On Lender of Last Resort facilities

On Lender of Last Resort facilities. By A J R, contributing blogger.

Nov 28, 2009

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As is elegantly summarized in Alexander, Dhumale and Eatwell [ADhE 2006], to manage risks, especially of systemic nature ("the awkward tendency for financial crises to cluster over time" [S 2000]), regulators choose from a "crisis management menu" [T 2009] of ex ante and ex post measures. Among the former we can find:

• capital adequacy requirements - e.g., the Basel I and II frameworks;

• large exposure limits;

• limitations on lending

The ex post measures they mention are deposit insurance and the lender of last resort (LOLR) function. Basically, "[t]hese regulatory measures compose the main framework of bank prudential regulation."

A detailed list of steps to be taken after weaknesses are detected after ex ante measures, but before direct support is warranted by the bank being in a distress situation, and of course before closure or liquidation, is printed in Figure 1 of BCBS "Supervisory Guidance on Dealing with Weak Banks," p. 5 [BCBS 2002]. We show several we'll mention later:

• Cash (equity) injection by shareholders (*)

• Suspension of shareholders' rights, including voting rights

• Prohibition on distribution of profits or other withdrawals by shareholders

• Removal of directors and managers

• Immediate and/or enhanced provisioning of doubtful assets (*)

• Stop principal or interest repayments on subordinated debt

• Appointment of an administrator

Most of the measures are designed to reduce the hemorrhage of money in case of weakness and to help the bank to strengthen itself. But the two measures highlighted with asterisk are direct ways (if successful) to avoid invoking the LOLR facilities.

How it differs LOLR support from those weak banks measures and other ex post ones? Which is the nature of lender of last resort facilities?

Definition, purpose of LOLR support

Freixas et alii [FGHS 1999] define LOLR as

the discretionary provision of liquidity to a financial institution (or the market [...]) by the central bank in reaction to an adverse shock which causes an abnormal increase in demand for liquidity which cannot be met from an alternative source.

This discretionary element that [FGHS 1999] mentions is important, and is used in the guidance to deal with weak banks [BCBS 2002]. It is obvious the need to keep awake in the night those who may need funds. If the LOLR function were automatic, moral hazard would be even greater than it already is, with the repeated bail-outs of unsecured creditors, the Treasuries support to any amount in individuals' accounts, and the more easy criteria for acceptance to be a member of the too-big-to-fail category.

Humphrey [H 1989], focusing in the system, sees the LOLR role as defined by Thornton and Bagehot [B 1873] as valid back in 1989:

…(1) to protect the money stock, (2) to support the whole financial system rather than individual financial institutions, (3) to behave consistently with the longer-run objective of stable money growth, and (4) to preannounce its policy in advance of crises so as to remove uncertainty. They also advised the LLR to let insolvent institutions fail, to lend to creditworthy institutions only, to charge penalty rates, and to require good collateral. Such rules they thought would minimize problems of moral hazard and remove bankers’ incentives to take undue risks.

Humphrey adds:

These precepts, though honored in the breach as well as in the observance, continue to serve as a benchmark and model for central bank policy today.

So we can say that until 1988 at least, LOLR followed closely the Thornton-Bagehot doctrine. We'll see below today's changing picture.

Aside from these valuable definitions, I'd like to add the following as main differentiating characteristics of this kind of support relative to the measures for weak banks:

• LOLR facilities are not designed for weak banks (or financial systems), but for those institutions or systems with liquidity/solvency problems – as such, most of the [BCBS 2002]measures must be tried first.

• The many different pathways than can be followed by the regulator are even less clearly determined.

• There is a need for high publicity in case of panics, both for just a single institution (to fight "internal descredit" (Bagehot [B 1873]) and in general failure ("to remove instability") – but the [BCBS 2002] measures are recommended to be applied as silently as possible, to prevent doing harm to the bank that is under such intervention.

Transparency of last resort support

Obviously, the last point is not applicable to many of the measures for weak banks. Those printed supra in italics will be highly publicized or at least will be known by rival banks pretty soon. But the intention is to delay as much as possible public knowledge about them. In many cases it is possible to avoid the knowledge the suspension of rights or the prohibition of distribution of profits until a general meeting of shareholders, and that can be almost a year, if you can wait for the next one to pass without intervention.

