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… the Tea Party

Jeb HensarlingHow is it that I often hold the same opinions on legislation as Jeb Hensarling?

Jeb Hensarling is not a person I am particularly fond of. He consistently votes against hate crime legislation, LGBTQ rights, pro-choice and women’s rights, and other morally correct things to do. He is socially conservative, and promulgates all of the negative social rhetoric that characterizes social conservativism. The world would be a better place if he were not a Member of Congress. Nevertheless, I actually agree with many of his positions on economics. How could I be so diametrically opposed to conservatism and yet agree with some of his policy?

I think the answer to this question lies in the distinction between social and economic policy, or more so, social conservatism and economic conservativism. I would characterize my political position as economically conservative, and much farther to the left socially. As a society we have coopted all of conservatism into Republicanism, and all of liberalism into being a Democratic, but truly that is not the case. The political spectrum is at least two-dimensional, and I certainly do not identity myself on the one-dimensional left-right spectrum.

Jeb Hensarling is the Chairman of the House Financial Services, which makes his opinions on financial matters of outsized importance. And recently, he has come out against a number of policies that I too do not hold favorably:

  • Export-Import Bank
  • Flood Insurance
  • Terrorism Insurance

Before diving into the policies and the foundations for our opposition, it is helpful to expound a bit on my personal economic philosophy. Market intervention is warranted by the government when there is the presence of a market failure. Furthermore, regulation is justified when government policy creates perverse incentives that ought to be contained. For instance, heavy industry generates pollution, which is a cost that people who do not necessarily consume the products of industry have to incur. This is known as a negative externality and is an example of a market failure. Therefore I believe that the government has a role in helping to resolve this failure.

Similarly, many countries in the world have deposit insurance for banks. Because of this assurance banks may take more risky gambles. This is known as moral hazard. Therefore I believe that the government is justified in regulating banking, insofar as the regulations are crafted to control the moral hazard that its policies create. However, beyond these types of corrective interventions in the market, I believe that the government should not intervene and let market forces prevail, which is to the benefit of all actors in the economy. I believe that those statements express a philosophy of economic conservativism. And certainly, in terms of economics, I may not be as far right as certain conservative politicians – the Rands come to mind – but I am certainly to the right of most self-identified liberals.

Export-Import Bank

Recently, since this section of the article was drafted, Congress outgunned our man Jeb and pushed the reauthorization of the bank through

The Ex-Im Bank is a government sponsored enterprise, first established during the FDR Administration. It borrows money at the government borrowing rate (Treasury rate), and then uses that money to support American industrial exports abroad. It has four main financial programs:

  • Direct loans to foreign purchasers
  • Guaranteeing loans made by banks to foreign purchasers
  • Insuring loans made by US exporters and banks to foreign purchasers
  • Loan guarantees for working capital lines of credit made by banks to American industrial firms

The purpose of these financial activities is to promote exports; in particular, to finance exports that the private sector deems too risky. Loan guarantees make up the bulk of Ex-Im financing. Direct loans are second up. Smaller firms typically take advantage of the working capital guarantees, particularly since their banks get nervous when receivables are in a foreign currency.

Due to the Ex-Im Bank’s ability to borrow at the Treasury rate it is a very profitably institution. So profitable in fact, it kicks money back to the Treasury – about $1 billion a year. The bank is not appropriated any budget funds, and has a very low default rate. However, the mission of the bank is not to generate income for the federal government. The purpose is to promote exports, support the American industrial and manufacturing economic base, and create jobs. Jobs jobs jobs!

airplaneHensarling & Co. dislike the Ex-Im Bank because they consider it “corporate welfare,” a clever piece of rhetoric meant to mean, ‘giving money to rich companies that don’t need taxpayer help making any more of it.’ They claim that for all the money it dishes out it is fundamentally excluding other businesses. Other worthy businesses. And this is not right, so they oppose the bank, which primarily support America’s largest companies, such as Boeing, GE, and Caterpillar.

