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“Dean Dad” is angry with me. A blogger for Inside Higher Ed and a community college dean, Matt Reed found my argument in yesterday’s Wall Street Journal that the federal government should stop giving student loans to people without regard to their demonstrated ability to do college-level work “as offensive an argument as I’ve seen in major media in a long, long time.”

As I wrote in my piece, I absolutely understand the impetus to give anyone who wants it access to college. Apparently, though, you must be utterly heartless to say maybe we should be concerned about the unintended consequences of related policies, which we see with throngs of unprepared people entering college and never finishing, many with loans they struggle to pay off because they don’t have the necessary credentials to increase their earnings.

Mr. Reed thinks that my view is about “getting tough on the poor and badly prepared.” I suppose that’s one way to spin it. But it is not really about “getting tough” with anyone – it is about first doing no harm by providing an external check on people’s potentially damaging borrowing plans. And it is not about “targeting” the poor or anyone else, but protecting the unprepared. Of course, the poor are disproportionately the ones who are inadequately prepared, and that is something we need to deal with. As I wrote, though, that is something we should do at the K-12 level, not compound the problem with debt and no degree.

Reed next delves a bit into caricature, stating, “When someone in the Wall Street Journal suggests getting tough with the poor for their own good, it is worth asking some questions.”  I’d say it’s worth asking questions whenever people propose things in any outlet, but I would also suggest we assume people have good motives. I don’t doubt that Dean Dad has fine motives – he no doubt does work he finds morally fulfilling – but if he is going to suggest extra suspicion of me because I wrote in the Journal, it is perhaps worth a reminder that he is a community college officer, writing in a higher education outlet, calling, among other things, for more money to go to community colleges.

Thankfully, in the second half of his piece Reed gets into some substantive arguments. For instance, he writes, “Why is student debt increasing? Is it because students abruptly became much less capable around 2008? That’s when debt loads exploded, and yet, McCluskey offers no evidence to suggest that academic ability suddenly nosedived then.” What else happened in 2008? Reed writes that there was a big drop in “state and local appropriations for public higher education.”

I don’t doubt for a moment that cuts in public funding for colleges have had effects on prices, as have lots of factors. And there is certainly a lot more that can be written on this topic than I could fit in the 700-or-fewer words allotted for my piece. Indeed, writing more is happening right now!

Let’s, though, look at some data. According to the first graph below, student debt levels have been rising pretty steadily since well before 2008, and there is no especially severe kink in 2008. And the big increase in the percentage of students with debt, as illustrated in the second graph, seemed to start in the early 1990s. Probably not coincidentally, the federal government hugely expanded student lending in the Higher Education Amendments of 1992.


How about the theory that state and local cutbacks explain tuition increases? They no doubt have an effect, but as I have shown repeatedly, public colleges have raised their prices in both good public funding times and bad. And what, likely, has enabled that? The data and research suggest it is in large part increased availability of student aid, including loans!

Reed next argues that many debts are hard to repay because “entry-level jobs don’t pay very well,” and he laments that “McCluskey never addresses either the supply of entry-level jobs, or the minimum wage.”  Again, you only get so many words in an op-ed, so you simply can’t tackle everything. But Reed’s argument shines a negative light not on me, but what he apparently thinks college prepares many people for: entry-level jobs often paying, he implies, minimum wage. If that’s the case, what is the point, at least economically, of getting a degree? And if it is the case that you now need a degree to get a minimum-wage, entry-level job, does that not at least suggest – even to a non-heartless person – that we are suffering from massive credential inflation spurred by too many people going to college? And is allowing someone to take on substantial debt not a very dangerous proposition if their likely destination is minimum-wage employment?

Alas, Mr. Reed then accuses me of not considering the “aspirations” of low-income students “important.” He concludes, “That’s a moral question, and that’s why I chose the word ‘offensive’ rather than ‘incorrect’” when characterizing my views. But suppose there are lower-income people – or any others – whose aspirations include not entering programs they are unprepared to complete and, in the process, incurring burdensome debt? Is it moral to hand them big bucks and just say “good luck paying that back”?

Yes, Mr. Reed, there can be competing moral goods.

Reed next takes offense at the possible baseline requirements for federal loans I offer in my piece: “To enroll in an associate degree program or higher, perhaps a minimum GPA of 3.0 on a 4.0 scale, and an SAT or ACT score equal to the national average, should be required.” He suggests that by not mentioning that such measures skew against “students of color and low-income students” I am being “dishonest.”

Again, I had limited space, so I could not explore every consequence or consideration stemming from my proposal. But Mr. Reed is absolutely right to question these suggestions. Indeed, I wrote “perhaps” they would be good measures, and in the next paragraph, wrote:

There are, of course, problems with this. Are a 3.0 GPA and 1000 SAT score the right threshold? And it is troubling to have government give some people loans while refusing others, especially since “objective” measures may not tell us everything important about individual borrowers.

Sadly, Reed ends his piece with more caricature – literally – saying that I ultimately call for “tough-minded bankers” to “crack down on the poor,” and he rails that, “Telling the poor they’re too risky to bother educating is not what a civilized society would do,” but instead “sounds like a Dickensian caricature.”

Does that really fit with what I wrote? It is correct that I think truly private lending is part of the solution to the college completion and debt problem, but did I really argue that the poor should be kept out of college “for their own good” and we shouldn’t “bother” educating them? It doesn’t seem that way to me. It seems like I specifically called not for treating the poor as some monolithic group, but as individuals:

All of this is why lending should be in private hands. Private lenders would have strong incentive to work with even the financially poorest, when college-ready, based on the likelihood they will succeed and repay their loans. Private lenders also would be using their own dollars, and so would have a powerful incentive to be honest with unprepared students, telling them, “The loan you want does not make sense for me…or you.” This would all be coupled with the flexibility to consider multiple measures of postsecondary readiness, as well as differing loan terms, and thus to treat potential borrowers as the unique people they are.

The good news, perhaps, is that Mr. Reed does not see me as a lost cause…I think. He concludes, “If your only message to the poor is that lifelong poverty is for their own good, I have nothing to say to you.”

Obviously, Mr. Reed had a lot to say to me. And, of course, I do not think “lifelong poverty” is good for the poor. Indeed, that is a major reason that we should think hard about handing debt to people who will likely not finish the programs they start and will then struggle to pay back their loans. As for what we should do to help the poor – as opposed to not hurt them further – I’d love to discuss solutions with Mr. Reed. But that will take a lot of back-and-forth, and probably a little less caricature.

Over at the Brookings Institution’s education blog, Paul Bruno offers a thoughtful critique of Overregulation Theory (OT), the idea that government regulations on school choice programs can undermine their positive effects. Bruno argues that although OT is “one of the most plausible explanations” of the negative results that two studies of Louisiana’s voucher program recently found, it is not “entirely consistent with the available evidence” and “does not by itself explain substantial negative effects from vouchers.”

I agree with Bruno–and have stated repeatedly–that the studies’ findings do not conclusively prove OT. That said, I believe both that OT is consistent with the available evidence and that it could explain the substantial negative effects (though I think it’s likely there are other factors at play as well). I’ll explain why below, but first, a shameless plug:

On Friday, March 4th at noon, the Cato Institute will be hosting a debate over the impact of regulations on school choice programs featuring Patrick Wolf, Douglas Harris, Michael Petrilli, and yours truly, moderated by Cato’s own Neal McCluskey. If you’re in the D.C. area, please RSVP at this link and join us! Come for the policy discussion, stay for the sponsored lunch!

Is the evidence consistent with Overregulation Theory?

Bruno notes that the differences in enrollment trends between participating and non-participating private schools is consistent with OT. Participating schools had been experiencing declining enrollment in the decade before the voucher program was enacted whereas non-participating schools had slightly increasing enrollment on average. This is consistent with the OT’s prediction that better schools (which were able to maintain their enrollment or grow) would be more likely eschew the vouchers due to the significant regulatory burden, while the lower-performing schools (which were losing students) were more desperate for students and funding, and were therefore more willing to jump through the voucher program’s regulatory hoops. However, Bruno calls this evidence into question:

For one thing, the authors of the Louisiana study specifically check to see if learning outcomes vary significantly between schools experiencing greater or lesser prior enrollment declines, and find that they do not. (Bedrick acknowledges this, but doubts there was enough variation in the enrollment trends of participating schools to identify differences.)

We should be skeptical of the explanatory value of the study’s enrollment check. There is no good reason to assume that the correlation between enrollment growth or decline among the small sample of participating schools (which had significantly negative growth, on average) is the same as among all private schools in the state. Making such an assumption is like a blind man holding onto the truck of an elephant and assuming that he’s holding a snake.

The study does not show the variation in enrollment trends among the participating and non-participating schools, but we could imagine a scenario where the enrollment trend among participating schools ranged, say, from -25% to +5% while the range at non-participating schools was -5% to +25%. As shown in the following charts (which use hypothetical data), there may be a strong correlation between enrollment trends and outcomes among the entire population, while there is little correlation in the subset of participating schools.