In the case of other soft ex post measures, it is conceivable to keep them under wraps for some time, supposedly more than a year. In his ‘Emergency Liquidity Facilities’ [DH 2002, p. 124], Dong He details support for a Finnish bank. The last resort help didn't get published until more than a year later. Also, not only the central bank did help, but this wasn't known until it was published with such delay in the central bank bulletin.

This is just a schematic way to explain the differences. In practice, some of the [BCBS 2002]measures that we've referred to as clearly separated in time overlap to some degree. Nothing prevents the regulator from injecting emergency funds, both to the interbank market or to the institutions, and simultaneously adopting many of the [BCBS 2002] measures.

There is few guidance on LOLR facilities if we exclude national laws. Dong He summarizes the relevant information for twenty nations in his paper's appendix, but, as he says, the "study of emergency lending operations is hampered by a general lack of information on country practices in this area".

LOLR support types – by need

We can try to classify LOLR support according to the need of it. By this criterium, it can be invoked mainly by two needs:

• because of undercapitalization by day-to-day operations – this is not a contentious point;

• because of a panic – when many players "run for the exit at the same time" [W-P 2009] due to the sequential service constraint, which was noted by both Thornton and Bagehot.

[W-P 2009] summarizes many cases of panics in the XIX century and explains how central banks appeared in several countries, and with them the LOLR support in both "emergency lending in normal times" and "in systemic crises", as [DH 2002] calls them. This last support is subject of much discussion today.

Liquidity problems caused by normal, day-to-day operations

If the bank is not suffering "internal discredit", but the regulator, thru routine work, discovers that the financial institution is in distress, which is more common an ocurrence than panics, it may be decided to provide "advances [...] to an immense amount" as Bagehot registered in his book, aside from possible using many of the measures for weak banks we mentioned at the beginning.

Although there is agreement on this, the path is full of perils. Bagehot notes:

But though the rule is clear, the greatest delicacy, the finest and best skilled judgment, are needed to deal [with such affairs].

I've counted twelve times the root "delic-" in his book applied to how fragile and difficult to manage is the system. See References.

Liquidity problems caused by panics – both individual and systemic

Why runs happen even when the bank is not insolvent and can find ways to gather capital at reasonable cost? The work of Diamond and Dybvig [DD 1983] shows that the uncoordinated character of dispersed, uninsured, small depositors can reach what seem several equilibria, among them a bank run, even in such favorable circumstances. Later, Morris & Shin confirmed this [MS 1999]:

Creditors of a distressed borrower face a coordination problem. Even if the fundamentals are sound, fear of premature foreclosure by others may lead to pre-emptive action, undermining the project.

Bagehot offers what it seemed a counterintuitive method to stop a run:

In opposition to what might be at first sight supposed, the best way for the bank or banks who have the custody of the bank reserve to deal with a drain arising from internal discredit, is to lend freely.

He also explains why this solution seems to work:

This discredit means, 'an opinion that you have not got any money,' and to dissipate that opinion, you must, if possible, show that you have money: you must employ it for the public benefit in order that the public may know that you have it. The time for economy and for accumulation is before. A good banker will have accumulated in ordinary times the reserve he is to make use of in extraordinary times.

And later adds, speaking of panics thru an example of successfully solving it (my emphasis):

The holders of the cash reserve must be ready not only to keep it for their own liabilities, but to advance it most freely for the liabilities of others. They must lend to merchants, to minor bankers, to 'this man and that man,' whenever the security is good. In wild periods of alarm, one failure makes many [...]. 'We lent it [...] by every possible means and in modes we had never adopted before; [...] we not only discounted outright, but we made advances on the deposit of bills of exchange to an immense amount, in short, by every possible means consistent with the safety of the Bank [...].' After a day or two of this treatment, the entire panic subsided, and the 'City' was quite calm.

In a way or the other, these considerations keep living in current legislation, at least until Dong He wrote his working paper for the IMF. We can also say that no single country preserves all those prescriptions in writing, there are always subtle changes that well check in the last section, "LOLR support types – by differences in application".

LOLR support types – by differences in application

We can too classify LOLR support according to its differences in application or last resort support.

