Unintended but Predictable Consequences

Obama and the Democrats are shocked and furious that Bank of America wants to charge customers a monthly fee for using a debit card, now that the Dodd-Frank financial services legislation reduced the fees retailers pay to banks for debit cards.

So now bank customers can pay for debit card usage directly when retailers did before. While retailers in principle should lower prices to reflect lower costs, that may not happen.

This is a terrible deal for consumers, all due to the predictable consequences of Dodd-Frank.

Was increasing consumer costs so Wal-Mart could have lower costs the change voters had in mind when they voted for Obama? No, but it is what they've gotten.

Unserious About the Budget

The negotiations over the budget compromise reached this week between Republicans and Democrats in Washington demonstrate the depths of Democrats' attachment to enormous levels of government spending.

Notwithstanding that the 2011 federal budget deficit is estimated to be a staggering $1.6 trillion, Obama's original budget called for an increase in government "discretionary" spending. After facing determined Republican efforts to cut spending this year, Obama and the Democrats came out for holding "discretionary" spending flat - that's right, in the face of a $1.6 trillion deficit, the Democrats proposed no reductions in spending.

The final compromise seems (I say "seems" because there is some debate that some of the cuts are recissions of spending authority that may not have been spent anyway, so the actual reduction may be less than the announced $39 billion) to cut spending by about $39 billion, or a cut of a little more than 2% of the budget deficit and 1% of government spending. That's it. Mountains of deficit spending, and Democratic opposition held the reduction to 2% of the deficit.

Look at the debate over funding the Corporation for Public Broadcasting ("CPB"), which gets over $400 million a year from the federal government. Government funding for the CPB started in the 1960s under the stated goal of promoting alternative programming to the dominance of the three broadcast networks. Well, there is so much alternative programming today - think of the hundreds of channels available on cable and satellite TV, plus the ability to stream entertainment from the internet - that the ostensible reason for the CPB no longer exists. Moreover, there is little doubt that devoted viewers and advocates of public TV would increase their donations to make up any funding shortfall if the government ended its subsidies to public broadcasting.

If a government with a $1.6 trillion deficit can't eliminate spending on the CPB, we are not being serious about the fiscal crisis facing the nation.

But the Democrats went to the mat to defend the CPB subsidies. They probably worry that Democratic fundraisers and activists, who fund so much of the left's political and social agenda, would divert some of their contributions toward public broadcasting and away from electing Democrats.

Machine Madness

This column by Sam Kazman in the Wall Street Journal discusses the impact of government regulations that mandate energy and water efficiency standards for washing machines. Due to these regulations, top loading washing machines clean clothes much less effectively than previously. Front loading washing machines generally provide superior cleaning, at a significant cost increase.

This raises the question: if energy and water efficiency were such desirable attributes of washing machines even if cleaning quality is reduced, than consumers could choose such models. And other consumers, who don't want to trade off efficiency for cleaning quality, could choose other models. Such is how matters operate in a free society.

The very fact that the government decided to promulgate such standards, rather than leave the choice to each of us individually, is because it feared many would prefer cleaning quality to energy/water efficiency. And because many people wouldn't make the "correct"choice, the government had to make the decision for us.

Just one more example of our nanny state at work, limiting our freedom.

A Vast Right-Wing Conspiracy

Economists from the Organisation for Economic Cooperation and Development (OECD) published a study that said property taxes are the best way to raise additional tax revenues since its effects on economic growth are less than other ways to increase taxes. The study concluded that increasing income and employment taxes are the worst way to raise taxes due to its negative impact on economic growth.

This is consistent with the supply-side revolution in tax and economic policies that Ronald Reagan unleashed almost 30 years ago, and keeping tax rates on income low is one of the important ways we can get the economy growing again.

Interestingly, the OECD is a Paris-based organization that works on economic and public policy issues. It is an established member of the many international organizations that influence policy. As such, it is no bastion of conservative thinking. The fact that such a group published a study extolling the virtues of a "regressive" property tax and depicting the problems of a "progressive" income tax illustrates how accepted it is by economists that higher income taxes reduce economic growth.

Free Lunches Aren't So Free

General Motors announced that it is withdrawing its application to borrow $14.4 billion in loans from the federal government.

