Regulating and Resolving Institutions Considered “Too Big to Fail”

Regulating and Resolving Institutions Considered “Too Big to Fail”. By Martin Neil Baily & Robert E. Litan
Testimony, Senate Committee on Banking, Housing and Urban Affairs
May 06, 2009

Thank you Mr. Chairman and members of the Committee for asking us to discuss with you the appropriate policy response to what has come to be widely known as the “too big to fail” (TBTF) problem. We will first outline some threshold thoughts on this question and then answer the questions that you posed in requesting this testimony.

The Key Points

Too Big to Fail and the Current Financial Crisis

• The US economy has been in free fall. Hopefully the pace of decline is now easing, but the transition to sustained growth will not be possible without a restoration of the financial sector to health.
• The largest US financial institutions hold most of the financial assets and liabilities of the sector as a whole and, despite encouraging signs, many of them remain very fragile.
• Many banks in the UK, Ireland, Switzerland, Austria, Germany, Spain and Greece are troubled and there is no European counterpart to the US Treasury to stand behind them. The global financial sector is in a very precarious state.
• In this situation policymakers must deal with “too big to fail” institutions because we cannot afford to see the disorderly failure of another major financial institution, which would exacerbate systemic risk and threaten economic recovery.
• The stress tests are being completed and some banks will be told to raise or take additional capital. There is a lot more to be done after this, however, as large volumes of troubled or toxic assets remain on the books and more such assets are being created as the recession continues.
• It is possible that one or two of the very large banks will become irretrievably insolvent and must be taken over by the authorities and, if so, they will have to deal with that problem even though the cost to taxpayers will be high. But pre-emptive nationalization of the large banks is a terrible idea on policy grounds and is clouded by thicket of legal problems.
• Getting the US financial sector up and running again is essential, but will be very expensive and is deeply unpopular. If Americans want a growing economy next year with an improving labor market, Congress will have to bite the bullet and provide more Treasury TARP funds, maybe on a large scale. The costs to taxpayers and the country will be lower than nationalizing the banks.
• Congress recently removed from the President’s budget the funds to expand the TARP, a move that can only deepen the recession and delay the recovery.

Too Big to Fail: Answering the Four Key Questions (Plus One More)

• Should regulation prevent financial institutions from becoming too big to fail? We need very large financial institutions given the scale of the global capital markets and, of necessity, some of these may be "too big to fail" (TBTF) because of systemic risks. For US institutions to operate in global capital markets, they will need to be large. Congress should not punish or prevent organic growth that may result in an institution having TBTF status.
• At the same time, however, TBTF institutions can be regulated in a way that at least partially offsets the risks they pose to the rest of the financial system by virtue of their potential TBTF status. Capital standards for large banks should be raised progressively as they increase in size, for example. In addition, financial regulators should have the ability to prevent a financial merger on the grounds that it would unduly increase systemic risk (this judgment would be separate from the traditional competition analysis that is conducted by the Department of Justice’s Antitrust Division).
  
• Should Existing Institutions be Broken Up? Organic growth should not be discouraged since it is a vital part of improving efficiency. If, however, the FDIC (or another resolution authority) assumes control of a weakened TBTF financial institution and later returns it to the private sector, the agency should operate under a presumption that it break the institution into pieces that are not considered TBTF. And it should also avoid selling any one of the pieces to an acquirer that will create a new TBTF institution. The presumption could be overcome, however, if the agency determines that the costs of breakup would be large or the immediate need to avoid systemic consequences requires an immediate sale to another large institution.
• What Requirements Should be Imposed on Too Big to Fail Institutions? TBTF or systemically important financial institutions (SIFIs) can and should be specially regulated, ideally by a single systemic risk regulator. This is a challenging task, as we discuss further below, but we believe it is both one that can be met and is clearly necessary in light of recent events.
• Too big to fail institutions have an advantage in that their cost of capital is lower than that of small institutions. At a recent Brookings meeting, Alan Greenspan estimated informally that TBTF banks can borrow at lower cost than other banks, a cost advantage of 50 basis points. This means that some degree of additional regulatory costs (in the form of higher capital requirements, for example) can be imposed on large financial institutions without rendering them uncompetitive.
  
• Improved Resolution Procedures for Systemically Important Banks. This is an important issue that should be addressed soon. When large financial firms become distressed, it is difficult to restructure them as ongoing institutions and governments end up spending large amounts to support the financial sector, just as is happening now. The Squam Lake Working group has proposed one solution to this problem: that systemically important banks (and other financial institutions) be required to issue a long-term debt instrument that converts to equity under specific conditions. Institutions would issue these bonds before a crisis and, if triggered, the automatic conversion of debt into equity would transform an undercapitalized or insolvent institution, at least in principle, into a well capitalized one at no cost to taxpayers.
• Where the losses are so severe that they deplete even the newly converted capital, there should be a bank-like process for orderly resolving the institution by placing it in receivership. Treasury Secretary Geithner has outlined a process for doing this, which we generally support. There are other important resolution-related issues that must be addressed and we discuss them below.
  
• The Origin of the Crisis and the Structure of the Solution. The financial crisis was the result of market failure and regulatory failure. Market failure occurred because wealth-holders in many cases failed to take the most rudimentary precautions to protect their own interests. Compensation structures were established in companies that rewarded excessive risk taking. Banks bought mortgages knowing that lending standards had become lax.
• At the same time, there were thousands of regulators who were supposed to be watching the store, literally rooms full of regulators policing the large institutions. Warnings were given to regulators of impending crisis but they chose to ignore them, believing instead that the market could regulate itself.
• In the future we must seek a system that takes advantage of market incentives and makes use of well-paid highly-qualified regulators. Creating such a system will take time and commitment, but it is clearly necessary.

Read the full testimony »

Libertarians: Stimulus Package Shrinks Economy, Destroys Private Sector Jobs

Stimulus Package Shrinks Economy, Destroys Private Sector Jobs, by Hans Bader
OpenMarket/CEI, May 31, 2009 @ 4:14 pm

Excerpts:

Most of the $800 billion stimulus package has yet to be spent, but it’s already harming the economy, both by triggering trade wars [...], and by driving up interest rates for businesses that need to borrow money to expand or create jobs. (The government is keeping down interest rates on its own debt by printing vast sums of money to buy its own bonds, in order to finance the exploding national debt, which will result in massively higher taxes).

As economist Arnold Kling explains, “most of the stimulus spending does not take place until next year and beyond, so the short-run gains are puny. On the other hand, the big increase in the projected deficit creates the expectation of higher interest rates, which raises interest rates now. These higher interest rates serve to weaken the economy. According to this standard analysis, the stimulus is going to hurt GDP now, when we could use the most help. Much of the spending will kick in a year or more from now,” when the economy will already be in recovery, and “when the economy will need little, if any, stimulus. This is the flaw with using spending rather than tax cuts as a stimulus. The lags are longer when you use spending. Of course, if the real goal is to promote government at the expense of civil society” through “political favoritism, then the stimulus is working exactly as intended.”

1.2 million Americans have lost their jobs since Obama signed the stimulus package into law. The Congressional Budget Office predicted it would shrink the economy “in the long run” (contrary to Obama’s claim that it would prevent “irreversible decline“), but create jobs in the short run.

But the stimulus package turned out to be harmful even in the short run, because it was so badly designed. It poured money into sectors of the economy where no help is needed because unemployment is low, while siphoning money out of sectors where unemployment is high. Moreover, “states hit hardest by the recession are getting the least amount of stimulus spending.”

The stimulus package is just one example of the Obama Administration running up the national debt to bail out the more fortunate while sticking less fortunate people with the bill. The auto bailouts are another. They run up the national debt to keep unskilled auto workers enjoying wages and benefits that are much better than those enjoyed by the average American (while ripping off pension funds and bondholders). As Mickey Kaus notes, “Why should the government tax unskilled workers making $18 an hour, who haven’t bankrupted their employers, in order to protect unskilled workers making $28 an hour, and who have bankrupted their employers, from having to take a pay cut?”

The stimulus package has directly destroyed tens of thousands of jobs. A provision in the stimulus package that blocked a mere 97 Mexican truckers from U.S. roads “caused Mexico to retaliate with tariffs on 90 goods affecting $2.4 billion in U.S. trade,” destroying 40,000 American jobs. And its vague “buy American” provisions, despite doing little to promote purchases of U.S. products, managed to ignite a trade war with Canada.

[...]. One of Obama’s own advisers admits that “the barrage of tax increases proposed in President Barack Obama’s budget could, if enacted by Congress, kill any chance of an early and sustained recovery.” Even the Washington Post, which endorsed Obama and once supported his auto bailouts, now has soured on them and their waste of taxpayer money.

How to Stop Another GM: Abolish Pensions

How to Stop Another GM: Abolish Pensions, by Eli Lehrer
OpenMarket/CEI, June 01, 2009 @ 4:27 pm

GM, of course, declared bankruptcy today. A number of things—bad management, poor products and screwy labor relations—hurt the company. But in the end, the biggest problem GM couldn’t solve related to the company’s liabilities to retirees. The company, which currently employs about 150,000 hourly workers, was responsible for the health care of over 1 million people and pension obligations for over 650,000 people. These pension obligations were probably the largest factor in GM’s demise and public policy should, at minimum, stop encouraging companies to take on anything like them.

