Out of the Storm News
I first got to know Anaheim Mayor Tom Tait in the early 2000s, when we were battling a perverse city ordinance that forced low-income people—typically, folks one step ahead of homelessness—to move out of grubby old motels every 30 days. Local residents were upset that one-time tourist lodging had become permanent homes and were seeking to use the government to force the motels to remain devoted to tourism.
We at R Street have known for a while that Sens. Richard Burr, R-N.C. and Dianne Feinstein, D-Calif. were planning to propose anti-encryption legislation that would be truly terrible both for American citizens and for American businesses. But the senators’ “discussion draft,” released last night, exceeded our worst expectations.
Misleadingly named the “Compliance with Court Orders Act of 2016,” the proposed law would actually impose wide-ranging obligations on telephone companies, online-service providers and manufacturers of smartphones, computers and other digital devices that would weaken and perhaps cripple your digital security, including your use of encryption to keep your communications and data private.
Essentially, the proposal would require any company that provides you with digital security either to be able to give the government the keys to unlock your data or else to provide “technical assistance” to the Federal Bureau of Investigation (or the Internal Revenue Service or any other state or federal agency that obtains a court order) to help hack your data and devices. It’s the equivalent of requiring a company that makes safes, like Diebold or Sentry Group, to sell only safes that government safe-crackers can break into.
Well, actually, it’s worse. As I’ve written, we find ourselves increasingly keeping far more self-revealing information on our phones or computers than we do even in our houses or apartments—the sheer scope of the digital information that we may use encryption to protect (for now!) is massive. If Congress can mandate digital insecurity for your phone, a state or city entity may not even need to do a physical search of your house or car to prosecute you. Sens. Burr and Feinstein take the view that if you’re foolish enough to use a smartphone or computer, government ought to be able to have access to anything you use those devices to communicate, process or store.
Here’s what the Burr-Feinstein proposal would require:
Any “covered entity” (more on that in a moment) that receives a court order placed by any government entity shall be responsible for “providing data in an intelligible format if such data have been made unintelligible by a feature, product or service owned, controlled, created, or provided by the covered entity or by a third party on behalf of the covered entity.” In short, if you use a feature like Microsoft’s or Apple’s full-disk encryption on your digital devices, the Redmond and Cupertino industry giants will have to either provide government with “backdoors” to your data or else provide hacking assistance.
But wait: how do we know that the Burr-Feinstein proposal will reach so much further than smartphones (although it’s bad enough that the senators want to weaken smartphone security)? Simple: the proposed law defines “covered entity” (that is, the companies that are included in the mandate) as “a device manufacturer, a software manufacturer, an electronic communication service, a remote computing service, a provider of wire or electronic communication service, a provider of a remote computing service, or any person who provides a product or method to facilitate a communication or the processing or storage of data.” So it’s not just your phone company, but also your computer vendor, the maker of your phone and any online service that stores anything on your behalf (this could include Amazon’s cloud services, as well as Google, Apple and Microsoft).
We at R Street are as sympathetic as anyone to the government’s need to provide both national security and law enforcement. But requiring companies that provide ever-stronger digital security to enable the weakening of digital security is simply perverse.
It’s also based on a misunderstanding of the balances struck in our Bill of Rights that aim to limit the scope of government power. Oddly, the senators, like the FBI, seem to believe that the Fourth Amendment is a grant to government of a fundamental right to succeed in every investigation upon which it embarks. But the plain language of the Fourth Amendment makes it clear that the amendment is supposed to operate as a limit on government power, not a grant to government of a right to investigatory success:
The right of the people to be secure in their persons, houses, papers and effects, against unreasonable searches and seizures, shall not be violated, and no Warrants shall issue, but upon probable cause, supported by Oath or affirmation, and particularly describing the place to be searched, and the persons or things to be seized.
It’s a right “of the people,” not a right belonging to the FBI, the Securities and Exchange Commission, the IRS, or to local or state police. Yes, there’s a provision for “Warrants,” but John Adams and the other framers of the Bill of Rights didn’t just limit the Fourth Amendment to situations involving warrants and court orders. Instead, they framed the Fourth Amendment more broadly, to prohibit “unreasonable” searches and seizures.
Should Congress mandate that our digital devices be made hackable and snoop-able by every government entity in this country (and, as a result, to every other government entity in any other country around the world that might have jurisdiction over Apple, Google, Microsoft, etc.)? In the digital age, when we keep our whole lives on our computers and phones, this new mandate meets every definition of “unreasonable.”This work is licensed under a Creative Commons Attribution-NoDerivs 3.0 Unported License.
What does the Federal Aviation Administration have to do with renewable-energy subsidies? Not much, except that senators are trying to sneak extensions of expiring green-energy tax credits into the bill reauthorizing the aviation regulatory agency.
