Friday, December 28, 2012

Community Reinvestment Act’s Problem

Conclusion leapers have blamed the Great Recession and Crash of 2008 on the greed of real estate lenders and speculators, but that does not explain the timing, and does not explain why individual follies coincided. When the whole economy is disturbed, the government is usually the cause, because only government can use systemic force.

In physics, the equation for force is F=MA, where F is force, M is mass, and A is acceleration. Applied to the economy, force consists of laws, taxes, and subsidies. Mass is assets and liabilities. Acceleration is a change in momentum.

Momentum is mass times velocity: MV. Suppose the mass of the economy is moving at some constant velocity, i.e. speed and direction. Then a force causes a change in the velocity, i.e. the mass accelerates by changing speed or direction or both.

One of the acts of force the U.S. federal government initiated is the Community Reinvestment Act of 1977 (title VIII of the Housing and Community Development Act of 1977) and its enhancement in 1995.

A major expansion of CRA-based loans began in 1995. There were economists who warned that this would cause major trouble. As stated in the Wikipedia article on the CRA:
“During one of the Congressional hearings addressing the proposed changes in 1995, William A. Niskanen, chair of the Cato Institute, criticized both the 1993 and 1994 sets of proposals for political favoritism in allocating credit, for micromanagement by regulators and for the lack of assurances that banks would not be expected to operate at a loss to achieve CRA compliance. He predicted the proposed changes would be very costly to the economy and the banking system in general. Niskanen believed that the primary long term effect would be an artificial contraction of the banking system. Niskanen recommended Congress repeal the Act.”

From 1995 to 2008, CRA loan commitments leaped from a few billion dollars to 6.1 trillion dollars. Some economists have not believed that the economy had CRAP - a Community Reinvestment Act problem. But now the prestigious National Bureau of Economic Research (the organization that officially designates the dates of recessions) has published a study that concludes that the CRA indeed was a major contributor to the Depression of 2008.

The title of the NBER publication is the question, Did the Community Reinvestment Act (CRA) Lead to Risky Lending? The answer of the authors is conclusive: "Yes, it did. ... We find that adherence to the act led to riskier lending by banks."

In 2000, the federal Housing and Urban Development department increased the quota of “affordable housing” for Fannie Mae, the government-sponsored mortgage-buying company, by fifty percent. Fannie Mae and its sibling Freddie Mac buy mortgages from banks, enabling them to provide more mortgages without limit. In a banking conference in 2000, Fannie’s Vice Chair described "CRA-friendly products" as mortgages with less than "3% down" and "flexible underwriting." Flexible lending includes what bankers called “liar loans,” loans for which the banks did not verify the claimed incomes and other data of the borrowers. According to an article in Investors Business Daily, Fannie and Freddie bought half the CRA loans.

Several economists had previously blamed the CRA for the housing crash, including Thomas Sowell in his 2010 book The Housing Boom and Bust. In my review of that book for Choice, a journal for librarians, I summarized Sowell’s proposition on the origins of the housing bubble as, first, restrictions on development that made land values rise rapidly in some areas such as California, and secondly, the Community Reinvestment Act, which coerced banks to provide mortgages to low-income and minority borrowers. Sowell argues that the anti-discrimination rationale that promotes home ownership for minorities is based on faulty analysis, and was futile as low-income lost their homes after 2007.

However, there is a more fundamental cause of the Depression of 2008, a governmental force that caused all the major depression of the USA along with those of other countries. There is a force that has periodically disturbed the economic space-time continuum. Applying F=MA, that governmental force has caused the mass of the economy, particularly land values and investments in real estate construction, to periodically accelerate and decelerate. The force that has disrupted the economy for the past 200 years is: massive subsidies to land values.

Government’s public goods and welfare subsidies make territory more attractive and productive, generating greater land rent and higher land values. The subsidies are implicit in artificially low interest rates due to money expansion, and the fiscal subsidies of taxing mostly labor and goods rather than having landowners paying back the rents generated by the public services.

As the economy expands, the higher land values induce “malspeculation,” the purchase of land based on the expectations of ever higher prices. At the peak, the most optimistic speculators are the ones left holding the land bag, as real estate crashes, bringing down with it the financial infrastructure. The high acceleration of economic mass near the peak of the boom is followed by a swift and severe deceleration, the crash and depression.

We are now into a new cycle, in which once again the Federal Reserve has expanded the money supply, this time more massively than ever before, to keep interest rates low, again a subsidy to real estate, which is again reviving, and will again a decade from now, crash. The next crash will be even worse than that of 2008, since there will also be a fiscal crisis from the ever growing federal debt, as the government will no longer be able to borrow funds cheaply.

