduction. The same is true for Ireland, where spending in the country went down between 2010 and 2011 by €27.9 billion after going up by €25.7 billion the year before. That’s a miniscule €2.2 billion drop from 2009 to 2011.

Most important, meaningful structural reforms were seldom implemented. Whenever cuts took place, they were always overwhelmed with large counterproductive tax increases. This so-called balanced approach—some spending cuts for large tax increases—has been proven to be a recipe for disaster by economists. It fails to stabilize the debt, and it is more likely to cause economic contractions.

Adjusting for Inflation

This version of the previous chart uses data from the European Commission’s Eurostat to show total government spending in real terms from 2000 to 2011. It is important to note that inflation hasn’t changed much in the past three years. Again, after the data is adjusted, we see that spending increases are the norm rather than the exception. This is evidence that nominal spending is what matters in the short run. The real question to be addressed is how bad spending cuts have been in nominal terms.

Government Spending By Country

The charts below show the profiles of European countries’ spending patterns to assess the magnitude of change in real government expenditures between 2002 to 2011. The data showing the United Kingdom’s government spending is presented in nominal and real pounds from 2000 to 2011.

GDP Growth Rates: The Swedish Approach

This chart uses GDP growth rate data from the OECD to illustrate the magnitudes of economic growth in Sweden, the United States, and France from 2006 to 2011.

The three-country comparison highlights that, while each recorded negative economic growth after the recession, Sweden not only took the largest hit but also experienced the largest rebound by 11 percent (from –5 percent in 2009 to 6.1 percent in 2010).

So what accounts for the difference in outcomes? First and foremost, France has yet to cut spending. In fact, to the extent that the French are frustrated by so-called budget cuts, their only real complaint is that future increases in spending will not be as large as planned. (The same can be said about the U.S. budget.)

By contrast, Sweden has significantly cut government spending without equivalent increases in taxes. Sweden’s finance minister, Anders Borg, successfully reduced welfare spending and pursued economic stimulus through a permanent reduction in the country’s taxes, including a 20-point reduction in the top marginal income tax rate. As a result, Sweden’s economic growth has, of late, trumped every other European country’s. Sweden’s commitment to reform has paid off in economic growth.

Successful Fiscal Reform

While the debate over austerity continues, the evidence suggests that austerity can be successful so long as it isn't modeled after the so-called “balanced approach.” Other European countries and the United States should take heed and stop succumbing to the lure of an easy answer—to close budget gaps with higher taxes.

The “balanced approach” has proven a recipe for disaster. In a 2009 paper, Harvard University's Alberto Alesina and Silvia Ardagna looked at 107 attempts to reduce the ratio of debt to gross domestic product over 30 years in countries in the OECD. They found fiscal adjustments consisting of both tax increases and spending cuts generally failed to stabilize the debt and were also more likely to cause economic contractions. On the other hand, successful austerity packages resulted from making spending cuts without tax increases. They also found this form of austerity is more likely associated with economic expansion rather than with recession.

While the “balanced approach” may give the appearance of pursuing fiscal solvency, in practice it stagnates the possibility of growth. Real fiscal reform comes from a commitment to cut spending and from structural changes to taxation and the regulatory environment.

For more information about this chart series, contact Robin Landauer. For media inquiries, contact media@mercatus.org

Not Liking Facebook

Hester Peirce — Thu, 24 May 2012 15:58:57 -0400

Expert Commentary

Facebook’s initial public offering (IPO) captured the imaginations of many people who had never before considered investing. Much of the interest came from Facebook users who wanted to own a piece of a company that has become a staple of their lives. Others dreamt of turning a quick profit by getting in and out of the stock within the first day or week. Widespread media coverage only added to the fervor.

Yet all this enthusiasm did not produce the IPO “pop” that so many had anticipated. Instead, it led to an IPO drop, with the company closing lower than it opened on its first day. The fact that the stock did not rise on Day 1 taught a valuable lesson on investing: investing is not a risk-free game. You can lose money. Proceed with caution.

The technical problems that plagued Facebook’s rite of passage to public company status may have contributed to investor losses and certainly contributed to investor confusion. NASDAQ, the exchange that won the prized Facebook IPO, encountered technical problems that contributed to the offering’s rough-and-tumble first day. Investors were left in limbo for hours -- not sure whether their purchase, sale, or cancellation orders had been processed. NASDAQ has admitted that, knowing what it does now, it would have delayed the IPO to address its systems issues.

The NASDAQ software glitches were not the first problems Facebook encountered in its quest to raise capital. A year ago, Goldman Sachs abruptly moved a private offering of Facebook shares overseas. Apparently, the move was driven by a fear that the media coverage of the deal might have caused it to run afoul of an ill-defined SEC regulation that prevents such offerings from being advertised.

The recently passed JOBS Act loosened this unwieldy advertising ban and took other steps to make raising capital easier in the United States. Among other measures, the JOBS Act provides relief for companies that want to go public, including by providing temporary relief from a particularly expensive Sarbanes-Oxley provision.

It would be a shame if the highest profile IPO since the passage of the JOBS Act leads to a new round of regulation that impedes IPOs. The recent JP Morgan flap illustrated how readily calls for regulation come when private market participants make embarrassing mistakes. Sometimes, though, regulation is not the answer. NASDAQ, which is in a perennial battle for listings with the NYSE and other exchanges here and abroad, is unlikely to be complacent about its technology problems.

NASDAQ’s CEO followed the lead of JP Morgan’s Jamie Dimon by admitting his company’s mistake and pledging to do better. NASDAQ has set aside money to compensate harmed investors and already faces at least one investor lawsuit. There are now news reports that the NYSE is courting Facebook. Because NASDAQ is undergoing painful market discipline for its mistake, new regulations do not seem necessary.

A Regulator Who Knows No Bounds

Hester Peirce — Thu, 24 May 2012 10:19:33 -0400

Expert Commentary

In a speech on Monday, Commodity Futures Trading Commission Chairman Gensler seized upon JP Morgan’s London trading travails as the latest example of just how easy it is for bad decisions made overseas to bounce over the Atlantic and harm the American financial system. Gensler’s solution is to let the CFTC regulate financial firms’ activities worldwide.

Gensler is correct that bad decisions made in one country can affect other countries’ economies, but U.S. regulators can’t shock proof the world. Perhaps Chairman Gensler, who, earlier this week, was complaining to the Senate Banking Committee about not having enough resources to do his job, should not try to add transactions conducted in Europe and Asia to his regulatory plate.

A letter last year from the Japanese Financial Services Agency pushed back against Gensler’s regulatory hubris: “As [the Dodd-Frank Act] is a US law, naturally we expect this law to be applied to US entities incorporated in the U.S. For Japanese financial institutions, laws and regulations of Japan, which are consistent with the internationally agreed framework … , should apply.”

In supporting his case for greater international reach for the CFTC, Gensler looked back to the 2008 crisis and the AIG experience:

As the financial system failed in 2008, most of us learned that the insurance giant AIG had a subsidiary, AIG Financial Products, originally organized in the United States, but run out of London. The fast collapse of AIG, a mainstay of Wall Street, was again sobering evidence of the markets’ international interconnectedness. Sobering evidence, as well, of how transactions booked in London or anywhere around the globe can wreak havoc on the American public.

Chairman Gensler should have told the other part of the story, which is that AIG’s domestically regulated domestic insurance subsidiaries were a large part of AIG’s downfall. The state-regulated insurance companies were involved in a multi-billion dollar program of lending out securities short-term and investing the lending proceeds in risky, long-term residential mortgage backed securities.

Many of banks put at risk by AIG’s aggressive securities lending program were foreign. Using Gensler’s logic, European regulators of those banks should be clamoring to regulate American insurance companies like AIG. Just as having European regulators telling U.S. insurance companies what to do would not be palatable to most Americans, an American regulator’s efforts to regulate foreign transactions will not be welcomed abroad.

Chairman Gensler would do well to focus on his domestic mandate, which should include a clear message that firms must bear the consequences of their own bad decisions about where and with whom to do business. Regulators can’t be everywhere all the time and they should not pretend they can protect the financial system from every bad event here at home, let alone across the world.

