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Tuesday September 19, 2017 @ 12:13:25 PM mt

Poll: Public Distrusts Wall Street Regulators as Much as Wall Street Say Gov't Regulators Are Ineffective Biased and Selfish

The newCato Institute 2017 Financial Regulation national surveyof 2,000 U.S. adults released today finds that Americans distrust government financial regulators as much as they distrust Wall Street. Nearly half (48%) have hardly any confidence in either.

Click here for full survey report

Americans have a love-hate relationship with regulators. Most believe regulators are ineffective, selfish, and biased:

  • 74% of Americans believe regulations often fail to have their intended effect.
  • 75% believe government financial regulators care more about their own jobs and ambitions than about the well-being of Americans.
  • 80% think regulators allow political biases to impact their judgment.

But most also believe regulation can serve some important functions:

  • 59% believe regulations, at least in the past, have produced positive benefits.
  • 56% say regulations can help make businesses more responsive to peoples needs.

However, Americans do not think that regulators help banks make better business decisions (74%) or better decisions about how much risk to take (68%). Instead, Americans want regulators to focus on preventing banks and financial institutions from committing fraud (65%) and ensuring banks and financial institutions fulfill their obligations to customers (56%).

Americans Are Wary of Wall Street, But Believe It Is Essential

Nearly a decade after the 2008 financial crisis, Americans remain wary of Wall Street.

  • 77% believe bankers would harm consumers if they thought they could make a lot of money doing so and get away with it.
  • 64% think Wall Street bankers get paid huge amounts of money for essentially tricking people.
  • Nearly half (49%) of Americans worry that corruption in the industry is widespread rather than limited to a few institutions.

At the same time, however, most Americans believe Wall Street serves an essential function in our economy.

  • 64% believe Wall Street is essential because it provides the money businesses need to create jobs and develop new products.
  • 59% believe Wall Street and financial institutions are important for helping develop life-saving technologies in medicine.
  • 53% believe Wall Street is important for helping develop safety equipment in cars.

Few Americans Want More Financial RegulationsThey Want the Right Kinds of Regulations, Properly Enforced

Polls routinely find that a plurality or majority of Americans want more oversight of Wall Street banks and financial institutions. This survey is no different. A plurality (41%) of Americans think more oversight of the financial industry is needed. However, only 18% think the problem with federal oversight of the banking industry is that there are too few rules on Wall Street. Instead, 63% say the government either fails to properly enforce existing rules (40%) or enacts the wrong kinds of regulations on big banks (23%).

Most Are Skeptical Dodd-Frank Will Prevent Future Financial Crises

Will Dodd-Frank financial reforms work? Nearly three-fourths (72%) of Americans dont believe that new regulations on Wall Street and the financial industry passed since the 2008 financial crisis will make future crises less likely. Just over a quarter (26%) believe such regulations will make future financial downturns less likely.

Americans Oppose Too Big to Fail

Americans reject the idea that some banks are so important to the U.S. economy that they should receive taxpayer dollars when facing bankruptcy. Instead, 65% say that any bank and financial institution should be allowed to fail if it can no longer meet its obligations. A third (32%), however, believe that some banks are too important to the U.S. financial system to be allowed to fail.

  • Part of the reason most oppose the Too Big to Fail model may be that 60% believe that banks would make better financial decisions if they were convinced government would let them go out of business.
  • Clinton voters (41%) are about twice as likely as Trump voters (20%) to believe some banks are too integral to the U.S. economy to fail. Libertarians are most opposed (81%) to bailing out banks.

Despite Distrust of Wall Street, Americans Like Their Own Banks and Financial Institutions

  • 90% are satisfied with their personal bank; 76% believe their bank has given them good information about the rates and risks associated with their account.
  • 87% are satisfied with their credit card issuer; 81% believe their credit card issuer has given them good information about the rates, fees, and risks associated with their card.
  • 83% are satisfied with their mortgage lender.
  • Of those who have used payday or installment lenders in the past year, 63% believe the lender gave them good information about the fees and risks associated with the loan.[1]

Americans Want Regulators to Prioritize Fraud Protection, Ensure Banks Keep Promises

Financial regulators have a variety of tasks and goals. The public, however, believes that regulation should serve two primary functions: to protect consumers from fraud (65%) and to ensure banks fulfill obligations to their account holders (56%). Other initiatives such as restricting access to risky financial products (13%) is a priority among far fewer people.

Democrats and Republicans Want a Bipartisan Commission to Run CFPB, Divided on CFPB Independence

  • Most support changing the structure of the Consumer Financial Protection Bureau (CFPB), a new federal agency created by Dodd-Frank in 2011. Nearly two-thirds (63%) of Americans think the CFPB should be run by a bipartisan commission of Democrats and Republicans, rather than by a single director. Support is post-partisan with 67% of Democrats and 64% of Republicans in favor of a bipartisan commission leading the agency.
  • A majority (54%) of Americans think that Congress should not set the CFPBs budget and should only have limited oversight of the agency. Given that only 7% of the country has confidence in Congress, these numbers are not surprising. A majority of Democrats (58%) support keeping the CFPB independent while a plurality of Republicans (50%) say Congress should closely oversee the new agency and set its budget.
  • Few Americans (26%) believe the CFPB has achieved its mission to make the terms and conditions of credit cards and financial products easier to understand. Instead, 71% say that since the CFPB was created in 2011 credit card terms and conditions have not become easier to understandincluding 54% who believe they have stayed the same and 17% who think they have become less clear.

Americans as Likely to Say CEOs, NFL Football and NBA Basketball Players Are Overpaid, But Most Oppose Government Regulating Pay

Americans are about equally likely to think that CEOs (73%) and professional athletes like NBA players (74%) and NFL players (72%) are paid too much. Yet, the public doesnt think the government ought to regulate the salaries of either corporate executives (53%) or professional athletes like NBA players (69%). Nonetheless, there is more support for regulating CEO pay (43%) than NBA salaries (28%).

Notably, compared to CEOs (73%) and NBA players (74%), far fewer believe that major tech company entrepreneurs are overpaid (51%).