Size limit

In some countries there are great limits to the amount of liquidity that can be provided – that is, they do not follow the principle of lending freely. As D. He says, p. 129, Argentina, Hong Kong, Turkey and the Philippines have clear limitations in the size limit of last resort support. Dong He adds that this kind of limits is controversial, as they can encourage runs.

Independence of regulator

In others, there is a need to coordinate the bank with the money reserves with politicians at the executive departments, because of law or because of subtle pressure. In the end, in many cases the much trumpeted independence of the regulator is not fully respected. In the IMF report on Turkey [IMF 2007] we find (details in References):

81. In practice the BRSA lacks full operational independence in regulatory and budgetary matters. Before issuing a regulation [...] must conduct consultations with the related Ministry and the Undersecretariat of the State Planning Organization. While nonbinding consultation is appropriate, the process is perceived as binding, thus raising the possibility of undue government interference. [...] All visits abroad by the BRSA management or staff, such as for on-site inspections or for training, must be approved by the government. [...]

[The situation is not as bad as it sounds in this text selection we made. Turkey made great progress in the years before this report was written, as the report says.]

Collateral

In some countries, the quality of the collateral doesn't follow Bagehot's criterium (to relax the standard). The Hong Kong Monetary Authority's policy is to accept only high-quality paper. Other countries follow the criterium: e.g., the Bank of Korea may support banks with "the collateral of any assets which are defined temporarily as acceptable security" in some cases. See examples in [DH 2002, p. 126].

Fisher [F 2000] argues that requiring adequate collateral diminishes moral hazard: the prospective borrower would reduce excessive risks because the risky assets won't be accepted as collateral.

Solvent and insolvent institutions

If the firm is just temporarily illiquid but it is solvent, Bagehot recommends to lend freely (although at "very high" interest rates). If the company is insolvent, he recommends to let it fail.

Several issues are raised here:

• In the hurry in which these crises are dealt with it is very difficult to know if the institution is solvent or not.

• The pressure to help the firm if it is systemically important is enormous, and Bagehot view is increasingly not followed today. See next section.

Impact of recent developments on LOLR principles

Several reasons force our contemporary regulator to provide assistance to institutions that previously would not qualify. Paramount among them are Too Big To Fail (TBTF) issues:

• bank failures have direct large costs of liquidation (see abstract of James below [J 1991]), which affect management and shareholders – much more so with big institutions

• the payments system is affected – stopping payments by a TBTF bank touches too many economic agents

• the interbank market (both as borrower and lender) is greatly affected if such a bank is liquidated

• all this helps reduce economic activity – but even worse, the bank knowledge about the customers (how good or bad is someone repaying his debts, his bills, etc.) is lost, further slowing the economy

• the Treasury also suffers, since it must support the interbank market and try to soften the situation

• compounding this, the size of such a bank can affect the banking system credibility much more than a small bank's failure – system disorders can emerge

Abandoning punitive rates

Rustomjee [R 2009, p. 19] offers two reasons why many "regulators have opted not to provide support at penalty rates":

• "charging a higher than market rate could aggravate [...] the bank’s liquidity or solvency challenge"

• "public knowledge that a bank is being offered emergency lending at a penalty rate could deepen the loss of confidence in bank management and could itself exacerbate any concerns either by banks that have lent to the weak bank, or depositors, so prompting a bank run."

Market makers of last resort (MMLR)

BoE's Tucker [T 2009], which defines LOLR as putting "a finger in the dyke," comments on the increasing "amount of credit that gets intermediated via markets" rather than via institutions in a speech this month and discusses the need to stand ready to act as MMLRs, which is really complex: When you buy from an individual bank you have some leverage to change things, but once you enter into the market as a buyer (that means potentially a really large number of transactions and counterparties) you cannot later renegotiate the price of the assets if their quality deteriorate.

References

[ADhE 2006] Alexander K, R Dhumale and J Eatwell /2006): 'Global Governance of the Financial System - The international regulation of systemic risk'. Oxford UK: Oxford University Press.

[B 1873] Bagehot W (1873) Lombard Street: A Description of the Money Market, London: HS King. http://www.econlib.org/library/Bagehot/bagLom.html

But in exact proportion to the power of this system is its delicacy I should har dly say too much if I said its danger.

And this foreign deposit is evidently of a delicate and peculiar nature.