Consumer Welfare and TV Program Regulation

Bruce M. Owen — Thu, 24 May 2012 10:13:23 -0400

Publication

There are few alleyways of the administrative state more obscure or more littered with obstacles to efficient markets and improvements in consumer welfare than the interventions regulating ownership and licensing of TV stations and programs. What distinguishes TV programs from other mass media content, including both traditional print and new online media, is the extreme eagerness of Washington to engage in efforts to prevent markets from working freely, often in response to interest group pressures and opportunities for political advantage and with almost complete indifference to the welfare of consumers.

This paper first briefly describes some unusual economic features of media content and the characteristics of free markets in media content and then lists some of the legacy interventions that prevent video markets from operating to the advantage of consumers. Lastly, it considers what reforms will be required to eliminate the distortions currently impairing these markets.

From the public’s perspective, getting rid of obsolete regulation of broadcast and MVPD video programming is essential to the efficient operation of a market that has long been an important (but could have been a much more important) source of consumer welfare. Consumers today pay more than $100 billion annually for MVPD services, implying a willingness to pay (actual payments plus consumer surplus) well in excess of that amount. MVPD or equivalent services that increase video program distribution capacity were delayed and suppressed for many years, and this consumer value was lost. This was in the effort to protect initial broadcast licensees from competition in the (nominal) pursuit of ill-defined and ephemeral public interest and localism objectives.

It's past time to stop extending interventions originally intended for an old technology (broadcasting) to a range of new competitive media. Even if one thought the restrictions on competition and entry that have existed from 1927 to the present day were originally justified by assumptions about spectrum scarcity and vague notions of the public interest in local content or sources, it is now clear these assumptions are incorrect. No longer is there any rational public policy basis for a government agency or its legislative overseers to dictate how much or what content the viewing public can see, any more than there ever has been for printed media. There is no market failure to which the current regulatory framework is responsive. There is no reason to think that regulators can improve on even less-than-perfect market outcomes in this sector of the economy. Most important, there is no reason for FCC bureaucrats to decide how much of the spectrum should be used for each of many existing and potential commercial services.

Program producers, aggregators (cable and former broadcast networks), and local distributors (MVPDs) should be allowed to reach agreements among themselves for the creation and delivery of programs and audiences in competitive markets without regard to which technology is used to produce or deliver their goods. Their freedom of contract will promote an efficient and expanding supply of video content to compete for advertising revenue and viewers’ dollars. An adequate supply of tradable rights in spectrum will reveal how much competition is possible among traditional wired and wireless, analog and digital, and fixed and mobile delivery services. Judging by the patterns of history, regulating in the expectation that competition will be inadequate will only help ensure that very result.

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Medicare Numbers Examined: Blahous and Bernstein Discuss the Fiscal Consequences of the Health Care Law

Charles Blahous — Wed, 23 May 2012 10:51:03 -0400

Video

On Monday, May 21st, e21 held an event: "Medicare Numbers Examined: Blahous and Bernstein Discuss the Fiscal Consequences of the Health Care Law, "an animated discussion between Jared Bernstein and Charles Blahous, author of the landmark study "The Fiscal Consequences of the Affordable Care Act."

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How Many Workers Support One Social Security Retiree?

Veronique de Rugy — Tue, 22 May 2012 16:08:27 -0400

Publication

With the Social Security Trust Fund exhausting faster than expected, another obstacle to the sustainability of the program is rearing its head: Social Security benefits rest on fewer and fewer taxpayers. This week's chart by Mercatus senior research fellow Veronique de Rugy uses data from the 2012 Social Security Trustees Report to show the number of workers that need to contribute to the system to ensure the benefits for one retiree.

Most of the major shifts in worker-to-beneficiary ratios before the 1960s are attributable to the dynamics of the program's maturity. In the early stages of the program, many paid in and few received benefits, and the revenue collected greatly exceeded the benefits being paid out. What appeared to be the program's advantage, however, turned out to be misleading. Between 1945 and 1965, the decline in worker-to-beneficiary ratios went from 41 to 4 workers per beneficiary.

The Social Security program matured in the 1960s, when Americans were consistently having fewer children, living longer, and earning wages at a slower rate than the rate of growth in the number of retirees. As these trends have continued, today there are just 2.9 workers per retiree—and this amount is expected to drop to two workers per retiree by 2030.

The program was stable when there were more than 3 workers per beneficiary. However, future projections indicate that the ratio will continue to fall from two workers to one, at which point the program in its current structure becomes financially unsustainable.

*Note on the data: At the inception of Social Security in 1935, there were few beneficiaries and a lot of workers. (See the number of beneficiaries per 100 covered workers inTable IV.B2 of the Trustees Report). As the post-WWII baby boomers were born, the worker-to-beneficiary ratio increased. As birth rates decline and the baby boomers retire, the worker-to-beneficiary ratio is on the decline. The increased longevity of Americans only further compounds the problem.

Dedicating Tax Revenue: Constraining Government or Masking Its Growth?

George R. Crowley, Adam J. Hoffer, One Time Pete — Wed, 23 May 2012 01:38:19 -0400

Publication

Evidence shows that tax revenues dedicated to politically popular expenditures like education or highways are used to increase general fund revenues and overall government size rather than for the intended purpose. Dedicated, or “earmarked” tax revenues, are generally ineffective in increasing expenditures for the program they are tied to, and they successfully increase total government spending.

Earmarking tax revenue is a budgetary practice that involves dedicating a percentage of the tax revenue from a specific source to a specific expenditure. Empirical studies have found evidence that while some portion on dedicated tax revenue does stick to its intended target, the majority goes elsewhere.

The fundamental issue with earmarking tax revenue is its fungibility. This means that additional earmarked revenue dedicated to a specific expenditure can be used as a substitute for previous funding that had been coming from the general fund. The money’s fungibility provides policy makers with a way to increase government size without highly unpopular increases in rates on general fund taxation sources. Should the tax increase they propose be approved, the earmarked revenues may be used in place of previously used general fund revenues, allowing these funds to be spent elsewhere. The result is no net effect on the target expenditure and an increase in total government size.

After examining data from 49 states, the results indicate that the majority of dedicated revenues fail to increase spending in their target expenditure category. These same earmarks, however, are quite effective at increasing spending on other expenditure categories.

To illustrate, let’s say a state government spends $100 from the general fund on education. The legislature passes a special sales tax on the basis of its revenue being set aside for education spending. Further, suppose this new tax brings in $50 in revenue. Although you may assume education spending will increase to $150, policy makers actually have the option to decrease spending on education out of the general fund. Even if the $50 earmarked for education spending is actually spent on education, total education expenditures may remain unchanged if the legislature decides to decrease general fund spending on education from $100 to $50. This allows them to spend $50 of revenue previously for education on another project, education spending remains the same as before, and the earmark is functionally equivalent to a $50 increase in unspecified general fund revenue.

To that end, the study investigates whether earmarked revenues are used for their intended purposes and whether overall spending and spending on categories other than the intended destination increase as the amount of earmarked revenues grows.

The table above shows that in general, earmarking is not an effective method of increasing expenditures on specific programs, and typically some (or all) of the increase in revenue dedicated to a program is compensated for by associated decreases in spending from the general fund. Of the 15 earmarks explored, only tobacco tax revenue and personal income tax revenue earmarked to education and sales tax revenue and vehicle registration revenue earmarked to local governments unambiguously led to increases in expenditures on the targeted category. In some cases, the earmarks had a negative effect on spending in the targeted category. In nearly every case where an earmark failed to stick to its targeted expenditure, nontargeted spending increased.

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Double Liability A Better Response to J.P. Morgan Mess

Hester Peirce — Tue, 22 May 2012 09:25:57 -0400

Expert Commentary

This excerpt was originally published in US News and World Report. Read the full text here.

Gasps about J.P. Morgan's more than $2 billion in trading losses dominated Washington conversation last week. J.P. Morgan, the government-anointed rescuer of its weaker brethren during the financial crisis, was not supposed to make a mistake like this. As people fret about the need for more regulation to keep big banks from losing money, it is worth asking whether regulating banks into profitability is really the answer.

J.P. Morgan's status as a banking entity means that, for some, Jamie Dimon's apology and the company's own damage control efforts are not enough. J.P. Morgan can't be trusted to clean up its admittedly massive mess the way similarly humiliated nonbanks do when they make money-losing business decisions.