The lure of pensions is obvious. A pension is another benefit that a company can provide to its workforce and, although quite attractive (“We’ll support you for life!”) it imposes few up front costs. A company that offers pensions has more money to invest in new products, pay dividends, and meet payroll while simultaneously being able to do well by its existing work force. The problem, however, is that all companies go through a lifecycle: they start small, become big, decline, and eventually go out of business. Of the 100 largest companies in 1900, only 7 existed in the same form by 2000. And this cycle of creative destruction is accelerating, of the 100 largest companies in 2000, by my count, at least 19 have either merged with a similarly-sized company, been bought out, gone bankrupt, or needed a government bailout to stay afloat.

To make matters worse, life expectancy continues to increase meaning that the number of retired people will also increases.Quite simply, pensions are almost always a bad idea for any private company. It’s likely that a company will offer the most generous pensions when it is at the height of its power, influence, and payroll. As things change in the company’s market, it will end up—as GM did—with enormous obligations to people who don’t work for it and no resources or market share to pay for them. As a result, it would make sense, from a public policy perspective, to change the tax code to create disincentives for any promise that a corporation wants to make to its employees down the road. Quite simply, it’s bad for corporations, bad for the economy, and bad for employees. Corporations should not receive any preferential tax treatment, writeoffs, or anything else for any obligations to employees beyond a year or two in the future. A typical corporation just isn’t going to be around to make good on any promises it makes in for the distant future.

Companies that want to offer pensions or retiree health care, of course, would remain free to do so but the tax code should, at minimum, look at this with extreme skepticism. It might well even exact a penalty on companies that chose to compensate their employees this way. As a corollary to this, the federal government should also stop accepting new participants in the Pension Benefit Guaranty Corporation (the federal agency that provides partial backing for private pensions) and look for ways to wind down its operations over time. (Since it has promised to manage certain pension funds and creates a certain reliance interest, it wouldn’t be fair to abolish it right away.)

At the margins, ending tax incentives for pensions and retiree health care would almost certainly increase Medicare costs and might well result in somewhat more people relying on Medicaid for nursing home care. But the alternative—endless bailout of pension funds and the companies that provide them—seems a lot worse.

Ignatius on Kerry's visit to Syria and Midde East policy

Kerry's Unusual Role in Mediating U.S.-Syria Relations. By David Ignatius
WaPo, June 1, 2009; 5:30 PM ET

The long-stalled U.S. diplomatic engagement with Syria is moving forward -- thanks to an unusual bit of mediation by Sen. John Kerry.

A mini-breakthrough in U.S.-Syria relations came Sunday in a telephone conversation between Secretary of State Hillary Clinton and Syrian Foreign Minister Walid Moallem, according to U.S. and Syrian sources. Moallem said that Syria would welcome a visit by U.S. Central Command officers to Damascus this month to discuss joint efforts to stabilize Iraq. In return, Clinton promised to develop a joint “road map” for improving bilateral relations between the two countries.

Kerry reportedly played a key role in breaking the logjam between the two countries, which had worsened after the Obama administration announced last month that it was renewing sanctions against Damascus under the Syria Accountability Act. The Syrians had been expecting that move, but they were upset by a presidential statement accompanying the renewal, which repeated harsh Bush administration language that said Syria posed an “unusual and extraordinary threat to the national security, foreign policy, and economy of the United States.” The Syrians said that unless this sharp language was withdrawn and the bilateral relationship improved, they wouldn’t provide the security assistance that Centcom wanted.

Enter the chairman of the Senate Foreign Relations Committee.

According to Syrian diplomatic sources, Kerry and Syrian President Bashar Assad have been developing a relationship of “respect and friendship,” including a long private dinner between the two men and their wives at the Narenj restaurant in the old city of Damascus when Kerry was there in March.

Kerry is said to have called Assad twice over the past two weeks to explore ways to improve relations; at the same time, he was talking to the Obama White House and State Department. In these and other conversations, apparently, the gap between the two countries was narrowed. Kerry’s office had no comment today.

The result of this mediation was Sunday’s carefully scripted conversation between Clinton and Moallem. Clinton told her Syrian counterpart, “We will be prepared to discuss with you all issues related to Syrian-American relations,” according to one transcript of the conversation. The U.S. pledged to “focus our efforts on forming a new sort of relationship,” according to this transcript. There was no pledge about when the U.S. will send an ambassador back to Damascus; the ambassador was withdrawn after the assassination of Lebanese Prime Minister Rafik Hariri in 2005, an attack for which many Lebanese blamed Syria.

The road map toward better relations will be discussed when Sen. George Mitchell, the U.S. special envoy for the Middle East, visits Damascus, probably this week. He will be the most senior U.S. official to visit Syria since relations went into the deep freeze three four years ago.

The Syria opening is part of a larger effort toward engagement by the Obama administration in the Middle East. President Obama will take that message to the heart of the Arab world Thursday in a Cairo speech that will discuss America’s desire for better relations, including contact with longtime adversaries, such as Syria and Iran.

Kerry’s role in all this is intriguing for two reasons: First, it shows that the former Democratic presidential candidate is carving out a role for himself as a foreign-policy player -- courageously taking on issues that are sensitive in political and policy terms. Second, it shows a fluid and creative foreign-policy process in the Obama administration, in which people outside the White House inner circle are able to get the president’s attention and push the envelope.

Ethanol's Grocery Bill - Two federal studies add up the corn fuel's exorbitant cost

Ethanol's Grocery Bill. WSJ Editorial
Two federal studies add up the corn fuel's exorbitant cost.
WSJ, Jun 02, 2009

The Obama Administration is pushing a big expansion in ethanol, including a mandate to increase the share of the corn-based fuel required in gasoline to 15% from 10%. Apparently no one in the Administration has read a pair of new studies, one from its own EPA, that expose ethanol as a bad deal for consumers with little environmental benefit.

The biofuels industry already receives a 45 cent tax credit for every gallon of ethanol produced, or about $3 billion a year. Meanwhile, import tariffs of 54 cents a gallon and an ad valorem tariff of four to seven cents a gallon keep out sugar-based ethanol from Brazil and the Caribbean. The federal 10% blending requirement insures a market for ethanol whether consumers want it or not -- a market Congress has mandated will double to 20.5 billion gallons in 2015.

The Congressional Budget Office reported last month that Americans pay another surcharge for ethanol in higher food prices. CBO estimates that from April 2007 to April 2008 "the increased use of ethanol accounted for about 10 percent to 15 percent of the rise in food prices." Ethanol raises food prices because millions of acres of farmland and three billion bushels of corn were diverted to ethanol from food production. Americans spend about $1.1 trillion a year on food, so in 2007 the ethanol subsidy cost families between $5.5 billion and $8.8 billion in higher grocery bills.

A second study -- by the Environmental Protection Agency's Office of Transportation and Air Quality -- explains that the reduction in CO2 emissions from burning ethanol are minimal and maybe negative. Making ethanol requires new land from clearing forest and grasslands that would otherwise sequester carbon emissions. "As with petroleum based fuels," the report concludes: "GHG [greenhouse gas] emissions are associated with the conversion and combustion of bio-fuels and every year they are produced GHG emissions could be released through time if new acres are needed to produce corn or other crops for biofuels."

The EPA study also explores a series of alternative scenarios over 30 to 100 years. In some cases ethanol leads to a net reduction in carbon relative to using gasoline. But many other long-term scenarios observe a net increase in CO2 relative to burning fossil fuels. Ethanol produced in a "basic natural gas fired dry mill" will over a 30-year horizon produce "a 5% increase in GHG emissions compared to petroleum gasoline." When ethanol is produced with coal burning mills, the process "significantly worsens the lifecycle GHG impact of ethanol" creating 34% more greenhouse gases than gasoline does over 30 years.

Both CBO and EPA find that in theory cellulosic ethanol -- from wood chips, grasses and biowaste -- would reduce carbon emissions. However, as CBO emphasizes, "current technologies for producing cellulosic ethanol are not commercially viable." The ethanol lobby is attempting a giant bait-and-switch: Keep claiming that cellulosic ethanol is just around the corner, even as it knows the only current technology to meet federal mandates is corn ethanol (or sugar, if it didn't face an import tariff).

As public policy, ethanol is like the joke about the baseball prospect who is a poor hitter but a bad fielder. It doesn't reduce CO2 but it does cost more. Imagine how many subsidies the Beltway would throw at ethanol if the fuel actually had any benefits.

Remember Ozawa: "If Japan desires, it can possess thousands of nuclear warheads"

The Axis of Evil, Again. By BRET STEPHENS
WSJ, Jun 02, 2009

Not 24 hours after North Korea's nuclear test last week, Iranian President Mahmoud Ahmadinejad issued a statement insisting "we don't have any cooperation [with North Korea] in this field." The lady doth protest too much.

When it comes to nuclear weapons and the means to deliver them, history offers two hard lessons. First, nearly every nuclear power has been a secret sharer of nuclear technology. Second, every action creates an equal and opposite reaction -- a Newtonian law of proliferation that is only broken with the intercession of an overwhelming outside force.