The loans are part of the government's $25 billion program to lend money at below-market interest rates to auto companies to subsidize their investment in more fuel-efficient cars.

But GM has decided that there is a price to pay for government handouts, since many car buyers have shunned bailed out GM and Chrysler, preferring to buy cars from Ford which didn't take government money.

While it may be optimistic to believe that GM's example will deter others from seeking bailouts in the future, it is good to see that the stigma from government bailouts will make others think twice before pursuing them again.

True Colors

Facing a dire fiscal crisis, the Camden, NJ government laid off half its police force and one-third its fire department. The city sought to cut pay to avoid or minimize layoffs, and the unions preferred to see many of its members lose their job so the remaining members could have higher pay.

The people of Camden will be the ones who suffer, losing the protections provided by greater numbers of police officers and firemen.

Newark, NJ faced a similar situation, where 167 police officers lost their jobs after the police union wouldn't agree to wage and benefit concessions.

This terrible outcomes highlight the obvious, but often overlooked, incentive that taxpayers have: taxpayers should want the most services for their tax dollars, which implies that, in the efforts to balance government budgets, taxpayers should strongly prefer to see reductions in government employees all-in compensation than layoffs which reduce the quality of government services provided.

This is exactly analogous to how most people view other goods and services they purchase, whether they try to pay less while getting good quality. Most people have bought items on sale, at discount stores, or bargained for a better price such as buying a car. Directly or indirectly, such a focus on getting a good deal serves to reduce the income of someone in the chain of supplying the good or service.

Whether a car salesman who gets a lower commission because you negotiate a lower price on the car you purchase, or lower revenues to the retailer which puts downward pressure on wages when you buy clothes on sale, most people try to get a better deal when they spend their money even if the impact leads to lower wages for someone else.

As taxpayers, we need to have the same mindset, and recognize how normal and natural it is to do so. Otherwise, looming disasters such as will afflict Camden and Newark will become commonplace.

He Told You So

I have long believed that the environmental movement reflects the anti-capitalist, anti-industrial agenda of the left.

Don't take my word for it. Patrick Moore, one of the founding members of Greenpeace, confirms this. Quoting from a recent column he wrote:

"To a considerable extent the environmental movement was hijacked by political and social activists who learned to use green language to cloak agendas that had more to do with anti-capitalism and anti-globalization than with science or ecology. I remember visiting our Toronto office in 1985 and being surprised at how many of the new recruits were sporting army fatigues and rebel berets in support of the Sandinistas."

So the next time the environmental movement expounds its views, recognize that it often reflects an agenda far different from "clean water and air".

A Modest Proposal

As I have discussed in previous columns on the health insurance market, one of the profound problems afflicting healthcare insurance is that many patients have an incentive to overuse healthcare services since the patient often faces reduced, or in some cases little or no, costs as compared to the full cost of the treatment.

Studies show that a high percentage of a person's lifetime use of healthcare services occurs in the last six months of life, as often very expensive healthcare treatments are employed to address severe health problems. If a person faces little cost for potential life-extending treatment, many will naturally want to the treatment. If Medicare has to pay hundreds of thousands of dollars, for treatment that perhaps extends your life by a month or two, you will be tempted to incur such costs and treatment if your out-of-pocket is a small fraction of the total.

Medicare has an unfunded liability of an estimated $60 trillion, dwarfing the nation's national debt. This liability measures how much more money it will cost the federal government to pay Medicare expenses than it will receive in Medicare taxes.

Suffice to say, the nation cannot afford a $60 trillion liability. The unstated significance of ObamaCare is to cut government spending on healthcare by controlling the healthcare marketplace. Many countries with socialized medicine spend a smaller fraction of their economic output on healthcare - not because they are efficient, but because they simply provide fewer expensive healthcare treatments. The use of waiting lists to delay surgery and denying introduction of new drugs and medical devices are some of the ways these countries reduce healthcare spending.

Sooner or later, America needs to change its healthcare system to either socialized model, such as the path ObamaCare would take us, or a model consistent with freedom and individual rights, where the patient bears a greater portion of the cost of treatment so they have an incentive to economize on spending.

One step in this direction would be to continue Medicare and Medicaid's practice of paying exorbitant costs for healthcare - but then charging those costs above a certain threshold to a person's estate. If a person is poor, they will little or no estate so they will experience little or no change in their financial position from this proposal. But for middle and upper income Americans, they will have to seriously consider whether the cost of expensive treatment is worth paying the price in terms of leaving less money to their children and grandchildren.