This simply is not the case. To construct the Ex-Im Bank as a deliberate attempt by the US government to support fat cats at the expense of other businesses is a distortion of reality. The government does not spend any money on the bank. Given the government’s ability to borrow at low rates, the government could set up any number of financial institutions with a similar financing model and support any industry it sees fit. It just happens to be that for 80 years the government has chosen to specifically support industrial exports (and many other industries, which the Tea Party is choosing not to mention). The opponents of Ex-Im are simply using the bank for political theatre. Like most of their arguments, their rhetoric is misleading.

Why don’t I particularly care for the Ex-Im Bank? It is because there is no evidence to point to a market failure in the export financing sector. Furthermore, the bank creates export subsidies, which distort international markets away from their natural equilibrium. It’s the same reason that I am in favor of free trade agreements. However, over 60 countries have export credit agencies like the Ex-Im Bank, so there is more or less an even playing field. But there would be just as much of an even playing field if every country scrapped their subsidies and let the market take care of international trade on its own.

Furthermore, the Ex-Im Bank is a government sponsored enterprise (GSE). It borrows at government rates and uses that money to guarantee loans aligned with the government’s long-term goals. This is exactly like Fannie Mae and Freddie Mac, the two most notorious GSE’s (which, not to my surprise, Hensarling also opposes and has sought to wind down). Now I am not saying that the Ex-Im Bank is headed towards a default a-bomb (nor am I saying that it is not), but in general, I am opposed to GSE’s. When the government supports a particular market and not others it picks winners and losers. Not particular companies as winners and losers (like Hen-chmen claims), but particular industries, as the recipients of capital or not. People see winners and shift their capital to those fields. Capital pools in one industry, whereas a more even distribution among industries may be more optimal. In addition, it actually creates moral hazard, wherein financers take on more risk than they normally would have because of the government guarantee.

With Fannie Mae and Freddie Mac, this all contributed to a huge housing bubble. The country did not need so many new single family homes. We needed affordable housing, infrastructure, investments in education, and a host of other capital intensive construction, but because of the government supporting home ownership, everyone went full speed ahead into housing until it was too late.

I don’t believe that we are in a manufacturing and industrial export bubble; however, the market may be distorted by the cheap capital flowing to the sector from the government. The market may naturally be demanding renewable energy, infrastructure, affordable housing, technology, and software, but instead a disproportionate flow of capital is going to heavy industry. In my opinion, it would just be better to not directly financially support particular industries with capital, and instead just create policies that allow industries to flourish naturally (tax policy, employment policy, intellectual capital and patents, etc.).

During an industry’s infancy direct capital support may even be the correct policy, but as an industry matures, which heavy industry in the United States certainly has, so too does the policy need to, and the capital support needs to taper and eventually disappear. This has not happened, and we continue to see massive American firms such as GE, Boeing, and Caterpillar, getting the largest sums of our export credit support.

Flood Insurance

I nearly wrote an article about government flood insurance a few years ago after Hurricane Sandy, but everything that needed to be said at the time was published by other people, so I abstained from writing my own opinion. But I think that now is an appropriate time to return to the topic.

hurricane-sandy-nyc

Private homeowner’s insurance does not cover flooding. It used to, until the 1950’s and 60’s, when losses were mounting to insurance companies, premiums were rising, poorer people in flood zones were left – ahem­ – without a paddle, and insurance companies began dropping flood coverage altogether. Federal flood insurance covers this gap. Homeowners pay premiums and the government covers losses. Originally, the program was implemented to reduce the government’s exposure to flood losses. FEMA was paying out large sums after natural disasters to uninsured homeowners, so the insurance program was extended to communities in flood zones that were willing to adopt flood mitigation and management plans. In addition, the federal government hoped that by pooling funds into a national program, localized events could be covered and absorbed by premiums paid into the system nationwide.

However, in practice, the supposedly self-sustaining program has become costly and far from self-sustaining. Rates remain below market levels and risk has been poorly quantified and distributed. The system (which is administered by FEMA – they’re doin’ a heckofa job!) has borrowed from Treasury on multiple occasions, and is currently $24 billion – ahem – underwater.