On the first point, it's worth recalling that every nuclear-weapons state got that way with the help of foreign friends. The American bomb was conceived by European scientists and built in a consortium with Britain and Canada. The Soviets got their bomb thanks largely to atomic spies, particularly Germany's Klaus Fuchs. The Chinese nuclear program got its start with Soviet help.

Britain gave France the secret of the hydrogen bomb, hoping French President Charles de Gaulle would return the favor by admitting the U.K. into the European Economic Community. (He Gallicly refused.) France shared key nuclear technology with Israel and then with Iraq. South Africa got its bombs (since dismantled) with Israeli help. India made illegal use of plutonium from a U.S.-Canadian reactor to build its first bomb. The Chinese lent the design of one of their early atomic bombs to Pakistan, which then gave it to Libya, North Korea and probably Iran.

Now it's Pyongyang's turn to be the link in the nuclear daisy chain. Its ties to Syria were exposed by an Israeli airstrike in 2007. As for Iran, its military and R&D links to the North go back more than 20 years, when Iran purchased 100 Scud-B missiles for use in the Iran-Iraq war.

Since then, Iranians have reportedly been present at a succession of North Korean missile tests. North Korea also seems to have off-shored its missile testing to Iran after it declared a "moratorium" on its own tests in the late 1990s.

In a 2008 paper published by the Korea Economic Institute, Dr. Christina Lin of Jane's Information Group noted that "Increased visits to Iran by DPRK [North Korea] nuclear specialists in 2003 reportedly led to a DPRK-Iran agreement for the DPRK to either initiate or accelerate work with Iranians to develop nuclear warheads that could be fitted on the DPRK No-dong missiles that the DPRK and Iran were jointly developing. Thus, despite the 2007 National Intelligence Estimate stating that Iran in 2003 had halted weaponization of its nuclear program, this was the time that Iran outsourced to the DPRK for proxy development of nuclear warheads."

Another noteworthy detail: According to a 2003 report in the L.A. Times, "So many North Koreans are working on nuclear and missile projects in Iran that a resort on the Caspian coast is set aside for their exclusive use."

Now the North seems to be gearing up for yet another test of its long-range Taepodong missile, and it's a safe bet Iranians will again be on the receiving end of the flight data. Nothing prevents them from sharing nuclear-weapons material or data, either, and the thought occurs that the North's second bomb test last week might also have been Iran's first. If so, the only thing between Iran and a bomb is a long-range cargo plane.

Which brings us to our second nuclear lesson. Secretary of Defense Robert Gates has lately been in Asia taking a tough rhetorical line on the North's nuclear activities. But it's hard to deliver the message credibly after Mr. Gates rejected suggestions that the U.S. shoot down the Taepodong just prior to its April test, or when the U.S. flubbed the diplomacy at the U.N. So other countries will have to draw their own conclusions.

One such country is Japan. In 2002, Ichiro Ozawa, then the leader of the country's Liberal Party, told Chinese leaders that "If Japan desires, it can possess thousands of nuclear warheads. Japan has enough plutonium in use at its nuclear plants for three to four thousand. . . . If that should happen, we wouldn't lose to China in terms of military strength."

This wasn't idle chatter. As Christopher Hughes notes in his new book, "Japan's Remilitarization," "The nuclear option is gaining greater credence in Japan because of growing concerns over the basic strategic conditions that have allowed for nuclear restraint in the past. . . . Japanese analysts have questioned whether the U.S. would really risk Los Angeles for Tokyo in a nuclear confrontation with North Korea."

There are still good reasons why Japan would not want to go nuclear: Above all, it doesn't want to simultaneously antagonize China and the U.S. But the U.S. has even better reasons not to want to tempt Japan in that direction. Transparently feckless and time-consuming U.S. diplomacy with North Korea is one such temptation. Refusing to modernize our degraded stockpile of nuclear weapons while seeking radical cuts in the overall arsenal through a deal with Russia is another.

This, however, is the course the Obama administration has set for itself. Allies and enemies alike will draw their own conclusions.

Egypt Needs Democracy and Term Limits

Egypt Needs Democracy and Term Limits. By Saad Eddin Ibrahim
Mubarak competes with Ramses II for time in office.
WSJ, Jun 02, 2009

Egyptians have traditionally thought of their country as the "Mother of the World." President Barack Obama says he wants to change the world. Egypt may very well be a good place to start.
Egyptians at home and abroad have been clamoring for change. Kefaya, which literally means "enough," is a slogan, an outcry, and a grassroots movement that has been organizing to reform our antique regime. Over 1,000 acts of civil disobedience have taken place all over Egypt in recent months. Participants have included the Bedouins of Sinai, the Nubians of Aswan, and even the Coptic monks of Upper Egypt.

Obviously, an American president elected on a platform of change is music to Egyptians' ears, and Mr. Obama will be a welcome guest. He is universally popular with Egyptians, Arabs and Muslims. But will average Egyptians really connect with him, let alone get a chance to meet him? With only 10 hours in the country, his visit will be carefully choreographed. Security forces will understandably separate him from the eager Egyptian crowds. Mr. Obama should consider scheduling a town meeting with representatives of Egyptian civil society. He had such a meeting when he visited France.

Mr. Obama will meet an Egyptian president who is still grieving over the untimely death in May of his 13-year-old grandson Mohammed. Despite the special bond between the two, Hosni Mubarak did not appear at the boy's funeral, or at that of the prime minister's wife a week earlier. This has led to widespread rumors about his health. Yet no native reporter dared to raise a question about the matter, as it is against the law to do so.

Mr. Mubarak is the third-longest serving Egyptian ruler in the country's last 2,000 years of recorded history. He has refused to step down or even appoint a vice president. There is widespread apprehension that he is grooming his son Gamal (46) to inherit the "throne." Over 60% of Egypt's population was born during Mr. Mubarak's tenure and have not known any other ruler. Many of them want "change" and are waiting anxiously for someone to help them bring it about.

Let's hope that whatever else he may have pressing -- Palestine, Iran, Iraq and Afghanistan -- Mr. Obama will try to be that change agent. One remarkable thing he can do for Egypt and the rest of the Muslim world is to offer American help in making governance more sound. He should promote the rule of law by promoting democratic elections and term limits for democratically elected presidents.

This may appear to be long shot. Mr. Obama's advisers will likely argue against it to avoid offending his host. But such a bold move would win him the hearts and minds of the world's 1.4 billion Muslims forever. With his legendary gift for communication, Mr. Obama should find a way to propose the idea and offer a Marshall-like plan of financial incentives. He can then call on Egyptians and other Muslims to do the rest.

Mr. Ibrahim, an Egyptian sociologist and human rights advocate, was imprisoned by the Mubarak regime. He has lived in exile since 2007 and is currently a visiting professor at Harvard.

The Justice Department's Antitrust Bomb: Assistant Attorney General for Antitrust Christine Varney

The Justice Department's Antitrust Bomb. By George L Priest
Microsoft and Intel will find refuge in the courts.
WSJ, Jun 02, 2009

As if commandeering the banking, finance and auto industries weren't enough, a couple of weeks ago the Obama administration decided to throw a bomb at modern antitrust law.

Assistant Attorney General for Antitrust Christine Varney claims that the Justice Department can aid economic recovery by prosecuting businesses that have been successful in gaining large market shares. In her announcement last month she argued that "many observers agree" that our current recession reflects "a failure of antitrust" and "inadequate antitrust oversight."

This is news to most economists. The cause of the recession is not easy money by the Fed, or the bursting of the housing bubble, or excessive risk-taking through complicated financial instruments? It's insufficient antitrust prosecution? The claim is hardly plausible. Prosecuting successful businesses will help the recovery? Again, hard to believe.

Why prosecute firms whose products large majorities of consumers have found most valuable? Ms. Varney gives no principled reason. She defends the change in policy on the grounds that it contradicts recommendations of a Justice Department report issued during the Bush administration, and because it appears consistent with the European approach to antitrust.

On her first point, the Justice department, aided by the Federal Trade Commission, issued a report in 2008 addressing the appropriate antitrust approach to potential monopoly behavior. It's fair enough for a succeeding administration to reject policies of its predecessor. But the Justice Department report was not authored by John Yoo or Alberto Gonzales. It was the work of a year-long study that considered recommendations from 29 panels and 119 witnesses, most of them critical of the minimalist Chicago School approach to antitrust law. The report's conclusions basically track Supreme Court law with modest extensions in areas where the Supreme Court has not ruled. Ms. Varney denounced the report in its entirety.

What does Ms. Varney propose as an alternative approach? Not much. Her basic proposal is to transform American antitrust law to more closely resemble that of Europe. She states that American antitrust policies have "diverged too frequently" from those of the Europe, and that "[w]e will focus our efforts on working through our previously divergent policies regarding single-firm conduct and pursuing vigorous enforcement on the [monopolization] front."

This is a huge mistake. The principal reasons American and European approaches to antitrust diverge are that the operative legal standards are different and that the Europeans have not adopted a tradition of rigorous economic analysis.

U.S. antitrust laws condemn practices that are "in restraint of trade," which has been interpreted to mean harm to competition. The European Union, in contrast, condemns practices that constitute "abuse of a dominant position."