A Deal Worth Making

Count me as a supporter of the recent deal between the Obama administration and Congressional Republicans to prevent the Bush tax cuts from expiring on January 1 and to resolve absurd state of estate tax law.

The compromise is just that: it reflects many elements which are disturbing. Most importantly, the tax cuts and estate tax are resolved only for the next two years, whereas the positive impact on economic growth from the Bush tax rates would be much more significant if the tax law was permanent.

To reignite economic growth and reduce unemployment, we need individuals, businesses, and investors to take risks on new investment opportunities, and the aftertax rate of return on those investments is the fundamental determinant of whether, and how much, new investment occurs. And since new investments have a return typically measured over many years (often decades), lowering taxes (or more accurately, not allowing tax rates to rise) permanently would raise aftertax returns much more significantly than a two year tax plan with the tax rates scheduled to rise afterward.

But allowing tax rates to rise would be much worse, so two years of lower taxes with the ability to refight the battle later is better than nothing.

The estate tax change is genuinely a good thing, since estate tax law has been subject to the absurdities that John McCain and others inflicted on the nation when the Bush tax cuts were first passed. Estates were not taxed at all in 2010, but death tax rates were scheduled to increase dramatically on January 1. The compromise raises the level at which estates gets taxed, and reduces the tax rate, while preserving the estate tax. I'd much prefer to see estate taxes abolished, since after a lifetime of paying taxes on one's money, it is obscene to take 55% of one's money at death (the pre-Bush tax cut rate that would have taken effect on January 1 without the new law). But a 35% tax rate on estates over $5 million is more equitable than a 55% tax rate on estates over $1 million that would have occurred on January 1.

What is most disturbing in the law are the provisions that pay off various Senators for their support, such as maintaining the ethanol subsidy. It is also disappointing that spending wasn't cut to offset the cost of various provisions to reduce their impact on the budget deficit.

But this is the political reality of divided government: Republicans can't get all they want, nor can Democrats.

It is interesting that a number of aspiring Republican presidential candidates, such as Mitt Romney and Sarah Palin, oppose the deal. While that may or may not be good politics, it is bad economics.

Meanwhile, the Democrat left who oppose the deal, vociferous in their denunciations of the bill and Obama for agreeing to it, demonstrate their belief that the earnings of Americans belong to the government and that a tax cut (or preventing taxes from rising) is "giving" money to the affluent.

Quite the opposite: lower taxes mean people keep more of their own money, while higher taxes means the government confiscates more of your money.

The Pigs at the Trough Have Learned Nothing

While the tax deal Barack Obama negotiated with Congressional Republicans contains many features that will help the economy grow, it also faces added elements ostensibly needed to win the votes of wavering senators.

One such deal is a continuation of ethanol subsidies, which will cost $4.9 billion in 2011. Not only has Al Gore, the green lobby's "star", come out against ethanol on environmental grounds, after championing it for so many years, but it is adding billions of dollars to the budget deficit at a time of staggering deficits.

Even if ethanol had merits, we should be eliminating all business subsidies as one step in improving our awful fiscal situation.

The fact that with trillion dollar deficits projected for years the government can include this $5 billion give away that doesn't even achieve the environmental goals for which it is intended demonstrates the lack of seriousness of our political leaders.

This is how government financial crisis arise, and why tragically it often takes such a crisis to force people to make decisions they otherwise wouldn't.

American Leadership, or Not

Many countries believe the Fed's recent round of quantitative easing is designed to depress the value of the U.S. dollar relative to other countries, and thereby to increase American exports by making goods produced in America cheaper in foreign currency terms.

This had led to much outrage expressed by international leaders, with Brazilian leaders saying the U.S. is engaged in a "currency war." Germany's Finance Minister Wolfgang Schaueble not only thinks QE2 is bad policy but says it violates the Obama administration's international commitments. Schaueble said: "These huge economic problems cannot be solved with more debt. That was the joint policy all developed nations, even the United States, agreed on at the G20 summit in Toronto."

Schaueble went on to say the United States should follow Germany's example of how to deal with the financial crisis - in which Germany cut government spending!