Instead, many observers are calling for a regulatory solution: Regulators would identify bad business decisions in advance and order banks not to make those decisions. That sounds great, except it doesn't work. Remember, more than 400 heavily regulated banks have failed since 2008 and many others survived only because of taxpayer bailouts...

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America's Small-Business Fetish

Veronique de Rugy — Tue, 22 May 2012 12:48:57 -0400

Expert Commentary

This excerpt was originally published in the June 2012 edition of Reason. Read the full text here.

On February 12, House Majority Leader Eric Cantor (R-Va.) sent a message to his 62,550 followers on Twitter: “Small business is the job growth engine in this country and we need to pursue policies that reflect that reality to create jobs.” Cantor was wrong on both counts. Despite overwhelming conventional wisdom to the contrary, small businesses are not the engine of growth. And the small businesses that do create jobs rarely stay small for long, which makes crafting policies that favor those fast-growing firms both difficult and unnecessary.

The cult of the small business is so prevalent that you are treated like a heretic in Washington if you don’t pledge to do something nice for the little guys. Targeted tax credits, special regulatory exemptions, preferential access to government contracts—nothing is too good for America’s DIY manufacturers and social networking startups. Support for the Small Business Administration (SBA), a federal agency tasked with handing out goodies to the modestly sized, remains strong, despite dozens of compelling studies demonstrating that its efforts amount to little more than poorly targeted corporate welfare.

In his 2011 budget, President Barack Obama requested $1.4 billion to fund SBA programs. Most of the agency’s money is spent on special credit programs for small businesses that have difficulty getting loans from regular banks. In fiscal year 2011, the SBA guaranteed $30 billion in such loans, which theoretically don’t cost taxpayers anything. In practice, however, whenever the economy goes south, the SBA can’t cope with the number of small businesses that default on the loans. In 2011 the SBA ended up spending $6.2 billion, a $4.8 billion increase over its requested amount, mainly because so many small businesses couldn’t make their payments.

The idea that small is glorious or that small businesses are the engine of growth is based on bad economics, and the result is bad policy...

Veronique de Rugy Debates How to Fix the Economy on Voice of America

Veronique de Rugy — Tue, 22 May 2012 16:32:07 -0400

Video

Veronique de Rugy says Japan’s experience shows that government spending increases costs but not growth. "They have, for years and years and years, tried to get out of their recession, or their slow or non-growth, through spending and spending and spending and being in debt and that has not worked," de Rugy said. During recessions, many governments spend money on public infrastructure to create jobs and spur long term growth. But de Rugy says, if government spending boosts demand and growth during recessions, it should not be needed when the economy is strong. "In times of boom or economic growth, government should be cut. The size of government, government spending, should go down. And that never happens," de Rugy said.

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Health Care Plan Rebates Have Hidden Costs

Christopher J. Conover, Jerry Ellig — Tue, 22 May 2012 12:52:59 -0400

Expert Commentary

This article originally appeared in Roll Call

Some consumers and businesses might see a little extra cash this summer as a result of the 2010 health care law. The Kaiser Family Foundation recently reported an estimated $1.3 billion in rebates will be delivered from health insurers who spent more than the law allotted on administrative expenses and profits.

What people don’t realize is that there’s a catch to this “free” money. The rebates are required by an obscure regulation in the health care law, called the “minimum loss ratio,” which also contains longer-term incentives for health insurers to increase costs that will be passed along to all of us. Instead of rushing to spend these extra dollars, rebate recipients are better off pocketing it to pay for higher premiums in the future.

The regulation is supposed to benefit policyholders by limiting what insurance companies can spend on administrative costs and marketing expenses — and by limiting profits. It requires insurance companies to pay a specified percentage of their premium income — usually 80 percent or 85 percent — for health care (or initiatives that will improve the quality of health care). So if an insurer spends only 84 cents of each premium dollar on health care benefits instead of 85 cents, it would have to rebate the difference to consumers. With the typical family health insurance premium now exceeding $15,000, that one percent difference could amount to $150.

Unfortunately, the regulation contains several incentives that actually discourage activity that clearly benefits the policyholder.

For example, insurance company expenses to prevent fraud are considered “bad” administrative costs. Suppose an insurance company is right at the maximum allowed spending on administrative costs, but it needs to spend an extra $100 to prevent $1,000 worth of fraud. It won’t, because it will get penalized.

Because fraud accounts for 3 percent to 10 percent of total health care spending, according to the National Health Care Anti-Fraud Association, we ought to be doing everything possible to prevent it rather than creating incentives to catch it only after the fact. Which do you think is more cost-effective? Putting a lock on your door to prevent burglaries or leaving your door open and paying cops to track down your stolen goods?

This requirement is a step toward regulating health insurance companies like electric or gas utilities. Traditionally, regulators have tried to let these companies cover their costs plus earn a “reasonable” profit. Experience shows us, however, that when regulation limits profits and allows companies to pass on costs to consumers, it kills the incentive for cost control. The easiest way for a company to make profits look reasonable in relation to costs is to raise prices.

Although health insurers will pay some rebates this year, the cash should be treated as a short-term benefit with a long-term cost. Rebates will likely disappear in the future as the companies become more familiar with the regulation and learn how to game it.

To do this, they don’t even have to be dishonest; they just have to get lazy. A health insurer can keep more profits by simply getting lax about how much it pays for medical procedures. For example, 85 percent of a $16,000 annual family premium leaves a bigger profit than if the premium were only $15,000. As long as the company can convince regulators that the cost of medical care has gone up, it can justify higher premiums.

These consequences are just another reason regulations need to receive more careful consideration. By fast-tracking the health care law, Congress and the administration took the chance to put cash in some voters’ pockets right before a major election while postponing a poorly understood and opaque cost until later. This is how the political system too often works, and it rarely benefits those who are not on the campaign trail. Let the voter beware.

Oversight of the Federal Housing Administration's Reverse Mortgage Program for Seniors

Anthony B. Sanders — Fri, 18 May 2012 16:52:11 -0400

Publication

Chairman Biggert, Ranking Member Gutierrez and Members of the Subcommittee, thank you for inviting me to testify today. My name is Anthony B. Sanders. I am Professor of Finance at George Mason University in the School of Management and senior scholar at the Mercatus Center. I was previously Director of asset- backed and mortgage-backed securities research at Deutsche Bank and the co-author of “Securitization” (with Andrew Davidson) as well as numerous economic and finance publications on housing and the housing finance system.

EQUITY EXTRACTION IN HOUSING

Beginning in 1995, American households began extracting equity from their housing in ever growing numbers (see Figure 1). This effectively removed the equity cushion and increased the loss severity on mortgages when the housing bubble burst.1 In the mid-to-late 1990s, the U.K. was trying to find a way to increase equity extraction from their housing market for seniors, ostensibly to diversify their senior’s investments towards bonds and equities and away from housing which tends to form bubbles that burst. The Bank of Scotland and Barclays used a shared appreciation mortgage structure that generated cash for seniors in exchange for forgoing a percentage of the appreciation of their house, enabling seniors to extract equity while staying in their homes.2 While it was enormously popular with seniors at first, complaints from consumer groups and family heirs removed some of the sparkle from this innovative approach to home equity extraction. But the real problem was that neither Bank of Scotland nor Barclays could successfully raise additional capital to fund this product by securitizing them.3 The rapid rise in housing prices in the UK (See Figure 2: from an index of 2,693.7 on December 31, 1995 to 9,738.6 on September 30, 2007 – almost a fourfold increase) resulted in seniors owing, for example, 75% of the gain in price of their house to the lender. But if house prices had dropped, the borrowers would have owed nothing and the lenders would have suffered losses. The loan balance can increase over time if an interest rate is charge on the equity extraction amount. The UK reverse mortgage (or shared appreciation mortgage) had little default risk since the borrower was receiving payments rather than making them. But default or acceleration could be triggered by failure to pay property taxes or maintain the dwelling (since the lender can have up to a 75% share in the appreciation). The latter is the moral hazard risk that borrowers, once they have their equity extraction, have less of an incentive to maintain their property.

THE FHA'S REVERSE MORTGAGE PROGRAM FOR SENIORS

The FHA has a similar reverse mortgage program for seniors to the UK SAM. With the home equity conversion mortgage (HECM), the borrower must still repay the amount owed to the lender. If the borrower has insufficient funds to pay off the HECM, the house is sold and the proceeds go to pay off the borrowed amount.4 So in this respect, the FHA’s HECM program is a UK SAM without saying so: house prices still determine the amount owed to the lender by the borrower as well as the amount that the borrower can extract.