Enrollment Growth and Performance, Participating Private Schools (Hypothetical)

Enrollment Growth and Performance, All Private Schools (Hypothetical)

In short, looking at the relationship between enrollment growth and performance in the narrow subset of participating schools doesn’t necessarily tell us anything about the relationship between enrollment growth and performance generally. Hence the study’s “check” that Bruno cites does not provide evidence against OT.

Is there evidence that regulations improve performance?

Bruno also cites evidence that regulations can have a positive impact on student outcomes:

Joshua Cowen of Michigan State University also points out that there is previous evidence of positive effects from accountability rules on voucher program outcomes in other states (though regulations may differ in Louisiana).

The Cowen article considers the impact of high-stakes testing imposed on the Milwaukee voucher program during a multi-year study of that program. The “results indicate substantial growth for voucher students in the first high-stakes testing year, particularly in mathematics, and for students with higher levels of earlier academic achievement.” But is this strong evidence that regulations improve performance? One of the authors of both the original Milwaukee study and the cited article, Patrick Wolf of the University of Arkansas (who will be on our panel this Friday), cautions against over-interpreting these results:

Ours is one study of what happened in one year for one school choice program that switched from low-stakes testing to high-stakes testing.  As we point out in the report, it is entirely possible that the surge in the test scores of the voucher students was a “one-off” due to a greater focus of the voucher schools on test preparation and test-taking strategies that year.  In other words, by taking the standardized testing seriously in that final year, the schools simply may have produced a truer measure of student’s actual (better) performance all along, not necessarily a signal that they actually learned a lot more in the one year under the new accountability regime.

If we had had another year to examine the trend in scores in our study we might have been able to tease out a possible test-prep bump from an effect of actually higher rates of learning due to accountability.  Our research mandate ended in 2010-11, sadly, and we had to leave it there – a finding that is enticing and suggestive but hardly conclusive.

It’s certainly possible that the high-stakes test improved actual learning. But it’s also possible–and, I would argue, more probable–that changing the stakes just meant that the schools responded to the new incentive by focusing more on test-taking strategies to boost their scores.

For that matter, even if it were true that the regulations actually improved student learning, that does not contradict Overregulation Theory. Both advocates and skeptics of the regulations believe that schools respond to incentives. Those of us who are concerned about the impact of the regulations don’t believe that they can’t improve performance. Rather, our concern is that regulations imposed from above are less effective at improving performance than the incentives created by direct accountability to parents in a robust market in education, and may have adverse unintended consequences.

To explain: We’re concerned that regulations forbidding the use of a school’s preferred admissions standards or requiring the state test (which is aligned to the state curriculum) might drive away better-performing schools, leaving parents to choose only among the lower-performing schools. We’re concerned that price controls will inhibit growth, providing schools with an incentive only to fill empty seats rather than to scale up. We’re concerned that mandatory state tests will inhibit innovation and induce conformity. None of these concerns rule out the possibility (or, indeed, the likelihood) that over time, requiring private schools to administer the state test and report the results and/or face sanctions based on test performance will improve the participating schools’ performance on that test.

Again: we agree that schools respond to incentives. We just think the results of top-down incentives are likely to be inferior to the results of bottom-up choice and competition, which have proved to be powerful tools in so many other fields for spurring innovation and improving quality.

Can Overregulation Theory alone explain the negative results in Louisiana?

Finally, Bruno questions whether OT alone explains the Louisiana results:

[E]ven if regulation prevented all but the worst private schools from participating, this would explain why students did not benefit from transferring into them, but not why students would transfer into them in the first place.

So Overregulation Theory might be part of the story in explaining negative voucher effects in Louisiana, but it is not by itself sufficient. To explain the results we see in the study, it is necessary to tell an additional story about why families would sort into these apparently inferior schools.

Bruno offers a few possible stories–that parents select schools “that provide unobserved benefits,” that the voucher program “induced families to select inferior schools,” or that parents merely “assume any private school must be superior to their available public schools”–but any of these can be consistent with OT.  Indeed, the second story Bruno offers is practically an extension of OT: if the voucher regulations truncate supply so that it is dominated by low-quality schools, and the government gives false assurances that they have vetted those schools, then it is likely that we will see parents lured into choosing inferior schools.

That’s not to say that there are no other factors causing the negative results. It’s likely that there are. (I find Douglas Harris’s argument that the private schools’ curricula did not align with the state test in the first year particularly compelling, though I don’t think it entirely explains the magnitude of the negative results.) We just don’t have any compelling evidence that OT is wrong, and OT can suffice to explain the negative results.

I will conclude as I began: expressing agreement. I concur with Bruno’s assessment that “it is likely that the existing evidence will not allow us to fully adjudicate between competing hypotheses.” Indeed, it’s likely that future evidence won’t be conclusive either (it rarely is), but I hope that further research will shed more light on this important question. Bruno concludes by calling for greater efforts to “understand how families determine where their children will be educated,” noting that by understanding how and why parents might make “sub-optimal — or even harmful” decisions will help “maximize the benefits of school choice while mitigating its risks.” These are noble goals and I share Bruno’s desire to pursue them. I just hope that policymakers will approach what we learn with a spirit of humility about what they can accomplish.

[A version of this blog post originally appeared at Jay P. Greene’s blog.]

You may recall from my last post that in August 2008 the failure of Lehman Brothers caused sizable losses to a large money-market mutual fund, The Reserve Primary Fund, which held hundreds of millions in Lehman IOUs.  These losses reduced the fund’s asset portfolio value below its total share value at the pegged redemption rate of $1 per share.  For about 24 hours the fund’s management dithered, neither reducing the share claims nor injecting capital to restore the assets.  Alert institutional shareholders saw that there wasn’t enough asset value to pay everyone $1 per share, but the first to redeem could get that much, and so quite rationally ran to redeem.  Belatedly, Reserve Primary “broke the buck” and liquidated at 97 cents on the dollar.  Other “prime” mutual funds experienced heavy redemptions that day and over the next two days, although none broke the buck.  (Many received capital injections from their sponsoring firms.)  On the third day the Treasury stepped in to guarantee the $1 share price of all money market mutual funds.

Many regulators and economic analysts have inferred from these events that money-market mutual funds (MMMFs) are inherently run-prone.  The fact that this was the first run in MMMF history, however, should give us pause.  There is a more plausible reading of the evidence.  Although the Reserve Primary Fund did invite a run by letting its total shareholder claims exceed its total assets in value for a day, MMMFs can be structured and managed so that this never happens.

In a nutshell, the stage is set for a run on a bank or mutual fund when claims can be redeemed on demand, and claimants have reason to believe that their total claims exceed total assets (plus any off-balance-sheet funds) available for paying them.  Bank deposits are debt claims to fixed dollar sums, so a sudden drop in the market value of assets can trigger a run if the bank is so thinly capitalized that market net worth becomes negative.  Mutual fund shares are not fixed-dollar debts, but equity claims to percentages of the asset portfolio, such that total claims are supposed to add up to 100% of the asset portfolio and no more.  (Neglect of the distinction between debt and equity funding, by the way, is embodied in the obfuscatory language according to which MMMFs and hedge funds are part of a “shadow banking” system.)  When assets drop in value, share accounts are to be marked down correspondingly, so that they never over-claim the assets.

Ordinary open-end mutual funds accomplish this by continuously adjusting the “net asset value” or NAV, the dollar price at which one share in the portfolio can be purchased or redeemed.  Money-market mutual funds typically operate with the accounting convention of a fixed $1 NAV.  To keep $1 shares from over-claiming the assets in the event of asset losses, such a MMMF needs only to continuously adjust the total number of shares.  That is, its contractual arrangement with shareholders provides that a proportional number of shares will be immediately subtracted from account balances.

As J. P. Koning has pointed out, this arrangement is not just a conceptual possibility, it has been put in place by some MMMFs in Europe under the rubric of a “reverse distribution” or “share-reduction” mechanism.  In September 2014 reported that “the world’s biggest money manager,” BlackRock Inc., was adopting a share-reduction mechanism as a way of coping with negative yields on money-market instruments.  Or, as a spokesman put it, BlackRock “determined that it is in the best interests of shareholders to implement a form of share-reduction mechanism, which enables a stable NAV to be maintained on days when the net yield on the fund is negative.”

Neglecting this practicable method for run-proofing stable-NAV mutual fund claims, many would-be reformers after 2008 arrived at a diagnosis of inherent run-proneness with systemic negative spillovers, and were inspired to propose additional legal restrictions on MMMFs to make them less fragile.  (“Additional” restrictions because mutual funds were already regulated by the SEC under the Investment Company Act of 1940.)  In a useful recent review of this literature on run-proofing proposals, Harvard finance professors Hanson, Sharfstein, and Sunderam accordingly declare that “MMF regulation should attempt to both reduce the ex ante incentives of MMFs to take excessive risks and increase the ex post ability of MMFs to absorb losses without setting off runs.”  They emphasize three proposals popular in the literature:

  • “requiring MMFs to adopt a floating NAV structure,” that is, outlawing the fixed $1 share value (they oddly characterize this as a way “to subject MMFs more fully to market forces,” it is unclear why they do not recognize a conflict between market forces and legal restrictions);
  • “requiring MMFs to have a 1% capital buffer combined with a “Minimum Balance at Risk” (MBR) provision whereby investors cannot immediately redeem all of their shares,” a proposal from four economists at the Federal Reserve Board and FRB New York; and
  • “requiring MMFs to have a 3% subordinated capital buffer.”