As the philosopher Hegel wrote, governments do not learn from history, and that is why the cycle is repeating again. The basic cause of the boom-bust cycle is not the CRA, but the subsidy to land values, because if not for that subsidy, land would be cheap to buy, enabling less affluent buyers to not need so much credit for the purchase of a home.


"Community Reinvestment Act." Wikipedia.

Paul Sperry. 20 Dec. 2012. New Study Finds CRA 'Clearly' Did Lead To Risky Lending.

Sumit Agarwal, Efraim Benmelech, Nittai Bergman, Amit Seru. 2012. Did the Community Reinvestment Act (CRA) Lead to Risky Lending? NBER Working Paper No. 18609.

Study Says Community Reinvestment Act Induced Banks To Take Bad Risks.
by J.D. Tuccille, 21 Dec. 2012.

Thomas Sowell. 2010. The Housing Boom and Bust. New York: Basic Books.

Sunday, December 16, 2012

The Pigou Club

Professor N. Gregory Mankiw of Harvard University initiated and hosts “The Pigou Club” of economists, journalists, and politicians who have favorably written about pollution levies as an efficient way to reduce emissions. Arthur Cecil Pigou was the economist who was the first to deeply analyze externalities (uncompensated effects on others) in his 1920 book The Economics of Welfare.

Pigou proposed a levy on negative external effects equal to the social cost, so that buyers and users pay the full social cost of products. The most common applications are tolls to prevent traffic congestion, parking meters that vary by time of day, and pollution levies.

The policy of charging those who create negative externalities is named Pigouvian, or Pigovian. Mankiw advocates higher gasoline taxes, but that would also tax those car owners with cars that run quite cleanly and are driven in roads that are not congested. The best Pigovian policy is to focus the charge on the negative element such as harmful emissions.

Tax the bad output, rather than the input. If a carbon tax is on the emissions, there is an incentive for inventors and entrepreneurs to minimize the toxic outputs. If a carbon tax is on the input, that incentive is gone.

Statist economists refer to a Pigovian tax as correcting a market failure, while free-market economists recognize that in a pure market economy, all activity is voluntary, and so there are no significant negative externalities in a pure market. Pollution invades others’ property, and such trespass would require compensation, which would prevent the external effect. Compensated effects internalize the costs.

Members of the Pigou Club include Al Gore, Alan Greenspan, Paul Volker, and Paul Krugman. Members range from conservative to statist liberal to green to libertarian. Essentially, any person who thinks clearly and objectively about externalities is going to be a Pigovian.

Environmentalists and economists have proposed a “green tax shift” to replace taxes on incomes and sales with taxes on environmental destruction. That would provide the double benefit of a greener environment and a more efficient economy.

Despite the Pigovian pollution charge being so obviously the optimal policy, the Obama administration has rejected it. An article in The New Yorker of 10 December 2012, “Paying for It” by Elizabeth Kolbert, describes Pigovian policy. It points out that global climate change is a planetary externality. Users of carbon-based fuels, especially coal and oil, are not paying the full cost of the energy. The cost is shifted to the victims of climate change, with ever worse storms and droughts and floods. The cost is also shifted to future generations who are unable to vote today.

To the extent that global warming has been caused by emissions, this is an environmental tax imposed on the human, animal, and plant world. Moreover, today’s massive pollution is unnecessary, because all economies could implement the green tax shift. The developing countries all have harmful taxes that could be replaced by Pigovian payments.

There seems to be not enough government revenue to pay for the billions of dollars needed to reduce pollution and protect against storms and rising seas, but when a disaster such as the New York City and New Jersey storms happened, funds arose to repair the $60 billion in damage.

Even oil companies have become Pigovian. It is therefore puzzling that President Obama has not come on board the Pigou train. He did not favor a tax on emissions as a candidate, and according to the New Yorker article, his spokesman Jay Carney stated, “We would never propose a carbon tax, and have no intention of proposing one.”

The executive branch of the U.S. government is insisting on higher taxes for the rich just because the money is there, and even though basic economics tells us that higher costs and lower profits will push ever more firms out of the country, and the firms remaining in the country will avoid bringing their foreign earnings back home.

Levies on pollution are a tax in form, but in substance, they prevent a subsidy, since consumers are subsidized when they do not pay the full cost of their purchases. A tax on land value too is the prevention of the subsidy of rent generated by public goods. Therefore the best taxes are those that are not taxes in substance, but the avoidance of subsidies.

Thus the administration seeks on the one hand to tax the rich, and on the other to hand the rich a land-value and pollution subsidy. Evidently the administration prefers to regulate pollution, but regulations have done a poor job of preventing today’s massive environmental destruction, and regulations do not enable a green tax shift.