FHA insurance for HECMs protects the lender rather than the borrower. In the event that the amount owed by the borrower exceeds the value of the property, the loss to the lender will be covered by FHA. But under the reverse mortgage program, any payments due the borrower are also protected. HUD has a legal obligation to make such payments in the event that the lender does not. So, HUD is “on the hook” for negative equity in a home (as well as defaults due to failure to pay property taxes and maintain property insurance).5

The costs to seniors, aside from the usual fees associated with lending are that FHA guaranteed HECMs may have an initial FHA Mortgage Insurance Premium (2% for HECM Standard product) as well as Annual FHA mortgage insurance (1.25% of reverse mortgage balance).6

The costs to taxpayers are the losses absorbed by HUD for the housing price shortfall, default and support. As our population ages and reverse mortgages become more common, we have to be careful about projected losses to taxpayers from yet another housing subsidy program.

THE FHA'S DILEMMA

The FHA, HUD and the Federal government face enormous challenges going forward. Federal debt held by the public is currently $10.9 trillion which has increased $6 trillion since January 2007 and $4.6 trillion since President Obama took office on January 20, 2009 (See Figure 4). The Federal government has been running trillion dollar plus deficits and will continue to do so (See Figure 5) which will result in even more Federal debt. Student loan debt is over $1 trillion and growing, another federally guaranteed program.

On the housing finance front, Fannie Mae, Freddie Mac and the FHA have captured the mortgage insurance industry with over a 90% market share. Fannie Mae and Freddie Mac have cost taxpayers $170 billion thus far and counting.7 And we do not yet know the final costs of the 14 loan modification programs from the Administration, including the Attorneys General Settlement. The Administration and Congress are pressuring FHFA to allow Fannie Mae and Freddie Mac to perform principal write downs and the costs could be staggering.8

This brings us to the FHA. The FHA is deeply insolvent with insufficient capital. The FHA Is estimated to have a current net worth of –$12.05 billion and an estimated capital shortfall of $31–50 billion. The good news is that the total delinquency rate in March declined to 15.78% while the serious delinquency rate declined to 9.47%. But with the U.S. housing market is disarray and house prices continuing to decline in many markets (see Figure 6), the losses could mount for the FHA and American taxpayers even further. And with housing prices declining, the FHA continues to insuring and subsidizing 3.5% down payment mortgages.9

The question remains as to why the Federal government is guaranteeing and subsidizing reverse mortgages for seniors. Stated differently, why do taxpayers have to subsidize seniors who want to stay in their homes when the simple solution is to let seniors sell their home and either rent another dwelling or purchase a smaller dwelling that meets their needs?

I am not against reverse mortgages as an equity extraction tool. But I do not see any reason for the Federal government to guarantee and subsidize it. And we need to stop micromanaging the home ownership decisions for American households. The Clinton Administration tried it in 1995 with the National Homeownership Strategy that contributed to a housing bubble and burst.10 Now Fannie Mae, Freddie Mac and FHA are raising credit standards encouraging those who can’t get credit to rent.11 And now residential rents are rising rapidly in urban areas.12

SUGGESTIONS

At a minimum, the Federal government should get out of the reverse mortgage insurance and subsidization business, particularly since there is an easy alternative: seniors sell their home and buy a smaller dwelling or rent.

We have thrown enormous subsidies at the housing market and have tried to steer households into ownership, then renting and now steering seniors toward equity extraction. We need to think about how much of the housing market should be subsidized (mortgage interest deductions, subsidized mortgage insurance, low down payment loans, etc.). Clearly, the massive subsidization has distorted housing and housing finance market and changes should be made.

There are numerous proposals for ending the government housing monopoly.13 These include eliminating Fannie Mae and Freddie Mac or converting them to a public utility and reinsurance company. But no matter how we deal with the government housing monopolies, we must address how much we want to subsidize housing going forward.

SUMMARY

A reverse mortgage for seniors is a reasonable idea, but should not be guaranteed by the Federal government. It is an ownership decision and the Federal government must stop trying to micromanage this decision, particularly since there is an easy alternative that does not require government guarantees.

Appendix: Figures

Footnotes:

1 https://files.nyu.edu/sml8/public/Laufer_EquityExtractionDefault_111611.pdf

2 http://www.telegraph.co.uk/finance/personalfinance/borrowing/mortgages/5329469/Shared-appreciation-mortgages-cheap-money-backfires-on-borrowers.html

3 http://www.sciencedirect.com/science/journal/10511377/14/3

4 HUD announced on December 2, 2011 the extension of the $625,500 limit for Home Equity Conversion Mortgages (HECM) through calendar year 2012.

5 When the reverse mortgage loan balance gets to 98% or more of the "maximum claim amount", which is the maximum amount that can be collected, lenders are allowed to assign the loan to HUD and be paid the balance. HUD then assumes responsibility for making any additional payments that are due the borrower. HUD will also take over responsibility if, for some reason, the lender cannot make the required payments.

6 http://portal.hud.gov/hudportal/HUD?src=/program_offices/housing/sfh/hecm/hecmabou and http://www.genworthreversemortgage.com/genworth/fees

7 http://www.washingtonpost.com/business/mortgage-giant-freddie-mac-asks-government-for-19m-posts- 12b-loss-in-q1/2012/05/03/gIQAkkplyT_story.html

8 http://confoundedinterest.wordpress.com/2012/05/03/cummings-letter-to-demarco-why-fanniefreddie- should-do-principal-writedowns-please-be-careful/

9 http://confoundedinterest.wordpress.com/2012/04/27/fhas-instant-undertow-mortgages-3-5-down-in-a- declining-home-price-environment/

10 http://confoundedinterest.wordpress.com/2012/05/01/homeownership-falls-to-15-year-low-after-clintons- great-leap-forward/

11 http://confoundedinterest.wordpress.com/2012/05/01/the-tightening-of-the-credit-noose-in-housing/ 12 http://www.latimes.com/business/la-fi-renters-nightmare-20120506,0,7137775.story

13 See http://mercatus.org/publication/house-cards, http://mercatus.org/events/reforming-gses-fannie- freddie-and-future, http://reason.org/news/show/trust-in-mortgage-backed-securities,

In Europe, Time for True Austerity

Veronique de Rugy — Fri, 18 May 2012 10:40:02 -0400

Expert Commentary

This article was originally published in the Los Angeles Times

Talks to form a coalition government in Greece collapsed again this week as a result of the country's belt-tightening backlash. The country now faces an unpleasant dilemma: agreed-upon austerity measures in exchange for bailout funds, or a messy default and exit from the Eurozone. Greece's deteriorating situation raises many questions about whether austerity is the right path for other struggling European nations trying to avoid this same fate.

For several years now, European governments have tried versions of austerity — usually understood as an attempt to reduce the ratio of government debt to gross domestic product — in hopes of reviving the continent's flailing economies. But not only have their efforts failed, we're now told, they have actually made things far worse.

According to one naysayer, former Obama administration chief economic advisor Larry Summers, austerity efforts are "counterproductive" to growth. In a recent Bloomberg TV interview, Nobel laureate and economist Paul Krugman said, "I wish I'd been wrong for the sake of the world" about his prediction that "Austerians" pushing for fiscal retrenchment would destroy Europe. This sentiment is echoed in countries such as the Netherlands, among others, which have announced they will start spending again. And newly elected French President Francois Hollande's victory was pegged to his absolute rejection of austerity measures.

There are two basic problems with this growing anti-austerity backlash. First, where spending was actually reduced, the cuts have been relatively small compared to the size of the problem and meaningful structural reforms were seldom implemented. Second, to the extent declining Europe countries pursued austerity, it has mainly been through large tax increases. If the economies of Spain, France, Britain and other European nations are suffering, it's not because of "savage" spending cuts. It's because small spending cuts are overwhelmed by tax increases.