That such an arrangement is strange must be plain; but its strangeness can only be comprehended when we know what the custody of a national banking reserve means, and how delicate and difficult it is.

But though the rule is clear, the greatest delicacy, the finest and best skilled judgment, are needed to deal at once with such great and contrary evils.

And great as is the delicacy of such a problem in all countries, it is far great er in England now than it was or is elsewhere. The strain thrown by a panic on the final bank reserve is proportional to the magnitude of a country's commerce [...].

2ndly. Because, being a one-reserve system, it reduces the spare cash of the Money Market to a smaller amount than any other system, and so makes that market more delicate.

But it is of great importance to point out that our industrial organisation is liable not only to irregnlar external accidents, but likewise to regular internal changes; that these changes make our credit system much more delicate at some times than at others; and that it is the recurrence of these periodical seasons of delicacy which has given rise to the notion that panics come according to a fixed rule, that every ten years or so we must have one of them.

This is the surer to happen that Lombard Street is, as has been shown before, a very delicate market.

In a time when the trading classes were much ruder than they now are, many private bankers possessed variety of knowledge and a delicacy of attainment which would even now be very rare.

So that our one-reserve system of banking combines two evils: first, it makes the demand of the brokers upon the final reserve greater, because under it so many bankers remove so much money from the brokers; and under it also the final reserve is reduced to its minimum point, and the entire system of credit is made more delicate, and more sensitive.

And this is the reason why the Bank of England ought, I think, to deal most cautiously and delicately with their banking deposits.

We must therefore, I think, have recourse to feeble and humble palliatives such as I have suggested. With good sense, good judgment, and good care, I have no doubt that they may be enough. But I have written in vain if I require to say now that the problem is delicate, that the solution is varying and difficult, and that the result is inestimable to us all.

[BCBS 2002] Basel Committee on Banking Supervision (2002): ‘Supervisory Guidance on Dealing with Weak Banks’, Basel: Bank for International Settlements.

[DD 1983] Diamond D and P Dybvig (1983) ‘Bank Runs, Deposit Insurance and Liquidity’, Journal of Political Economy, Vol. 91, pp. 401–19.

[DH 2002] Dong He (2002) ‘Emergency Liquidity Facilities’, Chapter 5 of C Enoch, D Marston and M Taylor, Building Strong Banks through Surveillance and Resolution, Washington DC: International Monetary Fund.

With the same title as a working paper (2000), Washington, DC: IMF.

[F 2000] Fischer S (2000) 'On the Need for an International Lender of Last Resort ' Essays in international economics, no. 220. Princeton University. http://www.princeton.edu/~ies/IES_Essays/E220.pdf

[FGHS 1999] Freixas X, C Giannini, G Hoggarth and F Soussa (1999) ‘Lender of Last Resort: A Review of the Literature’, Bank of England, Financial Stability Review, November. http://www.bankofengland.co.uk/publications/fsr/1999/fsr07art6.pdf

[H 1989] Humphrey T (1989) ‘The Lender of Last Resort: The Concept in History’, Federal Reserve Bank of Richmond Economic Review, March/April, pp. 8-16. http://www.richmondfed.org/publications/research/economic_review/1989/er750202.cfm

[IMF 2007] International Monetary Fund (2007) ‘Turkey: Financial System Stability Assessment’, IMF Country Report Number 07/361, November, Washington DC: IMF.

62. The 2001 amendment of the CBRT Law gave the CBRT [the central bank] substantially greater independence in the implementation of monetary policy and freed it of any obligation to finance the public sector. [...] However, a lacuna in the CBRT Law is lack of specificity concerning the removal from office of members of the governing bodies [...].

81. In practice the BRSA [very much like the FSA] lacks full operational independence in regulatory and budgetary matters. Before issuing a regulation, the BRSA must conduct consultations with the related Ministry and the Undersecretariat of the State Planning Organization. While nonbinding consultation is appropriate, the process is perceived as binding, thus raising the possibility of undue government interference. Moreover, the related Ministry is legally empowered to file a lawsuit for the cancellation of the Board’s regulatory decision. [...] All visits abroad by the BRSA management or staff, such as for on-site inspections or for training, must be approved by the government. [...]

125. The CMB [the Capital Markets Board] has adequate funding [...]. When markets are inactive, the potential shortfall must be covered by a budgetary transfer from the Ministry of Finance, which could have a bearing on its independence. [...]