One of the problems is the flood maps. Anyone living in a flood zone as indicated on these maps is legally required to have flood insurance. But the maps are outdated and not accurate. They underestimate the risk of floods. As a result, people who are in fact in flood zones, even though they do not have insurance because the maps do not require them to, are getting flooded out and requesting emergency relief funds. Plus, people who do have coverage are under-insured because the maps are not adequately estimating the risk that they are under.

The problem with risk identification does not point to a philosophical objection to the policy, but instead a problem with how it is carried out. These problems could be resolved by simply updating the flood maps and having premiums reflect actual risk. However, I have a more fundamental objection to the national flood insurance program: people who do not live in flood zones are subsidizing people who do live in flood zones.

I am from the Hudson Valley, which is historically a relatively safe place to live and not flood-prone. It is one of the reasons why I love my home region. And as a taxpayer, I do not want my tax money to be subsidizing people who have multiple homes or choose to live in riskier areas, such as beachside. Government policy should be incentivizing development in less-risk regions, and people who elect to live in riskier zones should foot the entire bill themselves (in this case through a private flood insurance market).

Of course, there are always questions of poverty and mobility. There are many impoverished communities around the United States in flood prone areas. I am amenable to a program that assists these communities, but this would be a vastly scaled down national flood insurance program, not the $24 billion indebted behemoth that we see today. Over time the country would be better off if flood-prone regions became less populated. Scaling back flood insurance would achieve that. Some of the saved money could even be used for relocation assistance, or any number of other assistance programs.

Terrorism Insurance

The Terrorism Risk Insurance Act (TRIA) was enacted after September 11, 2001 so that large development projects could continue as insurance companies, banks, and developers, readjusted their models for terrorism risk. It has been continually renewed since them. It is supported by Congresspersons and Senators from major metropolitan areas, developers, and of course insurance companies who can transfer their risk to the federal government. Organizations such as the NFL and NASCAR also support TRIA, since it helps to insure large events such as the Super Bowl.

Treading into appropriate risk and terrorism is an ideological minefield. Dare I ‘let the terrorists win’? Pushing aside those considerations (which, yes, I believe are asinine), if there is risk in development, then I believe that the federal government and by extension, the taxpaying public, should not have to bear the risk. This is a running theme in this article and a general belief of mine. Investors should bear risk, not anyone else. If large-scale development is too risky because of the potential for terrorist attacks, then do not engage in large-scale development, or at least modify plans to disperse risk and make them less desirable or less likely targets.

A market failure common in insurance is adverse selection. Adverse selection is when the people most likely to have to make a claim buy the most insurance. This overwhelms the mutual risk sharing pool of premiums (since not many people who are not making claims are paying in) and the insurance scheme fails. It is very common in health insurance. Sicker people bought more insurance, and as a result policies were always going up and up and up, forcing out healthier people (and putting them at risk for sudden and expensive health emergencies). The individual mandate in the affordable Care Act was meant to address this very issue of adverse selection. But I do not see any adverse selection taking place in the terrorism insurance market. The case can certainly be made that New York and a handful of other states bear more risk, but insurance is administered at the state level anyway, so this risk concentration is not contributing to any adverse selection at a national level.

Another theme in this article is that I do not categorically oppose all of these programs and want their subsidies rescinded, immediately. However, moderation and more specific selection of beneficiaries are imperative. With the example of terrorism insurance, perhaps developers in Washington DC do bear outsized risk due to the presence of the federal government. The government could then rightfully offer terrorism insurance for developments in the District of Columbia. And as I mentioned in the case of the Export-Import Bank, direct government support of infant industries may be warranted and appropriate. However, I do not agree with these largescale subsidy programs.