R Street long has advocated for ending renewable-energy subsidies, which protect the interests of energy-industry insiders over those of taxpayers and consumers. At the close of budget negotiations last year, R Street was dismayed that some wasteful and harmful renewable-energy subsidies were extended, yet we remained cautiously optimistic that their phase-out might be in sight.
Now we’re frustrated to learn about new efforts in the Senate to extend an additional $1.4 billion in green-energy subsidies through sneaky, last-minute add-ons to an unrelated bill. We agree with many in the conservative movement that the renewable-energy provisions have no place in the FAA legislation.
As members of the Green Scissors coalition, R Street has a longstanding commitment to identify and eliminate programs that are both wasteful and environmentally harmful. Not only do green-energy tax credits waste billions of taxpayer dollars, they also prevent innovation and investment in the energy industry that could make sources like wind and solar viable in the long term.
We should not waste taxpayer dollars on industries that—despite decades of being propped up by generous government subsidies—can’t stand alone as competitive energy sources in the market economy. We hope members of the Senate will oppose this amendment, as well as any new efforts to grant a lifeline to renewable-energy subsidies that have continued well-past their expiration dates already.This work is licensed under a Creative Commons Attribution-NoDerivs 3.0 Unported License.
After his first incarnation as California governor in the 1970s and ’80s, Jerry Brown spent a few years in the 1990s as a radio talk-show host. His Oakland-based “We the People” programs showcased “Gov. Moonbeam’s” oddball philosophical self, as he interviewed left-leaning guests and hashed out ideas that still remain outside the political mainstream. They were pretty entertaining, sometimes infuriating and often a little strange.
In one article posted on the radio show’s website, Brown said this about Disney World: “Like the triumph of McDonaldization, Disney-fication of existence promises certainty, predictability and wonderfully sanitary conditions. Few will worry about soil loss or global warming or an overcrowded world haunted by hungry people if they are infantilized and soothed.”
When Oakland Mayor Brown ran for California attorney general in 2006, this columnist questioned him about some of the viewpoints he expressed in those shows. It was his role as a radio host to explore ideas, he explained, which seemed reasonable enough, although it was clear Brown tended to explore only certain ideas. He often focused on looming ecological destruction and consumerism. He talked of economics in moral terms.
Fast forward to earlier this week. “Economically, minimum wages may not make sense,” he said, as he signed into law a measure that boosts the bottom-rung wage to $15 an hour by 2020. Brown had previously opposed the hike, for the obvious nuts-and-bolts reasons, but then dressed up his change-of-heart in “We the People”-like grandiosity: “Morally and socially and politically, they make every sense because it binds the community together and makes sure that parents can take care of their kids in a much more satisfactory way,”according to the Sacramento Bee.
“Work is part of living in a moral community,” he added. “And a worker is worthy of his or her hire and to be worthy means they can support a family.”
American Spectator readers surely understand theperils of a minimum-wage increase. It drives up the cost of labor and makes it tougher for people who need a foot in the door — young, unskilled people and minorities in particular — to find work. It will exacerbate business flight and put a damper on those who would otherwise start new enterprises. It will accelerate the use of self-service kiosks. It will drive up wages for everyone else, thus increasing the cost of goods and services. It will put more pressure on local governments and on welfare rolls.
Best-case scenario: In six years, the real market-driven wage will top 15 bucks and the policy will have had no impact whatsoever. But that’s a likelihood mainly in urban areas. Smaller towns and cities will no doubt bear the brunt of this policy. If a policy designed to help people doesn’t make sense economically, then how can it make sense morally or socially? Unemployment and welfare use don’t help parents better take care of their children or bind communities together.
In his latest incarnation as governor, Brown has reinvented himself as the last adult in Sacramento — someone who puts the brakes on the Legislature’s insatiable desire to tax and spend and regulate. But his increasingly unhinged rhetoric and recent actions suggest there’s nothing new under the dome.
Last Monday, Brown held a news conference with labor-union leaders and some Democratic legislators announcing that wage deal. With the deal struck, the measure flew through the legislative process. Brown signed the law this week. It applies to businesses with 26 or more employees, while smaller companies get an extra year to comply. It gradually increases the wage until it hits $15 and, from that point on, ties it to the inflation rate.
On the surface, Brown portrayed himself as someone who negotiated a middle way. “The law’s most immediate practical effect will be to end a pair of union-backed initiative drives that appeared headed for November’s general election,” reported City Journal’s Ben Boychuk. “Brown, ever the cautious progressive, thought the union’s proposal went too far, too fast.”
In reality, the difference between the union measures and the Brown law are slim. The unions would have kicked in the raise sooner and the Brown measure has a provision that allows the state to suspend increases during economic calamity. That’s window dressing. The governor simply caved to his closest allies, the state’s public-sector unions. At least his minimum-wage rhetoric isn’t as loopy as his global-warming talk.