We should include A. C. Pigou to the pantheon of the ten great economists: Adam Smith, David Ricardo, Henry George, Alfred Marshall, Milton Friedman, Carl Menger, Ludwig von Mises, Friedrich Hayek, and James Buchanan. The 100th anniversary of his book in 2020 may spur some Pigovian action, but meanwhile we will suffer eight more years of global damage.

Saturday, December 08, 2012

What is a Fair Share of Taxes?

What is fair is different from what is just. What is just is determined by the ethic of natural moral law as expressed by the universal ethic. The universal ethic prescribes that all acts, and only those acts, that coercively harm others, are evil. Justice is the implementation of the universal ethic in law. Justice is applied by prohibiting and penalizing evil acts, and by keeping all other acts free of restrictions or imposed costs.

The premises from which natural moral law derive are the biological independence of thinking and feeling, and the equal moral worth of all human beings. Thus a foundation of justice is equality before the law. People with equal conditions should be treated the same.

Equality implies that all persons are equal self-owners. If one person imposes his will on another, the victim becomes a slave, and the tyrant becomes a master, in violation of equality. Self-ownership implies that one fully owns one’s labor, and therefore any tax on wages or the products of labor, or the spending of wages, violates self-ownership, and is unjust.

Self-ownership does not apply to what the self does not create, namely, natural resources. The equality premise implies that all persons benefit equally from the value of what nature provides. The value of natural resources, including spatial land, is measured by how much people are willing to pay to use them, namely, the economic rent. Economic justice requires that all persons have an equal share of the natural land rent, and that each worker be free to keep his entire wage.

A just tax system does not tax wages, goods, exchange, value-added, and entrepreneurial profits. Economic justice is implemented by collecting the economic rent of land and distributing it either in equal shares of cash or in public goods that benefit the public generally. The rent generated by nature would be globally distributed, while the land rental generated by local population, commerce, and public goods would be distributed to the local population.

Since the rent morally belongs to individual persons in equal shares in the relevant communities, a strict application of equality would be to rent payments in cash, which individuals could use to pay for services such as education or, as members of some association, as dues for the provision of public goods. Such payments are often referred to as citizens’ or residents’ dividends.

“Fairness” means that you get what you deserve, and deserve what you get. Like justice, fairness applies equality. We are born with a genetically programmed sense of equality. Children instinctively feel that it is unfair for one to get a better toy than another. But the application of equality in fairness is broader than in justice

It is not fair for some persons to be more talented or beautiful than others. A person who is born with high intelligence, beauty, strength, and talent did nothing to earn these qualities. One person does not deserve to have a better genetic inheritance than another. Nature is unfair.

A financial inheritance is also unfair. When a child is born to rich parents, the child has done nothing to deserve the good fortune. It is unfair for one child to have a rich family while some other child has a poor family.

It is also not fair for some people to live in a country at peace, while other have to suffer thru war. Those who suffer from violence, persecution, and arbitrary negative discrimination do not deserve these outcomes.

But morality requires justice rather than fairness. As the saying goes, “life is unfair”. However, natural moral law, when applied, does remove that portion of unfairness, such as violence, that is also unjust.

When politicians and commentators talk about making people pay their “fair share” of taxes, they seldom analyze what “fairness” means. They presume that it is fair for the rich to pay a greater share of their income in taxes than the poor, and that even though the rich today are paying a very large portion of taxes, they should pay even more. But fairness advocates have no logical formula for determining how much is “fair.” They also provide no analysis as to what extent the incomes of the rich are deserved.

A pure fair tax would confiscate gains from those who have undeserved qualities such as genetic and financial inheritances. A truly fair tax would collect all the land rent and distribute it equally, because nobody deserves more of the land rent than anyone else, but it would go beyond that to tax and redistribute equally all gains other than what one earns from one’s labor.

But these outcomes are not what advocates of “fair” taxation want. The “fair share taxes” organization seeks to eliminate property taxes and to keep taxing income including wages. They also want to tax net worth, which would tax savings from labor.

The “fair tax” organization seeks a national sales tax, with no sound analysis of what fairness means. If a tax on wages is unfair, because one deserves what one earns, then it is equally unfair to tax wages when they are spent. A national sales tax would also subsidize land values as the public goods paid for by sales taxes would generate undeserved land rent and land value.

Most advocates of fairness in taxation have a subjective feeling of what is fair, and indulge in not having examined the ethical and economic aspects of fairness. We should be advocating justice rather than fairness, because any fairness that goes beyond justice violates liberty and natural rights. Young children want everything to be fair, but mature adults should realize that we just have to accept the unfairness of one person being struck by lightning while others are not.