Democrats support (56%) government regulating the salaries of CEOs but oppose regulating salaries of NBA players (66%) and famous actors (69%). In contrast, about 7 in 10 Republicans oppose government regulating the salaries of all three professions, even though they are more likely than Democrats to believe NBA players (60% vs. 47%) and famous actors (59% vs. 37%) are overpaid.

Most Support Risk-Based Pricing for Loans, Say Low Credit Scores are Due to Irresponsibility

Nearly three-fourths of Americans (74%) say theyd be unwilling to pay more for their home mortgage, car loan, or student loan to help those with low credit scores access these loans.

Americans may be unwilling to pay more to help those with low credit scores in part because a majority (58%) believe low credit scores are primarily due to irresponsibility, rather than circumstances beyond a persons control (41%).

  • Partisans sharply disagree about the cause of a low credit score. Most Democrats (57%) say low scores are primarily the result of circumstances beyond [ones] control while 74% of Republicans and 63% of independents say irresponsibility is the primary cause.

Americans are Unsure if Banks Charging Some People Higher Interest Rates is Justified or Predatory

A slim majority (52%) believe banks and financial institutions need to charge some people higher interest rates for loans and credit cards if those individuals present higher credit risks. Another 46% believe banks charge some people higher rates for loans in order to take advantage of those with few other options.

  • Partisans disagree about why banks charge people different rates. A majority (56%) of Democrats believe lenders charge some people higher interest rates because they are predatory and take advantage of the vulnerable. In contrast, two-thirds (67%) of Republicans believe banks need to do this to compensate themselves for some borrowers greater credit risk.

Most Oppose Accredited Investor Standard, Say Law Should Not Restrict Investment Options Based on Wealth

Due to current law, some investments are deemed too risky for the common investor and are only available to those with one million dollars in assets or who make $200,000 or more a year. However, a majority of Americans (58%) say the law should not restrict what people are allowed to invest in based on their wealth or incomeeven if the investments in question are risky. Thirty-nine percent (39%) think the law should restrict access to certain investments deemed risky.

  • Strong liberals are unique in their support (57%) of government restricting access to risky investments based on a persons wealth. Support drops to 45% among moderate liberals and to a third among conservatives.

Most Support Helping Low-Income Families Own Homes Unless Policies Escalate Mortgage Defaults

Nearly two-thirds (64%) of the public support government policies intended to make it easier for low-income families to obtain a mortgage. However, a majority (66%) would oppose such policies if they resulted in more mortgage defaults and home foreclosures.

43% of Americans Would Pay for $500 Unexpected Expense with Savings

Less than half (43%) of Americans say they would pay for an unexpected $500 expense using money from savings or checking. The remainder would put the expense on a credit card (23%), ask family and friends for money (8%), sell something (7%), borrow the money from a bank or payday lender (5%), or simply not be able to pay it (12%).[2]

Most Say Bad Financial Decisionmaking Due to Lack of Financial Education and Self-Discipline

The public says the top three reasons consumers make bad financial decisions include lacking financial education (70%), lacking self-discipline (60%), and facing financial hardship (54%). Less than half say that consumers being misled or tricked (43%), taken advantage of (42%), or incapable (30%) are primary causes.

  • Both Democrats (72%) and Republicans (72%) agree that a lack of financial education is key.
  • Republicans (70%) are nearly 20 points more likely than Democrats (51%) to say that a lack of self-discipline is a primary reason for unwise decisionmaking.
  • Democrats are roughly 20 points more likely than Republicans to say that poor financial decisionmaking is due to external circumstances such as financial hardship (66% vs. 45%), being tricked (52% vs. 32%), or being taken advantage of (52% vs. 30%).

Most Say Government Should Allow Individuals to Make Their Own Financial DecisionsEven If They Make the Wrong Ones

When it comes to promoting and managing consumers financial health, most believe (58%) that individuals should be allowed to make their own decisions even if they make the wrong ones. However, 4 in 10 say that sometimes government regulators need to write laws that prevent people from making bad decisions.

  • A majority of Democrats (57%) believe that sometimes regulators need to write laws that protect people from making bad decisions
  • Majorities of Republicans (73%) and independents (69%) dont think government should restrict peoples financial choices to protect them.

Few Americans Know a Lot about the Federal Reserve; Among Those Informed, the Fed Polarizes Partisans

  • Only 20% of Americans say they have heard of the Federal Reserve and understand what it does very well. Half (50%) have heard of the Fed but dont understand everything it does; 22% have heard of the Fed but dont know what it does while 6% have never heard of it.
  • Tea Partiers (67%), libertarians (57%) and conservatives (50%) are about three times as likely as liberals (19%) to say the Fed has too much power.
  • Pluralities of libertarians (50%) and strong conservatives (50%) believe the Fed helped cause the 2008 financial crisis. In contrast, a plurality of liberals (43%) believe the Fed cut the crisis short.
  • Among those with an opinion, 68% of Democrats want Federal Reserve officials to primarily determine interest rates in the economy. Conversely, 74% of Republicans want the free-market system to do this.

Click here for full poll resultsand methodological information

Sign up here to receive forthcoming Cato Institutesurvey reports

The Cato Institute 2017 Financial Regulation Survey was designed and conducted by the Cato Institute in collaboration with YouGov. YouGov collected responses online May 24-31, 2017 from a national sample of 2,000 Americans 18 years of age and older. Restrictions are put in place to ensure that only the people selected and contacted by YouGov are allowed to participate. The margin of error for the survey is \+/- 2.17 percentage points at the 95% level of confidence.

[1] Asked of 4% of respondents who have used payday or installment lenders in the past 12 months, N=71.

[2] One percent (1%) say they would find some other way to pay the unexpected expense.

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Tuesday September 19, 2017 @ 12:13:25 PM mt

USA Today on Tax Reform

On the topic of tax reform, I wrote the opposing view column yesterday for USA Today. But rather than oppose the newspapers editors, I agree with most of their views.

The editors said:

The federal tax code is an unholy mess. It consumes 6 billion hours of Americans time each year. It coddles politically entrenched industries. And it burdens Americas blue-chip corporations in their bid to compete with overseas rivals.