At a Vatican climate-change event last July, Brown stated: “We have to take measures against an uncertain future which may well be something no one ever wants. We are talking about extinction. We are talking about climate regimes that have not been seen for tens of millions of years. We’re not there yet, but we’re on our way.” And there’s nothing to suggest the governor’s environmental policies have moderated in any way.
On Wednesday, Brown was standing by the Klamath River near the Oregon border to announce the latest step in an ongoing plan to demolish four dams. “This historic agreement will enable Oregon and California and the interested parties to get these four dams finally removed and the Klamath River restored to its pristine beauty,” he said, regarding this long-controversial idea. Critics say the dam removal will undermine the local economy — a rural area already devastated by the continuing loss of resource-based jobs.
This is nothing new. “Left standing, a redwood grove is a miracle of beauty and home to an incredible variety of beings; laid low by chain saws and the commodified minds of our time, it is transformed into tangible returns on investment — the economy, stupid!” Brown wrote years ago regarding a protest against a lumber company.
Economically speaking, removing dams and shutting down logging, mining, and resource industries might do even more destruction than a minimum-wage boost. But it certainly makes “social and political sense,” especially to California’s urban-based liberal political constituencies. The governor still is perceived as the last adult in Sacramento, and that’s true on some limited budget issues. But that’s mainly a better reflection of the dismal state of California’s politics.
Mississippi and West Virginia have become the 30th and 31st states to pass legislation to create a statewide regulatory framework for ridesharing services offered by transportation network companies like Uber and Lyft.
Mississippi is the most recent state to join the club, as Gov. Phil Bryant on April 4 signed into law H.B. 1381. Somewhat unusually, the measure establishes the Mississippi Insurance Department and the state’s elected insurance commissioner as regulator of TNCs, who each would have to pay a $5,000 license fee to the department.
The law, which takes effect July 1, requires TNCs to maintain at least $1 million of liability coverage for their drivers from the moment a ride is arranged until a passenger is dropped off at his or her destination. Any time a driver is logged in to the ridesharing app, but not actually engaged in a ride, he or she will be required to maintain third-person bodily injury coverage of at least $50,000 per person and $100,000 per incident and physical damage coverage of at least $25,000. This so-called “Period 1″ coverage could be provided by the driver, the TNC or a combination of the two.
Drivers also would be required to undergo criminal background checks, which could be conducted by the TNC or by a third party. The legislation also specifically defined TNC drivers as independent contractors, so long as the TNC and driver both agree in writing, the TNC does not prescribe specific work hours or territories and the TNC doesn’t impose any noncompete clauses on drivers.
H.B. 4228 – West Virginia’s ridesharing effort, which we covered a bit back in February – was signed March 15 by Gov. Earl Ray Tomblin. It sets identical insurance requirements to the Mississippi bill, as both were based on last year’s major interindustry compromise between TNCs and major insurers. It also includes very similar language defining drivers as independent contractors, stipulated that TNCs therefore are not responsible for drivers’ workers’ compensation. It also takes effect July 1.
The law passed the state Senate unanimously and passed the House of Delegates in a 94-4 vote. An earlier attempt to pass statewide ridesharing legislation in 2015 had been hung up by a provision that would have required companies to include protections barring companies and drivers from refusing service or otherwise discriminating against gay, lesbian, bisexual and transgender riders. The signed bill requires companies to adopt nondiscrimination policies, but limits the protected classes to those already covered under existing state anti-discrimination law. However, companies can choose voluntarily to adopt more stringent nondiscrimination policies that do include LBGT consumers.This work is licensed under a Creative Commons Attribution-NoDerivs 3.0 Unported License.
R Street and Center for Democracy & Technology comments to U.S. Copyright Office on safe harbor provisions
See attached PDF.
Dear Chairman Blunt and Ranking Member Schumer:
We write to urge the Committee on Rules and Administration to schedule a markup of the Equal Access to Congressional Research Service Reports Act of 2016 (S. 2639) during the April work period.
We make this recommendation for three reasons. First, a theme of modernization and rejuvenation underpin both public access to CRS reports and the forthcoming consideration of the Librarian of Congress nominee, and thus lend themselves to contemporaneous consideration. Second, the general press of Committee business combined with increasing responsibility for planning the upcoming presidential inauguration may indicate an earlier hearing is more convenient for all. Finally, the compressed 2016 Senate calendar and an expected logjam of legislation leaves a decreasing number of days where the matter can be considered by the full chamber and reconciled with the House.
The matter of public access to CRS reports has been subject to sustained discussion. A group of former CRS employees with more than 500 years combined experienced called for public access, as has a coalition of more than 40 organizations and a dozen free market groups. The legislation introduced by Sens. McCain and Leahy builds off of prior legislative efforts and addresses the concerns raised by CRS. We believe it is time to move forward on the issue.
Thank you for your consideration.