And how does Barack Obama feel about the Fed's QE2 policy in light of this international criticism of American policy? He supports the Fed's actions.

The U.S. dollar has a unique role in the world economy as the global reserve currency. Many nations (through their central banks holding most of their foreign currency reserves in dollars) and individuals look to the dollar as the ultimate safe store of value; the dollar is the currency used to price many commodities (such as oil); and is the benchmark for setting interest rates.

Having the global reserve currency provides the United States great financial flexibility. For decades, China and Japan have been sending America products that fill our homes, and in returns we have been sending them dollars that fill their central bank reserves. It also allows the federal government to run huge deficits and confidently believe it can easily borrow the money to support such debts.

However, the price for having the reserve currency is that the United States has a global responsibility to manage our financial affairs in a prudent manner. Huge budget deficits, a housing-led financial crisis, and debasing the dollar through QE2 all contradict the required prudence.

This is why there is such international outrage directed at the United States, for understandable reasons.

What do we need to address this problem? Stop QE2, cut government spending dramatically to reduce the budget deficit, approve the free trade agreements with South Korea and other nations that the Democrats have stalled for several years, and implement policies that promote economic growth through lowering tax rates and reducing regulatory burdens such as ObamaCare.

Solutions exist which can improve the economy, ease international tension, and restore American leadership to the world. Unfortunately, Barack Obama is not the man for such a job.

Surprise, Surprise

The Federal Reserve has recently began another round of what it calls quantitative easing (dubbed in the press QE2, to reflect the second time the Fed has engaged in this policy since the financial crisis began and as a play-on-words with the famous passenger liner). And the amounts are huge; the Fed is spending $900 billion on this effort: $600 billion in new money and $300 billion by reinvesting proceeds from previous bonds it bought that have matured.

Quantitative easing is a fancy term for printing money, since it means that the Federal Reserve will buy bonds on the open market from investors and pay for it with newly created money (in the modern era, such vast amounts of newly created money are in the form of electronic credits deposited to an investor's account, not printed dollars - although such credits could of course be converted into dollar bills if desired).

The Fed's stated goal is to lower interest rates of U.S. government bonds, since, all else being equal, by adding its demand to the market, the price of bonds should rise (and interest rates decline as bond prices rise). This is the application of the laws of supply and demand to the bond market. And lower interest rates on government bonds tend to lead to lower interest rates on mortgages and loans to corporations, to higher stock prices, and to greater risk taking on the part of investors who seek higher returns away from government bonds.

But the problem with the Fed printing money is it raises the specter of higher inflation in the future, since, all else being equal, more money in circulation means prices should rise. This is the application of the laws of supply and demand to the money supply and the economy's price level. Further, if investors believe inflation will increase in the future, they will demand higher interest rates on bonds today to compensate them for investing their money at a fixed rate of return.

So some factors suggest QE2 will lead to lower interest rates, and other factors suggest it will lead to higher interest rates. The Fed is betting that lower interest rates will predominate, while many have criticized the Fed for downplaying the risks from higher inflation.

So who is right? Well, so far, QE2 has led to higher interest rates! That could change with new market conditions, but so far the Fed's plan is not doing what it intended.

That Was Fast IV

Industrial giant 3M announced it will no longer offer group health insurance to retirees not old enough for Medicare, beginning in 2015. Instead, 3M will offer some financial support for such retirees to purchase their own insurance.

The reality of ObamaCare is making a mockery of President Obama's claim that people can keep their current insurance policies if they want: the government has changed the health insurance marketplace, making it difficult or impossible for companies and health insurers to continue with existing insurance plans.

While this may be an "unintended consequence", I believe it is exactly intended - with the goal of driving more people to government provided health insurance, since if ObamaCare destroys wide swaths of the private market, the government will expand its role in healthcare.

Believe It or Not

The government at all levels is being overwhelmed by its compensation practices. Staggering pension and healthcare liabilities, if unchecked, will bankrupt either the economy or government budgets. Paying above market wages and benefits raise taxes and reduce funds for other government services.

The Wall Street Journal reports that New York City pays $100 million to teachers who were laid off due to their school being closed. Moreover, 59% hadn't applied for school openings nor attended teacher job fairs.

If we pay people for not working, don't be surprised when they don't work.