[J 1991] James C (1991) ‘The Losses Realised in Bank Failures’, Journal of Finance, September, pp 1223–42. James-TheLossesRealisedinBankFailures1991.pdf

This paper examines the losses realized in bank failures. Losses are measured as the difference between the book value of assets and the recovery value net of the direct expenses associated with the failure. I find the loss on assets is substantial, averaging 30 percent of the failed bank's assets. Direct expenses associated with bank closures average 10 percent of assets. An empirical analysis of the determinants of these losses reveals a significant difference in the value of assets retained by the FDIC and similar assets assumed by acquiring banks.

[MS 1999] Stephen Morris and Hyun Song Shin: Coordination Risk and the Price of Debt. Cowles Foundation Discussion Paper no. 1241. December 1999

[R 2009] Rustomjee C (2009) 'Bank Regulation and the Resolution of Banking Crises, Unit 2'. London: School of Oriental and Management Studies-CeFiMS.

[S 2000] Sinclair, Peter JN (2000) ‘Central Banks and Financial Stability’, Bank of England Quarterly Bulletin, November: 377–89. http://www.bankofengland.co.uk/publications/quarterlybulletin/qb000403.pdf

[T 2009] Paul Tucker (2009) 'The crisis management menu'. Speech by Mr Paul Tucker, Deputy Governor for Financial Stability at the Bank of England, at the SUERF, CEPS and Belgian Financial Forum Conference: "Crisis Management at the Cross-Roads", Brussels, November 16, 2009.

[W-P 2009] Wickman-Parak B (2009): Financial stability in focus. Speech by Ms Barbro Wickman-Parak, Deputy Governor of the Sveriges Riksbank, at the Swedish Chambers, Gothenburg, October 29, 2009. Wickman-Parak-FinancialstabilityinfocusOct292009.pdf

Where U.S. Health Care Ranks Number One - Isn't 'responsiveness' what medicine is all about?

Where U.S. Health Care Ranks Number One. By MARK B. CONSTANTIAN
Isn't 'responsiveness' what medicine is all about?
WSJ, Jan 08, 2010

Last August the cover of Time pictured President Obama in white coat and stethoscope. The story opened: "The U.S. spends more to get less [health care] than just about every other industrialized country." This trope has dominated media coverage of health-care reform. Yet a majority of Americans opposes Congress's health-care bills. Why?

The comparative ranking system that most critics cite comes from the U.N.'s World Health Organization (WHO). The ranking most often quoted is Overall Performance, where the U.S. is rated No. 37. The Overall Performance Index, however, is adjusted to reflect how well WHO officials believe that a country could have done in relation to its resources.

The scale is heavily subjective: The WHO believes that we could have done better because we do not have universal coverage. What apparently does not matter is that our population has universal access because most physicians treat indigent patients without charge and accept Medicare and Medicaid payments, which do not even cover overhead expenses. The WHO does rank the U.S. No. 1 of 191 countries for "responsiveness to the needs and choices of the individual patient." Isn't responsiveness what health care is all about?

Data assembled by Dr. Ronald Wenger and published recently in the Bulletin of the American College of Surgeons indicates that cardiac deaths in the U.S. have fallen by two-thirds over the past 50 years. Polio has been virtually eradicated. Childhood leukemia has a high cure rate. Eight of the top 10 medical advances in the past 20 years were developed or had roots in the U.S.

The Nobel Prizes in medicine and physiology have been awarded to more Americans than to researchers in all other countries combined. Eight of the 10 top-selling drugs in the world were developed by U.S. companies. The U.S. has some of the highest breast, colon and prostate cancer survival rates in the world. And our country ranks first or second in the world in kidney transplants, liver transplants, heart transplants, total knee replacements, coronary artery bypass, and percutaneous coronary interventions.

We have the shortest waiting time for nonemergency surgery in the world; England has one of the longest. In Canada, a country of 35 million citizens, 1 million patients now wait for surgery and another million wait to see specialists.

