Bailout Watch

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Senior Fellow John Berlau argues that a bill from Senators Tim Johnson and Mike Crapo intended to reform Fannie Mae and Freddie Mac would only make things worse.

Post image for Johnson-Crapo Is Phony Fannie-Freddie Reform

Ever since the phrase appeared in Shakespeare’s Romeo and Juliet, “A rose by any other name would smell as sweet,” and its variations, have become familiar expressions. A corollary is that garbage by any other name would stink just as badly, if not worse.

The latter phrase seems applicable to the “reform” of the government-sponsored housing enterprises Fannie Mae and Freddie Mac just introduced by Senate Banking Committee Chairman Tim Johnson (D-S.D.) and Ranking Member Mike Crapo (R-Idaho). The media often describe this plan as “ending” Fannie and Freddie.

And yes, it does “end” them in the sense that there will no longer be entities named Fannie and Freddie. But most of their functions would simply be transferred to a new giant government entity called the Federal Mortgage Insurance Corporation. Not only would the government’s role in subsidizing and micromanaging housing not be reduced, in some ways it would substantially be increased.

The legislation would create, for the first time, an explicit taxpayer guarantee of the GSEs’ $5.6 trillion in debt. The “affordable housing trust fund,” a slush fund for “housing advocacy” groups such as ACORN with political agendas until it was closed due to Fannie and Freddie’s financial woes, would be reopened and parked in the new FMIC.

Worst of all, and sending the worst possible signal to potential private sector investors in the housing market, Fannie and Freddie common and preferred shareholders would be wiped out permanently under the bill’s Section 604.

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In my previous post, I described the “California rule,” which puts state governments in a legal straitjacket when trying to reform underfunded public pensions. Specifically, it places pensions in a privileged position relative to other types of compensation, like salary or health insurance benefits, by making them more difficult to change. This post highlights a real-world example of the California rule’s dangers.

The place is Pacific Grove, California, a town of 15,000 residents on the Monterey Peninsula’s northern tip, with an annual budget of $11 to $12 million. In 2008, John Moore, a Pacific Grove resident and retired attorney, learned that the City of Pacific Grove had issued $19 million of pension bonds two years earlier, while at the same time it gave the police union a 30% raise.

After making several requests under California’s Public Records Act, Moore uncovered a tale of self-dealing by Pacific Grove and union officials to rip off California taxpayers. The result of Moore’s investigation, “The Fall of Pacific Grove,” was published in The Pine Cone, a Monterey County paper; it’s now available online thanks to the California Public Policy Center.

In 2002, the Pacific Grove city council adopted a 50 percent pension increase for public safety workers, after being told by the city manager that the increased benefit would cost around $51,500 per year. However, the city manager withheld from the council an actuary report that estimated the benefit at over $800, 000 per year. The hidden actuary report was not discovered until 2009. The results have been predictable and dire. Pacific Grove’s pension deficit has ballooned to $45 million, plus $20 million in pension bonds, and is growing at 7.5 percent a year, according to Moore.

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These days, local governments announcing bankruptcy seems like routine in California. Since the onset of the 2008 financial crisis, many state and local governments have seen their pension funds take huge losses. Yet, many of the underlying problems that have made pension shortfalls difficult to address go back many years — more than half a century, in fact.

One major reason public pensions have been so difficult to reform is their having a special legal status above other kinds of employee compensation. A new Federalist Society paper by Emory University law professor (and CEI alumnus) Alexander Volokh explains how this strange situation came to be and offers some ideas for reform.

One of the most important developments in public pension policy occurred in 1955. That’s when the California Supreme Court created what became known as the “California rule” regarding the legal status of public pensions. The case, Allen v. City of Long Beach, concerned a challenge to a 1951 city charter amendment that increased the employee pension contribution and changed the formula for determining payouts.

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broken-piggy-bankIn my previous post, I looked at some basic principles that should guide state policy makers when tackling pension reform. Now, we turn to the politics. And in that regard, Rhode Island’s 2011 pension reform offers a useful example for other states to consider.

In his Brookings study, “Pension Politics: Public Employee Retirement System Reform in Four States,” Drew University political science professor Patrick McGuinn looks at recent reform efforts in four states’ experience in implementing pension reform.

Two of these states—Utah and Rhode Island—enacted significant structural changes to their pension systems while the two others—New Jersey and Illinois—enacted more limited changes that were less innovative.

Drawing lessons from those four states, he then outlines some basic principles for how to implement reform, citing examples.