American Association of Law Libraries
American Library Association
American Society of News Editors
Americans for Tax Reform
Association of Alternative Newsmedia
Association of Research Libraries
Bill of Rights Defense Committee/Defending Dissent Foundation
Center for Data Innovation
Center for Media and Democracy
Center for Responsive Politics
Center for Science and Democracy at the Union of Concerned Scientists
Charles E. Shain Library of Connecticut College
Citizens for Responsibility and Ethics in Washington
Council for Citizens Against Government Waste
Free Government Information
Government Accountability Project
Hesburgh Libraries – Univ. of Notre Dame
Middletown Thrall Library
National Coalition for History
National Security Archive
National Security Counselors
National Taxpayers Union
New America’s Open Technology Institute
R Street Institute
Taxpayers for Common Sense
The Niskanen Center
University of Notre Dame
In recent years, conservative policymakers in states across the nation have come to question whether the one-sizefits-all “tough on crime” approaches adopted in the 1980s and 1990s are still effective long-term solutions to improve public safety. Prison overcrowding and high recidivism rates have prompted state and federal lawmakers to rethink criminal-justice policy and examine ways to reduce excessive mandatory-minimum sentences, improve indigent defense, curtail civil-asset forfeiture and expand prisoner reentry programs. The efforts to date have been promising, as measured by their ability to alleviate state budgetary pressures without compromising public safety.
Another important goal of criminal-justice reform, generally overlooked by conservatives, should be to address inequities within the juvenile-justice system. Too often, children who aren’t old enough to buy cigarettes legally nonetheless are thrust automatically into an adult penal system ill-suited to the unique challenges and opportunities teenagers present.
Under current law in New York and North Carolina, 16-year-olds who are arrested are tried in adult criminal court without exception. Michigan is one of seven states to prescribe the same rules for 17-year-olds. The other 41 states treat 18 as the youngest age to try individuals as adults. These other states frequently have policies that would permit at least some juveniles to be tried in adult criminal court and sentenced to regular prisons for certain serious crimes.”. But the default policy is first to steer juvenile delinquents toward rehabilitation, and generally to pair any form of detention with educational and rehabilitative services.
States that are unwilling to enact a rehabilitation-focused approach to juvenile offenders face myriad unintended consequences, for individuals, families and communities. This policy study explores some of those consequences and contrasts them with the benefits (economic, as well as personal) that “raise the age” juvenile-justice reform can create.
WASHINGTON (April 6, 2016) – In most states, individuals aren’t generally tried in criminal courts as adults until they reach age 18. A new R Street study from Policy Analyst Nathan Leamer examines the law in Michigan, one of nine states with a different approach, and considers both the ineffectiveness and unintended consequences of the state’s policy of automatically trying 17-year-olds as adults.
“Unlike in 41 other states, 17-year-olds in Michigan are not afforded a flexible approach and focus on rehabilitation. Instead, 17-year-olds exist in a strange legal limbo,” writes Leamer. “In every other aspect of their lives, they are treated as adolescents: required to attend school, subject to child-labor laws and driving restrictions, and unable to vote. However, these same children automatically are treated as adults by the criminal courts, no matter how minor or severe the offense.”
More than 20,000 Michigan youths have been convicted as adults since 2003; nearly 60 percent were nonviolent, first-time offenders. Though the state intended to reduce future crime rates with a “tough on crime” stance, the law has had the opposite effect in many regards.
The author notes research that demonstrates youths tried before an adult court were 85 percent more likely later to be rearrested for violent crimes and 44 percent more likely to be rearrested for felony property crimes compared to those tried before a juvenile court. Furthermore, youths tried as adults were 26 percent more likely to be re-incarcerated within the following six years.
A system that defaults to processing those under age 18 as juveniles would place the onus on the state to demonstrate why more severe treatment might be necessary. States like Connecticut, which implemented similar reforms, have seen dramatic benefits, according to Leamer.
“A 2010 report on the changes from the Connecticut Juvenile Justice Alliance found that ‘savings can be demonstrated throughout the system.’ Savings in court costs, reduced rates of detention, improved clinical evaluations and lower recidivism all contributed to lower costs for the state,” Leamer writes.
“‘Raise the age” reforms would ensure juvenile offenders in Michigan retain access to resources designed to ensure they are quickly rehabilitated and reintegrated into society, recognizing that the end goal should be youth who “become taxpayers rather than burdens on taxpayers.”
Dear Alaska State Legislator or Legislative Staff Member:
I am a public-health physician who has been involved in tobacco control since the 1970s. I have been a local health director, a state health director and president of two national public-health organizations. Since Congress’ 2007 introduction of the Food and Drug Administration tobacco law, I have devoted a substantial amount of my time to issues surrounding tobacco harm reduction and e-cigarettes and related vapor products (e-cigs).
My work in this arena has led me to the conclusion that e-cigs offer personal and public-health benefits that could not otherwise be achieved They also are doing so without any increase in recruiting teens to nicotine or tobacco addiction. More about who I am and how I got involved in the e-cig issue is presented on pages 15 and 16 of the attached paper.