The European emphasis on "dominance" has consistently led to confusion. A good example is the way the proposed GE-Honeywell merger was treated in 2001. It was uncontested both in the U.S. and in Europe that the proposed merger would create economic efficiencies, lowering product costs to the benefit of consumers. In the U.S. this was reason to approve -- if not applaud -- the merger. But in Europe the expected cost savings would make the merged firms even more dominant. The EU blocked the merger, to the harm of U.S. and European consumers.

Another example is the recent $1.45 billion fine levied by the EU against Intel. Although the EU has not released its full report documenting what violations it found, it appears that the principal concern was Intel's practice of giving "loyalty discounts" to repeat customers, presumably increasing Intel's dominance in the microprocessor business.

Should a firm be punished for giving discounts? A discount to a repeat customer is a ubiquitous business practice from local delis to auto repair shops, hardly monopolists in any sense. At various points in her presentation Ms. Varney stated that the ambition of antitrust law is to secure low prices for consumers.

Intel, of course, operates on a different scale than a deli. But the fact that it has been able to maintain roughly an 80% market share for decades provides strong evidence that it is producing a valuable product. The antitrust questions with regard to dominant firms should be: What is the source of dominance and how has it survived over time?

The EU complaint claims that Intel has practiced a variation of predatory pricing. As is well-established in U.S. law, predatory pricing claims are highly questionable in the intellectual property field. Although the EU competition unit has added economists to its staff since GE-Honeywell, its antitrust theories are roughly 30 years behind those in the U.S.

The antitrust problem is likely to become increasingly troublesome over time. In a dynamic economy we should expect the development of novel business practices as firms attempt to attract consumers in order to maximize product sales. In the U.S. -- Ms. Varney's views aside -- success in competition is rewarded. In Europe it is suspect, a particularly perverse presumption given that national and international competition has been increasing and will continue to increase.

The saving grace here is that, unlike her European counterpart Neelie Kroes (who is antitrust prosecutor and judge at once), Ms. Varney is only the director of an administrative agency. She and her department can prosecute cases but they cannot convict. The positions put forth in the now-rejected 2008 Justice Department study derive largely from opinions of the Supreme Court. And in the last three monopolization cases considered by the Supreme Court (spanning over a decade) there were no dissenting opinions. Even if President Obama makes the court more liberal the court's antitrust opinions are secure.

Ms. Varney's proposed change in direction of antitrust policy may impose extraordinary litigation costs on the government and on her targets. It is unlikely to have a significant effect on U.S. antitrust law.

Mr. Priest teaches antitrust law at Yale Law School.

GM: Timid management and coddled workers couldn't compete with Toyota

How GM Lost Its Way. By Paul Ingrassia
Timid management and coddled workers couldn't compete with Toyota.
WSJ, Jun 02, 2009

Decades of dumb decisions helped send General Motors to a bankruptcy court yesterday, but one stands out.

The year was 1998, and the United Auto Workers was striking at two factories in Flint, Mich., that made components critical to every GM assembly plant in the country. The union was defending production quotas that workers could fill in five or six hours, after which they would get overtime pay or just, you know, go home.

Most strikes are forbidden during the life of a labor contract, so to provide legal cover the union started filing grievances. GM lawyers contended the walkouts violated the contract anyway and drafted a lawsuit -- the first by the company against the UAW in more than 60 years. But GM's labor-relations department freaked out because the lawsuit would antagonize the union.

Just think about that. The union had shut down virtually all of GM, costing the company and its shareholders billions of dollars, and yet the company's labor negotiators were afraid of giving offense. After heated internal arguments, the suit was filed and GM seemed on the verge of winning. But the company settled just before the judge ruled.

UAW members marched victoriously through downtown Flint. GM executives who advocated a tougher stand got pushed out of the company.

The picture of a heedless union and a feckless management says a lot about what went wrong at GM. There were many more mistakes, of course -- look-alike cars, lapses in quality, misguided acquisitions, and betting on big SUVs just before gas prices soared. They were all born of a uniquely insular corporate culture.

The GM bailout probably will cost close to $100 billion, counting money from the governments of the U.S., Canada and Germany. On paper, the new company should emerge from Chapter 11 fully able to compete in the brutally competitive auto industry. Whether it will actually prosper is far less certain, but some things are beyond dispute. Bankruptcy didn't have to happen and the fact that it did happen is incredibly sad given GM's many contributions to American society and culture.

General Motors invented the modern corporation by developing the concept of giving operating executives power and responsibility to run far-flung operations subject to central financial control. While Henry Ford invented mass manufacturing, GM's long-time president and chairman of the board, Alfred P. Sloan Jr., developed mass marketing: a "car for every purse and purpose," as he put it in the company's 1924 annual report. This meant a hierarchy of brands ranging from practical Chevrolets to prestigious Cadillacs. GM's industrial might helped win a world war and made America rich in its aftermath.

For half a century, between the 1920s and the 1970s, GM seemed to have an instinctive feel for what Americans wanted before consumers themselves even knew it. Chrome, tail fins, muscle cars and even the first catalytic converters that let cars run on lead-free gasoline were developed at GM.

But the company signed generous labor deals during the 1970s, including the right to retire after 30 years with full pension and benefits, partly because it believed the contracts would cripple its smaller competitors, Ford and Chrysler. Then along came Honda, Nissan and Toyota, which didn't have to deal with labor contracts at all. That was the beginning of the agonizing decline.

This fate could have been avoided with better foresight and less hubris, but by 18 months ago bankruptcy was inevitable. GM's U.S. market share had declined to 22% from 52% in the early 1960s. There were too many brands, too much debt, a cumbersome union contract as big as a phone book, and an enormous dealer network built for the glory years of yesterday instead of the market share of today.

The question for Presidents George W. Bush and Barack Obama was whether to stand by and watch, or instead to use the public purse to shape the bankruptcies of both Chrysler and GM to mitigate the damage to a shaky U.S. economy. They intervened, which was the unpleasant but correct decision.

By and large, Mr. Obama's automotive task force has done its job pretty well, forcing the companies and the UAW to make difficult decisions that they should have made themselves long ago. GM will shed four of its eight U.S. brands -- Saab, Saturn, Pontiac and Hummer -- thousands of dealers, 11 factories, and much of its debt. It is no small irony that a Democratic administration brought in a bunch of private-equity types to impose rational management on big business.

That said, a couple of aspects of the GM and Chrysler bailouts could come back to haunt U.S. taxpayers and the Obama administration.

The company that controls Chrysler, Italy's Fiat, is getting a special government incentive -- a potential increase in its Chrysler ownership stake -- to build a small car in America that will get 40 miles per gallon. General Motors made a similar decision to build a high-mileage small car in the U.S. of its own accord, but certainly with an eye toward current political "realities."

Both moves fit the green agenda of Mr. Obama and congressional Democrats. They're also egregious examples of mission creep. GM and Chrysler should get just one marching order from the government: Earn enough money so taxpayers will recover as much as their investment as possible. If the new small cars flop because gas prices drop, the result will be more losses and, potentially, Bailout II.

The other questionable call is the government's big ownership stake in both companies -- 60% of General Motors and a much smaller share of Chrysler. The rationale is reasonable. The government is providing the $50 billion of financing needed to restructure GM so taxpayers might as well get something for their money. But this relegates unsecured lenders to the back of the line behind the government and the union. More worrisome, it invokes the question famously asked before the U.S. invasion of Iraq: You can go in, but can you get out?

The answer will depend on the success of GM, which in turn will hinge on whether the new company can cast off the culture of the old one. One encouraging sign is that, thanks to the labor contract amendments imposed by the Treasury's task force, UAW members will be required to work 40 hours a week before getting overtime pay. Less encouraging is that workers still will be allowed six unexcused absences before being fired. It doesn't take that many at a Honda plant.

As for management, not long ago a group of executives was reviewing a prototype new Buick model, about the size of a BMW 3 Series, at GM's design studios. The sporty styling had been developed in China for sale both there and in the U.S. But the company's cautious product planners suggested conducting customer clinics to gauge reaction to the design and possibly changing both the front and back end. It would have delayed the project and cost tens of millions of dollars.

CEO Fritz Henderson wisely said no. But the very next day the product planners were charging ahead with their clinic plans anyway, just in case the boss wanted to see the results of their research. Maybe the new Buick should be named the CYA. Neither billions in losses nor the brink of bankruptcy, it seems, have been enough to change many traditional ways of doing things at GM.

Heaven only knows what will be enough. But a company with a cautious, slow-moving management and a union committed to defending ridiculous work rules won't have a chance of succeeding. Perhaps everyone remaining at the new GM will realize that. The rest of us can only hope for the best.

Mr. Ingrassia won a Pulitzer Prize in 1993 for covering the last crisis at GM. His book on Detroit's current crisis, "Crash Course," will be published by Random House in January.

Busy Not Running GM - And not choosing GM's office space

Busy Not Running GM. WSJ Editorial
And not choosing GM's office space.
WSJ, Jun 02, 2009

President Obama announced the bankruptcy of General Motors yesterday before GM's CEO even spoke, and the feds will soon own 60% of the company. But whatever you do, please don't think the government is now running GM.

"What we are not doing -- what I have no interest in doing -- is running GM," Mr. Obama said in yesterday's bankruptcy announcement. "When a difficult decision has to be made on matters like where to open a new plant or what type of new car to make, the new GM, not the United States government, will make that decision."