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Few people would raise their hands when asked that question. But actually putting a state’s financing on sound footing is difficult in practice. That makes Rhode ‘s Island’s pension reform not only unique, but also a good example for other states to consider.  Rhode Island got not only the policy, but also the politics right, according to Drew University political science professor Patrick McGuinn in a new Brookings Institution study.

In other words, how pension reform is accomplished is as important as what the reforms entail. In his study, McGuinn offers some sound principles on the politics — the “how” — of pension reform. Another new study, commissioned by the Society of Actuaries (SOA), offers some basic principles on the policy — the “what”.

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Thus describes an Illinois state Senator the challenge states face in reforming their public employee pension systems. Given that reality, it’s astounding reform would ever succeed. But succeed it has, in states with very large pension shortfalls that threaten to blow up their budgets.

Staring into the financial abyss, it seems, can help politicians overcome their strong temptation to offer generous benefits to their supporters — government employee unions in the case of pensions — and passing off the bill to future generations. Yet, government unions will defend their benefits even in states in extreme financial distress, as the recent Rhode Island pension settlement shows.

On February 14, Rhode Island officials reached an agreement to end six legal challenges to the state’s 2011 pension reform, the most far-reaching in the nation to date. The agreement scales back some of the savings in the 2011 reform bill, but  preserves most of them. Governor Lincoln Chafee and State Treasurer Gina Raimondo invested considerable effort and political capital in crafting and enacting the 2011 pension reform. So why did they agree to scale back any of it?

Because they had to. The state was forced into negotiating by a judge, ruling on a union legal challenge to the pension reform legislation. As Drew University political science professor Patrick McGuinn describes the decision in a new Brookings Institution study, “Pension Politics: Public Employee Retirement System Reform in Four States” (which points to Rhode Island’s reform as a model):

In December 2012, a Superior Court judge ordered the unions and the governor/treasurer’s office into mediation to resolve the dispute—an extremely unusual (and perhaps even unconstitutional) move.

In effect, the judge ordered the Chafee administration to negotiate with the unions to amend a law that had already been passed by the legislature and signed by the governor.

While legally dubious, the February 2014 agreement may be the least bad option in terms of achieving sound policy — which in the case of Rhode Island means preventing a budget meltdown. If a judge is willing to order the state government to renegotiate a law already on the books, who knows what might come next in court?

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Post image for Bad Highway Policy Is a Bipartisan Affair

Two major pieces of surface transportation policy news dropped this week. President Obama is readying the release of his budget, which will contain over $300 billion in transportation funding. Across the aisle, Rep. David Camp, R-Mich., the powerful chairman of the House Committee on Ways and Means, released a sweeping proposal to overhaul the U.S. tax code, which includes a component that would direct $120 billion in tax savings into the Highway Trust Fund.

The president’s latest budget is far from surprising, as it differs very little from his previous surface transportation proposals. Of the combined highways and transit spending ($278 billion), he proposes to allocate 25 percent ($72 billion) to mass transit — a mode that makes up about 5 percent of trips.

Thankfully, neither proposal has any chance of being enacted, at least as standalone comprehensive packages. Unfortunately, most of Congress’s “business” is recycling and repackaging previous proposals, which means some aspects might well find their ways rolled into future legislation. With the current highway bill, MAP-21, expiring at the end of September 2014, Congress will begin the reauthorization process in the coming months. It is likely that some of these bad ideas will pop up again.

First, the president’s budget. He wants a $302 billion, four-year transportation bill. Half of that would supposedly come from tax reform, amounting to a massive bailout of the Highway Trust Fund. This is par for the course for President Obama, who has long advocated eliminating the Highway Trust Fund in favor of a slush fund that would enable additional gimmicky projects such as high-speed rail and urban streetcars.

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Post image for No Obamaloans at the Post Office!

While Sen. Elizabeth Warren may proudly brand herself a populist, in her latest crusade, she is casting her lot with fat cats. Warren wants to bestow banking privileges upon the United States Postal Service (USPS), an organization with executives living high on the hog even as, by Warren’s own admission, its “financial footing” is in doubt.

The USPS pleaded poverty last month as it raised the price of a first-class stamp from 46 to 49 cents and promised that more rate increases are on the way. Yet in 2012, it managed to pay Postmaster General Patrick Donahoe $512,000 in total compensation, according to page 67 of the annual report filed by the Postal Regulatory Commission. And in 2008, then-Postmaster General John E. Potter received more than $800,000 in total compensation and retirement benefits. As The Washington Times noted, “that is more than double the salary for President Obama.”