This letter is to urge the Alaska Legislature to defer any action on e-cigarettes and related vapor devices (e-cigs) until the Legislature has had a better opportunity to understand the potential public-health benefits that e-cigs can offer and the potential harms of regulating them as if they were tobacco cigarettes.
Tobacco cigarettes are by far the most addictive and hazardous nicotine-delivery products. The tar in cigarette smoke, not the nicotine, causes cancer and heart and lung disease. E-cigs contain no tobacco. There is no combustion, no tarry smoke. E-cigs contain the same nicotine as pharmaceutical gums, patches, etc. The traces of tobacco-related toxins in e-cigs and these pharmaceutical products are too small to be of public-health significance.
No nicotine-delivery product can be considered 100 percent risk-free. When compared to the risk posed by cigarettes, both e-cigs and the pharmaceutical nicotine products present less than 5 percent of the risk posed by cigarettes; most likely less than 1 percent of such risk, to both users and bystanders.
The question here is one of alternatives. The real-life alternative for smokers who are unable or unwilling to quit is either to continue smoking and suffer the consequences or to switch to a much lower-risk nicotine product that will satisfy their urge to smoke. The fact that cigarette smoking is still our number one preventable cause of death, after a half-century of tobacco-control programming, suggests the time has come to consider adding a new element to tobacco-control programming.
E-cigs represent a disruptive technology. Before the advent of these products, no one ever considered the possibility that there might be a product that could satisfy the urge to smoke for large numbers of smokers, and do so without attracting large numbers of teens to nicotine addiction. While e-cig marketing has attracted significant numbers of nonsmoking teens to experiment with these products, very few have continued their use; none or almost none have transitioned from consistent use of e-cigs to cigarettes. Nearly all teen (and adult) use of these products has been by smokers who use them as an alternative to cigarettes, or to step down to eventual zero nicotine consumption.
Even without tobacco and e-cigs, our lives are not nicotine-free. Potatoes, tomatoes, eggplant, peppers and other common vegetables contain enough nicotine for someone easily to consume the nicotine equivalent of a cigarette a day. Thus, it makes no sense to speculate that traces of exhaled nicotine from e-cigs present any risk of concern to bystanders.
Tobacco-control advocates justify their opposition to e-cigs citing fears that they may present the same health risks as cigarettes or may attract more teens to nicotine addiction. For better and for worse, scientific evidence is already on hand to put both of these fears largely to rest.
The opposition to e-cigs relies mainly on tradition, the goal of “a tobacco-free society” and tobacco control’s partnership with the pharmaceutical industry. These concerns, in the minds of tobacco-control leadership, rule out any possibility of ever considering any potential public-health benefit to any non-pharmaceutical nicotine-delivery product. The following link provides some insight into the unreasonable nature of the opposition. Dr. Peter M. Sandman, an expert in risk communication, excoriates the Centers for Disease Control and Prevention leadership for purposely misinterpreting CDC’s own survey data and misleading the public on e-cigs. http://www.psandman.com/col/e-cigs.htm.
Attached is a paper I wrote two years ago to enable legislators and other non-technical policymakers to better understand e-cigs. Research since that time has further supported the conclusions presented in both the paper and this letter. The paper includes (on pages 15 and 16) a description of who I am, and how I came to be involved with both e-cigs and the R Street Institute.
The bottom lines are these: 1) Imposing restrictions and increasing taxes on cigarettes and smoking will reduce tobacco-related addiction, illness and death. 2) Imposing these same restrictions and taxes on e-cigs will have the opposite effect. It will discourage smokers who would otherwise switch to keep smoking. 3) Vaping is not smoking and should not be defined as such.
Dear Secretary Lew,
On behalf of the undersigned organizations we write to urge you to address the inversion issue by working with Congress to pass tax reform. In addition, we urge you to reject implementing Treasury’s newly proposed regulations or those put forward by Senator Bernie Sanders (I-Vt.).
These regulations will do nothing to address the underlying competitiveness problem and will only add to an already complex tax system. New regulations will likely only make it more difficult for already disadvantaged American companies to conduct business abroad.
As you have said repeatedly, the only real solution to inversions is through Congress enacting business tax reform. The simple fact is American businesses are inverting or being acquired by foreign competitors at an alarming rate because of our complex and outdated tax code.
As it relates to inversions, we believe any tax reform proposal must address two issues.
First, the U.S must reform its code by eliminating the existing worldwide system and replacing it with a territorial system, which is what the majority of the developed world uses.
As you know, our worldwide tax code subjects foreign source income earned by American businesses to the corporate income tax, even though this income has already been taxed in the country where it was earned.
Some have criticized Pfizer’s recent inversion move by arguing the company owes $35 billion in taxes, but this is income that the company only has to pay because the archaic U.S. tax code subjects business to double taxation on profits earned overseas.