The authors favor the third type of restriction as a way to “reduce ex ante incentives for risk-taking” while also allowing a MMMF to “maintain the current fixed NAV structure for ordinary MMF investors and thus preserve any transactional benefits those investors reap from the existing system.”  Like most contributors to the literature (an exception is a chapter by Agapova), they do not consider a contractual share-reduction mechanism, let alone note that it allows the transactional benefits of a fixed $1 NAV to be combined with 100% capital financing.  Possibly this oversight is the result of the mechanism having disappeared from use in the United States, simultaneously with American MMMFs (though not European MMMFs) replacing mark-to-market accounting of short-term assets by amortized cost valuation, and mark-to-market accounting of total share value by “penny-rounding” (not until book-value NAV falls below 99.5 cents does the MMMF have to inject capital or break the buck).

Somewhat surprisingly, proposals for these kinds of legal restrictions have come even from some sources that ostensibly favor greater reliance on free markets.  For example, the Shadow Financial Regulatory Committee in February 2012 and again in September 2012 issued a statement that called for outlawing the $1 fixed NAV for MMMFs, with the exception of retail funds whose sponsors provide “an explicit contractual guarantee” to inject enough capital to redeem at par whenever necessary and who meet new “capital and liquidity requirements.”

The SEC has adopted many of the proposals for new restrictions on MMMFs, including one of the least popular.  In the name of reducing liquidity, credit, and interest-rate risks, a set of restrictions adopted in February 2010 imposes a minimum liquidity ratio (cash or Treasuries to total assets), a AAA rating requirement for 97% of assets, a shorter average portfolio maturity than previously required, and periodic stress tests.  In July 2014, the SEC announced additional restrictions, to be phased in over two years.  A few months from now, the new rules will be fully in place.  The most important two new rules are:

  • Institutional prime and tax-free funds, but not institutional government funds, will be required to adopt a variable NAV.  (As a reminder, “prime” funds hold mostly paper issued by multinational banks and other financial firms, but also some short-term Treasuries.  Tax-free funds hold tax-exempt state and municipal bonds; government funds hold only US Treasury and agency bonds.  All three types are divided between retail and institutional versions.  The former are now limited by SEC rules to natural persons.  The latter have higher minimum investments and lower expense per share ratios and thus are favored by institutional investors and cash managers at large corporations.)  There is no good rationale for this requirement given the equally run-proof alternative of a fixed NAV combined with a share-reduction mechanism.
  • Funds are given the discretion, whether they want it or not (they cannot contractually bind themselves not to use it), “to impose liquidity fees or to suspend redemptions temporarily, also known as ‘gate,’ if a fund’s level of weekly liquid assets falls below a certain threshold.” Hanson, Sharfstein, and Sunderam, and many other analysts, rightly reject such “gating rules” as means to diminish runs.  Inability to precommit not to impose a gate can be expected to weaken a MMMF.  Knowing that a gate might be imposed, especially if another fund has just done so, investors will likely become more anxious to redeem now rather than wait and see.

In recent years more than half of the MMMF industry’s assets ($3.085 trillion at the end of 2015) has been held in prime funds.  But the mix is now changing and the total is falling because institutional investors who prefer a fixed NAV free of gates are now compelled to switch out of prime to lower-yielding government funds.  Mutual fund providers have begun to respond to institutional investor preferences by converting entire funds.  For example, in December 2015 the Fidelity group, “to assure shareholders that they will have daily access to funds used primarily for transactions,” converted three funds with shareholder approval.  The Fidelity Cash Reserves fund became Fidelity Government Cash Reserves; VIP Money Market became VIP Government Money Market; and Fidelity Retirement Money Market became Fidelity Retirement Government Money Market II.  Institutional investors are being limited to options they consider inferior, as shown by the drop in the size of institutional prime funds exceeding the gain in institutional government funds.

To criticize most generally the reform strategy of seeking to improve financial institutions by imposing restrictions on them, I suggest that reformers and policy-makers who seek what Cecchetti and Schoenholtz call “the optimal mechanism for securing the safety and soundness of MMMFs” need to consider that we can approach optimal arrangements only through a wide-open market competition among alternatives.  To think that we can derive optimal financial institutions (those that most fully exhaust gains from voluntary trade) by theorizing about them is an unwarranted pretense.  We need to allow different strategies for providing prime MMMFs that are safe (and have other desirable features, which we may trade off against safety) to compete head to head.  To affirm that a “subordinated capital buffer,” for example, is the optimal or efficient arrangement, for example, we must see it pass the market test by out-competing share-reduction mechanisms with fixed $1 share values, and other arrangements, for the favor of investors.  Quite likely, there is no single type of prime MMMF that best serves all potential users, but rather a variety of types would attract customers.  If some well-informed investors prefer a fixed-NAV fund that is not run-proof, because it offers them other advantages, there is a heavy burden of proof to show that such a fund should not be allowed.  The goal of a robust financial system calls for a diverse ecosystem of mutual funds, not a monoculture that is susceptible to a single disease.  Top-down restrictions promote a monoculture.

A case for not allowing free competition among a variety of contractual MMMF arrangements must presumably appeal not just to theoretically possible non-pecuniary externalities from allowing run-prone funds, but to evidence of serious non-pecuniary externalities.  This burden has not been met.  First, it has not been shown that the run on The Reserve Primary Fund was the shock that prompted heavy redemptions at other funds, rather than both being consequences of a common shock, namely the failure of Lehman Brothers and the associated decline in the market value of short-term claims on other financial institutions.  We will never know, because the Treasury quickly intervened, how long the redemptions at other funds would have continued. Second, it is far from clear that run-prone funds, like Reserve Primary under its atypically poor management (the main owner was on vacation, leaving his inexperienced son in charge), would be dangerously common in the financial marketplace emerging from unrestricted institutional competition.

Some proponents of restrictions on MMMFs have argued that the possibility of declining asset prices due to heavy redemptions makes even floating-NAV funds vulnerable to me-first runs. Thus Hanson, Sharfstein, and Sunderam speak of an “impetus to Diamond-Dybvig style runs” arising from the possibility that “MMFs forced to liquidate [illiquid] assets may have to sell them at heavily discounted, ‘fire-sale’ prices.”  Those who wait to redeem will face a lower NAV because early redemptions will push down the value of the fund’s assets.  The Diamond-Dybvig model of a self-justifying bank run, however, depicts an intermediary issuing debt claims whose total always exceeds the liquidation (“fire-sale”) value of its assets during the middle period of its three-period life.  It is not surprising that an insolvent bank is run-prone.  It is hard to see how this scenario is relevant to a MMMF that promptly marks down its total claims to the market value of its portfolio.  As a matter of fact, “Diamond-Dybvig style runs” among uninsured banks (prompted by mutually-validating fears that others will run, causing insolvency via fire-sale losses), as distinct from “bad-news” runs prompted by pre-run insolvency, are very hard to find in the historical record.

If me-first runs due to feared fire-sale losses were an actual problem among MMMFs, a fund could provide safety against over-claiming by valuing the fund’s assets (and correspondingly investor account balances) using its own actually realized sale prices, not observed transaction prices elsewhere.  Thus if selling assets to replenish the fund’s cash buffer after settling a $1000 check costs the fund more than $1000 in book value of assets, it could reduce the customer’s remaining balance accordingly.  This would eliminate any beat-the-crowd dynamic in which shareholder rush to sell because they rationally anticipate declining payoffs from fire-sale losses as other shareholders liquidate.  Whether this mechanism would have more-than-offsetting disadvantages in the eyes of customers, the financial market would show us – provided we leave the market free to operate.

[Cross-posted from]

New IRS reporting requirements force U.S. banks to disclose interest-earning accounts of non-resident aliens to the government. (Apparently this is tax-authority mutual back-scratching: foreign nations are expected to reciprocally report this type of information about U.S. citizens with accounts abroad.) Under this regulation, refusing to disclose non-resident alien accounts results in a fine.

The Florida and Texas Bankers Associations are trying to challenge this regulation, but are being frustrated by interpretative jiggery-pokery that prevents their serious legal arguments from even being heard. While the federal district court allowed this lawsuit to proceed, the U.S. Court of Appeals for the D.C. Circuit reversed course and held that the associations couldn’t challenge the regulation because, under the Anti-Injunction Act (AIA), one can’t challenge a tax until the government has attempted to enforce the allegedly improper law and collect the attendant tax. The D.C. Circuit—seemingly imitating Chief Justice Roberts’s reasoning in NFIB v. Sebelius—held that the penalty triggered by failing to follow the new reporting requirements was a tax, thus subjecting the lawsuit to the AIA.

Cato has banded together with the National Federation of Independent Business to file an amicus brief in support of Supreme Court review. The AIA’s statutory language should be interpreted as the Supreme Court has interpreted the Tax Injunction Act (TIA)—confusing, but not the same law—because they contain almost exactly the same language. Under the TIA, one cannot challenge a regulation that deals with either the “assessment” or “collection” of taxes. Similarly, the AIA only prohibits challenges that have the “purpose” to “restrain” “assessment” or “collection” of a tax. Since the fine at issue is a penalty for regulatory non-compliance, not a tax as properly understood, the AIA shouldn’t bar judicial challenges.