Consider Britain, where supposed austerity measures represent a "stunning failure of policy," according to Krugman in his New York Times column. In 2009, BritishPrime Minister Gordon Brown promised he would reform social programs and dramatically cut spending and taxes. Instead, he increased the top marginal income tax rate shortly before he left office. When David Cameron replaced him in 2010, he promised to pursue the same austerity measures. However, in 2011-12, spending increased from $1.15 trillion to $1.2 trillion, and public pensions have yet to be reformed. Instead, the government increased the capital gains tax, national insurance tax and value-added tax along with other fees and duties.

In Spain, the conservative party raised the retirement age from 65 to 67 in January 2011, but it has failed to implement comprehensive structural reforms. It was, however, successful in pushing through higher personal income and property tax rates in an attempt to balance its books. This year, the government has proposed reducing the deficit by $35.2 billion through a combination of tax increases ($16 billion) and spending cuts ($19.2 billion). But the spending reductions, even if implemented, won't be enough to compensate for an overly optimistic growth rate. Although the increase of the corporate income tax will be real, so will the increase in public pension and unemployment benefits.

Then there are the French, who elected a Socialist president for the first time since the 1980s. Hollande wants to replace what he calls austerity with "pro-growth" policies. But there is nothing austere about France's spending, which rose by $33.4 billion between 2009 and 2010 and an additional $29.5 billion in 2011. French public spending already equals 56% of GDP. Hollande's own wishful projections show total tax receipts rising from 45% of the economy to 47% in five years thanks to his plan to impose a 75% top marginal income tax rate for those earning more than $1.3 million and an increase in the corporate income tax. If this is pro-growth, then garlic breath is pro-romance.

If the critics of austerity can't find contemporary examples of where it's been successfully implemented, they can look at history. Research consistently shows that successful attempts to reduce government debt ratios follow a single-minded devotion to actually cutting spending rather than just talking about it.

In a 2009 paper, Harvard economists Alberto Alesina and Silvia Ardagna looked at 107 examples in developed countries over 30 years and found that successful austerity packages — defined by a reduction in debt to GDP greater than 4.5% after three years — resulted from making spending cuts without tax increases. They also found that this form of austerity accompanied by the "right policies" (easy monetary policy, liberalization of goods and labor markets, and other structural reforms) is more likely associated with economic expansions rather than with recessions. This makes intuitive sense: Austerity based on spending cuts signals that a country is serious about getting its fiscal house in order in a way that taxing and spending certainly does not.

On the other hand, they found that the so-called balanced approach — typically a mix of spending cuts and tax increases — is a recipe for failure. It fails to stabilize the debt, and it is more likely to cause recessionary economic contractions. And when it comes to plans such as Hollande's that would explicitly increase spending and taxes, they find little chance of either economic expansion or debt reduction.

As Britain slips back into recession, the Cameron government might want to remember that lesson. That's what Italy is doing. After years of failing to cut spending, Italian Prime Minister Mario Montihas taken steps to reform the pension system, and he recently pledged to make $5.5 billion in spending cuts over the next six months to avoid a hike of the national sales tax from 21% to 23% in October. That decision came after Italy's ministers tied the country's deepening recession to the mainly revenue-driven $38.4-billion debt package adopted in December.

If the Italians actually want to revive their economy, they — and other Europeans — should hurry past the talking stage and abandon the so-called balanced approach to their situations. They must start actually cutting spending and reforming their bloated governments. They have nothing to lose but their debt.

Ongoing Government Failures in Air Transportation

Kenneth Button — Thu, 17 May 2012 11:59:01 -0400

Publication

The enactment of the 1978 Airline Deregulation Act saw the first dismantling of a comprehensive system of government control in the United States since 1935: the sun-setting of the Civil Aeronautics Board (CAB). It freed interstate passenger airlines from most economic regulation of market entry and price setting. Freight carriers had been freed in 1977. The overall results have been generally lower fares, more services, and more diverse types of service. Moves to deregulate U.S. international airlines began with the initiation of Open Skies policies in 1979, but only really gained momentum in the early 1990s, again with significant consumer benefits. The large transatlantic market was largely deregulated in 2007.

Despite these changes, and the significant economic and social benefits that have come with them, there are still pockets of powerful government intervention in the air transportation sector. Some of these relate to the nature and growth of what is often generically called social regulation and pertains to such things as the environment, safety, security, consumer protection, and the provision of social services. These are not, however, the main concern here, although some comments will be made with a particular focus on issues of consumer protection, the environment, and security in terms of their implications for the airline industry’s performance. There are also generic economic regulations governing things such as minimum wages and working age that extend across the entire American economy; these non- specific interventions are not reviewed here.

Our concern is thus with situations where the involvement of government through the use of regulation and public ownership stymies the full potential benefits air transportation can generate. We focus primarily on a number of areas where direct economic regulation still exists and is detrimental to the efficient workings of the air transportation sector. For example, competition within the U.S. airline market, so-called cabotage, is confined to that between national carriers, limiting the potentially beneficial effects of more efficient foreign carriers entering the market. Restrictions on the ownership of U.S. airlines also prevent the potential gains from free factor mobility—in this case, foreign capital being injected into U.S. carriers—from being realized.

In addition to the residual economic regulation of airlines, there are government failures in the provision of aviation infrastructure. All the major airports in the United States, save one, are municipal entities or are owned by quasi-public bodies like the New York Port Authority. They are not run on a commercial basis and are not subject to the full rigors of the market. Air navigation services that provide air traffic control come under the auspices of the state-controlled Federal Aviation Administration (FAA), financed through taxation rather than user fees. Basically, the prices charged by the infrastructure providers have little to do with market principles, and the largely political mechanisms for financing infrastucture are almost arbitrary, often depending on the outcome of pork-barrel decision-making.

The aim of this work is not to collect a vast amount of new data, but to focus on the nature of some remaining distortions in the provision of air transportation services in the United States and to offer some very general quantification for what this may mean, appreciating that, by definition, the free-market counterfactual cannot be accurately determined. Also, international experiences can be drawn upon to highlight what has happened elsewhere. We make no attempt here to place hard figures on the costs of the distortions that exist: by definition, we have no real idea of what the market outcomes would be. If we did, we could simply regulate for them. Where possible, we offer some quantification of orders of magnitude.

The reforms to the U.S. air transportation market since the late 1970s have clearly brought about economic improvements, including lower average prices for users, and greater choice among suppliers, and service attributes more in line with what customers seek. However, the market remains far from perfect, with a range of residual economic regulations stymieing the full potential of the sector. Although many of these continuing regulations relate to infrastructure, a number of serious constraints remain on the direct market for airline services. Indeed, there are some additional constraints that have been added in recent years. These are in addition to imperfections associated with policies related to the environment, security, and safety.

The deregulation of the airlines in the 1970s, though influenced by academic work showing some of the costs of the regulatory regime, was largely a reaction to the macroeconomic stagflation of the day and the belief that inflation was a cost-push phenomenon. In many ways, it was also an easy quick fix. The regulatory structure that replaced it focused, initially through social subsidies and later through supposed measures of consumer protection, on meeting the concerns of vocal but relatively small groups. The remainder of the U.S. air transportation system has not seen significant changes in its institutional structure: public ownership in one form or another is the norm, and economic pricing and commercial investing is largely absent. This is despite mounting evidence from other countries that there are more efficient options.

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Airline Deregulation: Myth or Reality?

Kenneth Button — Tue, 22 May 2012 09:04:40 -0400

Publication

The late 1970s saw the removal of many of the economic regulations that controlled the supply of U.S. domestic freight and passenger airline services. This was followed in the 1980s with the Open Skies initiative, aimed at removing many of the impediments to the free supply of international air services. The effects of these reforms have been seen in generally lower and more diverse fares, enhanced ranges of services, and more innovation by the airlines in the way they approach their customers.[1] However, residual regulations remain, and some new ones have subsequently been added. This paper looks at how these residual regulations, and the addition of new ones, have dampened the liberalizing effects of the 1970s legislation and reduced the benefits that U.S. airline users could enjoy.

The major “deregulation” of interstate freight airline services occurred in 1977, followed by similar regulatory changes for passenger services in 1978. The legislation of the 1970s demonstrably produced net welfare gains for the American people, primarily by allowing domestic airlines to compete on price and innovations in their services. The air transportation infrastructure, however, has remained heavily regulated, and domestic airlines are largely protected from foreign competition.

Since the 1970s, there have also been measures to tighten safety, security, and environmental regulation that, in some cases, have raised questions in terms of overall value for the money.