That Was Fast III

McDonald's has announced it may drop health insurance for 30,000 of its restaurant workers if certain changes are made to ObamaCare.

The specific provision that is causing a problem for McDonald's is the requirement that health insurance spend at least 80-85% of its premiums on medical expenses. Because of high turnover and low premiums for its health insurance for restaurant workers, administrative costs are higher than 15-20% of the total premiums.

McDonalds has requested that regulators waive the requirement so it can continue to offer health insurance to its restaurant workers.

Barack Obama said people could keep their existing health insurance policies if they wanted under his "reform". But ObamaCare has made it impossible for some health insurance, and uneconomic for other plans, to continue.

That Was Fast II

As I wrote in July, the Democrats' policies are so bad that in some instances the deleterious effects occur very quickly and clearly.

This isn't so with many government policies, where the negative consequences can take to manifest themselves and can be obscured due to the passage of time and the complexities of many economic issues.

So a policy whose negative effect is so clear and quick must really be bad to so qualify.

And Obama's healthcare debacle does so. This week, new regulations took effect requiring insurance companies to issue insurance for children without considering pre-existing conditions, known as guaranteed issue.

While that sounds nice, the result has been that most of the major insurers this week stopped issuing children's only health insurance policies.

Why would the insurers do this? Because if a person is guaranteed to be issued a health insurance policy without taking into account pre-existing conditions, nothing stops the person from getting the policy until a medical condition arises. So insurance tends to be bought only by sick people, with those needing the most expensive coverage most likely to buy, driving up medical claims costs per customer. The insurance companies then have to increase premiums to cover the cost, which provides greater incentives for people to wait until a medical condition arises worth paying the increasing premiums. This is a vicious cycle, and leads to the destruction of the market.

And it just did for children's only policies.

To make this point more clear, let's use a very simplified example. Health insurance in reality is more complicated than my example, since there are many possible outcomes beyond two that I use for this illustration, and there are co-pays and deductibles. But this demonstrates the essence of the problem.

Imagine there are two outcomes for consumers regarding their medical costs for the next year: they either have no medical costs for the year or they have a major medical condition that costs $100,000. And let's say for the overall population that there is a 10% chance the catastrophic problem occurs and 90% chance there is no cost. And let's add that there is no way to test or screen to see if customers have this medical condition before they buy insurance - in other words, you only know you have this condition when symptoms develop.

If the insurance company can sell insurance to a broad, representative sample of the population, on average it will incur $10,000 of medical costs per customer, since $10,000 is the expected outcome (10% chance of paying $100,000 and 90% chance of paying $0).

Let's also assume the insurance company needs to add 20% to its medical costs to cover its overhead and earn a profit. So in this case, the insurance company would charge $12,000 for an insurance policy. Customers would have a strong incentive to buy insurance, since if they went without insurance they would have a 10% chance of facing a huge medical bill of $100,000. So insurance serves its fundamental purpose, which is to protect against large, uncertain risks.

But now imagine that the law requires guaranteed coverage and prevents insurers from using pre-existing conditions to deny coverage.

Smart customers will realize they can avoid paying $12,000 when they have no major medical problem and can instead wait until the condition develops - and then buy insurance for $12,000 to pay $100,000 of medical bills. That's a great deal for the savvy customer.

So after some period of time, the behavior of savvy customers will change the sample of people buying insurance - healthy customers tend not to buy insurance and those who develop symptoms rush to buy insurance - so now 20% of the insured population develops the major medical problem. The insurer's expected medical cost per customer is now $20,000, and now charges $24,000 for insurance coverage - up from $12,000.

Now the initially unsavvy customers - people who are representative of the overall population in terms of having a 10% chance of developing this major medical problem - buy less insurance, since the cost is now $24,000 but there chances of paying $100,000 are still the same 10%.

As these customers drop insurance, the percentage of actual customers who have the major medical problem further increases. If the pool is now comprised 40% of those have or develop the medical problem, the expected medical bills are now $40,000 per customer. This leads to higher prices for insurance, which then provides more reason for customers to only buy insurance when the medical condition arises.

The result? The insurance company stops selling guaranteed issue policies since the market breaks down.

And this is why the health insurers stopped selling children's insurance this week.

We can thank ObamaCare for this and many more gifts to come.