Moreover, with the way in which the D.C. Circuit read the “penaltax,” it created an issue under the Administrative Procedure Act (APA). The APA contains a “strong presumption” of judicial review prior to enforcement of substantive regulations like the one at issue here. Congress intended that all agencies’ substantive regulations would be subject to such review under the APA—not that the IRS would have no accountability before federal courts. People have a right to be sure of a regulation’s meaning before engaging in costly compliance efforts—and that’s exactly what pre-enforcement judicial review provides.

Finally, the APA contains stringent procedural requirements for how regulations are to be promulgated. For example, there must be an adequate explanation of the rule, notice and an opportunity for comment, and publication of proposed rules in the Federal Register. The Treasury Department and IRS frequently ignore these requirements—recall the various Obamacare delays, waivers, rewrites, and suspensions—and these agencies must be reigned in.

The Supreme Court should take up Florida Bankers Association v. U.S. Department of Treasury and reverse the lower court’s dangerous precedent. You shouldn’t need to wait until the government attempts to enforce a penalty against you before being able to challenge it.

Seattle’s $15 minimum-wage law has received plenty of attention from those on both sides of the issue. What has received less attention is the way in which this ordinance distinguishes between businesses—and discriminates against interstate commerce.

The ordinance separates employers into two categories, those with 500 or more employees (Schedule One) and those with fewer (Schedule Two), and mandates that the first category implement wage increases more quickly than the second. But the law creates a special rule for Seattle franchises, placing them into the first category if the total number of employees in the franchise network is 500 or more.

A group of franchise owners, led by the International Franchise Association, challenged the ordinance, to no success in the lower courts. Cato is now supporting their petition to the Supreme Court. Seattle insists that this categorization is neutral as between in-state and interstate commerce, because a franchise network could be entirely within Washington. The reality is that all Seattle franchises that are in Schedule One have either an out-of-state franchisor or are associated with out-of-state franchises of the same brand. The law thus discriminates against interstate commerce in precisely the way the Commerce Clause was intended to prevent.

When the delegates met in Philadelphia in 1787 to revise the Articles of Confederation, one of their main concerns was the protectionism the states exhibited under the Articles. As James Madison said at the time, “Most of our political evils may be traced to our commercial ones.” The Constitutional Convention debated many things between May and September 1787, but there seems to have been general agreement that the new Constitution would give Congress power to regulate—“make regular”—interstate commerce.

Although today’s federal government has far exceeded the positive Commerce Clause power the Framers intended to give it—in terms of federal programs and regulations—the principle that states and local governments may not enact laws that discriminate against interstate commerce dates back to Chief Justice Marshall’s opinion in Gibbons v. Ogden (1824), and indeed all the way to the animating purpose of the Convention. That principle—known as the negative or Dormant Commerce Clause—applies both when Congress has passed legislation in the area and when it hasn’t. See Case of the State Freight Tax (1873).

One scholar has remarked that, under the Articles, the states were “marvelously ingenious” at designing protectionist measures. Seattle’s franchise categorization is just one such measure, which discriminates against interstate commerce in a subtler way than most of the protectionism that courts have considered.

While arguing that its law is constitutional, Seattle points to the fact that the burden of the law will fall on in-state actors (the Seattle franchises). Where the burden falls, however, is irrelevant to whether a law discriminates against interstate commerce. Just last term, in Comptroller of the Treasury of Maryland v. Wynne, the Supreme Court held that Maryland’s income tax scheme violated the Commerce Clause by taxing residents on income they earned out-of-state—even though, by definition, the burden of the income tax law fell on Maryland residents. Seattle’s franchise categorization also violates the Dormant Commerce Clause’s extraterritoriality principle because it makes the wage burden placed on Seattle franchisees dependent on the hiring decisions of independent (and most likely unknown) franchises in other states.

The Supreme Court should take up International Franchise Association v. City of Seattle and consider not the economic wisdom of minimum-wage requirements generally but the effect of this particular law on interstate commerce.

Washington, DC opened its long-delayed streetcar for business on Saturday. Actually, it’s a stretch to say it is open “for business,” as the city hasn’t figured out how to collect fares for it, so they won’t be charging any.

Exuberant but arithmetically challenged city officials bragged that the streetcar would traverse its 2.2-mile route at an average speed of 12 to 15 miles per hour, taking a half hour to get from one end to the other (which is 4.4 miles per hour). If there were no traffic and it didn’t have to stop for passengers or run in to any automobiles along the way, they admitted, it would still take 22 minutes (which is 6 miles per hour).

“After more than $200 million and a decade of delays and missteps,” observed the Washington Post, “it took the streetcar 26 minutes to make its way end-to-end on the two-mile line. It took 27 minutes to walk the same route on Saturday, 19 minutes on the bus, 10 minutes to bike and just seven minutes in a Uber.” After all the costs are counted, the Uber trip probably cost less.

The streetcar opening caught the attention of the Economist, which called it “pointless” because it follows a route that is already served by a bus that is faster, can get around parked cars that are slightly sticking into the right of way, and actually goes somewhere beyond the already gentrifying H Street neighborhood. Despite the problems and criticisms, DC officials were already talking about extending the line another 5 miles. 

Washington isn’t the only city caught up in the streetcar fad. Following Portland’s example, Atlanta, CharlotteCincinnati, Kansas City, and several other cities have opened or are building streetcar lines. Most of these lines are about two miles long, are no faster than walking, and cost $50 million or more per mile while buying the same number of buses would cost a couple million, at most.

Portland wants to build 140 miles of streetcar lines. At the average cost of its most recent line, this would require as much money as it would take to repave every street in the city–streets that are falling apart because the city doesn’t have enough money to maintain them. According to the latest census, seven times as many downtown Portland employees bicycle to work as take the streetcar, but another survey found that two out of three Portland cyclists “have experienced a bike crash on tracks.” 

New York’s Mayor de Blasio wants to spend $2.5 billion on a 16-mile streetcar between Brooklyn and Queens. Apparently that city is so flush with cash that it doesn’t have anything better to spend its money on than a slow transit line that won’t even stop near a subway station.

These cities argue that streetcars stimulate economic development. Yet a recent study sponsored by the Federal Transit Administration found that not only was there no evidence of such stimuli, none of the cities that had built streetcars were systematically measuring such impacts. Instead, most were busy subsidizing or coercing (through prescriptive zoning) new development along the streetcar routes.

In fact, there is no reason to think that a slow, congestion-causing, bicycle-accident-inducing rail line would promote new development. Streetcars were technologically perfected in the 1880s, so for Washington to subsidize the construction of a streetcar line today is roughly equal to New York City subsidizing the opening and operation of a factory in Manhattan that would make non-QWERTY typewriters, or Los Angeles subsidizing the manufacture of zoopraxiscopes. Rather than build five more miles of obsolete line, the best thing Washington can do is shut down its new line and fill the gaps between the rails with tar.

For the last 20 years, Ohio has had its own kind of “Ministry of Truth,” otherwise known as the Ohio Elections Commission (OEC). Anyone who claimed that someone – typically a political opponent – was lying to advance or defeat a politician could file a complaint such that a panel of bureaucrats would determine the “truth.”

What will go down as the abuse of the “political statement law” was in 2010 when Rep. Steven Driehaus complained that a pro-life advocacy group accused him of supporting “taxpayer-funded abortions” by voting for the Affordable Care Act. The OEC determined that there was probable cause that the statement was false. The ruling was widely publicized in the media less than a month before the election. Then discovery started on the formal prosecution, requiring disclosure of all of the targeted group’s communications with allied organizations, political parties, and members of Congress.

Imagine just the time and money required to respond to this kind of complaint in the last month before an election – not to mention the PR fallout – such that the damage is done regardless of the result of the legal process. Accordingly, Susan B. Anthony List brought a lawsuit challenging the Ohio law (a version of which existed in about a dozen states). But after the election, Driehaus withdrew his complaint, the prosecution was shuttered, and so the OEC claimed that no harm was ultimately done and so the lawsuit had to be dismissed as moot. 

The Cato Institute filed an amicus brief before the Supreme Court mocking the absurdity of the law, joined by America’s leading political satirist P.J. O’Rourke (also an H.L. Mencken Research Fellow at Cato). Using humor to illustrate absurdity, we showed the silliness (and danger) of allowing potential criminal penalties for “false” statements like “Read my lips: no new taxes!” or “If you like your healthcare plan, you can keep it.” The brief generated a great response, so much so that it was reprinted in Politico and the Pennsylvania Journal of Constitutional Law, and The Green Bag gave it one of its “Exemplary Legal Writing” honors for 2014. Ultimately, the Supreme Court unanimously held that the statute could indeed be challenged.

On remand, the federal district court quickly enjoined the Ohio statute as violating the First Amendment. Then last week, the U.S. Court of Appeals for the Sixth Circuit affirmed that ruling, effectively killing the “False statement” law. The court described many good reasons for its decision, including the timing and resource-draining issues noted above. However, even if these problems were solved, the government still should not be in the business of evaluating core political speech prior to an election. The result was a victory for the freedom of speech.