The President is so busy not running GM that he had time the night before to call and reassure Detroit Mayor Dave Bing about the new GM's future location. GM is being courted to move its headquarters to nearby Warren, Michigan. And Mr. Bing told the Detroit News that he had received a call Sunday evening from the President "informing me of his support for GM to stay in the city of Detroit with its headquarters at the Renaissance [Center]."

The newspaper went on to report that "The mayor said he's more secure in knowing GM will stay in Detroit, a move paved by several conversations Bing and his administration had with several top White House officials in recent days."

We don't know whether GM should stay in Detroit. But we do know that the location of a company's headquarters is one of those decisions typically not made by people who are busy not running the company.

A Victory in Pakistan

A Victory in Pakistan - WSJ.com
The army retakes Swat from the Taliban, but don't stop there.
WSJ, Jun 02, 2009

D.C. Should Create Its Own School Voucher Program

D.C. Should Create Its Own School Voucher Program. By Andrew J. Coulson
This article appeared in the DC Examiner on May 29, 2009.

Thousands rallied in DC earlier this month to save a federal program that helps low-income families afford private schooling. On the same day, President Obama signaled that he opposes school vouchers, but will seek funding so that students already attending private schools may continue to do so through the end of high school. When they've graduated, the voucher program would die. That isn't good enough.

The voucher students have little brothers and sisters. They have neighbors and friends. Under the president's proposal, none of those children would ever enjoy the chances that voucher recipients like Mercedes Campbell have had.

In an interview with ReasonTV, Mercedes said the opportunity to attend a private school has transformed her. "It's different, now that I go to Visitation.... It's like a whole new world."
Unless something is done, most poor kids in DC will never glimpse that world, let alone live in it. House Minority Leader John Boehner, of Ohio, has proposed a bill to reauthorize the voucher program, but it faces a stiff headwind as long as Democrats in Congress defer to teacher union opposition.

But there is another option: The District of Columbia can create its own scholarship program.
Can DC afford it? Average tuition at voucher-accepting schools is about $6,600, according to a federal study released last month. By contrast, the city is currently spending about $1.3 billion on k-12 education, for fewer than 49,000 students.

That works out to well over $26,000 per pupil -- comparable to tuition at the prestigious Sidwell Friends school to which the president sends his own daughters, Sasha and Malia. So DC could easily offer a voucher even larger than the one currently provided by the federal government.

Is it politically viable? Perhaps. Though Democrats in Congress are almost universally opposed to school choice programs, the same is not true at the state and local levels. Speakers at the rally to save the voucher program included DC councilman Marion Barry, former mayor Anthony Williams (who was instrumental in creating the federal program), former councilman Kevin Chavous, and civil rights leader Benjamin Chavis.

And just two weeks ago, the Florida legislature passed a bill strengthening that state's private school choice tax credit program, with the support of nearly half the Democratic caucus in the house, and two thirds of African American Democrats. The biggest champions of a similar program in New Jersey are Democratic Mayor Corey Booker, and fellow Democratic state senator Raymond Lesniak.

The political dynamics are different in city halls and statehouses than they are on Capitol Hill. The unions may lobby just as fiercely in every case, but the pushback from constituents is stronger at lower levels of government.

Few seats in the U.S. House or Senate are decided on the basis of education platforms, but education plays a larger role in the election of state and local officials. As parents get angrier and demand educational alternatives for their kids, politicians outside of Congress are more apt to take notice.

What's more, DC already has what amounts to a targeted school voucher program -- and it's larger than the federal voucher program that President Obama wishes to phase out. The District currently sends nearly 2,500 special needs students to private schools because it is not able to serve them itself. The program is uncontroversial.

Why not extend to all families a choice currently enjoyed by so few? The Department of Education's recent study shows that students who have been in the voucher program since it began in 2004 are performing more than two school years ahead of their public school counterparts in reading. There is unconscionable to deny that benefit to other students.

When the "common school" reformers began their campaign for state-run schooling more than 200 years ago, one of their core goals was to ensure that the education of America's poorest citizens did not fall by the wayside.

Despite the best efforts of generation after generation of subsequent reformers, that goal remains unmet for far too many children. We can't wait any longer. DC kids can't wait any longer.

The 'Unseen' Deserve Empathy, Too

The 'Unseen' Deserve Empathy, Too. By John Hasnas
This article appeared in The Wall Street Journal on May 29, 2009

While announcing Sonia Sotomayor as his nominee to the Supreme Court, President Barack Obama praised her as a judge who combined a mastery of the law with "a common touch, a sense of compassion, and an understanding of how the world works and how ordinary people live." This is in keeping with his earlier statement that he wanted to appoint a justice who possessed the "quality of empathy, of understanding and identifying with people's hopes and struggles."

Without casting aspersions on Judge Sotomayor, we may ask whether these are really the characteristics we want in a judge. Clearly, a good judge must have "an understanding of how the world works and how ordinary people live." Judicial decision-making involves the application of abstract rules to concrete facts; it is impossible to render a proper judicial decision without understanding its practical effect on both the litigants and the wider community.

But what about compassion and empathy? Compassion is defined as a feeling of deep sympathy for those stricken by misfortune, accompanied by a strong desire to alleviate the suffering; empathy is the ability to share in another's emotions, thoughts and feelings. Hence, a compassionate judge would tend to base his or her decisions on sympathy for the unfortunate; an empathetic judge on how the people directly affected by the decision would think and feel. What could be wrong with that?

Frederic Bastiat answered that question in his famous 1850 essay, "What is Seen and What is Not Seen." There the economist and member of the French parliament pointed out that law "produces not only one effect, but a series of effects. Of these effects, the first alone is immediate; it appears simultaneously with its cause; it is seen. The other effects emerge only subsequently; they are not seen; we are fortunate if we foresee them." Bastiat further noted that "[t]here is only one difference between a bad economist and a good one: The bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen."

This observation is just as true for judges as it is for economists. As important as compassion and empathy are, one can have these feelings only for people that exist and that one knows about -- that is, for those who are "seen."

One can have compassion for workers who lose their jobs when a plant closes. They can be seen. One cannot have compassion for unknown persons in other industries who do not receive job offers when a compassionate government subsidizes an unprofitable plant. The potential employees not hired are unseen.

One can empathize with innocent children born with birth defects. Such children and the adversity they face can be seen. One cannot empathize with as-yet-unborn children in rural communities who may not have access to pediatricians if a judicial decision based on compassion raises the cost of medical malpractice insurance. These children are unseen.

One can feel for unfortunate homeowners about to lose their homes through foreclosure. One cannot feel for unknown individuals who may not be able to afford a home in the future if the compassionate and empathetic protection of current homeowners increases the cost of a mortgage.

In general, one can feel compassion for and empathize with individual plaintiffs in a lawsuit who are facing hardship. They are visible. One cannot feel compassion for or empathize with impersonal corporate defendants, who, should they incur liability, will pass the costs on to consumers, reduce their output, or cut employment. Those who must pay more for products, or are unable to obtain needed goods or services, or cannot find a job are invisible.

The law consists of abstract rules because we know that, as human beings, judges are unable to foresee all of the long-term consequences of their decisions and may be unduly influenced by the immediate, visible effects of these decisions. The rules of law are designed in part to strike the proper balance between the interests of those who are seen and those who are not seen. The purpose of the rules is to enable judges to resist the emotionally engaging temptation to relieve the plight of those they can see and empathize with, even when doing so would be unfair to those they cannot see.

Calling on judges to be compassionate or empathetic is in effect to ask them to undo this balance and favor the seen over the unseen. Paraphrasing Bastiat, if the difference between the bad judge and the good judge is that the bad judge focuses on the visible effects of his or her decisions while the good judge takes into account both the effects that can be seen and those that are unseen, then the compassionate, empathetic judge is very likely to be a bad judge. For this reason, let us hope that Judge Sotomayor proves to be a disappointment to her sponsor.

What I Learned as a Car Czar

What I Learned as a Car Czar. By Ion Mihai Pacepa
History shows government and automobile manufacturing don't mix.
WSJ, Jun 01, 2009

They say history repeats itself. If you are like me and have lived two lives, you have a good chance of seeing the re-enactment with your own eyes. The current takeover of General Motors by the U.S. government and United Auto Workers makes me think back to Romania's catastrophic mismanagement of the car factories it built jointly with the French companies Renault and Citroen. I was Romania's car czar.

When the Romanian dictator Nicolae Ceausescu decided in the mid-1960s that he wanted to have a car industry, he chose me to start the project rolling. In the land of the blind, the one-eyed man is king. I knew nothing about manufacturing cars, but neither did anyone else among Ceausescu's top men. However, my father had spent most of his life running the service department of the General Motors affiliate in Bucharest.

My job at the time was as head of the Romanian industrial espionage program. Ceausescu tasked me to mediate the purchase of a minimum, basic license for a small car from a major Western manufacturer, and then to steal everything else needed to produce the car.

Three Western companies competed for the honor. Ceausescu decided on Renault, because it was owned by the French government (all Soviet bloc rulers distrusted private companies). We ended up with a license for an antiquated and about-to-be-discontinued Renault-12 car, because it was the cheapest. "Good enough for the idiots," Ceausescu decided, showing what he thought of the Romanian people. He baptized the car Dacia, to commemorate Romania's 2,000-year history going back to Dacia Felix, as the ancient Romans called that part of the world. In that government-run economy, symbolism was the most important consideration, especially when it came to things in short supply (such as food).