Dozens of other USPS executives also rank among the vaunted “one percent.” According to the Federal Times, “As the U.S. Postal Service was careening toward a record $8.5 billion loss in 2010, it was paying more than three dozen top executives and officers salaries and bonuses exceeding that of Cabinet secretaries.” In fact, in 2012, Rep. Kathy Hochul, D-N.Y., and other House Democrats sponsored legislation to limit USPS executive salaries to those of cabinet secretaries under the president.

The USPS and its defenders respond that this compensation isn’t as high as that of executives at competitors Federal Express and United Parcel Service, and Warren might argue that it’s not as high as the that of the CEOs of the nation’s biggest banks. But it’s certainly higher than the average compensation of the top folks at community banks and credit unions, as well as other lenders that will be hurt if the USPS expands into banking. And it is certainly more that that made by the average taxpayer, who will almost certainly be even further on the hook for the USPS’s woes.

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ECONOMIC MOBILITY
Iain Murray, Vice President for Strategy:
“The fact is: Today’s America is divided between those who work for government and those who don’t. Those who work for government have a job for life, guaranteed retirement and other benefits, and financial security,” said Murray. “Those who don’t, have uncertain prospects. They are at the mercy of an administration that is making their benefits more expensive and restricting their access to credit with more and more regulations. That is the true inequality in President Obama’s America.”

Ryan Young, Fellow:
“Given what reports suggest will appear in the president’s State of the Union address, we need to keep in mind three things. First: A higher minimum wage is not a free lunch, and will force some employers to reduce hours or fire workers. And, second, extending unemployment benefits will keep unemployment unnaturally high,” said Young. “The third thing is: If the president is truly concerned about the poor, he should support policies that would make the poor better off instead of focusing on income inequality. One of these policies could be a deregulatory stimulus that would make it easier to start a business and hire workers.”

REGULATORY REFORM
Wayne Crews, Vice President for Policy:
“Ours is the era of big borrowing and big regulation — and big executive power, perhaps untethered by Congress or the Constitution. The latter will be a centerpiece of President Obama’s State of the Union address,” said Crews. “What America needs instead is a leaner government that rejects overspending and over-regulating. Leadership means unleashing the entrepreneurial sector from over-regulation, and allowing U.S. citizens their natural right to opt out of big, destabilizing government programs like the president’s health care law.”

ENERGY
Myron Ebell, Director of CEI’s Center for Energy and Environment:
“If President Obama were really committed to boosting the economy, he would tell Democratic Majority Leader Harry Reid to bring the pro-energy, pro-jobs bills passed by the House to the Senate floor for a vote,” said Ebell.” I would recommend the president announce his intentions to approve the Keystone XL Pipeline in the State of the Union address. However, he seems more determined to order new EPA regulations that will raise energy prices and impoverish Americans.”

JOBS & ECONOMY
Aloysius Hogan, Senior Fellow:
“An actual focus on jobs is sorely needed in America, but the president’s promises past and present haven’t borne fruit. Hiring is held back by ObamaCare, according to business surveys. Jobs are being killed by the administration’s regulatory policy such as those in the coal-mining industry. Financing of start-ups and expansion is hamstrung by Volcker Rule red tape,” said Hogan. “America’s labor-force participation rate is the lowest in more than a generation, and the president’s approach to jobs is not helping the situation.”

TECHNOLOGY
Ryan Radia, Associate Director of Technology Studies:
“I expect the president will echo his recent proposal to ‘reform’ the National Security Agency’s mass surveillance programs in his State of the Union address. His latest plan focuses on shifting the burden of collecting, storing and securing Americans’ phone records to telecom companies or another private ‘third party,’” said Radia. “The problem is the government will still be able to access privately held phone records without a warrant. What is worse: outsourcing bulk-data collection to America’s private sector would undermine trustworthy digital relationships, and with them, the nation’s enviable position atop the global information economy.”

FINANCIAL MARKETS
John Berlau, Senior Fellow:
“Given the impact regulations have on our economy, I would like to see President Obama address some of the consequences we are seeing from the Dodd-Frank Act,” said Berlau. “We need a moratorium on issuing new Dodd-Frank regulations in order to allow for a review of the negative, unintended consequences of the current ones. Even Democrats, like Rep. Maxine Waters of California, are concerned about these overly burdensome rules and the suffering they are causing main street banks and credit unions.”