While Donald Trump may wish to eviscerate the First Amendment, the state of Ohio (and effectively any state government) can no longer threaten their political candidates and advocates into silence.

Presidential candidate Donald Trump, speaking Friday: “We’re going to open up those libel laws. So when The New York Times writes a hit piece which is a total disgrace or when The Washington Post, which is there for other reasons, writes a hit piece, we can sue them and win money instead of having no chance of winning because they’re totally protected.” Trump also said of Amazon, whose Jeff Bezos owns the Washington Post, a newspaper that just ran an editorial seeking to rally opposition to Trump: “If I become president, oh do they have problems. They’re going to have such problems.”

The President has no direct power to change libel law, which consists of state law constrained by constitutional law as laid out by the Supreme Court in New York Times v. Sullivan. A President could appoint Justices intent on overturning the press protections of Sullivan or promote a constitutional amendment to overturn it. Assuming one or the other eventually was made to happen, further changes in libel law would probably require action at the state level, short of some novel attempt to create a federal cause of action for defamation.

But although Trump is unlikely to obtain the exact set of changes he outlines, the outburst is psychologically revealing. Donald Trump has been filing and threatening lawsuits to shut up critics and adversaries over the whole course of his career. He dragged reporter Tim O’Brien through years of litigation over a relatively favorable Trump biography that assigned a lower valuation to his net worth than he thought it should have. He sued the Chicago Tribune’s architecture critic over a piece arguing that a planned Trump skyscraper in lower Manhattan would be “one of the silliest things” that could be built in the city. He used the threat of litigation to get an investment firm to fire an analyst who correctly predicted that the Taj Mahal casino would not be a financial success. He sued comedian Bill Maher over a joke.

I have been writing about the evils of litigation for something like 30 years, and following the litigious exploits of Donald Trump for very nearly that long. I think it very plausible to expect that if he were elected President, he would bring to the White House the same spirit of litigiousness he has so often shown as a public figure.

[cross-posted from Overlawyered]



The RAND Corporation has published the second report in its “Strategic Rethink” series, this one entitled “America’s Security Deficit: Addressing the Imbalance between Strategy and Resources in a Turbulent World.” It is a noble undertaking, conducted by well-respected scholars and analysts. But I’m not particularly optimistic that conditions are ripe for the strategic rethink that they seek, and that the country desperately needs.

The strategy-resources gap should be corrected by adopting a new strategy, one that pares down the United States’ permanent overseas presence, and compels other countries to take on more responsibilities for their own defense (as Japan shows signs of doing). Instead, U.S. policymakers seem willing to undertake merely incremental changes at the margins, retaining U.S. primacy, and trying to cover the strategy-resources gap with wishful thinking and unrealistic assumptions.

RAND’s summary of the report explains “currently projected levels of defense spending are insufficient to meet the demands of an ambitious national security strategy.” And its Key Finding reads as follows:

Limitations on defense spending in the context of emerging threats are creating a “security deficit.”

  • Fielding military capabilities sufficient, in conjunction with those of our allies and partners, to deal with the disparate challenges faced by the United States will require substantial and sustained investments in a wide range of programs and initiatives well beyond what would be feasible under the terms of the Budget Control Act.

Advocates for higher military spending have been saying this since the BCA was first passed. Those who also claim to care about the nation’s persistent fiscal imbalance typically note that the Pentagon’s budget is not the primary driver of the nation’s debt, and they would focus, first, on so-called mandatory spending (Social Security, Medicare, and Medicaid) which accounts for a far higher share of total federal expenditures, in order to find the additional money needed to close the security gap.

They are correct on the first point, the need to reform entitlements, but not on the need for more military spending.

We should be clear about what that entitlement solution would look like, and why it hasn’t yet occurred. As a practical matter, it entails telling people to accept cuts in benefits that they have been told (falsely) are theirs by right. Millions of American retirees actually believe that the money that they receive every month under Social Security, or the health care funded by Medicare, is actually their money, the money that they paid into the system during their working years.

Of course, it isn’t “their” money. The benefits for current retirees are paid by taxes on current workers.

But, leaving that aside, under the necessary overhaul, entitlement benefits will be cut, but not enough to cover the difference. Thus, higher payroll taxes, too. Bitter pills all around.

Unsurprisingly, very few American politicians have actually proposed such measures, and the few who have done so have mostly focused on reducing payments to future beneficiaries, not to those already in the system, or nearing retirement. As my colleague Dan Mitchell points out, in a moment of uncharacteristic optimism, such half-measures would be better than doing nothing at all, but it will take a major political shift before any such proposal ever becomes law.

Remember where the current anxiety over supposedly inadequate spending levels for the military all started: the Super Committee, and the hoped-for Grand Bargain of tax and entitlement reform. Then there was the failure to reach any agreement, and the BCA-imposed caps on discretionary spending (divided evenly between defense and non-defense).

But Congress has managed to work around the caps through special legislation in nearly every fiscal year since they first passed the budget-capping law in 2011. Which suggests that they weren’t all that serious about controlling costs in the first place.

So, we are back to where we started: a mismatch between our strategic ends, and the resources available to execute that strategy. And this represents a particularly difficult challenge for people like Marco Rubio and Ted Cruz who have called for huge increases in the military’s budget. Where will they find the money?

There are alternatives for solving America’s security deficit, besides simply spending more. We could adjust our strategy to our fiscal reality, and stop pretending that our money problems will magically sort themselves out.

The Obama administration hasn’t considered those alternatives, however, in part because choosing among competing strategic priorities is difficult, but mostly because Congress’s repeated evasions of the BCA have convinced the administration that actually aligning our strategy with our resources isn’t really necessary. Only serious spending discipline, enforced by a Congress committed to resolving our long-term fiscal imbalance, will prompt the strategic rethink that is long overdue. 

Yesterday, a dispute settlement panel at the World Trade Organization released an official report finding that local content requirements in India’s solar power scheme violate global trade rules.  The ruling condemns a particular protectionist policy that dilutes the effectiveness of solar subsidies by diverting them to inefficient domestic manufacturers.  The case is one more example of how global trade rules help to prevent green energy initiatives from becoming expensive crony boondoggles.

Although the report was just released, we’ve known what the outcome would be since last September.  At the time, I wrote about how India’s local content requirement harms its own green energy initiative:

The ruling ought to be celebrated by advocates of solar power.  The local content requirement acts as a drag on the program by making solar power plants more expensive to build.  Allowing solar energy producers to purchase panels on the global market not only reduces prices for those producers, it also furthers the development of efficient supply chains for solar panel production.

Predictably, however, some green groups are not happy with the decision.  According to the Sierra Club, “the WTO has officially asserted that antiquated trade rules trump climate imperatives.”  They’re fully committed to the idea that—contrary to the lessons of history and economics—full-fledged green industrial policy will lead to a future of “100 percent clean energy.”  They believe filling the economy with “green jobs” is politically and economically necessary to achieve their environmental goals.

But this policy approach is self-defeating, and I’ve pointed out its shortcomings on this blog before:

The inconvenient truth is that green industrial policy isn’t going to lead to a future of renewable energy, but it does benefit cronies and politicians.  Bureaucrats who don’t make decisions based on market realities still respond to incentives, making them susceptible to capture by special interests at public expense (see Solyndra).  Even if bureaucrats are enlightened saints, the centralization of decision-making benefits large firms at the expense of entrepreneurs and other innovative competitors.  Over time, the relationship between commercial success and political acumen leads businesses to invest more in lobbying and leads to a culture of rent-seeking and privilege

But the Sierra Club does rightly note that the U.S. government is being somewhat hypocritical in going after India’s solar subsidies at the WTO.

Bringing this case is a perverse move for the United States.  Nearly half of U.S. states have renewable energy programs that, like India’s solar program, include “buy-local” rules that create local, green jobs.

And the United States doesn’t just include protectionist local content requirements in its subsidies.  Like India and Europe, the U.S. government also imposes import tariffs in the form of antidumping and anti-subsidy duties on solar panels and wind turbines.  Simon Lester and I have argued that these sorts of tariffs should also be prohibited.

Taxing the same products you subsidize is inherently counterproductive.  The same is true when you condition subsidies on the use of domestic products.  Unless, of course, you are a domestic manufacturer that gets all the money and faces no competition. 

The “Bootleggers and Baptists” dynamic of green energy cronyism is a powerful driver of public policy.  International trade rules and dispute settlement can help to counteract that.

Watching the Presidential primary debates, there are numerous instances where I – and no doubt many others here at Cato and elsewhere – think, “I should really correct that inaccuracy in a blog post tomorrow.”  But sometimes you wake up and find someone else has already done the job for you.  Here are Washington Post fact checkers Glenn Kessler and Michelle Ye Hee Lee skillfully taking down one of Donald Trump’s ridiculous statements on trade:

“I don’t mind trade wars when we’re losing $58 billion a year [to Mexico], you want to know the truth. We’re losing so much. We’re losing so much with Mexico and China — with China, we’re losing $500 billion a year.”

— Trump

Trump has the numbers right on the trade deficit with Mexico and overstates them with China — but he gets the economics very wrong in both cases. A trade deficit means that people in one country are buying more goods from another country than people in the second country are buying from the first country.