Some taxes should be cut. The corporate income tax of 35%, for instance, should be set at 20% or lower, with a lot fewer loopholes. The current rate gives an advantage to companies not headquartered in the United States. And its complexity encourages all manner of tax gamesmanship.


The editors continued:

At the same time, everyday Americans need to confront the fact that their rates are far higher than they need be thanks to massiveand highly populardeductions for such expenditures as mortgage interest, health care, charitable gifts and state and local taxes.

Of these, only the charitable gifts break has a strong case for being left alone. The tax-free status of health plans needs a limit. The deductions for mortgage interest and state and local taxes should be gradually phased out or capped, as they have perverse effects.

I agree with that too. Leave the charity deduction alone, cut or eliminate the mortgage interest and state and local tax deductions, and cap the health insurance exclusion.

My article said that if Republicans cannot agree on substantial offsets to rate reductions, they should scale back their tax package to just the most pro-growth elements, particularly a corporate tax rate cut. If the GOP focuses on growth-generating reforms, the deficit may increase in the short term, but the tax base would expand over time offsetting the initial budgetary effect.

The important thing is that Americas businesses and their workers desperately need a more competitive tax code. The Republicans have a rare chance right now to get it done.

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Tuesday September 19, 2017 @ 12:13:24 PM mt

The Green Investment Pension Con

Public pensions are complicated beasts. They represent the aggregation of promises made to public employeesboth current and formerto pay them benefits from their retirement until their demise. They sum to a growingalbeit somewhat imprecisestream of payments that presently extends to close to the end of the current century. The predilection of politicians to make promises that wont come due until long after theyve left office has resulted in many states with promised benefits far in excess of the money set aside to meet them.
Many state pension authorities managing underfunded pensionsoften nudged by their legislatureshave aggressively invested their pension assets in an attempt to achieve supra-normal returns and reduce the shortfall, which would be infinitely preferable to them than increasing taxes, reducing benefits, or trimming other government spending.
But such a strategy amounts to a suckers game. On average, putting money in hedge fundsor practically any actively-managed stock fund for that matterhas returned less, after fees, than investing in a diversified stock/bond portfolio and does little to limit the downside risk should a sustained bear market develop, let alone another fiscal crisis.
For this reason, more prudent states have made an earnest attempt to reduce their management costs and risk by embracing passive investing, whereby the bonds and stocks owned consist of a broad-based index of the entire market. In essence, portfolio managers have no real decisions to make when they invest in a market index, so the management costs are minimal.
While a strategy that eschews actively selecting a portfolio may offer the highest long-term returns with the least risk, some object to such a strategy for a government pension. Holding stock of every single member of the S&P 500the most common index used in passively-managed index fundsentails investing in companies and industries that some find objectionable. Activists have objected to companies that they perceive as being insufficiently welcoming to gay and lesbian workers (Cracker Barrel), or who pay a portion of their workforce below what they deem a livable wage (Walmart), or whose senior management has committed personal peccadillos (Abercrombie & Fitch), or treated women employees poorly (Tesla), or breached one of a number of other myriad precepts put forth by such groups. These days, some non-profits perceive any active participation with the current Trump Administration as being objectionable.
Perhaps the most objectionable sorts of investments for liberal activists these days consist of companies that extract and sell fossil fuels. Many perceive climate change, abetted by the burning of fossil fuels, as an existential threat to the planet and fear the actions taken by the governments across the worldand especially the United Statesto be insufficient to effect a change.
The frustration that many feel about climate change inaction by the federal government has led them to pursue change at the state and local level. This political pressure has led to 34 states creating their own climate action plan, and 29 states now mandate that utilities increase the proportion of renewable energy they purchase. California has gone even further and has imposed strict new limits on emissions from new automobiles.
Another way that activists have pushed state and local governments to fight climate change has been to push for government pensions to eschew investments in companies that extract fossil fuels. Such a policy can be complicated since most index funds merely hold a basket of the stocks of companies in the exchange, these become out of bounds. Such a policy asks an important question: Can a pension fund avoid fossil fuel investments or other objectionable investments and still earn a comparable rate of return with minimal risk, as in an ordinary index fund?
The answer is no.
Past Performance Is No Guarantee of Future Returns
These days there are are a number of variants of socially responsible funds to help people avoid investing in companies whose business model, industry, or ethical practices they find disagreeable. Some of these funds are also passively managed and come with relatively low fees. For instance, in 2015 the S&P 500 created a fossil-fuel-free index, and investors can effectively invest in it by purchasing a SPideR ETF. Vanguardconsidered to be the leader in passively-managed fundsoffers the Vanguard FTSE Social Index Fund.
Some environmental activists have observed that broad-based, environmentally responsible stock funds that excluded shares of companies that extract fossil fuels outperformed the broader stock market index over the last three years. For instance, Vanguards Social Index Fund outperformed its broad market index both in the past 12 months and the past three years. Vanguards U.S. fossil-free index, created last year, has also outperformed the broader market since its inception.
These outcomes have led some to suggest that if state pension plans had invested in such vehicles the last few years they could have both higher returns as well as the moral high grounda win-win situation.
For instance, in 2016 the research firm Corporate Knights concluded that if the New York State Common Retirement Fund, the third largest state fund in the country, had moved away from investing in fossil fuels it would have actually boosted its returns the previous three years by $5.3 billion. It presented these results as an example of one way that states could reduce pension funding shortfalls while helping the environment.
Are public pension managers doing a disservice to pensioners and taxpayers by failing to adapt to a changing economy by investing in companies that are polluting the planet?
In a word, no. Investing in an environmentally or ethically conscious way will invariably impose some sort of cost on an investor. While an individual investor may be willing to receive a lower return to assuage his conscience, asking a states current and future retireesor the taxpayers who support themto do the same in a world of underfunded pensions is a dangerous precept. And to pretend doing such a thing is costless is misleading.