Under the pre-1970s regime there were few direct subsidies in American domestic airline service provision, although the licensing system led to some cross-subsidization of loss-making routes from revenues from profitable ones.

Deregulation added some direct subsidies for routes involving remote communities through the Essential Air Services program, and later funds became available as part of local development initiatives. The initial funding requirements for “essential” routes proved less than expected as airlines adapted to the more competitive market, and in many cases their costs fell to the point where formerly subsidized routes became commercially viable. More recently, however, evidence suggests that some of the remaining “essential” services have become gold-plated services operative at subsidized levels that exceed the basic needs of communities.[2] Some recognition of the issue is reflected in modifications in the 2012 Federal Aviation Authority (FAA) Air Transportation Modernization and Safety Improvement Act.

The bigger issue is the lack of any significant reforms regarding air transportation infrastructure or the airports and air traffic control elements of the air transportation industry. These are controlled by municipal and federal bodies and operated with very limited application of anything approaching market principles. The U.S. air navigation system is part of the U.S. Department of Transportation and operated by the FAA. There is de facto little pricing for services; rather, revenues are generated through taxation.

Airports services, including slots and gates, are not priced according to market-based principles with "first come" a common principle used regarding take-offs and landings. In particular, fees do not reflect the prevailing congestion levels at airports and the congestion caused by different types of aircraft at different times of the day. There have been some efforts at auctioning slots with accompanying secondary markets as a form of introducing competition for the market, but this has been applied only to a few seriously congested facilities. These include New York LaGuardia and Washington Reagan National airports and applies only to some of the capacity at each. [3] The curent regulatory structure stands in stark contrast to what is happening in many other parts of the world, where there is considerable experimentation with the introduction of more market-based approaches to the supply and use of air transportation infrastructure[.[4]

Added to this, and far from fully considered here, have been a plethora of new regulations and controls relating to environmental and security matters. These topics deserve full coverage in their own right, but from a narrow economic perspective they impose additional time and disruption costs on passengers and shippers of cargo and a cost on tax-payers.[5] There may be justifications for government interventions in these areas when the underlying problems are genuine market failures, but currently little attention is given to the question of whether these policies are being implemented efficiently.

In recent times, the airline market has become increasingly global with considerable amounts of cross investments between airlines and the emergence of the three mega airline alliances: the Star Alliance, Oneworld, and SkyTeam. While the U.S. market is, to some extent, integrated into this system, the integration has been gradual and is incomplete. The result is that U.S. air travelers have not always enjoyed the full potential of globalization. In particular, investment in U.S. airlines is limited in a number of ways in terms of the extent of foreign participation and control, and competition to stimulate efficiency within the U.S. domestic market is limited to American carriers. Subsidies also remain for certain types of service and the mechanism for subsidizing is highly politicized with little evidence of any genuine cost-benefit analysis.[6]

Finally, because air transportation has become a global industry and many American policies must be set within this broader context, the United States has pursued an Open Skies stance for more than 30 years with some success in terms of encouraging the liberalization of bilateral air service agreements. However, it has done so not strictly in terms of fostering complete air transportation markets but selectively to the advantage of the nation’s airlines. In particular, the policy has focused just on the international legs of services rather than complete networks that embrace cabotage (services offered between cities within the country), and with little interest in developing efficient global markets for investment and labor. America cannot change international agreements unilaterally, but it has been instrumental in supporting some positive reforms. The ethos of U.S. initiatives has, however, often involved supporting the interests of the nation’s carriers in entering larger markets rather than in providing competitive stimuli for greater overall efficiency and maximizing benefits for airline users.

The lesson from the experiences of other countries that have liberalized their air transportation infrastructure is that the introduction of more market-oriented systems has led to unexpected results, generally more favorable to the travel- ing public. The U.S. market experienced similar unexpected benefits following the deregulatory changes in the late 1970s in the domestic market. Given the successes of many of the recent deregulatory experiments in other countries, it seems the time has come, 35 years after airline price deregulation, to begin experimenting with more infrastructure reforms in the United States.

Footnotes

^{1. Steven A. Morrison and Clifford Winston, The Evolution of the Airline Industry (Washington, DC: Brookings Institution Press, 1995).}

^{2. U.S. Government Accountability Office (GAO), “Commercial Aviation: Programs and Options for Providing Air Service to Small Communities” (report, GAO-11-733, Washington, DC, 2007).}

^{3. D. Starkie, “Allocating Airport Slots: A Role for the Market?” Journal of Air Transport Management 4 (1998): 111–16.}

^{4. GAO, “Air Traffic Control: Characteristics and Performance of Selected International Air Navigation Service Providers and Lessons Learned from Their Commercialization” (report, GAO-05-769, Washington, DC, 2005); and House Subcommittee on Aviation, Committee on Transportation and Infrastructure, Air Traffic Control, FAA’s Modernization Efforts—Past, Present, and Future, 108th Cong., 1st sess., 2003.}

^{5. GAO, “Airline Passenger Protections: More Data and Analysis Needed to Understand Effects of Flight Delays” (report, GAO-11-733, Washing- ton, DC, 2011).}

^{6. GAO, “Commercial Aviation: Programs and Options for Providing Air Service to Small Communities” (report, GAO-07-793T, Washington, DC, 2007).}

Government Creates the Next Bubble in Higher Education

Antony Davies — Thu, 17 May 2012 10:36:34 -0400

Expert Commentary

This article originally appeared in The Washington Examiner and was co-authored by James R. Harrigan

^{College grade inflation: Inflation-adjusted growth in college tuition and fees since the base year of 1981 (set at 100 percent). Public four-year institutions, which were cheaper to begin with, have led the way with tuition increases approaching 270 percent. Private four-year institutions and public two-year colleges have both raised prices by about 180 percent in the same period. Source: The College Board Advocacy and Policy Center.}

A phoenix has risen from the ashes of the Occupy movement. As anger over the housing crisis wanes, protesters have returned home from their camps to find student loan bills -- one trillion dollars' worth. Ironically, it is now they who are looking for government bailouts -- and from a hole that government essentially put them in.

The impending student loan crisis, like the recent housing crisis, is born of government meddling, and promises to have similar results. But with the students, the coming bankruptcies will be much worse.

The anatomy of the housing crisis is simple. Years ago, the U.S. government decided that the path to prosperity was homeownership. When the free market did not provide what the government considered "enough" housing, the government used both carrots and sticks to force markets to lend more money for mortgages.

When private banks shied away from high-risk borrowers, the government instructed its enterprises, Fannie Mae and Freddie Mac, to direct more than 40 percent of their lending toward low-income borrowers. These two government-sponsored enterprises took lending risk away from private banks and placed it on the backs of taxpayers instead.

The government also offered tax incentives for people to take on more mortgage debt, and the Federal Reserve made mortgages cheaper by holding interest rates at historically low levels. Predictably, people rushed to secure cheap mortgages, fueling a boom in homebuying and causing home prices to soar over 400 percent from 1976 to 2010. When the rush tapered off, households realized they could not afford to pay their mortgages and declared bankruptcy in droves.

The anatomy of the student loan crisis is similar. Having decided that the path to prosperity is a college education, and that the free market was not providing "enough" college education, the federal government created Sallie Mae (and later, used the Department of Education) to take lending risk away from banks and place it on the backs of taxpayers. The tax code provided modest tax incentives for students to take on more loans, and lately, the Federal Reserve has continued to make borrowing cheap by holding interest rates low. Sound familiar?

As with housing, the price of college education has skyrocketed over the last 30 years (see charticle). Just as homebuyers borrowed to speculate on houses they could not afford, students now borrow to speculate on educations that many will not complete, and which others may find to be of little value.

The impending burst of the education bubble will be far more damaging than the housing bubble. When homeowners got behind on their mortgages, they can declare bankruptcy to free themselves of crippling debt. Either they or their bank can offset some of what they owed by selling the collateral -- the house. Students cannot rely on either of these things. Bankruptcy does not wipe out student loans, and an education cannot serve as collateral.

In both housing and higher education, government failed to seek out the reasons why there was not "enough" lending going on. Many people were in no position to afford the loans, and the banks couldn't afford the risk. With unbounded hubris and dogged myopia, politicians decided to "fix" the market by forcing people and banks to do what each had determined was imprudent.