So in Mexico’s case, Americans in 2015 purchased $294 billion in goods from Mexico, while Mexico purchased $236 billion in goods from the United States. That results in a trade deficit of $58 billion. In the case of China, Americans in 2015 bought $482 billion in goods from China, while Chinese purchased $116 billion from the U.S., for a trade deficit of $366 billion.

But that money is not “lost.” Americans wanted to buy those products. If Trump sparked a trade war and tariffs were increased on those Chinese goods, then it would raise the cost of those goods to Americans. Perhaps that would reduce the purchases of those goods, and thus reduce the trade deficit — but that would not mean the United States would “gain” money that had been lost.

Trump frequently suggests, as he did in the debate, that Mexico could pay for the wall out of the $58 billion trade deficit. But that is nonsensical. The trade deficit does not go to the government; it just indicates that Americans are buying more goods from Mexico than the other way around.

It’s been nearly two weeks since we heard about Justice Antonin Scalia’s untimely passing. Given the demands of the news cycle, I found myself on CBS radio about 20 minutes after I got wind (in a phone call from the ubiquitous Josh Blackman) of this tragic development that would upend the holiday weekend.  And then it was into the media maelstrom for the next 72 hours or so, the waves from which continue with no end in sight.

That week was one of the most difficult of my professional life. Not because churning out op-eds, delving into a jurist’s work, and responding to the political narrative is particularly new or challenging – to use the line from the GEICO ads: if you’re a think tank scholar, it’s what you do – but because, like most in the originalist legal community, I was in mourning. Scalia wasn’t a libertarian, but he helped our movement immensely (and was typically in dissent where we disagreed). Besides, for lawyers under 50 or so, it’s impossible to imagine a Supreme Court without him. 

Unlike Roger Pilon and Walter Olson, however, I didn’t know him personally. In fact, I only met him a few times, essentially just for a quick handshake or book-signing. The only meeting of note was when a Federalist Society officer introduced me at the 2012 lawyers convention, describing me as coordinator of the amicus-brief effort in NFIB v. Sebelius (the first Obamacare case). Justice Scalia nodded, sighed, and said, “yeah, sorry about that.”

And yet, when his funeral rolled around this past Saturday, I was shaken. I had thought about attending, but didn’t want to be out of place among people who truly knew him. Besides, I was doing some more media commentary before the ceremony started and then needed to get home to help care for my seven-week-old son. So I watched the funeral on TV, mesmerized and misty-eyed. In retrospect, I probably should’ve directed the car from CBS studios to head up to the Basilica of the National Shrine of the Immaculate Conception – I would’ve arrived maybe 15 minutes after the funeral started – but I wasn’t really thinking straight.

At least there will be a memorial at the Supreme Court at some point later this winter or spring. (I had stood in line last Friday to pay my respects when Justice Scalia was lying in state, but ultimately abandoned that effort when the line stopped for President Obama’s arrival and I started freezing after foolishly neglecting to bring my coat – so alas it would not be a repeat of my experience waiting overnight to say goodbye to President Reagan.) Hopefully I will have regained my bearings by then.

In the meantime, Justice Scalia’s absence – while a huge loss for the nation – hardly hampers the functioning of the Supreme Court even if his seat remains vacant until after the election, as it should.

Why are independent, strong-minded courts so important to a free society? One reason is that they – and often only they – are the ones who can stop government agencies from trampling on the rights of the citizens.

Consider, for example, the Obama Administration’s present aggressive campaign to push the bounds of federal employment and labor law far beyond anything Congress has been willing to pass. As I’ve noted before, judges have repeatedly found these administration power plays to overstep the law. See, for example, posts here (Equal Employment Opportunity Commission suffers epic Sixth Circuit loss in EEOC v. Kaplan), here (Breyer and liberal Supreme Court majority, even while siding with plaintiff in underlying case, smack around EEOC “guidance” ploy); see also here (many more examples, at Overlawyered).  

Now here are four more examples from recent months.

* The U.S. Department of Labor sued oil field contractor Gate Guard demanding it reclassify some independent contract workers as employees. As our friends at the Washington Legal Foundation recount, Judge Edith Jones ruled on behalf of a Fifth Circuit appeals panel that Gate Guard was entitled to fees under an unusual “bad faith” provision (footnotes omitted here and below): 

It is often better to acknowledge an obvious mistake than defend it. When the government acknowledges mistakes, it preserves public trust and confidence. It can start to repair the damage done by erroneously, indeed vindictively, attempting to sanction an innocent business. Rather than acknowledge its mistakes, however, the government here chose to defend the indefensible in an indefensible manner. As a result, we impose attorneys’ fees in favor of Gate Guard as a sanction for the government’s bad faith.

At nearly every turn, this Department of Labor investigation and prosecution violated the department’s internal procedures and ethical litigation practices. Even after the DOL discovered that its lead investigator conducted an investigation for which he was not trained, concluded Gate Guard was violating the Fair Labor Standards Act based on just three interviews, destroyed evidence, ambushed a low-level employee for an interview without counsel, and demanded a grossly inflated multi-million dollar penalty, the government pressed on. In litigation, the government opposed routine case administration motions, refused to produce relevant information, and stone-walled the deposition of its lead investigator.


* We commented one year ago on the amazing case of EEOC v. Freeman Cos., in which the Fourth Circuit found that the federal commission had relied on “pervasive errors and utterly unreliable analysis” in its attempt to go after a Maryland employer’s policies on criminal background checks of employees. The appeals court sent the case back for further proceedings to district judge Roger Titus, who had previously shredded the EEOC’s proffered expert evidence as “laughable” and “mind-boggling.” Then the EEOC – feeling that perhaps its luck was due to turn – resisted an award of attorneys’ fees to the defendant. As Alison Somin recounts for the Federalist Society, this was a sure loser bet. Somin quotes the resulting order in which Judge Titus wrote:

World-renowned poker expert Kenny Rogers once sagely advised, “You’ve got to know when to hold ‘em. Know when to fold ‘em. Know when to walk away.” In the Title VII context, the plaintiff who wishes to avoid paying a defendant’s attorneys’ fees must fold ‘em once its case becomes so groundless that continuing to litigate is unreasonable, i.e. once it is clear it cannot have a winning hand. In this case, once Defendant Freeman revealed the inexplicably shoddy work of the EEOC’s expert witness in its motion to exclude that expert, it was obvious Freeman held a royal flush, while the EEOC held nothing. Yet, instead of folding, the EEOC went all in and defended its expert through extensive briefing in this Court and on appeal. Like the unwise gambler, it did so at its peril. Because the EEOC insisted on playing a hand it could not win, it is liable for Freeman’s reasonable attorneys’ fees.”  

* That wasn’t the only bad news for the EEOC’s legal team recently. A Wisconsin federal judge in EEOC v. Flambeau has rejected the commission’s notion that employers violate the Americans with Disabilities Act when they ask employees to take medical exams as part of so-called wellness programs in their health insurance coverage (discussion, Littler and Proskauer; background here and here). 

* And in another widely watched case, the Seventh Circuit in EEOC v. CVS Pharmacy (via Jon Hyman) has rejected the commission’s position that employers violate the law when they proffer widely used garden-variety exit agreements to departing workers (on the theory that the language is not sufficiently encouraging of later legal action, which supposedly constitutes “retaliation”).

Imagine what these agencies and others would be getting away with were our judiciary someday reduced to a spirit of subservience to the executive branch of government.



Calls for higher tax rates often suffer from a myopic focus on the one percent, but these proposals largely fail to acknowledge that tax rates, and the incentives they create, influence work decisions for everyone.  Nowhere is narrow focus more evident than the tax proposals from the two rivals for the Democratic nomination. Bernie Sanders has proposed more than $19 trillion in new taxes over the next decade, and Hillary Clinton’s own plans only look modest by comparison. My colleague Alan Reynolds briefly alluded to a recent paper from Mario Alloza of University College London that examines the relationship between tax rates and income mobility. He finds that higher marginal tax rates reduced mobility over the period analyzed, particularly for people with low incomes or less education. These findings imply that proposals to significantly increase taxes could make it harder for people at the bottom of the income distribution to work their way up.

Alloza looks at panel data between 1967 and 1996 to examine whether tax rates affect the probability of staying in the same decile in the following two years. He examines different scenarios including pre-tax, post-tax and post-tax and transfer. Most of the paper focuses on federal taxes, but he also examines a case where state and payroll taxes are included as well. Increases in the marginal tax rate are associated with a reduction in short-run relative income mobility. Households are roughly 6 percent more likely to stay in the same income quintile when the marginal tax rate is increased by one percentage point. This mechanism holds for all of the different tax and transfer scenarios. Even accounting for the impact of transfers and benefits, higher rates curbed the upward mobility of people at the lower end of the income distribution. This suggests that the impact of tax rates on income mobility is not confined to redistribution effects, but the changes in labor market incentives.