Narrowing the scope of the stock held in a portfolio necessarily increases its volatility. Holding fewer stocks and industries results in a market basket that is more susceptible to market fluctuations. It is possible that the narrower portfolio works in favor of the investor in certain circumstances, but modern portfolio theory suggests that the probabilities are that it will, in fact, underperform the broader market index.
The rationale against such arithmetic is that such a fund excludes companies that produce an asset that is in decline, leaving it with what ought to be, at first blush, a superior-performing mix of companies. However, theres no reason to believe this is true. For starters, the fortunes of an individual company are not wholly tied up in the fortunes of the larger industry.
For instance, the tech sector has grown exponentially in the 21st century, and companies such as Facebook, Google, and Apple have made hundreds of billions of dollars for their investors. However, investors in Microsoft, which had the highest market cap in the S&P 500 in 1999, have lost money by holding onto its stock.
In the U.S. smoking has been on a long decline both in the U.S. and elsewhere for the last twenty years, and there are only about half as many smokers in the country today as there were at the turn of the century. A similar trend has occurred in most developed countries.
A world where the popularity of its main product is steadily declining would presumably spell disaster for any company, but that has not been the case at all for Altria, the maker of the immensely popular Marlboro cigarettes. Its profits have grown throughout the 21st century, as has its stock price.
In 2000, The California Public Employee Retirement System (Calpers), the largest public pension fund in America divested its holdings in the tobacco industry, citing moral concerns about supporting a product known to be deadly. A number of other pensions followed suit. With mounting medical evidence of the dangers of tobacco and public consumption declining, it seemed like a financially sound decision as well.
As a result Calpers have missed out on as much as $3 billion in gains.
Betting against fossil fuels is no less counterintuitive. ExxonMobil, by far the largest fossil fuel company in the U.S., has a stock price that moves closely with the price of oil, so any success in reducing demand for oil would at first blush harm their bottom line and stock price. However, it has also made a strong play into natural gaswhich emits much less carbon dioxide when burnedand it has been increasing its investments in algae biofuels of late. Thus, a political environment less friendly to carbon emissions need not harm its stock price.
It also has a reputation of being an extremely well-managed firm that manages to keep its costs under control under all circumstances, a feat that has earned it the admiration of its industry rivals.
Whats more, the notion that the fortunesand stock priceof ExxonMobil and other firms in its industry will collectively fall if and when pro-carbon policies and technological changes take off assumes a modicum of market myopia. If there were a collective perspective that carbon taxes are likely in the next five to ten years, the market would have already incorporated such information into its stock price. Given that its stock price is down over 20 percent since its peak in early 2014 suggests that this may indeed have occurred to some extentwhich means that Exxonmobils fortunes areas beforesubject to its management performance as well as the fortunes of the broader energy markets.
It isnt Easy Being a Green Index
Besides the impossibility of saying with any certainty that a carbon-free portfolio will outperform a broader internet index, the cost of actually constructing such an index results in management fees significantly higher than a simple index fund that attempts to mimic the behavior of the broader market. A market index can be constructed via a simple computer formula, and management fees tend to be quite low. The Vanguard 500 Index Fund, for instance, has an expense ratio of just .14 percent, compared to the average actively managed fund ratio of 1.25 percent.
However, a fund governed by certain moral or environmental principles requires a constant examination of the companies in the index and their behavior, which unavoidably results in a higher expense ratio. The Vanguard FTSE Social Index Fund has a management fee of .22 percentlower than nearly all actively- managed funds but still 50 percent higher than Vanguards 500 index fund. The S&P 500 Fossil Free SPideR has an expense ratio of .4 percentthrice that of the regular Vanguard Index Fund.
In its 2015 report on the problems of the Fiduciary rule, the Obama White House embraced the use of index funds for long-term investors because of the ultimate advantage of low expense ratios.
Higher management fees ultimately translate into lower returns and the performance of the Vanguard Social Index bears that out. While it did outperform the broader market index from 2012-2015, a period that coincided with a steep decline in oil and coal prices, the five and ten year comparisons show the broader index with higher returns, consistent with theory.
The idea that a state portfolio manage can improve his investment performance by assuming that the future will entail a substantial reduction in carbon, and that this environment will pull down the fortunes of ExxonMobil and other oil producers is facile. It may very well occur, but to assert that with any degree of certainty borders on hubris.
The Responsibilities of a Public Pension Fund Manager
The fiduciary responsibility of a public pension manager ought to be to pursue the maximum long-term return while minimizing the long-term risk. The fact that a government pension is, in a way, eternal introduces a modicum of complications and freedoms into that equation, but it doesnt change that goal.
A public pension funds extended time horizon can allow the fund manager to pursue relatively illiquid investments that may not have a payoff for decades down the road. The tradeoff for that illiquidity should be, on average, a higher return.
Pension fundsas well as insurance companies and other entities with long-term liabilitiesstrive to match their long-term liabilities with similarly-lived assets, which serves to further reduce their exposure to risk. This preference for long-lived assets is one reason that the U.S. Treasury has begun considering the sale of fifty-year bonds. However, allowing political exigencies to determine a public pension funds portfolio complicates such decisions.
There is one crucial difference between a privately-managed hedge fund and a public pension fund. A private investment firm that performs poorly will ultimately lose clients and money if it fails to perform.
A state-run pension fund has no competition, and the consequences of poor performance are usually less dire for such investment managers. For this reason, the danger of political activism, catering to special interests, and making financial decisions based on rationale that go beyond the best interests of the plan participants is exceedingly problematic. That a government can potentially supplement a financially deficient plan with tax dollars may be trueand something the state of Illinois will soon have to contemplatebut it should not be an invitation to use a public pension to carry out a political agenda in a way that exacerbates volatility and reduces potential returns.

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Tuesday September 19, 2017 @ 12:13:24 PM mt

I Hear You Matt Damon

In school choice circles, a lot of people dont much care for actor Matt Damon, at least his education politics. (Im not sure where they stand on The Bourne Identity or Stuck on You.) Damonson of education professor Nancy Carlsson-Paigehas been a vocal advocate for government schooling, and is the narrator of the documentary Backpack Full of Cash, which you might recall is the film those outraged over Andrew Coulsons School Inc. say PBS must show to balance out perspectives. But heres the thing: Damon sends his own kids to private school!