"Too luxurious for the idiots," Ceausescu decreed when he saw the first Dacia car made in Romania. Immediately, the radio, right side mirror and backseat heating were dropped. Other "unnecessary luxuries" were soon eliminated by the bureaucrats and their workers' union that were running the factory. The car that finally hit the market was a stripped-down version of the old, stripped-down Renault 12. "Perfect for the idiots," Ceausescu approved. Indeed, the Romanian people, who had never before had any car, came to cherish the Dacia.

For the Western market, however, the Dacia was a nightmare. To the best of my knowledge, no Dacia car was ever sold in the U.S.

Ceausescu, undaunted, was determined to see Romanian cars running around in every country in the world. He tasked me to buy another Western license, this time to produce a car tailored for export. Oltcit was the name of the new car -- an amalgam made from the words Oltenia, Ceausescu's native province, and the French car maker Citroen, which owned 49% of the shares. Oltcit was projected to produce between 90,000 and 150,000 compact cars designed by Citroen.

Ceausescu micromanaged Oltcit, but he didn't even know how to drive a car, much less run a car industry. To save the foreign currency he coveted, he decreed that the components for the Oltcit were to be manufactured at 166 existing Romanian factories. Coordinating 166 plants to have them deliver all the parts on time would be a monumental job even for an experienced car producer. It proved impossible for the Romanian bureaucracy, which pretended to work and was paid accordingly. The Oltcit factory could produce only 1% to 1.5% of its intended capacity owing to the lack of the parts that those 166 companies were supposed to furnish simultaneously. The Oltcit project lost billions.

Ceausescu was an extreme case, but automobile manufacturing and government were never a good mix in any socialist/communist country. In the late 1950s, when I headed Romania's foreign intelligence station in West Germany, I worked closely with the foreign branch of the East German Stasi. Its chief, Markus Wolf, rewarded me with a Trabant car -- the pride of East Germany -- when I left to return to Romania.

That ugly little car became famous in 1989 when thousands of East Germans used it to cross to the West. The Trabant originally derived from a well regarded West German car (the DKW) made by Audi, which today produces some of the most prestigious cars in the world. In the hands of the East German government, the unfortunate DKW became a farce of a car. The bureaucrats and the union that ran the Trabant factory made the car smaller and boxier, to give it a more proletarian look. To reduce production costs, they cut down on the size of the original, already small DKW engine, and they replaced the metal body with one made of plastic-covered cardboard. What rolled off the assembly line was a kind of horseless carriage that roared like a lawn mower and polluted the air worse than a whole city block full of big Western cars.

After German reunification, the plucky little "Trabi" that East Germans used to wait 10 years to buy became an embarrassment, and its production was stopped. Germany's junkyards are now piled high with Trabants, which cannot be recycled because burning their plastic-covered cardboard bodies would release poisonous dioxins. German scientists are now trying to develop a bacterium to devour the cardboard-and-plastic body.

Automobile manufacturing and government do not mix in capitalist countries either. In the spring of 1978 Ceausescu appointed me chief of his Presidential House, a new position supposed to be similar to that of the White House chief of staff. To go with it he gave me a big Jaguar car. That Jaguar, which at the time had been produced in a government-run British factory, was so bad that it spent more time in the garage being repaired than it did on the road.

"Apart from some Russian factories in Gorky, Jaguars were the worst," Ford executive Bill Hayden stated when Ford bought the nationalized British car maker in 1988. How did the famous Jaguar, one of the most prestigious cars in the world, become a joke?

In 1945, the British voters, tired of four years of war, kicked out Winston Churchill and elected a leftist parliament led by Labour's Clement Attlee. Attlee nationalized the automobile, trucking and coal industries, as well as communication facilities, civil aviation, electricity and steel. Britain was already saddled by crushing war debts. Now it was sapped of economic vigor. The old empire quickly passed into history. It would take decades until Margaret Thatcher's privatization reforms restored Britain's place among the world's top-tier economies.

The United States is far more powerful than Great Britain was then, and no American Attlee should be capable of destroying its solid economic and political base. I hope that the U.S. administration, Congress and the American voters will take a closer look at history and prevent our automotive industry from following down the Dacia, Oltcit or Jaguar path.

Lt. Gen. Pacepa, the highest ranking Soviet bloc official granted political asylum in the U.S., is the author of the memoir "Red Horizons" (Regnery, 1987).

WSJ Editorial Page: The Obama Motor Co.

The Obama Motor Co. WSJ Editorial
WSJ, Jun 01, 2009

Back in December, in an economy far, far away, then-CEO Rick Wagoner tossed out the scary cost to taxpayers of $100 billion if General Motors wasn't saved by the government. Well, GM was saved in December and again in March, and as early as today the feds will rescue it a third time in a prepackaged bankruptcy that is already costing at least $50 billion, and that's for starters. Welcome to Obama Motors, and what is likely to be a long, expensive and unhappy exercise in political car making.

Taxpayers have so far put up nearly $20 billion, which was supposed to be a loan at market rates but under Treasury's forced restructuring will mostly be converted into equity in the new GM. The feds are also putting up $30.1 billion in "debtor in possession" financing and will effectively nationalize the once-mighty auto maker by taking roughly 60% ownership. (That's not counting $12.5 billion to save GMAC, the company's financing arm.) The Canadian government will go along for the ride for 12% of the new GM, the UAW will get about 17.5%, and the hapless bond holders have to settle for 10%.

The Obama Treasury is portraying this as the best solution to the mess it inherited, leaving GM with much-reduced legacy costs for health care, a cleaned-up balance sheet, a humbler UAW that has forgone some performance pay, and a more efficient dealer network and product line. GM, we are told, will now be able to make a profit and some day even return money to taxpayers. If you close your eyes and imagine that GM's private managers would be able to make decisions based solely on business judgment, you can even start to believe.

But then you snap out of it.

Every decision the feds have made since December suggests that nonpolitical management will be impossible. First they replaced Mr. Wagoner -- whom they are nonetheless still paying -- with the more pliable Fritz Henderson as CEO and Kent Kresa as Chairman. The latter are good at playing Washington but unproven in making popular cars. Then Treasury bludgeoned the bond holders in both Chrysler and GM to take pennies on the dollar, which will not make creditors eager to lend to the companies in the future.

There's also the labor agreement that the UAW approved last week, which goes some way toward reducing costs but probably not enough to make the new, smaller GM competitive. The new agreement simplifies some work rules and job descriptions but makes no reductions in hourly pay, pensions or health care for active workers. The agreement must also be renegotiated in two years by an Obama Administration running for re-election and weighing the need to keep Big Labor happy against the risks to taxpayer-shareholders. Who do you think wins that White House debate?

The Administration's concessions to the UAW also restrict the company's ability to import smaller, more fuel-efficient cars that it already makes overseas. UAW President Ron Gettelfinger boasted on PBS's "NewsHour" last week that "we, quite frankly, put pressure on the White House, the [auto] task force, the corporation" to bar small-car imports from overseas. GM is also selling its Opel operation in Europe as part of this restructuring, and the Washington Post reports that one of Treasury's sale conditions is that Opel's new owners must stay out of the U.S., and even out of China, where GM's business is strong.

This is raw trade protectionism. It is also textbook cartel behavior and would be an antitrust violation if practiced by a business. But the benefits for GM are illusory because the import limits mean the company will have to spend even more to retool its domestic plants to make the little green cars that President Obama and Congress are demanding. No one knows if Americans will buy such cars, even if GM can make them competitively in the U.S.

The Administration promises to wield a light ownership hand, but it's only a matter of time before Congress starts to micromanage GM's business judgments. Every decision to close a plant will be second-guessed, much like a military base-closing. And what about buying parts from foreign suppliers? Will those also be banned when Mr. Gettelfinger demands it, even if the costs are lower? GM's managers and directors will have one eye on enhancing shareholder value, but the other on pleasing their political minders in Washington.

The Obama Administration has been whispering to the press that it could start selling its stake within a year to 18 months, and that it hopes to be out of the business entirely in five years. But even assuming that the taxpayer investment stops at $50 billion, GM would have to be worth a cool $80 billion for taxpayers to break even on their 60% stake. By way of comparison, GM's market capitalization at its recent peak in 2000 was only $56 billion.

The larger corruption will be when government tries to vindicate its ownership by favoring GM over Ford and the other auto makers that aren't wards of the state. The TARP legislation contained one blatant example in the form of a $7,500 tax credit for consumers who buy GM's new electric car, the Chevy Volt. Expect more such favoritism, including huge new subsidies for green cars if consumers prove resistant to their charms.

Mr. Obama likes to say he's a pragmatist who only prefers a government solution when it will work. But in resurrecting an industrial auto policy that even the French long ago abandoned, the President has made himself GM's de facto CEO. Our guess is that he'll come to regret it as much as taxpayers will.

McGovern: We could defend ourselves with a military budget half the current size

My Advice for Obama. By George McGovern
We could defend ourselves with a military budget half the current size.
WSJ, Jun 01, 2009

Most Americans probably agree that we have elected a highly articulate, talented president in Barack Obama. He has also given us a potentially great Secretary of State in Hillary Clinton. It makes me proud to witness these two recent political rivals working together to strengthen and enrich America at home and abroad. Recognizing the major economic crisis our new leader has inherited, we must hope his proposed economic plan will be helpful.