These effects are even more pronounced for people with low-income or less than a college degree. Tax changes focused on compressing the income distribution by taking more from those at the top could also make it harder for these people at the bottom to climb the economic ladder. When Alloza restricts his sample to non-college households, he finds that a one percentage point increase in the marginal tax rate increases the probability of moving down to lower deciles by roughly one percent, increases the likelihood of remaining in the same decile by roughly the same amount, and reduces the probability of moving up to a higher income decile by almost one and a half percent. For households in the lowest income decile, an increase in the marginal tax rate reduces their probability of moving up to a higher decile by almost one and half percent in the post-tax and transfer scenario.  Higher marginal tax rates reduce the mobility for these groups in particular.

These results provide more evidence that taxes matter for all people when they make decisions about work. Higher tax rates limit income mobility by changing work incentives, particularly for people near the bottom of the income distribution. Public policy should not further reduce the scope of opportunity for these people, and increasing tax rates would likely do just that.  

In a confounding ruling that breaks with a general consensus among federal courts, federal District Court Judge Mark Kearney of the Eastern District of Pennsylvania has ruled that recording police officers is not protected by the 1st Amendment unless the recorders are making an effort to “challenge or criticize” the police.  On Judge Kearney’s logic, standing silently and recording the police is not sufficiently expressive to warrant 1st Amendment protection.

The reasoning behind this distinction is bizarre, and is out of step with rulings in several federal circuits that recording police in public is constitutionally protected without regard for whether the recorder is attempting to make a statement or issue a challenge to law enforcement.  

A couple quick takes from civil liberties scholars disputing Judge Kearney’s attempt to distinguish the facts of this case:

 Radley Balko’s take at The Washington Post:

 Under Kearney’s standard, most of the citizen-shot videos of police abuse and shootings we’ve seen over the past several years would not have been protected by the First Amendment. In the overwhelming majority of these videos, there’s none of the “expressive conduct” Kearney apparently wants to see from the camera-wielder. In many of them, the police officers are never made aware that they’re being recorded. That’s how some of these videos were able to catch the officers lying about the incident in subsequent police reports.

I suppose you could argue that recording something as noteworthy as a police shooting or an incident of clear brutality would be self-evidently an act of either expression or news-gathering. But judging from his opinion, it’s far from clear that Kearney would make this distinction. It’s also hard to see how he could. It would mean that whether or not your decision to record the police is covered by the First Amendment would be dependent on whether the recording itself captures the police violating someone’s rights or doing something newsworthy. Even the courts often disagree over what is and isn’t a violation of someone’s constitutional rights (this ruling itself is as good an example as any). And “newsworthiness” is of course a highly subjective standard. You could make a strong argument that both of the events in these two cases — an anti-fracking protest and a 20+ officer police response to a house party — are plenty newsworthy.

 And over at Volokh Conspiracy, Eugene Volokh notes:

 [T]he court held, simply “photograph[ing] approximately twenty police officers standing outside a home hosting a party” and “carr[ying] a camera” to a public protest to videotape “interaction between police and civilians during civil disobedience or protests” wasn’t protected by the First Amendment.

I don’t think that’s right, though. Whether one is physically speaking (to challenge or criticize the police or to praise them or to say something else) is relevant to whether one is engaged in expression. But it’s not relevant to whether one is gathering information, and the First Amendment protects silent gathering of information (at least by recording in public) for possible future publication as much as it protects loud gathering of information.

Your being able to spend money to express your views is protected even when you don’t say anything while writing the check (since your plan is to use the funds to support speech that takes place later). Your being able to associate with others for expressive purposes, for instance by signing a membership form or paying your membership dues, is protected even when you aren’t actually challenging or criticizing anyone while associating (since your plan is for your association to facilitate speech that takes place later). The same should be true of your recording events in public places.

The ACLU has already announced an appeal, which would give the 3rd Circuit Court of Appeals an opportunity to knock down the strange distinction drawn by Judge Kearney.

The ability of individuals to record police in public without fear of reprisal is an essential mechanism for injecting transparency where it is sorely lacking, for holding the government accountable for misconduct, and in many cases for protecting good police officers from misattributed blame.

 For more of our work on recording police, check out this video:

Cops on Camera

These are challenging times for monetary economists like myself, what with central banks making one dramatic departure after another from conventional ways of conducting monetary policy.

Yet so far as I’m concerned, coming to grips with negative interest rates, overnight reverse repos, and  other newfangled monetary control devices is a cinch compared to meeting a challenge that nowadays confronts, not just monetary economists, but economists of all sorts.  I mean the challenge of  getting one’s ideas noticed by that great arbiter of all things economic, Tyler Cowen.

Last week, however, Tyler may have given me just the break I need, in the shape of a brief Marginal Revolution post entitled,  “Simple Points about Central Banking and Monetary Policy.”

Tyler’s “simple points” are these:

Central banks around the world could raise rates of price inflation, and boost aggregate demand, if they were allowed to buy corporate bonds and other higher-yielding assets.  Admittedly this could require changes in law and custom in many countries[.]

There is no economic theory which says central banks could not do this, as supposed liquidity traps would not apply.  These are not nearly equivalent assets with nearly equivalent yields.

Tyler isn’t one to traffic in banalities, so it’s no surprise that his claims are controversial.  Why so? Because the prevailing monetary policy orthodoxy, here in the U.S. at least, insists that, rare emergencies aside, the Fed should stick to a “Treasury’s only” policy, meaning that it should limit its open-market purchases to various Treasury securities.  For the Fed to do otherwise, the argument goes, would be for it to involve itself in “fiscal” policy,  because its security purchases would then influence, not just the overall availability of credit, but its allocation across different firms and industries.  So far as the proponents of “Treasuries only” are concerned, Tyler’s remedy for deflation would create a set of privileged or “pet” corporate securities, analogous to, and no less obnoxious than, the “pet banks” of the Jacksonian era.

All of which is good news for me, because I’m prepared, not only to side with Tyler in this debate, but to offer further arguments in support of his position.  For I took essentially the same position in a paper I prepared for Cato’s 2011 Monetary Conference.  In that paper, I first counter various arguments against having the Fed purchase private securities, and then proceed to recommend a set of Fed operating-system reforms involving broad-based security purchases.  I figure that, with a little luck, Tyler may find those arguments and suggestions worthy of other economists’ attention.

Here is a quick summary of my paper’s arguments and suggestions.

Concerning the “pet corporate securities” argument, to give it that name, I find both it and the anti-Jacksonians’ original complaint against pet banks equally unpersuasive.  If those state banks to which Jackson distributed government’s funds yanked from the  second Bank of the United States were “pet banks,” just what, prey tell, was the B.U.S. itself while it held all of the government’s deposits, if not a single (and correspondingly more odious) government “pet”?

Likewise, if purchasing corporate bonds means favoring particular corporations, and venturing thereby into “fiscal” policy, isn’t “Treasuries only” not itself a means of shunting scarce credit to one particular economic entity — in this case, the federal government — at the expense of all the others?  Is there not, indeed, something positively Orwellian about the suggestion that, by buying Treasury securities, the Fed steers clear of “fiscal” policy?

Though they never heard of Orwell, the Fed’s founders would certainly have considered such talk perverse.  Far from seeing “Treasuries only” as a means for keeping the Fed and the fisc at arms length, they took precisely the opposite view: so far as they were concerned, to allow a central bank to purchase government debt was to risk having it become a tool of inflationary finance. Consequently they favored a “commercial paper only” rule, or rather a “commercial paper and gold only” rule, with a loophole allowing purchases of government paper only for the sake of stabilizing the Fed’s earnings at times of low discount activity.  Like all loopholes in the Federal Reserve Act, this one was not left unexploited for long.  Yet it was not until 1984 that the opposite, Treasuries only alternative took force.  Nor is Treasuries only the rule elsewhere.  The ECB, in particular, ordinarily accepts euro-denominated corporate and bank bonds with ratings of A- or better as collateral for its temporary open-market operations.

The operating system reform I recommended involved replacing both the discount window and the anachronistic and unnecessary primary dealer system with an arrangement resembling the Term Auction Facility (TAF) created in December 2007, at which the Fed auctioned off credit to depository institutions against the same relatively broad set of collateral instruments, including corporate bonds, accepted at its discount window.  To assure competitive allocation of credit among bidders offering different types of collateral, the facility could make use of a “product-mix” auction of the sort Paul Klemperer developed for the Bank of England.  To rule out subsidies and limit its exposure to loss, the Fed could also follow the Bank of England’s example by setting bid rates for the various types of eligible collateral, reflecting predetermined penalties or “haircuts.”  Finally, to allow emergency credit to be supplied as broadly as possible, and therefore in a manner fully consistent with Walter Bagehot’s last-resort lending principles, the Fed could open its auction facility to various non-depository counter-parties, including money market mutual funds.

Besides making liquidity traps relatively easy to avoid, as Tyler suggests, adopting such an alternative system would have many other advantages.  It would reduce the systemic importance of  present primary dealers.  It would guard against the risk of having the Fed gobble-up collateral that’s essential to private-sector credit creation.  It would allow a single operating system to meet both ordinary and emergency demands for credit.  Like the TAF, it would avoid the “stigma” of discount-window lending.  In fact, it would dispense entirely with the need for direct lending to troubled financial (and perhaps some troubled non-financial) institutions.  Most importantly, it would render any sort of ad-hoc central bank lending during financial crises otiose, and by so doing would bring the Federal Reserve System one step closer to being based on the rule of law, instead of the arbitrary rule of bureaucrats.