Just as the government sought to engineer an increase in homeownership, it now seeks to engineer an increase in higher education. This is the stuff of which bubbles are made.

The solution is economic freedom: Let private banks determine lending without government interference. Allow people to decide for themselves whether one level of debt or another is prudent. This latest bubble will burst, as they all do. The government, unfortunately, will be there to create another.

Scaling the Great Wall

Tyler Cowen — Thu, 17 May 2012 10:18:42 -0400

Expert Commentary

This article was originally published in the May 2012 edition of Washingtonian

Shopping for a month at an Asian supermarket can open your eyes to wonderful foods, cause a lot of confusion, and yield some interesting discoveries about how we choose what to put on the table.

Most of us are familiar with the American supermarket–maybe too familiar. The Safeway or Wegmans or corner market supplies a lot of convenient food–and a lot of those aisles are full of things that are only a rough approximation of food–but that very convenience can make the local supermarket a rut. The deadening hand of routine takes over our shopping lives: We know what we want, where to find it, when to get it, and what to do with it. These habits can be the biggest obstacles to discovering new regions of the food universe.

But abstain from your routine for a week or so and your natural ability as an innovator flourishes. An innovating consumer has a profound effect on the marketplace and the food economy. After all, maybe the American supermarket, for all its conveniences, isn’t actually the best way to sell–or buy–food. At the very least, maybe it’s not the best way to do it all the time.

With that thought in mind, I conducted an experiment. For a month, I’d refrain from buying food from mainstream supermarkets and instead choose–exclusively–an ethnic grocery store, in this case a big Chinese/Asian market in Falls Church called Great Wall.

Full disclosure: During the experiment, I still traveled to other cities and ate in restaurants–supermarkets have never completely dominated my food life. In any case, for a month I’d go cold turkey on traditional American supermarkets, and for every day out of town I had to do an extra day shopping at the ethnic market.

The idea behind this experiment grew out of my economic approach: Food is a product of economic supply and demand, so try to figure out where the supplies are fresh, the suppliers are creative, and the demanders are informed.

When it comes to ethnic markets, most of the shoppers are well informed. They come from cultures where food preparation receives more attention than in the United States. They’re also largely immigrants or children of immigrants. Either they hail from cultures where most food prices are lower than they are here or the immigrants have lower incomes themselves, or both.

It seemed natural to select what’s probably the world’s oldest and perhaps most sophisticated food culture, Chinese.

Great Wall Supermarket is in the Merrifield area of Falls Church, about a 20-minute drive from DC in a part of Fairfax County with plenty of Chinese immigrants. The Chinese-owned store, in a strip mall, has ten long aisles as well as some side spaces.

The most daunting task is finding something. At first, even though I’d been there many times and I’m relatively familiar with Chinese cuisine–by Western standards at least–it could take me 20 minutes to find just one or two items. It felt like walking into a labyrinth, even with my savvy 21-year-old stepdaughter helping out.

Many of the jars are labeled in Chinese characters, with the English small and hard to find. So if you’re told “aisle eight, in the middle, on the right,” it’s a help but not a solution. You’re still confronted with an array of hard-to-distinguish jars. Even if you know something about Chinese food, “bean sauce” comes in a number of colors and varieties, and the store has dozens of soy sauces. Once I moved beyond the highly visible items such as meats, I struggled to find what I wanted–at least at first.

The dried goods and candy were hardest to browse through. Not everything had an English label. Often I didn’t know exactly what I was looking for, if only because the name of something in a book or cookbook didn’t correspond exactly to the name on the package. Was ya cai the same as “pickle mustard vegetable” or “pickled mustard green”? I still don’t know for sure, although I think so, and that’s assuming I can find the English inscription at all.

What’s more, when I entered those aisles, I sometimes had the feeling people were staring at me, thinking: What does he want here? I learned quickly how dependent I normally am on background cultural knowledge and simple rules of thumb.

I decided to consult a Chinese graduate student at George Mason University, where I teach. Rong Rong is studying for a PhD in economics and is from a region near Shanghai. She has a friendly manner and is possibly the sharpest student in her cohort. Rong Rong told me to try the double-mushroom soy sauce, which she claims tastes just like what her mother serves in China.

I asked Rong Rong if she had trouble finding items in Great Wall. The answer was no, although she did admit to being confused at Giant, despite almost five years living in the United States. She found Giant’s cereal aisles the hardest to master, and even though her English is very good she can’t read all of the labels nearly as fast as I can or recognize from a glance what an item is going to taste like.

Another obstacle in using Great Wall is asking for directions to sought-after items. By all appearances the staff works hard, and finding an employee isn’t difficult. The problem is that virtually all of the workers are–oddly enough–Spanish-speaking, most likely from El Salvador, with varying abilities in English.

I speak Spanish, but this isn’t always much help. I don’t know some of the words for Chinese items in Spanish, but more commonly there isn’t a good translation. Salsa dulce de los frijoles doesn’t carry the same connotation as “sweet bean sauce” and requesting it in Spanish didn’t get me where I wanted to go. Dulce y agrio does map directly into “sweet and sour,” but that simple translation is the exception. It’s not easy to find out the Spanish word for pickled fresh bamboo shoots.

In most cases, the Latino staff knows neither the English nor the Chinese words for what’s on their shelves. Entering the store is like being robbed of part of one’s linguistic facilities. Another Chinese graduate economics student, Siyu Wang, noted that the prevalence of Spanish speakers among the workers was one of her biggest surprises when she first visited Great Wall.

There are some Chinese staff, including most of the cashiers, but their English is limited. One strategy that does work, when it can be applied, is to bring a Chinese cookbook containing the characters for the desired items. Show the relevant characters to someone who works in the store. If you can find a Chinese employee, he or she will lead you directly and enthusiastically to the right place.

Mostly, I learned where things were by walking down all of the plausible aisles and then looking in places that seemed logical. Over time, that worked better as I got to know the market.

With each visit, I increasingly divided the store into “parts I use” and “parts I don’t use.” Those I used included the produce, the meats and fish and tofu, and the spices and sauces, plus the frozen goods, the dumplings, and the different noodles, dried and fresh. I didn’t do much with the American or Latino goods, the bags of dried fish, the cans of condensed milk, the Asian sweets, or the cookware...

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Privacy and the Future of Facebook

Adam Thierer — Thu, 17 May 2012 10:10:43 -0400

Expert Commentary

“Facebook’s success rests on convincing investors that the company will continue to grow and innovate,” said Adam Thierer. “Intrusive privacy regulation could slow the development of more and better online content.”

For years, Europe has applied a strict regulatory blueprint to the Internet, and Thierer says we should be careful to avoid using such tight standards with Facebook.

“America's refusal to follow Europe’s regulatory path might help explain why so many U.S. online firms are leaders in the global digital marketplace.”

“New privacy regulation is unnecessary since government already possesses sufficient power to punish firms who break privacy promises made to consumers,” said Thierer. “We saw this last year when the FTC brought charges against Facebook for failing to uphold privacy promises."

Greece's Influence on the Eurozone Is Ludicrous

Maurice P. McTigue — Thu, 17 May 2012 09:26:32 -0400

Expert Commentary

This excerpt was originally published in US News Debate Club. Read the full text here.

Greece's irresponsible fiscal behavior leading up to the Great Recession caused its current problems, not the recession itself. The recession simply made abundantly transparent what insiders knew, but were unwilling to accept: Greece's fiscal behavior was unsustainable. Greece is now at a point where it only makes economic sense that they either leave voluntarily or have the European Union expel them.

One consequence of a Eurozone departure will be real hardship for the people of Greece. Their short-term expectations of lifestyle and affluence will be significantly reduced. And although the spending power of their money will be dramatically lower than the euro's, their competitiveness will dramatically improve as a result of this devaluation. There will be increasing demand for Greek goods and services, particularly in industries like tourism, and gradually they will earn back their affluence.

Changing monetary values has long been the market's mechanism for rewarding good economic management and penalizing poor economic management. The creation of the Eurozone, however, distorted this tool. The value of the Euro is dominated by the huge economies of Europe like Germany, France and Italy. Since the economic performance of small economies like Greece and Portugal have little effect on the value of the Euro, their poor fiscal management prior to the recession was not reflected in currency values. Instead, it was disguised by the surrounding, large economies.

So why has tiny, little Greece been able to roil the financial markets of the world?