TRIA is likely a program that had its merits in 2001 and 2002 when America was one big patriotic brothel and everyone wanted to do anything that they could to fight the terrorists and help the country get out of a recession quickly. However, since then, there have not been any terrorist attacks and there has never been a terrorist insurance claim filed (the Secretary of the Treasury has to declare an act of terrorism for the government to backstop the insurers, and he declined to do so after the Boston Marathon Bombing). Since 2001 terrorism insurance has just become a profit getting boondoggle for the insurance companies. New developments are required to have terrorism protection by the banks, so the insurance companies are guaranteed revenue, while the federal government backstops the majority of the risk. The risk is also extremely difficult to quantify and model, because terrorism attacks have been extremely rare, are subjectively defined, and the loss distribution of the attacks has been extremely wide. This directly calls into question the insurance industry’s pleas for government support.

Twin Towers

Luckily, there have not been any terrorist attacks in the United States since September 11. As a result, terrorism insurance has only cost tax payers $1 million a year in administrative fees. However, were there to be an attack, in addition to the loss of life, injuries, and property damage, a huge hole may get blown in the national budget. Taxpayers, whether or not they are shareholders of development companies, would have to fill this hole.

Essential Air Services

I am not aware of Representative Hensarling’s position on Essential Air Services (EAS), but it is a government program in the vein of the others that I have discussed here in this article. I am not a fan of the program.

Prior to 1978 the government heavily regulated air travel. Fares and routes were mandated by the government. This system provided flights to smaller and more remote cities around the country. After deregulation, communities feared that airlines would eliminate flights to smaller cities, since these flights are less profitable. In response, the government enacted EAS, subsidizing flights to 160 rural communities around the country (43 of these communities are in Alaska). Excluding Alaska, which has separate operating parameters, the program cost $241 million in 2014. Apply the Eric Test: Is there evidence of a market failure in the rural aviation industry? I don’t believe so.

Small Airport

By subsidizing flights to smaller rural cities the government is making the cities marginally more attractive places to live. However, the economy works most efficiently when labor moves to where it is in demand. During the early and mid-20th century smaller rural cities were certainly labor centers. Agriculture was more labor intensive and employed more Americans, mining was more prominent, and industry and manufacturing was more dispersed. However, in the current economy demand is concentrated in larger cities that have hi-tech firms, universities, established industries, cargo infrastructure, and large health care systems. Smaller rural cities ought to shrink in size until they reach equilibrium – residents who desire to remain in the city and receive satisfaction from doing so can live there, and they can pay workers in the service industry sufficient wages so that everyone in the city can maintain happy and healthy lifestyles. EAS disturbs this equilibrium, and we are all paying for it! I don’t like it.

I do not propose that these communities be immediately cut off. People and communities need time to adjust. However, over time, service needs to be transferred away from these communities, and I suspect that population will decrease as well. Many of these communities were once thriving, due to the presence of industry, such as mining, which is no longer present. These people would now be better off, and so would the rest of the country, if they moved to other population centers where their labor is in demand and they have easier access to public and private services, such as quality health care, education, shopping, entertainment, banking, government services, and social networks. Kill EAS, Jeb!

Government subsidies and related economic support programs are often pet projects of politicians from around the country. That is why so often politicians from across the aisle get in bed together on these issues. If the policy benefits their district or state they will support it, political and economic philosophies aside. To see through this political theatre and their rhetoric apply the Eric Test: Is there evidence to indicate the presence of a market failure? If not, oppose the policy or regulation.

https://www.washingtonpost.com/opinions/robert-samuelson-the-misleading-debate-on-the-export-import-bank/2014/07/01/91bb7208-0138-11e4-8572-4b1b969b6322_story.html

http://www.nytimes.com/2015/06/26/business/jeb-hensarlings-fight-against-ex-im-bank-succeeds-for-the-moment.html?_r=0

http://www.insurancejournal.com/news/national/2014/05/22/329812.htm

http://www.politico.com/story/2014/03/jeb-hensarling-financial-services-compromise-104502

https://www.transportation.gov/sites/dot.gov/files/docs/Subsidized%20EAS%20report%20for%20non-Alaska%20communities-Jun%202014.pdf

http://www.theguardian.com/business/2014/jun/19/congress-renews-tria-terrorism-insurance-bill

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… Manhattan

I recently noticed on Facebook that a New York Times article in a column called “The Hunt” has gained some traction, mainly in a negative light. The article is titled, “How to Get to Manhanttan? Save, Save, Save,” and it tells the story of a very young woman who was able to afford a nice apartment on the Upper East Side. The problem with the story is that the math just doesn’t add up.