This double taxation does not exist for companies headquartered in any of the 28 of 34 OECD countries with tax systems that exempt between 95 to 100 percent of foreign source income, including Canada, France, Germany, Japan, and the U.K.
Second, the U.S must lower its corporate income tax rate to an internationally competitive rate. With a combined state-federal rate of 39.1 percent, the U.S. has the highest rate in the developed world.
We have not made any substantial change to our tax rate since passage of the Tax Reform Act of 1986. In the meantime, the average rate in the developed world has dropped from more than 47 percent to just 25 percent.
We hasten to add that corporate income taxes affect more than just corporations. Study after study has concluded that up to 75 percent of the cost of this tax is passed onto labor and so reducing this tax rate will also increase middle class wages.
The bottom line is that inversions are occurring because our tax rate is higher and our code more complex than all of our competitors. The way to solve this competitiveness problem is tax reform, not new regulations.
Vice President of Government Affairs, Americans for Prosperity
President, Americans for Tax Reform
Andrew F. Quinlan
President, Center for Freedom & Prosperity
Chief Strategy Officer, Conservative Reform Network
President, Council for Citizens Against Government Waste
President and CEO, FreedomWorks
President, Galen Institute
Executive Director, Grassroot Institute of Hawaii
Lisa B. Nelson
CEO, Jeffersonian Project
President, Less Government
Senior Fellow, National Center for Policy Analysis
President, National Taxpayers Union
Executive Director, R Street Institute
President, Taxpayers Protection Alliance
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The giant American housing finance sector is as important politically as it is financially, which makes it hard to reform. From the 1980s on, it was unique in the world for its overreliance on the “government-sponsored enterprises” (“GSEs), Fannie Mae and Freddie Mac—privately owned but privileged and with “implicit” government guarantees. According to Fannie and Freddie, their lobbyists and members of Congress reading scripts from Fannie in its former days of power and glory, this made American housing finance “the envy of the world.” In fact, it didn’t, and the rest of the world did not experience such envy. But Fannie and Freddie did attract investment from the rest of the world, which correctly saw them as U.S. government credit with a higher yield: this channeled the savings of thrifty Chinese and others into helping inflate American house prices into their historic bubble. Fannie and Freddie were a highly concentrated point of systemic vulnerability.
Needless to say, Fannie and Freddie, and American housing finance in general, then became “the scandal of the world” as they went broke. What schadenfreude my German housing finance colleagues enjoyed after years of being lectured by the GSEs on the superiority of the American system. Official bodies in the rest of the world pressured the U.S. Treasury to protect their investments in the insolvent Fannie and Freddie – which, of course, it did and does. The Treasury is also protecting the Federal Reserve, which in the meantime became the world’s biggest investor in Fannie and Freddie securities.
More than seven years later, America is still unique in the world for centering its housing finance sector on Fannie and Freddie, even though they have equity capital that rounds to zero. Now, they are primarily government-owned and entirely government-controlled housing-finance operations, completely dependent on the taxpayers. Nobody likes this situation, but it already outlasted numerous reform proposals.
Is there a way out that looks more like a market and less like a statist scheme? A way that reduces the distortions of excessive credit that inflates house prices, runs up leverage and sets up both borrowers and lenders for failure—in other words, can we reduce of the chance of repeating the mistakes of 1980 to 2006? I suggest seven steps to reform American housing finance:
- Turn Fannie and Freddie into SIFIs at the “10 percent Moment”
- Enforce the law on Fannie and Freddie’s guarantee fees
- Encourage skin in the game from mortgage originators
- Form a new joint FHLB mortgage subsidiary
- Create countercyclical LTVs
- Reconsider local mutual self-help mortgage lenders
- Liquidate the Fed’s MBS portfolio
Turn Fannie and Freddie into SIFIs at the “10 Percent Moment”
The original bailout deal for Fannie and Freddie created a senior preferred stock with a 10 percent dividend. As everybody knows, the amended deal makes all their net profit a dividend, which means there will never be any reduction of the principal, no matter how much cash Fannie and Freddie send the Treasury. It is easy, however, to calculate the cash-on-cash internal rate of return (IRR) to the Treasury on its $189.5 billion of senior preferred stock. So far, this is about 7 percent – positive, but short of the required 10 percent. But as Fannie and Freddie keep sending cash to the Treasury, the IRR will rise, and will reach a point when total cash paid is equivalent to a 10 percent compound return, plus repayment of the entire principal. That is what I call the “10 Percent Moment.” It provides a uniquely logical point for reform, and it is not far off, perhaps late 2017- early 2018.
At the 10 Percent Moment, whenever it arrives, Congress should declare the senior preferred stock fully repaid and retired as, in financial substance, it will have been. Simultaneously, Congress should formally designate Fannie and Freddie as systemically important financial institutions (SIFIs). That they are indeed SIFIs, able to put not only the entire financial system but also the finances of the U.S. government at risk, is beyond the slightest doubt.