I am supposed to be outraged by the apparent hypocrisy, but I dont think Damons selection falls under that heading. Damon and many progressives love public schooling but dont like what it has become, especially under the standards-and-testing tidal wave of No Child Left Behind, and the only somewhat less inundating Every Student Succeeds Act. They dont care for the reduction of education to basically a standardized test score. As Damon, who attended progressive public schools in Cambridge, MA, has said, I pay for a private education and Im trying to get the one that most matches the public education that I had, but that kind of progressive education no longer exists in the public system. Its unfair.

No doubt lots of peoplechoice fans and detractors alikewho want education to be more than a score sympathize with Damons frustration. The problem is that Damon champions exactly the wrong system to get sustainable change. By its nature, public schooling, if not doomed to reduction to simple metrics, is in constant, near-death peril of it.

When people cant vote with their feetwhich is very tough to do in a system in which where you go to school depends on where you can afford a hometheir only hope to make schools do what they want is government action. But government is controlled by politics, which is itself driven by soundbites. And what is ideal for a soundbite on whether schools are working? Why test scores, of course! The scores are up, or the scores are down, or 25 percent of the kids are proficient, and so on.

The key to escaping such peril is not hoping that nick-of-time, death-defying, Jason Bourne-esque political miracles will constantly save us, but basing education in freedom. Attach cash to studentsvia backpacks, if you mustgive educators autonomy to teach and run schools as they see fit, and ground accountability in educators providing schools to which parents willingly entrust those backpack-bearing kids.

Of course, there is much more that is problematic about government education than just simplistic standardization. Far more deeply, if it is unfair that Damon cant find the progressive schools he wants in the public system, it also unfair that many religious peoplewho by law cannot get the education they want in public schoolsor Mexican Americans, or countless other peopleare also unable to access the education they want. Thankfully, the key to getting fairness for them is the same one to getting fairness for Damon: school choice.

Dont blame Matt Damon for his choices. Blame the choice-killing system he defends.

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Tuesday September 19, 2017 @ 12:13:24 PM mt

The Two-Per-Cent Solution

The Feds persistent failure to reach its 2 percent inflation target ever since that target was first made explicit in 2012 has elicited a great deal of commentary in the last couple months, from economists, journalists, and some Fed officials themselves. And well it ought to, for whatever one may think of the Feds choice of target, the fact that the Fed has been persistently falling short of it suggests that something is awry, if not with U.S. monetary policy, then perhaps with the U.S. economy more generally.

Although plenty of explanations have been offered for the inflation shortfall, none of them is even close to being satisfactory. Bias or noise in the inflation numbers? Bias would explain things if the Fed were targeting some supposedly ideal measure of inflation. But it isnt: its targeting the rate of change of the Personal Consumption Expenditure (PCE) index, and so long as that measure of inflation falls below the Feds target, the Fed isnt really hitting its self-assigned target, even if the real inflation rate is higher than the PCE index suggests. As for noise, it should make the Fed just as likely to overshoot as to undershoot its target. Unemployment still isnt quite low enough? Despite what some foolish Phillips-curve reasoning suggests, putting more people to work doesnt make things more expensive. The publics long-run inflation expectations are down? No doubt. But surely thats a result, rather than a cause, of the persistently low values of actual (or measured) inflation?

Aggregate Demand is Part of the Story (But Only Part)

Of existing explanations, the least question-begging emphasize the fact that total spending, or its statistical counterparts such as nominal GDP, just hasnt been growing rapidly enough to achieve the Feds inflation target. As Mickey Levy puts it in a paper he gave at last weeks SOMC meeting,

Obviously, if nominal GDP had accelerated in response to the Feds aggressive easing as planned, both wages and inflation would have risen faster, and inflationary expectations would be higher.

Scott Sumner has made essentially the same point: The only way to have low inflation despite low RGDP growth, he observes,

is if the Fed has such a tight monetary policy that NGDP growth remains slow. And thats exactly what theyve done since 2009. If you produce 4% NGDP growth year after year after year [when the norm has been substantially higher] then why be surprised that inflation remains low?

In fact, as David Beckworth pointed out recently, using the chart reproduced below, since the third quarter of 2009 NGDP has grown at an average rate of just 3.4 percent, compared to 5.4 percent between 1990 and 2007 and 5.7 percent for the full Great Moderation period of 1985-2007:

According to Beckworth the decline reflects a monetary regime change consisting in part of the Feds having failed to allow spending to bounce back at a higher growth rate during the recovery as it had done in past recessions.

But while explanations that attribute the Feds failure to reach its inflation target to slow NGDP growth have the distinct virtue of taking the equation of exchange (MV = Py) seriously (which is more than can be said for some of the others), they still beg the question: why hasnt the Fed achieved higher NGDP growth?

To observe that it hasnt done so because it hasnt been directly targeting NGDP wont do. After all, a 2 percent inflation target implicitly calls for whatever NGDP growth rate it takes to achieve 2 percent inflation. Arguments to the effect that the Fed has failed to achieve 2 percent inflation because it has failed to achieve 5 percent NGDP growth (or some such number) instead of 3.4 percent growth do no more than state the original question in slightly modified form.

The Regime Change that Matters

In fingering regime change Beckworth gets closer to the truth. Only the regime change that really matters isnt the shift away from level to rate targeting that he emphasizes. Its the switch, in October 2008, from the Feds conventional monetary control arrangements, with a market-based fed funds target achieved with the help of open-market operations, to its current IOER-based (leaky) floor system in which the fed funds rate is moved up or down by raising the rate of interest the Fed pays on banks excess reserves, either alone or together with the rate it offers in its overnight reverse repurchase (ON-RRP) agreements.

What does the Feds switch to a floor system have to do with the low inflation and NGDP numbers weve been seeing ever since? Bear with me, and Ill explain.