I think it will. But as someone on the sidelines, may I suggest a few other steps?

First, why not order all U.S. troops out of Iraq and Afghanistan by Thanksgiving? They should be greeted at home with a duplication of the GI Bill of Rights that I enjoyed as a combat bomber pilot following World War II.

This means offering each soldier a college education at any school of his or her choice. In 1945, after completing my few remaining months for a Bachelor's degree at Dakota Wesleyan, I enrolled at Northwestern University and went all the way to a Ph.D. in history without any cost to me except hard work. Other veterans chose to buy a farm or start a business with low-cost, government-guaranteed loans.

We now spend $12 billion a month on wars in Iraq and Afghanistan -- two mistaken invasions that have increased violence and terrorism in the Middle East. For a fraction of what we are spending on these badly conceived interventions, we could fund a new GI Bill with full medical care for the tens of thousands of veterans who have lost legs or arms or suffered lasting nerve or brain damage.

The second step I would take is to ask Congress to shift half of our military budget to other sources of national security. For almost 50 years, American foreign and national-security policy were believed to require a military budget big enough to win wars against Russia, China and a smaller country such as North Korea simultaneously. We waged what was called a Cold War against an alleged "Sino-Soviet bloc."

As we now know there was no such thing as a bloc involving Russia and China. The relations between these two large communist nations could have better been described as a rivalry.
In his second term, Ronald Reagan met with Soviet leader Mikhail Gorbachev, who proposed that the two countries end the Cold War and the arms race. Reagan agreed, and the danger of war between the two nuclear giants has since subsided. As for China, no one any longer fears war with this most-populous, fast-developing country to which we have extended "most favored nation" trading status. It would seem that no nation now threatens us.

There is the terrorist danger, but this is not a military problem. Terrorism is a by-product of military weakness. The terrorist has no battleships, bombers, missiles, tanks, organized armies or heavy artillery.

The only significant terrorist attack on the U.S., on Sept. 11, 2001, was carried out by 19 young men from Saudi Arabia and Egypt armed only with boxcutters. They used these devices to intimidate the crews of four airplanes into surrendering control of their planes. The terrorists then suicidally flew the planes into buildings.

This event, which took place nearly a decade ago, dramatized the limitation of a huge military budget in assuring national security. Nonetheless, our military budget is higher than ever -- $515 billion annually, not including the cost of Iraq and Afghanistan.

This figure is greater than the combined military budgets of the rest of the world. We could defend ourselves with an arms budget half that size. If we directed the $250 billion we could save annually into national health care, improved education, a better environment and restoring our infrastructure, the nation would be more secure, better employed and have a higher standard of life. Or the savings might be used for annual reductions in the national debt.

To cut spending for more and more costly armaments and these two wars would require both common sense and a measure of political courage on the part of the president and Congress. Why? Because all 50 states have either a military installation or a defense contract or both. These create payrolls and jobs.

That is a major reason for investing an equal sum in the public programs suggested here, which should provide as many or more jobs than are now offered by surplus military spending. Much of the arms spending is for things that are capital-intensive but low on job creation. The reverse is true for public investment in such things as upgrading our decaying infrastructure, protecting the environment, providing quality teachers and schools, and improved health care.

Finally, I would like to see America build the fastest, safest and cleanest-powered railway system in the world. This nationwide system of passenger and freight rail service should be integrated with equally superior public transit facilities in our cities.

Very few Americans are in the market for a tank or aircraft carrier. There are many eager consumers for the world's best, fastest and safest rail and transit systems.

All aboard!

Mr. McGovern is a former senator from South Dakota and the 1972 Democratic presidential candidate.

The United States and China, Cooperating for Recovery and Growth

The United States and China, Cooperating for Recovery and Growth. By Secretary T Geithner

June 01, 2009

Why It's So Hard to Close Gitmo

Why It's So Hard to Close Gitmo. By David B Rivkin Jr and Lee A Casey
Holding jihadists in existing U.S. facilities probably violates international law.
WSJ, May 30, 2009

President Barack Obama is retaining many important Bush administration antiterror policies, including the detention without trial of jihadist captives as well as military commissions. He is determined, however, to close the Guantanamo detention facility because he believes doing so will not cause many problems in the U.S., and will improve our image abroad and bolster international support for U.S. antiterror policies. He will be disappointed on all counts.

Guantanamo has always been a symbol, rather than the substance, of complaints against America's "war on terror." It's the military character of the U.S. response to 9/11 that foreign and domestic critics won't accept.

There are also longstanding ideological currents at work here. At least since the 1970s, "progressive" international activists have sought to level the playing field between nation states (especially the U.S. and Israel) and nonstate actors such as the Palestine Liberation Organization and Hamas. Although international humanitarian law is supposed to apply neutrally to all belligerents, international opinion now gives nonstate actors far more leeway to ignore fundamental norms such as the rule against deliberately targeting civilians. The underlying implication is that terrorist tactics, however regrettable, are justified as the only means of achieving laudable goals like national liberation.

This mindset will not change if Guantanamo closes. At the same time, closing the detention facilities will create numerous headaches quite beyond the security issues raised by dangerous detainees who might escape or serve as a magnet for terrorist attacks in U.S.-based facilities.

One immediate problem, identified by FBI Director Robert Mueller, is the very real possibility that the Guantanamo detainees will recruit more terrorists from among the federal inmate population and continue al Qaeda operations from the inside. Radical Islamists already preach jihad in prisons -- this was how the just-arrested New York synagogue bombers were recruited -- and criminal gangs have proved that a half-in/half-out management model works.

A longer-term problem is that once Guantanamo is closed the option of holding captured enemy combatants any place overseas will be undermined. Over time, more and more such individuals, including the ones convicted by military commissions, would have to be brought to the U.S., especially as Europe backs away from taking such individuals. Aggregating the world's worst jihadists on American soil, from which they can never be repatriated, is not a smart way to fight a war.

Meanwhile, the legality of incarcerating captured terrorists in U.S. domestic prisons is far from clear. Today the Guantanamo detainees are held under well-established laws of war permitting belligerents to confine captured enemies until hostilities are over. This detention, without the due process accorded criminal defendants, has always been legally justified because it emphatically is not penal in nature but a simple expedient necessary to keep captives from returning to the fight. It was on this basis that the Supreme Court approved the detention of war-on-terror captives, without trial, in Hamdi v. Rumsfeld (2004).

The Guantanamo detainees are "unlawful" enemy combatants and not "prisoners of war" under the Geneva Conventions. Yet they are still combatants, not convicts. By contrast, the individuals held in the federal prison system, and especially those in the maximum security facilities suggested for the Guantanamo detainees, are convicted criminals.

It is very doubtful that under the customary laws and customs of war, the Hamdi decision, or Common Article 3 of the Geneva Conventions (which the Supreme Court also has applied to the war on terror) the Guantanamo detainees can be treated like convicted criminals and consigned without trial to the genuinely fearsome world of a super-max prison.

Segregating the detainees from the overall prison population -- to maintain the "non-penal" character of their confinement as well as to frustrate any recruiting activities or continuing al Qaeda operations -- is also legally dubious. Unless a new Guantanamo is to be constructed, this segregation will have to take place in existing isolation wards used to discipline (and sometimes protect) federal inmates.

This could mean solitary confinement, perhaps for 23 hours a day, without regard to a detainee's conduct or disciplinary status. The chances that courts would consider this to be the "humane" treatment required by the Geneva conventions are not overwhelming.

The Obama administration can be certain these conditions will be challenged in the courts, and it is difficult to see how, in light of current judicial attitudes, the detainees will be denied the entire panoply of constitutional rights claimed by ordinary inmates -- including lawsuits challenging their conditions of confinement. If courts conclude that these conditions are unconstitutional, or that they cannot be held indefinitely as enemy combatants, judges could mandate the release of these jihadists into the U.S.

Mr. Obama can still reverse his decision to close Guantanamo. This would cost him significant political support among his base. But making unpopular decisions to serve the national interest is a president's duty and obligation. In this regard, Mr. Obama should follow his predecessor's example and put American national security before the vagaries of popular approval.

Messrs. Rivkin and Casey worked in the Justice Department under Presidents Reagan and George H.W. Bush, and have served as expert members of the U.N. Subcommission on the Promotion and Protection of Human Rights.

Money and the Schools

Money and the Schools. WSJ Editorial
More isn't better.
WSJ, May 30, 2009

Brace yourself, because there's good news on education -- and in New Jersey of all places. On Thursday, the New Jersey Supreme Court let stand a 2008 law replacing a judge-made funding formula that had been in place since the 1980s. Under the old formula, created by the 1981 Abbott decision, 31 of the state's poor school districts received the lion's share of state education funding. Funding in these so-called "Abbott districts" has been exceeding $17,000 per student, well above the state average of $13,500.

Test scores have improved among younger students, but University of Arkansas professor Gary Ritter says education reformers had hoped for better results in earlier years of the program given that urban districts like Camden are now spending more than rich suburbs. Derrell Bradford of Excellence in Education for Everyone says scores at the lower grades look better because testing has been dumbed down, and he attributes any improvement to the fact that Abbott students can use vouchers for preschool. By any measurement, Abbott students still lag behind those in districts spending far less per student.

