The Pelican Post

Barack Obama proclaimed March 7^th-March 13^th to be the National Consumer Protection Week. Supporting the creation of an independent Consumer Financial Protection Agency, Obama said:

“[…] our Government must do more to stand up for consumers. From excessive bank account overdraft fees to abusive mortgage lending practices, our broken financial system produces profits at the expense of American families.”

Do we really need the government to “do more” considering that it plans to do more of what helped create the current financial crisis?

Mark Calabria of the Cato Institute believes that “as designed, it [i.e. the Consumer Protection Agency] would increase the likelihood of future crises rather than reduce them.” Arguing that the intention is to expand government reach over non-banks financial products, Calabria calls for a repeal of government efforts to push risky lending and easy credit.

At a recent Loyola Economics Club meeting, Dr. George Selgin pointed out that we spend considerable time deciding which technology to buy, but when it comes to choosing a bank for our savings we often look only at the interest rate. As uninformed depositors, consumers unwittingly contributed to the current financial crisis.

Consumer indifference in the area of banks is encouraged by the overly protective safety net of insured deposits guaranteed by the government. As editor of RealClearMarkets John Tammy explains, “because our savings are over-insured, we don’t stop to consider the activities or the health of the institutions we bank with.”

Tammy believes that if the FDIC were to be abolished, the private sector would have the incentive to step in and insure deposits; a private form of insurer would emerge. It is likely that markets would provide greater and more effective oversight of the activities of insured banks, leading to more careful investing from consumers. Tammy continues:

“If savers were faced with the possibility of losing their savings altogether, it’s near certain that just as they diversify their stock holdings as a form of wealth protection, so would they diversify their bank deposits.”

The over-insured depositor is a moral hazard to our economy. The current administration has to realize that consumer protection does not necessarily improve the US financial system. It is time to revisit the federal deposit insurance program and introduce reforms that will allow free markets to incentivize responsible behavior.

Chris Edwards of the Cato Institute highlights the level of government intervention by examining the various forms of federal aid to the states. As he writes in Downsizing the Federal Government:

“There are more than 800 state and local aid programs, based on my count of programs in the Catalog of Federal Domestic Assistance. They range from the giant $225 billion Medicaid to hundreds of programs that most taxpayers have probably never heard of, such as a $15 million program for Nursing Workforce Diversity, a $120 million program for “Boating Safety Financial Assistance,” and a $150 million program for Healthy Marriages.”

President Obama recently announced several aid programs for Louisiana. As described in the President’s FY2011 Budget, these programs provide “lower taxes, better teachers and classrooms, and important investments in our roads, highways, and airports.” Louisiana will receive:

• Tax cuts for 1.6 million families
• $1 billion for schools, students, and teachers
• $895.8 million to fix and expand the state’s network of roads and highways, modernize airports, and expand water and sewer infrastructure
• $543 million in new funding for Pell Grants to help families pay for college
• $518.6 million for housing assistance

With the current federal deficit at $12 trillion and expected to increase, is this federal aid really appropriate? Edwards provides a number of reasons to believe that this kind of spending does not make sense:

• Grants spur wasteful spending and bureaucracy
• Aid allocation is haphazard
• Federal aid reduces state policy diversity
• Grants cause policymaking overload and make government responsibilities unclear
• Common problems are not necessarily national priorities

Our Constitution provides for a system of federalism, which lets states identify and address their own priorities.  This system encourages creativity among the states and helps prevent the concentration of too much power in Washington. Unfortunately, federalism has taken a beating and states are now in the habit of looking to Washington first.

Congress could encourage more federalism by cutting federal grants-in-aid. More power would consequently be returned to states and the private sector and unnecessary federal spending would be minimized.

As Diana Furchtgott-Roth of the Manhattan Institute points out, there is widespread hostility towards the financial sector even though:

• 140 banks failed in 2009
• regulators and Congress encouraged banks to make high-risk loans
• many banks were required by Hank Paulson to take the TARP money in 2008
• all but one large bank repaid TARP funds with interest

In order to regulate banks, President Obama is adopting both the Volcker Rule and the Financial Crisis Responsibility Fee. However, the consequences of having both regulations simultaneously interfering with the financial industry are highly uncertain.

Jason Zweig believes that the Volcker rule would distort banks’ behavior. But Diana Furchtgott-Roth argues that it “would restrict banks to core customer-based activity, strengthening the banking system.”

Obama’s proposed bank fee, which is actually a tax, could discourage intra-bank lending, hinder the banking system, and reduce the supply of credit available to customers. The likely effects of the after-TARP fee may undermine Obama’s plan to expand lending programs for small businesses.

Will the after-TARP tax along with the Volcker Rule effectively stabilize the banking system? It doesn’t seem likely. Reform is necessary, but the recovery will not be advanced by taxing institutions that play a key role in generating economic growth.

President Obama has announced his 2011 budget proposal. When FY 2010 ends on September 30 the deficit will total to $1.6 trillion, much higher than the Congressional Budget Office’s forecast.

The Bush tax cuts will expire at the end of this year and if Obama extends their term, the federal deficit estimates will be even higher. Brian Reidl estimates the national debt to count for 98 percent of the GDP by FY 2020, higher than last week CBO’s forecast of 67 percent.

Next year’s budget totals $3.83 trillion, and the Obama administration describes it as “a budget that helps middle class families.” Chris Edwards explains that the 2011 budget will be “$1.1 trillion more than the federal budget nine years ago had promised. That’s a 41 percent forecasting error.” Will this kind of forecasting error keep happening?

The government has become too big and taken too many actions beyond its core responsibilities. To effectively control spending, legislative changes to current budget rules will need to be made.

One useful step would be for the federal government to give states more freedom to find innovative and cost-effective ways to solve problems.  One of the “laboratories of democracy” could certainly come up with something better than our existing Medicaid program, for example. So if there is a silver lining in the projected deficits, it is that dramatic reform may be inevitable.

As of January 22, the current public debt totals more than $12.3 trillion. The Congressional Budget Office reports that if current laws and government spending remain the same, the budget for FY 2010 is estimated at more than $1.3 trillion.

During the Middle Class Task Force meeting, Vice President Biden and President Obama announced new tax cuts to help American middle class families. The following day, Obama proposed a freeze on spending.

Tax cuts generally increase consumer spending. This year American families will most likely use additional savings to pay off their debts. This also happened following last year’s economic stimulus.

A freeze in government spending would help reduce the federal deficit. However, the announced budget freeze accounts for only 17% of the budget, leaving out large sectors with increasing costs (Medicare, Medicaid, military spending, and homeland security.)

The rate of future economic growth looks increasingly uncertain. New laws reducing government revenues and increasing government spending could still increase the federal budget deficit. By 2020 the federal debt could reach 67% of the GDP, the highest level since the 1950s.

Where do we go from here?  There are no easy answers.  For a look at some of the options, take a look at the CBO’s suggestions for decreasing the federal deficit.