To do so I must first explain in a bit more detail how a floor system works. In so doing, Im going to abstract from the role of ON-RRPs, for those arent actually part of an orthodox floor system, in which the IOER rate alone serves as the central banks policy rate.In the U.S., the situation is complicated by the fact that various GSEs keep balances at the Fed, but arent eligible for interest on those balances. Consequently banks and those GSEs can mutually profit by having the GSEs lend their excess Fed balances to the banks for a rate somewhere between the IOER rate and zero. To partially address this leak in what would otherwise have been a solid IOER-based federal funds rate floor, the Fed offered the GSEs and some other non-bank financial institutions the opportunity undertake reverse repos with it, thereby establishing a solid ON-RRP subfloor below the leaky IOER-rate floor. This arrangement serves to limit the extent to which the effective fed funds can fall below the IOER, although it still allows it to vary between that rate and the ON-RRP rate, as can be seen in the chart below. Those two rate therefore serve as upper and lower bounds of the Federal Reserves post-2008 fed funds rate target range.

A Floor System Calls for Substantial Excess Reserves

Abstracting, then, from the leakiness of the Feds IOER-rate floor, and the presence of an ON-RRP rate sub-floor, the basicidea of a floor system is that the interest rate on excess reserves displaces the fed funds rate as the key monetary policy rate. Thats because, in an ideal (leak-free) floor system, banks would neither lend nor borrow federal funds, whether from other banks or from non-bank financial institutions. Instead, they find it more profitable to hold excess reserves. A necessary and sufficient condition for this is that the IOER rate be sufficiently high relative to equivalent private-market rates of interest. In that case, banks will find it more attractive to hold excess reserves than to lend in private overnight markets, including the fed funds market. So long as they accumulate sufficient excess reserves, they can also protect themselves against any need to borrow funds overnight to meet either their net settlement needs or their legal reserve requirements. Of course the banks will find it especially easy to accumulate excess reserves if the Federal Reserves creates large quantities of fresh reserves, as the Fed did through its various rounds of quantitative easing. Still in the long run what matters most for the existence of a floor system is, not that any particular nominal quantity of reserves should be available, but that banks should have a robust demand for excess reserves, as they will only so long as such reserves yield a sufficiently attractive return.

In an orthodox floor system, such as is established when these conditions hold, the market for bank reserves functions as in the diagram below, taken from Marvin Goodfriends locus classicus on the subject:

As the diagram shows, so long as banks hold sufficient excess reserves, monetary policy becomes a matter of making desired changes to the IOER rate alone. Through arbitrage those changes will influence other interest rates. Changes in the actual stock of bank reserves, on the other hand, are neither necessary nor sufficient to influence the general state of interest rates. Instead, banks holdings of excess reserves increase and decline in lock-step with shifts in the supply of total reserves, leaving not only interest rates but lending, spending, and the inflation rate largely unchanged.

Whence the Deflationary Bias?

Youre still wondering what all this has to do with the Feds persistent undershooting of inflation. Trust me, Im getting there!

It might appear that the switch from a conventional to a floor system should make no difference in the Feds ability to pursue whatever policy it wishes. After all, all that has changed is the mechanism by which the Fed pursues its policy targets, rather than its ability to set and pursue those targets. Whereas before, to loosen (or tighten) policy, the Fed may have had to increase (or reduce) the available supply of bank reserves, now it only has to lower (or increase) the IOER rate. So, why shouldnt it be able to lower that rate enough to get inflation to 2 percent, or whatever other figure it prefers?

The answer is that, while in principle it could achieve a higher rate of inflation by lowering its IOER rate sufficiently (or, in the actual case, by lowering both its IOER and ON-RRP rates sufficiently), it cannot generally achieve any inflation rate that it wants while also maintaining a floor system. On the contrary: as Ill explain in a moment, although the masterminds behind the Feds turn to a floor system dont seem to have realized it, maintaining such a system necessarily introduces a deflationary bias in monetary policy.

To see why, recall that, to maintain a floor system, the IOER rate has to be high relative to corresponding market rates. Otherwise banks wont be inclined to accumulate and sit on substantial excess reserves. Instead, theyll increase their lending in wholesale and other markets that offer them better risk-adjusted returns. To serve as a floor (and forgetting about GSE-based leaks), the IOER rate must be an above-market rate.

That the Feds IOER rate has in fact been kept above corresponding market rates is easily shown by comparing it to its closest private-market counterparts. Of those the closest is probably the Depository Trust & Clearing Corporations GCF (General Collateral Finance) U.S. Treasury and Agency-Based MBS Repo rate index. The next figure shows how the IOER rate has generally been kept above, and often well above, that comparable market rate:

A comparison of the IOER rate and yields on various shorter-term Treasury securities tells a similar story:

As can be seen, whenever market rates have tended to increase, the Fed has made a point of having its IOER rate keep up with those changes. It has done so, moreover, despite the fact that it has persistently fallen short of its inflation target. Clearly the rate adjustments cannot be justified by appeal to the Feds desire to stick to that target. They can, on the other hand, be accounted for as inevitable consequences of the Feds determination to keep its shiny new (albeit leaky) floor system going.

A Wicksellian Perspective

Im still not quite done, for Ive yet to explain in the clearest way possible why a floor system introduces a low inflation bias in monetary policy. Doing that requires that I appeal to Knut Wicksells understanding of how an economys rate of inflation depends on the relation between its central banks chosen policy rate and the economys corresponding natural rate of interest. According to Wicksell, a policy rate set below its natural level will tend to promote inflation, while one set above its natural level will tend to promote deflation.

One can quibble with the details of Wicksells argument, as I myself have done by noting that a nations inflation rate depends, not just on its central banks monetary policy stance, but on the state of economic productivity, among other things. (For this reason I think it better to speak of an above-natural policy rate inevitably leading, not necessarily to deflation or disinflation, but to an excessively low rate of NGDP growth.) The point remains that a central bank that tends to set its policy rate too high will also tend to generate less inflation than it wants.

To see that this is exactly what will happen if a central bank insists on preserving a floor system, imagine that we are back in the pre-2008 monetary control regime, with no IOER and a market-determined fed funds rate. Assume as well that the rate is both on target and at its natural level that is, the Feds target is consistent with a modest (if not zero) rate of inflation.