"Fixing" the Tax Code: Key Principles for Successful Reform

contact@mercatus.org (Mercatus.org) — Wed, 16 May 2012 14:44:04 -0400

Publication

The most basic goal of tax policy is to raise enough revenue to meet the government’s spending requirements with the least impact on market behavior. The United States’ tax code has long failed to meet this aim: by severely distorting market decisions and the allocation of resources, it impedes both potential economic growth and potential tax revenue.

While there is widespread agreement on the need for tax reform, there is no consensus—either between or within parties—on specific elements of reform. To move the debate forward, policy makers need to know the goals of successful tax reform and what steps to take to achieve those goals.

What Are the Goals of Tax Reform?

Clearly, the nation’s increasingly dire economic and fiscal situation has increased the motivation—and the urgency—to reform the federal revenue system, along with the federal government’s other unsustainable institutions and practices. But what would an ‘ideal’ tax code look like?

Luckily, policy makers need not fly blind when it comes to defining the principles and goals key to a successful revenue system. Academic research suggests that a successful revenue system should be:

Simple. The complexity of the tax system makes it difficult and costly to comply with; it also makes it easy to scam. Congress should make the tax code as simple and transparent as possible so as to increase compliance and reduce compliance costs.

Equitable. Policies intended to benefit or penalize select individuals and groups riddle the tax code; these policies also result in immeasurable unintended consequences. Fairness is subjective, but “tax fairness” would at least reduce the number of provisions in the tax code that favor one group or economic activity over another.

Efficient. Because the tax code alters market decisions in areas such as work, saving, investment, and job creation, it impedes economic growth and reduces potential tax revenue. An efficient tax system must provide sufficient revenue to fund the government’s essential services with minimal impact on taxpayer behavior.

Predictable. The negative effects of the current tax code result not just from what it does today, but also from what it may do in the future. Such uncertainty deters economic growth. An environment conducive to growth (and thus, increased revenues as a result of a larger economy) requires a tax code that provides both near- and longterm predictability.

What Reforms Are Most Likely to Advance These Goals?

There is broad consensus across academic research as to which key policies are most likely to promote solid, sustainable economic growth and revenues—and which policies are most likely to fail.

Lower Rates. Exhaustive economic research repeatedly proves this most basic effect: the more you tax capital or labor, the less you get. It also makes clear that incentives matter. Successful reform will lower current individual and corporate tax rates.

• “Both macroeconomic and microeconomic perspectives suggest that [higher] taxes slow economic growth, thereby limiting the scope for revenue gains.” Jeffrey Miron, Harvard University, "The Negative Consequences of Government Expenditure,” Mercatus Working Paper, September 2010.

• There is a negative tax multiplier of -1.1; taking money out of the economy through taxation costs the economy more than the actual dollar amount taken out. Robert Barro, Harvard University, and Charles Redlick, “Macroeconomic Effects from Government Purchases and Taxes,” Mercatus Working Paper, July 2010.

• Consequences of raising taxes on economic growth: “a tax increase of 1 percent of GDP reduces output over the next three years by nearly three percent.” Christina Romer, Former Chair, Council of Economic Advisers (2009–2010) and David Romer, University of California, Berkley,“The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks,” American Economic Review, June 2010.

• The United States’ corporate tax rate is among the highest in the industrialized world; this increases business’ flight to lower-tax countries, taking their jobs, money, and tax dollars with them. To regain competitiveness, reduce the U.S. corporate tax rate to at-or-below the 25% average rate of other OECD nations. Jason Fichtner and Nick Tuszynski, “Corporate Tax Reform: Why the United States Needs to Restructure and Reduce its Corporate Income Tax,” Mercatus Working Paper, Forthcoming.

• Similarly, further increasing the nation’s corporate tax rate would result in some combination of lower wages, fewer jobs, higher prices for consumers, and lower returns on investment. Fichtner and Tuszynski, forthcoming.

• “[D]omestic labor bears slightly more than 70 percent of the burden of the corporate income tax.” William Randolph, International Burdens of the Corporate Income Tax, Congressional Budget Office Working Paper, August 2006.

• Combining lower marginal rates with reduced government spending is likely to foster economic growth. Andreas Bergh, Lund University and Magnus Henrekson, Research Institute of Industrial Economics, “Government Size and Growth: A Survey and Interpretation of the Evidence,” January 2011.

• High tax rates encourage avoidance and evasion. Martin Feldstein, Harvard University, “The Effect of Marginal Tax Rates on Taxable Income: A Panel Study of the 1986 Tax Reform Act,” The Journal of Political Economy, June 1995.

• Historically, raising taxes increases Congress’ incentive to spend and decreases its incentive to cut. Barro and Redlick (2010).

• Other high-quality, empirical studies on the impact of tax rates on growth: Romero-Avila and Strauch (2008); Bergh and Karlsson (2010); Mountford and Uhlig (2008); Alesina and Ardagna (2009); Blanchard and Perotti (2002); Giertz (2006); Rogerson (2006); and Davis and Henrekson (2004).

Broaden Base, Eliminate Loopholes. One of the keys to successful fiscal reform is to move away from a spending system that depends upon an easily manipulated income tax system. Tax reform should lower rates, broaden the tax base, and eliminate loopholes; this will increase stability, and lead to greater economic growth, added employment, and perhaps even increased revenues. Barro and Redlick (2010); Fichtner and Jacob Feldman, “Lessons from the '86 Tax Reform,” Mercatus Working Paper, April 2011.

• Over the past 30 years, a rising percentage of citizens pay little or no federal taxes; this means that for these people the tax-price of government services is zero, resulting in a greater demand for government services, greater entitlement spending, and higher debt. Bruce Yandle, Clemson University, and Jody Lipford, Presbyterian College, “The Relationship between Tax-payers and Tax-spenders: Does a Zero Tax-Price Matter?” Mercatus Working Paper, August 2011.

• As the president’s Fiscal Commission recommended, tax rates should be flattened and the tax base broadened so that more citizens will feel the costs of spending and support actions to stop the cycle of excessive government spending and debt. Yandle and Lipford (2011).

• Spending through the tax code masks the true size of government, and “can lead to higher taxes, larger government, and an inefficient mix of spending…” Leonard Burman, Syracuse University Center for Policy Research, and Marvin Phaup, George Washington University, “Tax Expenditures, the Size and Efficiency of Government, and Implications for Budget Reform,” August 2011.

• Loopholes severely distort market behavior, influencing behavior based on tax preferences rather than the best and most productive economic decisions. “These preferences narrow the tax base, reduce revenues, distort economic activity, complicate the tax system, force tax rates higher than they would otherwise be, and are often unfair.” Donald Marron, Urban-Brookings Tax Policy Center, “Cutting Tax Preferences Is Key to Tax Reform and Deficit Reduction,” Testimony before the Senate Committee on the Budget, February 2011.

No Double Taxation.

• [C]orporate profits are generally subject to ‘double-taxation,’ whereby firm profits are taxed first at the corporate level and then again at the individual level.” Fichtner,“Reforming the U.S. Corporate Tax System to Increase Tax Competitiveness,” Joint Economic Committee Study, May 2005.

• “Increasing the double taxation of corporate income by raising tax rates on capital gains and dividends would dramatically reduce capital formation and wages, and would not raise the expected revenue.” Stephen Entin, Institute for Research on the Economics of Taxation President and Executive Director, Testimony before the Senate Finance Committee, September 2011.

Reduce Bad Incentives. Predictable tax policy is essential to long-term economic growth.

• History has shown that reforms seldom last that reduce Congress’ ability to gain political influence (in the case of the tax code, either through spending or tax breaks for special interests). Keeping the tax code as simple—by taxing a broad base at the same rate—and transparent as possible will help reduce the ability of politicians to incrementally reverse reforms. Fichtner and Katelyn Christ, “Uncertainty and Taxes: A Fatal Policy Mix,”Mercatus Working Paper, December 2010.

• The 1986 Tax Reform Act was remarkable for its bipartisan passage and sweeping reforms. But because the legislation failed to fix the revenue system’s large institutional problems, reforms were clawed back almost immediately. As a result, the tax code looks even worse today; in 1985 there were only 25 temporary tax provisions; in 2010 there were 141 provisions set to expire by the end of 2012. Fichtner and Feldman (2011).