As soon as Fannie and Freddie are officially, as well as in economic fact, SIFIs, they will get the same minimum capital requirement as bank SIFIs: 5 percent of total assets. At their current size, this would require about $250 billion in equity. This is a long trip from zero, but they could start building capital, while of course being regulated as undercapitalized until they aren’t. Among other things, this means no dividends on any class of stock until the capital requirement is met.
As SIFIs, Fannie and Freddie will get the Fed as their systemic risk regulator. In general, they should be treated just like big bank SIFIs. Just as national banks have the Fed as well as the Office of the Comptroller of the Currency, they will have the Fed as well as the Federal Housing Finance Agency.
Since it is impossible to take away Fannie and Freddie’s too-big-to-fail status, they should pay the government for its ongoing credit guaranty, just as banks pay for theirs. I recommend a fee of 0.15 percent of total liabilities per year.
Fannie and Freddie will be able to compete in mortgage finance on a level basis with other SIFIs, and swim or sink according to their competence.
Enforce the law on Fannie and Freddie’s guarantee fees
In the Temporary Payroll Tax Cut Continuation Act of 2011, Title IV, Section 401, “Guarantee Fees,” Congress has already decided how Fannie and Freddie’s guarantee fees (g-fees) must set. Remarkably, the law is not being obeyed by their conservator, the Federal Housing Finance Agency.
The text of the statute says the guarantee fees must “appropriately reflect the risk of loss, as well the cost of capital allocated to similar assets held by other fully private regulated financial institutions.” [Italics mine]
This is unambiguous. The simple instruction is that Fannie and Freddie’s g-fees must be set to reflect the capital that private banks would have to hold against the same risk, and also the return private banks would have to earn on that capital. The economic logic is clear: to get private capital into the secondary mortgage market, make Fannie and Freddie price to where private financial institutions can fairly compete.
This is in fact a “private sector adjustment factor,” just as the Fed must use for its priced services. The difference is that the Fed obeys the law, and the FHFA doesn’t.
Of course, the FHFA finds this legislative instruction highly inconvenient politically, so it ignores it or dances around it. But Congress didn’t write the act to ask the FHFA what it liked, but to tell it what to do. The FHFA needs to do it.
Encourage skin in the game for mortgage originators
A universally agreed-upon lesson from the American housing bubble was the need for more “skin in the game” of credit risk by those involved in mortgage securitization. But lost in most of the discussion was the optimal point at which to apply credit-risk skin in the game. This point is the originator of the mortgage loan, which should have a junior credit risk position for the life of the loan. The entity making the original mortgage is in the best position to know the most about the borrower and the credit risk of the borrower. It is the most important point at which to align incentives for creating sound credits.
The Mortgage Partnership Finance (MPF) program of the Federal Home Loan Banks was and is based on this principle (I had the pleasure of leading the creation of this program). The result was excellent credit performance of the MPF mortgage loans, including through the crisis. The principle is so obvious, isn’t it?
I do not suggest making this a requirement for all originators, but to design rules and structures in mortgage finance to encourage this optimal credit strategy.
Form a new joint FHLB mortgage subsidiary
Freddie Mac was originally a wholly owned, joint subsidiary of the 12 Federal Home Loan Banks (FHLBs). Things might have turned out better if it had remained that way.
FHLBs (now there are 11 of them) are admirably placed to operate secondary markets with the thousands of smaller banks, thrifts and credit unions—and perhaps others— that originate mortgages in their local markets. As lenders to these institutions, FHLBs know and have strong ability to enforce the obligations of the originators, both as credit enhancers and as servicers. But to be competitive, and for geographic diversification, they need a nationwide scope.
The precedent for the FHLBs to form a nationally operating mortgage subsidiary is plain. They should do it again.
Create countercyclical LTVs
As the famous investor Benjamin Graham pointed out long ago, price and value are not the same: “Price is what you pay, and value is what you get.” Likewise in mortgage finance, the price of the house being financed is not the same as its value, and in bubbles, prices greatly exceed the sustainable value of the house. Whenever house prices are in a boom, the ratio of the loan to the sound lendable value becomes something much bigger than the ratio of the loan to the inflated current price.
As the price of any asset, including houses, goes rapidly higher and further over its trend line, the riskiness of the future price behavior becomes greater—the probability that the price will fall a lot keeps increasing. Just when lenders and borrowers are feeling more confident because of high collateral “values” (really prices), their danger is in fact growing. Just when they are most tempted to lend and borrow more against the price of the asset, they should be lending and borrowing less.
A countercyclical LTV (loan-to-value ratio) regime would reduce the maximum loan size relative to current prices, in order to keep the maximum ratio of loan size to underlying lendable value more stable. The boom would thus induce smaller LTPs (loan-to-price ratios), steadier LTVs, and greater downpayments in bubbly markets—thus providing an automatic dampening of the price inflation and a financial stabilizer.