Annie_Facebook

Annie, a financial services adviser and the subject of the piece, put down 35% on a $426,000 apartment. That’s $149,100. Plus, she spent $30,000 on renovations and remodeling. In total, she used $179,100 of her savings. From the article, it sounds like she worked for about two years and a quarter before making the bid on the apartment. That means she was putting away $6,633.33 a month, at bare minimum. Assuming she was putting away 100% of her take-home pay into savings, her average annual salary was a whopping $79,600. I personally worked in banking consulting until the beginning of this year, starting right out of college just like Annie, and I never made that much even before taxes.

But further questions remain. She certainly couldn’t have saved 100% of her salary. Even though she lived at home she must have used some of her income on transportation (particularly to get to work, even if it is deductible), food, entertainment, clothing, other personal items, and leisure and entertainment. Did she pay for any benefits through her employer, such as health insurance, life insurance, long-term disability insurance, eye care, or dental care? Most likely. What about her 401(k)? Certainly someone as financial savvy as Annie  would be putting away money for retirement at her young age and taking advantage of what we can assume was a match from her employer. And then of course there are taxes. Working in New York and living in New Jersey, Annie must have been hemorrhaging paychecks to the Man on those long nights stuck in the Lincoln tunnel. All in all, this article would lead you to believe that Annie was making six digits out of college.

The last question that needs to be raised really doesn’t need to be asked at all. By now, it should be apparent that Annie received considerable financial help, most likely from her parents, in the purchase of this apartment. So one could assume that she doesn’t have any student debt because her wealthy benefactors most likely supported her through Binghamton University as well. And herein lays my major complaint with this story. The article lauds the virtues of saving and what it can get you in the (relatively) long run. However, the subject of the article is a daughter of wealthy circumstance. I concede that she likely saved a large ton of money, especially for someone of her age. But the fact remains that for the 99% a free education is not possible, and even someone with the discipline of Mother Theresa could never afford that apartment after working for less than three years without someone pitching in with a fat check.

My true complaint is not with Annie though. She legally bought this apartment and she has every legal right to live in it and pursue satisfaction and happiness in her life however she pleases. The problem in this case is the NY Times. By failing to run the numbers and fact check this article they failed their readership. But through this failure they have reinforced the false ideal that hard work and discipline alone can help you achieve your materialistic goals. Rather, the NY Times should be espousing alternatives means by which young people and the middle-class can find safe, comfortable housing in New York City and other places around the world. What we need is innovation. Innovation in how we finance shelter. And innovation in how we actually shelter ourselves and how we conceive of adequate and satisfying shelter. This article reinforces materialistic societal norms and makes people believe that they are doing something wrong if they are not walking a taught tight rope towards their “American dream.” Didn’t we learn with the Triple-F Fiasco (Fannie-Freddie-Foreclosure!) that the American dream can easily turn into a nationwide nightmare? Renters can be happy people too. The NY Times doesn’t seem to realize this. With income inequality large and growing the NY Times and its readership need to realize that wealth and assets are not the only way to lead the good life. People can choose their own path.

I suppose since this blog is called “The Economics Of …” and I titled this post The Economics of Manhattan I should talk about economics a bit. I hope that my readers do not think that economics is about making everyone rich or maximizing wealth for everyone. I am an economist because I want to maximize opportunity for everyone – their opportunity to be happy, whether it is through wealth and asset accumulation, or whether it being through less materialistic means. My hope is that societies will put policies in place so that the opportunity is available to everyone, not that society will define what happiness is and have everyone marching towards that goal through the engines of the economy.

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