New Jersey taxpayers pay the highest property taxes in the country -- $7,000 on average -- to fund their own schools, and then they pay state income taxes to further fund Abbott districts. Under the new law, state funds will be sent automatically to wherever the needy kids are, even if they attend suburban schools. The real reform would be to let parents decide which schools deserve their kids and allow the funding to follow. But at least we've had one more object lesson that more money doesn't mean better schools.

Did Larry Summers really sign off on these policies?

Say It Ain't So, Larry. By Irwin M. Stelzer
Did the president's top economic adviser really sign off on these policies?
The Weekly Standard, June 08, 2009, Volume 014, Issue 36

Ninety years ago the Chicago White Sox intentionally lost--dumped, to you sports fans--the World Series. Legend has it that a young fan implored the team's star, "Shoeless" Joe Jackson, as he emerged from the court house, "Say it ain't so, Joe." The Shoeless one allegedly responded, "Yes, I'm afraid it is, kid."

Let's hope that chief White House economic adviser Larry Summers wouldn't respond similarly if someone were to charge that he sat silently when the administration's political types decided it would be just fine to submit a budget that will take the ratio of debt-to-GDP from around 40 percent to 80 percent--most critics say 100 percent is where the debt-to-GDP ratio will in fact end up in ten years. Surely Summers knows that many economists use a rule-of-thumb that suggests that such an increase will force interest rates up between 1.25 and 1.5 percentage points, with unpleasant consequences for our economic growth rate. Or that, according to the highly regarded Stanford professor John Taylor, we could only inflate our way out of the problem by allowing a 100 percent rise in the price level over a ten-year period.

More important, it was only a few weeks ago that Summers told an audience at the Brookings Institution that it is "a criterion of fiscal sustainability that ensures that once the economy has recovered, the ratio of the nation's debt to its income stabilizes rather than continuing to grow. . . . Once your income has returned to normal . . . your debts can't be rising relative to your income." But just such an increase is built into the president's ten-year budget.

Summers is famous for his intellect and ability to shoot down nonsensical ideas, so if he was not asleep or absent, he must have gone along. Say it ain't so, Larry.

The administration, led by GM and Chrysler CEO Barack Obama, also decided to lay hands on the auto industry. First it shortchanged the companies' creditors--pension funds and investors who had lent the -companies money on terms that gave them preferential access to the companies' assets should there be a bankruptcy. What matter contractual obligations when the United Auto Workers is awaiting payback for its support of Obama in the primary and general election campaigns? Surely Summers knows that such a move will make investors more reluctant to lend in the future and inclined to charge higher interest rates to any companies they do finance. Some say Summers sat in on these meetings and either lost the argument--implausible, in the view of those who have jousted with him in the past--or remained silent. Say it ain't so, Larry.

The administration has also promised to lower health care costs by introducing new IT systems and expanding insurance coverage. Virtually every expert says that information technology might be a nice thing--automated records, easily accessible--but at best will have only a trivial effect on costs. And just how expanding coverage can lower costs remains a mystery to most economists. Unless, of course, the administration is planning to ration health care, a nightmarish system that until recently led the National Health Service in Britain to deny treatment to patients suffering from macular degeneration until they were blind in one eye. Summers knows all about these cost figures and the inefficiencies of rationing. Did he decide to go along to get along? Say it ain't so, Larry.

Then there is energy policy. The president says he can make us independent of foreign oil. Summers knows he can't. He knows too that many economists contend fuel efficiency standards are more likely to deny consumers the cars they want than to have any effect on global climate, given the developing countries' plans to build thousands of new coal-fired generating stations. Summers had the opportunity while at Harvard to sit at the feet of the wonderful energy economist Professor William Hogan (as did I, although the thought of Summers meekly sitting at the feet of a colleague does strain credulity). So he must have decided either to nod off during the energy policy meetings at the White House or to defer to climate and energy policy czar Carol Browner. Say it ain't so, Larry.

The administration is determined to encourage trade union membership and the growth of union power. Rules for reviewing the expenditures of union officers are being relaxed. "Card check" is to replace the secret ballot in union recognition elections. Compulsory arbitration is to be accorded a large role in the future, putting government arbitrators in a position to respond favorably to union demands. Summers once believed that unionization contributes to long-term unemployment. That was 20 years ago, and he now says circumstances might have changed. But it is worth reading what he wrote in The Concise Encyclopedia of Economics:

Another cause of long-term unemployment is unionization. High union wages that exceed the competitive market rate are likely to cause job losses in the unionized sector of the economy. Also, those who lose high-wage union jobs are often reluctant to accept alternative low-wage employment. Between 1970 and 1985, for example, a state with a 20 percent unionization rate, approximately the average for the fifty states and the District of Columbia, experienced an unemployment rate that was 1.2 percentage points higher than that of a hypothetical state that had no unions. To put this in perspective, 1.2 percentage points is about 60 percent of the increase in normal unemployment between 1970 and 1985.

So is he in favor of card check, compulsory arbitration, and the rest of the Obama trade union agenda? Say it ain't so, Larry.

There's more, but you get the idea. When Barack Obama won the election and began to staff up, those of us who worried that the administration's policies would lean so far in the direction of political pandering as to create serious economic problems took heart when we learned that Larry Summers was to be at the center of policy-making. His fearless intelligence and debating skills would certainly prevent the administration from making terrible, irrevocable policy errors. Christina Romer, chosen by Obama to chair his Council of Economic Advisers, might prefer that appointment to fidelity to her academic research findings--tax cuts are more effective in stimulating an economy than is spending--but surely Larry Summers would not. So great is his reputation that Obama's chief political adviser, David Axelrod, told the press, "I'm not sure we would have gotten him but for the fact that we have a crisis that is equal to his talents."

Many of us joined Axelrod in praising Obama for landing Summers. And those who know him even slightly had no doubt that he has the good sense to treat fools slightly more kindly than his reputation would lead one to expect. So he could be heard. But we wonder if his voice of sanity has gone the way of Paul Volcker's, stifled and ignored. Say it ain't so, Larry.

Irwin M. Stelzer is a contributing editor to THE WEEKLY STANDARD, director of -economic policy studies at the Hudson Institute, and a columnist for the Sunday Times (London).

A New York putsch could one day hurt D.C. schoolchildren

Textbook for Failure. WaPo Editorial
A New York putsch could one day hurt D.C. schoolchildren.
WaPo, Sunday, May 31, 2009

WHETHER NEW York Mayor Michael Bloomberg will retain control of the city's public schools will soon be decided by state lawmakers in Albany. This is an issue about which there should be no debate. By any measure, the city's schools are better off today than under the byzantine system that preceded mayoral control. Too much is at stake -- for New York's 1.1 million students as well as for education reform efforts nationwide -- for the legislature to turn back the clock. If the vested interests of the education establishment succeed in their bid to kill off mayoral control in the nation's largest school system, it will make it harder for other cities to sustain the oversight of schools by mayors. Places such as Washington, D.C., are likely to become the next targets.

The 2002 law that gave Mr. Bloomberg direct authority over the schools, replacing a system of local control overseen by a central Board of Education, expires at the end of June. Lawmakers must decide if mayoral control should be maintained, abolished or modified; the lobbying is ferocious. Critics -- including the United Federation of Teachers -- want to curb the mayor's influence, saying that he and Chancellor Joel Klein have ruled like dictators. Among the suggested changes, presented under the specious guise of "checks and balances," are proposals for reconfiguring the education panel that replaced the old school board so that it would be able to overrule the mayor and giving broad new powers to local community councils. So much for accountability and responsibility; apparently the fact that Mr. Bloomberg was overwhelmingly returned to office in 2005 after staking his political future on running the schools isn't enough.

It's important to recall the grim reality prior to mayoral control: struggling and unsafe schools, failing students, inequities in funding, corrupt politics and patronage. Mr. Bloomberg and Mr. Klein instituted such reforms as ending social promotion and standardizing curriculum. They closed chronically low-performing schools and innovated with new and charter schools. No less an authority than U.S. Education Secretary Arne Duncan hailed the undisputed progress of these seven years. "I'm looking at the data here in front of me," Mr. Duncan told the New York Post. "Graduation rates are up. Test scores are up. Teacher salaries are up . . . ." Indeed, test scores announced this month showed 68.9 percent of students in fourth grade and 57 percent of students in eighth grade met or exceeded grade-level readings standards, up from 46.5 percent and 29.5 percent, respectively, in 2002.

Why sacrifice progress and momentum when there are so many students yet to be helped? One answer is in the clear dislike by teachers union officials of the hard-charging Mr. Klein, who, much like his D.C. counterpart, Michelle A. Rhee, is absolutely fearless in putting the interests of children ahead of job protection, seniority or being liked by city pols. Unions talk a good game about wanting to be change agents, but here, when real reform is on the table, they opt for sabotage. Easier to criticize a style of governing than the benefits of real leadership. Easier to look out for your own institutional interests than what's good for pupils.

A lot is riding on the outcome in New York; Washington, where the same union leaders have inserted themselves into the fight over education, should pay particular attention.