Often discussed are countercyclical capital requirements for financial institutions, which reduce the leverage of those lending against riskier prices. The same logic applies to reducing the leverage of those who are borrowing against risky prices. We should do both.
Canada provides an interesting example of where countercyclical LTVs have actually been used.
Reconsider local mutual self-help mortgage lenders
In the long-forgotten history of mortgage lending, an important source of mortgage loans were small mutual associations owned by their depositors and operating with an ethic that stressed saving, self-discipline, self-help, mutual support and home ownership. Demonstrated savings behavior and character were key qualifications for borrowing. The idea of a mortgage was to pay it off.
In the Chicago of 1933, for example, the names of such associations included: Amerikan, Archer Avenue, Copernicus, First Croatian, Good Shepherd, Jugoslav, Kalifornie, Kosciuszko, Narodi, Novy Krok, Polonia, St. Paul, St. Wenceslaus, Slovak and Zlata Hora…you get the idea.
In my opinion, the ideals of these mutual associations are worth remembering and reconsidering; they might be encouraged (not required) again. We would have to make sure that current loads of regulatory compliance costs are not allowed to smother any such efforts at birth.
Liquidate the Fed’s MBS portfolio
What is the Fed, a central bank, doing holding $1.7 trillion of mortgage-backed securities (MBS)? The founders of the Fed and generations of Fed officers since would have found that impossible to imagine. The MBS portfolio exists because the Fed was actively engaged in pushing up house prices, as part of its general scheme to create “wealth effects,” by allocating credit to the housing sector using its own balance sheet. It succeeded— house prices have not only risen rapidly, but are back over their trend line on a national average basis.
Why is the Fed still holding all these mortgages? For one thing, it doesn’t want to recognize losses when selling its vastly outsized position would drive the market against it. Some economists argue that even big losses do not matter if you are a fiat currency central bank. Perhaps not, but they would be embarrassing and unseemly.
Whatever justification there may have been in the wake of the collapsed housing bubble, the Fed should now get out of the business of manipulating the mortgage market. It can avoid recognizing any losses by simply letting its mortgage portfolio steadily run off to zero over time through maturities and prepayments. It should do so, and cease acting as the world’s biggest savings and loan.
Especially with the reforms to Fannie and Freddie discussed above, we would get closer to having a market price of mortgage credit. Imagine that!
Will these seven steps solve all the problems of American mortgage finance and ensure that we will never have another crisis? Of course not. But they will set us on road more promising than sitting unhappily where we are at present.
Would it surprise you to learn that government sometimes asks people to do the impossible?
Last year, Nevada passed legislation that allows transportation network companies such as Uber and Lyft to operate legally in the state. TNCs are an increasingly popular alternative to traditional taxi or limo services that let individuals use a smartphone app to summon a ride.
As part of the legislation, the Nevada Transportation Authority was required to do a study about the relative effectiveness of different types of background checks performed on TNC drivers. While Uber and Lyft use a name-based background check, others have advocated requiring fingerprint background checks instead. Uber and Lyft maintain that fingerprint checks are unduly burdensome and have suspended operations in jurisdictions where these checks are required.
Are fingerprint background checks any more effective than name-based checks? It’s clearly an important question, and the Nevada Legislature is to be commended for seeking to actually study the matter. Unfortunately, as it turns out, the legislation asking for the study did not actually include the money or authority needed for the NTA to carry it out:
Transportation Authority Chairwoman Ann Wilkinson acknowledged Monday that the authority’s report to the Legislative Commission is incomplete, but she delivered a chart to its members outlining some of the differences in place between how regulators oversee ride-hailing drivers and those who work for bus, taxi and limousine companies…
Wilkinson said in December her agency lacks the authority to require FBI testing of any existing state-approved network company drivers. The legislation also didn’t provide money to pay for FBI background checks.
She said there are only 10 drivers that have undergone both checks — not a large enough sample to reach a fair policy conclusion.
Well, you can’t have everything. As I’ve written before, there are serious issues with the FBI’s fingerprint background-check system. Fingerprints end up in the database due to arrests, but half the records in the FBI database do not indicate whether a given arrest ultimately resulted in a sustained conviction. That means the FBI database is effectively an arrest database. Given that about a third of all arrests do not result in conviction for a crime, use of the database as a proxy for an individual’s criminal background is highly dubious.
As of yet, there is no evidence that fingerprint background checks are more effective at protecting public safety than name-based checks. Given the news out of Nevada, it doesn’t look like that’s going to change any time soon.This work is licensed under a Creative Commons Attribution-NoDerivs 3.0 Unported License.
From Real Clear Markets
Do the bureaucrats who run government agencies long to increase their power? Are they ambitious to extend their reach over private institutions and citizens? Of course they do and of course they are.
In particular, does the committee of government agency heads known as “eff-sock” (FSOC, or the Financial Stability Oversight Council) have a notable will to power, desire to expand its jurisdiction and bring more companies under its orders? You bet it does.