Now suppose the Fed decides to switch to a floor system. To do that, it first has to set an IOER rate at least as high as the established fed funds rate, and therefore either at or above the natural funds rate, so as to encourage banks to accumulate excess reserves, in anticipation of boosting the supply of reserves. These steps are needed to get the fed funds market onto the flat portion of the reserve demand schedule shown in Goodfriends diagram above. Thenceforth, to stay in the new regime, as natural rates increase the Fed must increase the IOER as well. While a below-natural IOER rate will undermine the floor system by causing banks to shed their excess reserves, an above-natural IOER rate wont. A permanent floor system is, for this reason, a recipe for monetary over-tightening.

Obviously, if the Fed decides to introduce a floor system at a time when policy is already tight, so that the going fed funds rate is already an above-natural rate, the switch will tend to result in additional over-tightening, since it must involve introducing an IOER rate thats at least as high as the already excessively high established fed funds rate. Something like this appears, in retrospect, to be what happened in October 2008.

A Missing Piece

My explanation for the Feds persistent tendency to undershoot its inflation target is still not quite complete. For it rests on the underlying premise that the Fed is determined, by hook or by crook, to maintain a floor system of monetary control. What proof have I of that?

It is a good question. My answer is, first of all, that the proof lies at least partly in the pudding. For, as Ive stated, were it not for its determination to keep a floor system in place, it would be difficult to explain the Feds insistence upon raising its policy rate despite falling short of its inflation target. Further evidence consists of the Feds present normalization plan, which calls for eventual increases in the federal funds rate by close to 175 basis points. So far as Fed officials have indicated, that increase is to be achieved entirely by means of equivalent increases in the IOER rate. In short, if the Fed has any intention of ever returning to its pre-IOER operating system, or to a true corridor system in which the IOER rate serves not as an upper but as a lower bound for the fed funds rate, it has given no indication of it. On the contrary: having spoken to several Fed insiders on the matter, Im assured that the Fed has every intention of sticking to the present system.

Why it should wish to do so is a different matter. Im pretty sure that part of the reason is that Fed authorities are themselves unaware of the over-tightening bias present in a floor system. They applaud, on the other hand, the fact that a floor system allows them to separately manage interest rates on the one hand and the state of bank liquidity on the other. In recentCongressional testimony,I likened the Feds gain in flexibility in a floor system its being able to set its policy rate however it likes, while altering the supply of bank reserves however it likes to the gain an automobile owner might secure, in being able to turn the wheel as much as she likes, while also stepping on the gas peddle however much she likes, by shifting from Drive to Neutral. The problem, of course, is that, while the driver seems to have more options, the car no longer gets her where she wants to go.

The Solution

What do you suppose it is? The Fed has to abandon its misguided floor system, the sooner the better, by moving to reduce its IOER rate, instead of increasing it as it has been planning to do. As the rate falls from above market to below market, the money multiplier will revive; and that revival will, believe you me, prove more than adequate to boost spending enough to get the PCE inflation rate to 2 percent and beyond. To keep it from getting too high, the Fed will have to plan on more aggressive balance sheet reductions or resort to its Term Deposit Facility or both. All this is difficult, but not impossible. The Fed can certainly do it if it tries. What it cant do is stick to the present floor system and reliably hit its inflation target.

[Cross-posted from]

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Tuesday September 19, 2017 @ 10:42:01 AM mt

Americans Distrust Wall Street and Its Regulators

Americans don't trust either financial firms associated with Wall Street or the regulators who are trying to control financial firms' activities. Thaya Brook Knight and Emily Ekins discuss the findings ofa new Cato Institute survey.

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Tuesday September 19, 2017 @ 03:48:08 AM mt

FEMA Spending

Congress is set to approve a multi-billion dollar aid package for Hurricanes Harvey and Irma. Much of the funding will be for the Federal Emergency Management Agency (FEMA).

The figure below shows real, or inflation-adjusted, spending on FEMA since 1970. (FEMA was created in 1979, but federal budget figures include spending on predecessor agencies). Put aside the mid-2000s spike from Katrina, and you can see that FEMA spending has trended strongly upwards. FEMA spending averaged $1 billion a year in the 1980s, $3 billion a year in the 1990s, and more than $10 billion a year recently.

Background on FEMAs history, role, and performance here. DownsizingGovernment charting utility here.

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Tuesday September 19, 2017 @ 03:48:07 AM mt

Larry Summers Conflates Economics and Politics on Shrinking Government

Former Treasury Secretary Larry Summers claimed at a Wednesday lunch that the Republican vow to significantly reduce the size of government is a foolish pipe dream due to structural economic realities.

What are these realities, according to Summers?

  1. An aging population will mean upward pressure on entitlement spending on unchanged policy.
  2. The rise in inequality requires government spending to ameliorate the consequences.
  3. Prices tend to rise relatively quickly in service sectors such as education and healthcare, necessitating more government spending.
  4. Rising national security threats and increased military spending by geopolitical foes will necessitate more U.S. military spending too.

Where to start?

Summers is right that, on unchanged policies, government spending would balloon due to aging.

The Congressional Budget Office projects spending on Social Security would rise from 4.9 to 6.3 percent over the next 30 years, whilst Medicare spending would nearly double from 3.1 percent of GDP to 6.1 percent. The impact of all that extra spending, even as non-Social Security and healthcare spending is projected to fall from 8.9 percent of GDP to 7.6 percent, is a growing budget deficit and accumulated debt. This would raise net debt interest payments further, such that by 2047 the U.S. budget deficit stood at (a completely unsustainable) 9.8 percent of GDP.

These long-term projections come with all the usual caveats. They use assumptions about the likely path of productivity growth in the economy, population growth, and the extent of labor force participation. Nevertheless, this analysis does highlight the scale of the contingent liabilities embedded in current policy.

Summers is also right about movements in relative prices, at least if historic trends continue. Labor intensive service industries, particularly where government involvement and support is high, seem to have seen price explosions relative to general price indices. Absent a future productivity take-off in medicine and education, it is certainly plausible that government will be under pressure to spend even more in these areas to maintain services.