[Cross-posted from]

While we at the Center for the Study of Science recommend you listen to the Cato Daily Podcast, well, daily, today’s edition may be of particular interest. Host Caleb Brown spoke with Senator James Inhofe (R-OK) about the Clean Power Plan, regulatory overreach and American competitiveness. While they didn’t delve much into climate science, they touched on the inadequacy of global climate agreements.

We don’t want to spoil all the fun, so take a look below–or, better yet, subscribe to the Cato Daily Podcast on your app of choice (iTunes / Google Play / CatoAudio).

The Clean Power Plan (Sen. James Inhofe)

New research on Louisiana’s voucher program revealed mixed results. Yesterday, the Education Research Alliance for New Orleans (Tulane University) and the School Choice Demonstration Project (the University of Arkansas) released four new reports examining the Louisiana Scholarship Program’s impact on participating students’ test performance and non-cognitive skills, level of racial segregation statewide, and the effect of competition on district-school students. Here are the key findings:

  • Students who use the voucher to enroll in private schools end up with much lower math achievement than they would have otherwise, losing as much as 13 percentile points on the state standardized test, after two years. Reading outcomes are also lower for voucher users, although these are not statistically different from the experimental control group in the second year.
  • There is no evidence that the Louisiana Scholarship Program has positive or negative effects on students’ non-cognitive skills, such as “grit” and political tolerance.
  • The program reduced the level of racial segregation in the state. The vast majority of the recipients are black students who left schools with student populations that were disproportionally black relative to the broader community and moved to private schools that had somewhat larger white populations.
  • The program may have modestly increased academic performance in public schools, consistent with the theory behind school vouchers that they create competition between public and private schools that “lifts all boats.” [Emphasis added.]

The positive impact on racial integration and evidence that competition improved district-school student performance are both positive signs, but the significant negative impact on the performance of participating students is troubling. (Ironically, the evidence suggests that the voucher program may have improved the performance of non-voucher students more than the voucher students.) That said, although the impact on student performance is negative, the second year results show improvement over the first year. 

What caused the negative effects is a topic of intense debate. Until NBER published a study on Louisiana’s voucher program last month, all the previous random-assignment studies had found neutral-to-positive effects on students’ test performance and student outcomes such as the likelihood of graduating high school and enrolling in college. Several education policy researchers (myself included) suspect that Louisiana’s high degree of regulations drove away higher-performing private schools, leaving only the most desperate private schools that were willing to accept intrusive government regulations in order to slow or reverse declining enrollment. Louisiana’s voucher program forbids private schools from charging more than the value of the voucher, requires an admissions lottery rather than the school’s own admissions standards, and mandates that schools administer the state standardized test. The findings of the latest study are consistent with this view, although they are not conclusive:

Less than one-third of the private schools in Louisiana chose to participate in the LSP in its first year, possibly because of the extensive regulations placed on the program by government authorities (Kisida, Wolf, & Rhinesmith, 2015) combined with the relatively modest voucher value relative to private school tuition (Mills, Sude & Wolf, 2015). Although it is only speculation at this point, the Louisiana Scholarship Program regulatory requirements may have played a role in preventing the private school choice program from attracting the kinds of private schools that would deliver better outcomes to its participants. 

However, other researchers, including the authors of the latest study, offer other plausible explanations. For example, it’s possible that the performance of private-school students suffered on the mandatory state test because the schools’ curriculum was not yet aligned with the state curriculum. If so, merely adjusting to the new test (rather than actual gains in learning) would explain at least a part of the improvement in performance in the second year. It’s also possible that reforms improving district and charter schools may have made the private schools look relatively worse. However, the authors not that there were negative effects outside of New Orleans (where the reforms over the last decade have been the most intense), so this does “not completely explain [the negative] results.”

Next Friday (March 4th) at noon, the Cato Institute will be hosting a policy forum exploring whether Louisiana-style school choice regulations are helpful or harmful. Neal McCluskey, director of the Cato Institute’s Center for Educational Freedom, will moderate a discussion featuring two of the recent study’s authors, Dr. Patrick Wolf of the University of Arkansas and Dr. Douglas Harris of Tulane University, along with Michael Petrilli, President of the Thomas B. Fordham Institute, and yours truly. The forum will be followed by a sponsored lunch.

Readers interested in attending can RSVP at this link.

If you can’t make it to the event, you can watch it live online at and join the conversation on Twitter using #SchoolChoiceRegs.

An important and timely paper from Columbia University economist Karl Mertens finds that amount of income reported on tax returns is highly sensitive to marginal tax rates, and that the effect is mainly from changes in real activity not tax avoideance.   Mertens estimates “elasticities of taxable income of around 1.2 based on time series from 1946 to 2012. Elasticities are larger in the top 1% of the income distribution but are also positive and statistically significant for other income groups… . Marginal rate cuts lead to increases in real GDP and declines in unemployment.”  Other recent research also shows that “higher marginal tax rates reduce income mobility” while eliminating higher tax brackets improves upward mobility.   Both Democrat candidates for the presidency, Sanders and Clinton, want to greatly increase marginal tax rates on high incomes and on realized capital gains. By contrast, all Republican candidates propose to reduce marginal tax rates.    Mertens’ research unambiguously predicets that economic growth would slow or stop under the Democrats’ proposed tax increases, but accelerate under Republicans’ tax reforms.  

Arguing that “It’s been clear that the detention center at Guantanamo Bay does not advance our national security,” and that “It undermines our standing in the world,” President Obama has at last presented a plan to close Gitmo. The plan Obama outlined today was already well-known in most of its particulars. After transferring the 35 detainees already eligible and quickly reviewing the threat posed by the rest, the United States would then seek to move the remaining detainees to American prisons and military bases. 

The arguments for closing Gitmo are powerful. As Obama himself has long argued, the facility has provided terrorists with a potent recruiting narrative. The tortured policy of labeling the prisoners non-combatants in order to circumvent Geneva Convention prohibitions on torture and the need for due process violated both the Constitution and American ideals of justice. As Obama noted today, “Keeping this facility open is contrary to our values. It undermines our standing in the world. It is viewed as a stain on our broader record of upholding the highest standards of rule of law.” Closing the facility will not only deprive terrorist organizations of recruiting material it will also save the United States a good deal of money.

Unfortunately, the reality is that Obama’s plan is unlikely to go anywhere fast. In 2010 Congress passed a ban on bringing detainees to domestic prisons and there is little support among Congressional Republicans for lifting the ban. Speaker of the House Paul Ryan responded by arguing that “It is against the law – and it will stay against the law – to transfer terrorist detainees to American soil.” Obama might seek to close Guantanamo through an executive order, but the legality of that approach is highly dubious, and even the White House acknowledges that it is unclear whether that would be a politically viable route. Representative Lynn Jenkins (R-Kan)  summarized the sentiment among Republicans in Congress: “Submitting a plan to close the prison at Guantanamo Bay is yet another sign that President Obama is more focused on his legacy than the will of the American people. Republicans and Democrats are united on this issue: bringing the inmates housed at Guantanamo Bay to the United States is a nonstarter.”

The immediate beneficiaries of Obama’s plan won’t be the detainees; it will be the leading Republican candidates, all of whom oppose the plan. Last December Donald Trump criticized Obama’s plan to close Gitmo, saying “I would leave it just the way it is, and I would probably fill it up with more people that are looking to kill us.” At a recent town hall in South Carolina Ted Cruz argued that “The people in Guantanamo at this point, it’s down to the worst of the worst. A really alarming percentage of the people released from Guantanamo return immediately to waging Jihad, return immediately to going back trying to murder Americans.” And during the GOP debate in January that followed word that the administration was preparing a plan for closing Gitmo, Marco Rubio seized the moment to propose how he would deal with Islamic State supporters:  “The most powerful intelligence agency in the world is going to tell us where they are; the most powerful military in the world is going to destroy them; and if we capture any of them alive, they are getting a one-way ticket to Guantanamo Bay, Cuba, and we are going to find out everything they know.”

That’s bad enough for Obama, but it might wind up worse for Hillary Clinton. Clinton is on the record repeatedly calling on Obama to speed up the process of closing the base. In a secret memo to Obama in 2013 Clinton argued that “We must signal to our old and emerging allies alike that we remain serious about turning the page of GTMO and the practices of the prior decade.” Though this plays well with Clinton’s Democratic base during the primaries, it will prove a touchier subject during the general election. Even though a November Washington Post/ABC News poll showed that the public trusts Clinton more than any of the Republican candidates to handle the threat of terrorism, polling on Guantanamo specifically shows that a consistent and sizeable majority of the public supports keeping Gitmo open for business.

In the short run the most likely outcome of this latest clash is a few news cycles dominated by Republican criticism of Obama’s plan and little change in the status quo. Obama may desperately want to close Gitmo before he leaves office, but Republican control of Congress and the presidential election will combine to make that impossible. Obama’s biggest legacy will be to have reduced the number of detainees and to have avoided sending any new detainees there on his watch. In the long run, however, the decision about whether to close Gitmo for good lies with the next president.