A Fearful America

The Labor Department announced that the unemployment rate rose to 9.6% as the economy lost 54,000 jobs in August.

Normally at this time in a recovery, unemployment is declining and GDP is growing quickly.

What happened? Businesses and investors have become very cautious about making new investments, whether in the form of spending capital on new factories or increasing expenses to expand operations or develop new products lines. With tax increases looming, the further socialization of the healthcare industry underway, an unprecedented monetary policy that stokes the fears of future inflation, the assault on the financial services industry through new legislation and its demonization by politicians and the media continuing, non-defense government spending running at unprecedented levels, the increase in the minimum wage pricing some workers out of jobs, and previously negotiated free trade agreements stalling in Congress, businesses and investors have many good reasons to be nervous about the future.

One manifestation of this fear is the mountain of cash that American companies are keeping on their balance sheets, at over $2 trillion in aggregate. In more optimistic times (i.e., during other recoveries from recession), companies would be rushing to invest that money, or return it to their shareholders to invest, which would be the most effective stimulus plan of all.

But that requires a confidence in the future that is lacking. Another "change" that we can thank Barack Obama for.

Repentant Sinners

If Barney Frank doesn't waffle, his recent statement that Fannie Mae and Freddie Mac "should be abolished" may be the best thing a Democrat has said in a long time.

If Canada can have home ownership rates above those of the U.S. without their equivalent of a Fannie Mae or tax subsidies for mortgage interest, so can we.

And then we can avoid a housing-led financial crisis in the future.

The More Things Change, the More They Remain the Same

Fannie Mae and Freddie Mac, the two government-sponsored entities that were designed to promote home ownership, have been the biggest drain on the government's coffers by far in the TARP bailout. The government has poured $148 billion into them so far, on top of guaranteeing trillions of dollars of their debt.

These staggering losses are a manifestation of their seminal role in fueling the housing bubble and ensuing financial crisis. The government used them to subsidize housing, and in Democratic Congressman Barney Frank's words, he wanted to "roll the dice" with Fannie and Freddie to promote home ownership among low income people.

That "role of the dice" led to our catastrophic financial crisis.

So you might think, in a rational world where the Obama Administration claims it wants to prevent future financial crises, that the government would recognize that subsidizing the housing industry and mortgages should end, so bubbles are less likely to develop and so taxpayers are no longer on the hook for bad mortgage loans.

But the power to influence and control the housing industry, and to direct subsidies to favored constituents, is to tempting to the Obama crowd. Treasury Secretary Timothy Geithner has kicked off the administration's discussions of "housing reform" by saying that ther government should retain a role in the the mortgage finance business. Moreover, Geithner says one reason for this need for a government role is that 90% of new mortgage loans made over the past three years have had government support - suggesting that the private market can't provide sufficient mortgage lending.

What it really means is that it is hard for private mortgage lending to compete with government subsidized lending. Canada, which despite its left-oriented government policies has no equivalent to Fannie and Freddie, has no problem providing private mortgages with home ownership rates at or above those of the United States.

The government needs to end its myriad of subsidies for housing: it needs to wind down Fannie Mae and Freddie Mac and other government-sponsored mortgage supporters; it needs to repeal the Community Reinvestment Act which promotes non-economic lending; it needs to end the mortgage interest deduction to reduce the incentives to borrow; and it needs to end the favored tax treatment of capital gains on housing vs. other investments.

Now They Tell Us

The U.S. Department of Transportation analyzed data recorders from Toyota vehicles in accidents they have been blamed on sudden acceleration. The result? The accelerator was engaged while they brakes were not.

In other words, the drivers mistakenly pressed the accelerator and not the brake - or at least claimed so in the accident investigation to deflect blame from themselves.

This is consistent with the government's investigation of supposed "unexplained" acceleration of Audi cars in 1989.

Out of 3,000 sudden acceleration complaints involving Toyotas and Lexuses, only one was confirmed as a problem with the vehicle, due to a floor mat issue.

Toyota, which built a highly profitable auto company without government subsidies or bailouts because it made cars people want to buy with a market cost structure, deserved better than the assault politicians and the media unleashed on the company earlier this year.

In a world where the U.S. government is a large shareholder in GM and Chrysler, it makes one wonder how much of the Toyota-bashing was driven by a desire to help the government-owned auto companies and the UAW.