The main problem that I have with Larrys argument is not his description of these economic phenomena. Its that on the implications of these facts and his further points about inequality and defense spending, he conflates economics with politics. He is guilty of a category error, combining elements of positive economics with normative judgments, especially when it comes to necessity to tackle inequality.

If you assume (as others such as Will Wilkinson have argued) that the public will not accept a smaller government because they do not want it, that entitlements cannot be touched and that there is an income elasticity for government spending> 1 (Wagners Law), then the trends outlined above are likely to grow government. But this need not be the case from an economic perspective. There are plenty of other policy options available. In other words, Larrys political judgments help drive what he describes as economic reality.

This reminds me of the Brexit debate, when multiple economic agencies, including the UK governments own Treasury, proclaimed there could only be economic losses from the UK leaving the EU. Looking at their assumptions, one saw these results arose largely by construction. Assuming Britain would sign no new free trade deals and change no regulations, but still suffer reduced trade within Europe, then Brexit inevitably would make Britain poorer.

So what does Larry miss?

First of all, theres a whole host of areas where the federal government could reduce spending outside of healthcare and Social Security spending. Though quantitatively some of these areas might be small, and others would be politically difficult, qualitatively they would reduce the scope of government substantially. Chris Edwards has outlined a potential $457.8 billion in savings in the recent Cato Handbook for Policymakers.

Second, though aging does put upward pressure on spending, the above figures show that the current entitlement framework is unsustainable without mammoth increases in the tax burden, which would reduce the potential growth rate of the economy. Entitlement reform in itself then is an exercise in downsizing government relative to current policy, and only reform here can maintain or reduce the size of government overall. Larry might be right that entitlement reform is politically difficult, but that is not an economic argument.

Third, and finally, though there are other economic explanations for the rising relative prices of education and health services, it seems likely that at least part of the story is precisely the role of administrative bloat and lack of competition brought about by government involvement. If so, then Larrys argument gets things the wrong way round the necessity of more government spending will be (in part) a consequence of government interference in the first place.

As my colleague Dan Mitchell has acknowledged, downsizing government is no doubt a difficult endeavor. Thats one reason why Cato has a whole stream of work dedicated to it. But Summers should not pretend that political choices are the same as economic realities.

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Tuesday September 19, 2017 @ 03:48:07 AM mt

President Trump Welcomes Anwar Ibrahim's Jailer to the White House

Anwar Ibrahim, former deputy prime minister and finance minister of Malaysia and later leader of the opposition in the parliament, is currently in jail for the second time on trumped-up charges. His jailer,Malaysian Prime Minister Najib Razak, will be welcomed to the White House by President Trump on Tuesday.

A Wall Street Journal editorialnotes:

A visit to the White House is a diplomatic plum that world leaders covet. So why is President Trump bestowing this honor on Malaysian Prime Minister Najib Razak, who jailed an opposition leader and is a suspect in a corruption scandal that spans the globe?

Mr. Najib will visit the White House next week for a presidential photo-op that could help him win the next general election and imperil Malaysias democracy.

From 1981 to 1998 Anwar was a rising star in the UMNO party, which has produced all of Malaysias prime ministers since its formation in 1963. In the late 1990s, however, he became a vocal critic of what he described as the widespread culture ofnepotismandcronyismwithin UMNO. This angeredPrime MinisterMahathir Mohamad.

They also disagreed on how to respond to the Asian financial crisis, as Wikipedia describes:

[As finance minister, Anwar] also instituted anausteritypackage that cut government spending by 18%, cut ministerial salaries and deferred major projects. Mega projects, despite being a cornerstone of Mahathirs development strategy, were greatly curtailed.

Although many Malaysian companies faced bankruptcy, Anwar declared: There is no question of any bailout. The banks will be allowed to protect themselves and the government will not interfere. Anwar advocated a free-market approach to the crisis, including foreign investment and trade liberalisation. Mahathir blamed currency speculators likeGeorge Sorosfor the crisis, and supported currency controls and tighter regulation of foreign investment.

Anwar was removed from office and then jailed in a trial that was criticized around the world. Amnesty International said that his trial exposed a pattern of political manipulation of key state institutions including the police, public prosecutors office and the judiciary. After his release from jail in 2004 he became leader of an opposition party and then in 2015 was sent back to jail.

In 2005 Anwar visited the Cato Institute.In the photo above, Im giving him a copy of my book Libertarianism: A Primer, which he told me had already read in prison. What a thing for an author to hear!Understandably, the thought of the president of the United States honoring his jailer is especially painful.

When the English Leveller John Lilburne was tried for sedition and treason in 1649, he declared, I shall leave this Testimony behind me, that I died for the Laws and Liberties of this nation. American presidents should honor heroes who can make such claims, not their oppressors.

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Tuesday September 19, 2017 @ 03:48:07 AM mt

Hurricanes and Global Warming

Discussions about global warming and hurricanes obscure the human tragedies unfolding before our eyes. With climate science being as politicized as it is, weve received quite a lot of inquiries as to whether those rushing to blame this on human emissions are onto something, and its natural to wonder whats going on when the news cycle is dominated by storms. The truth of the matter is: we dont yet have the data to know.

On August 30, National Oceanic and Atmospheric Administrations Geophysical Fluid Dynamics Laboratory said:

It is premature to conclude that human activitiesand particularly greenhouse gas emissions that cause global warminghave already had a detectable impact on Atlantic hurricane or global tropical cyclone activity.

This update cites research showing a 2 to 11% increase in hurricane intensity by the end of this century. Given the enormous year-to-year variability in storms, the highest figure would take nearly fifty years to emerge from the noise in the data, and the lowest oneprobably over a century.

As we said at the outset, this subject is better treated in a comprehensive fashion after the tragedies of today start to heal. For those of you who are thirsting for answers, I strongly recommend following my colleague here at Catos Center for the Study of Science, Ryan Maue, on Twitter. Ryan was one of the first to predict the extent of Harveys rainfall; youve likely seen his images atop the Drudge Report or journalists citing his work. In fact, the New York Times noted him in their article How to Follow Irmaand we agree.

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