When my friend, cardiac surgeon Peter Alivizatos, returned to Greece after 10 years heading the heart transplantation program at Baylor University in Dallas, the one-year heart transplant survival rate there was 50%—five-year survival was only 35%. He soon increased those numbers to 94% one-year and 90% five-year survival, which is what we achieve in the U.S. So the next time you hear that the U.S. is No. 37, remember that Greece is No. 14. Cuba, by the way, is No. 39.

But the issue is only partly about quality. As we have all heard, the U.S. spends a higher percentage of its gross domestic product for health care than any other country.

Actually, health-care spending now increases more moderately than it has in previous decades. Food, energy, housing and health care consume the same share of American spending today (55%) that they did in 1960 (53%).

So what does this money buy? Certainly some goes to inefficiencies, corporate profits, and costs that should be lowered by professional liability reform and national, free-market insurance access by allowing for competition across state lines. But the majority goes to a long list of advantages that American citizens now expect: the easiest access, the shortest waiting times the widest choice of physicians and hospitals, and constant availability of health care to elderly Americans. What we need now is insurance and liability reform—not health-care reform.

Who determines how much a nation should pay for its health? Is 17% too much, or too little? What better way could there be to dedicate our national resources than toward the health and productivity of our citizens?

Perhaps it's not that America spends too much on health care, but that other nations don't spend enough.

Dr. Constantian is a plastic and reconstructive surgeon in New Hampshire.

Wahid and the Voice of Moderate Islam - Indonesia's first democratic president espoused a philosophy of religious and ethnic tolerance

Wahid and the Voice of Moderate Islam. By Paul Wolfowitz
Indonesia's first democratic president espoused a philosophy of religious and ethnic tolerance.
WSJ, Jan 07, 2010

Abdurrahman Wahid, who died last week at the age of 69, was the first democratically elected president of Indonesia, the world's fourth largest country and third largest democracy. It has the largest Muslim population of any country in the world. Although he was forced from office after less than two years, he nevertheless helped to set the course of what has been a remarkably successful transition to democracy.

Even more important than his role as a politician, Wahid was the spiritual leader of Nahdlatul Ulama, the largest Muslim organization in Indonesia, and probably in the world, with 40 million members. He was a product of Indonesia's traditionally tolerant and humane practice of Islam, and he took that tradition to a higher level and shaped it in ways that will last long after his death.

Wahid recognized that the world's Muslim community is engaged in what he called in a 2005 op-ed for this newspaper "nothing less than a global struggle for the soul of Islam" and he understood the danger for Indonesia, for Islam and for all of us from this "crisis of misunderstanding that threatens to engulf our entire world."

Wahid was one of the most impressive leaders I have known. Although his formal higher education was limited to Islamic studies in Cairo and Arabic literature in Baghdad, his breadth of knowledge was astounding. With a voracious appetite for knowledge and a remarkably retentive memory, he seemed to know all of the important Islamic religious and philosophical texts. He also loved reading a wide range of Western literature (including most of William Faulkner's novels) as well as Arabic poetry. He enjoyed French movies, and cinema in general, and could identify the conductor of a Beethoven symphony simply by listening to a recording. He was an avid soccer fan and once compared the different styles of two German soccer teams to illustrate two alternative strategies for economic development. He loved jokes, particularly political ones. During Suharto's autocratic rule he published a collection of Soviet political humor in Indonesian, with the obvious purpose of teaching his own people how to laugh at their rulers.

Despite all that learning, Wahid had a common touch that enabled him to express his thoughts in down-to-earth language. He thus gained broad legitimacy for a moderate and tolerant vision. He could speak to young Indonesians, grappling with the relationship between religion and science by explaining to them the thoughts of a medieval Arab philosopher like Ibn Rushd (known to Christian philosophers as Averroes). And he was all the more effective because he himself had grappled with controversial ideas.

Wahid had been somewhat attracted in his youth by the writings of Said Qutb and Hasan al Banna, the founders of the Muslim brotherhood, but his deep humanism led him to reject them. When I visited him recently he told me of a long-ago visit to a mosque in Morocco where an Arabic translation of Aristotle's "Nichomachean Ethics" was on display. Seeing that book had brought tears to his eyes and Wahid explained: "If I hadn't read the 'Nichomachean Ethics' as a young man, I might have joined the Muslim brotherhood."

No doubt, what had so impressed Wahid was that Aristotle could arrive at deep truths about matters of right and wrong without the aid of religion, based simply on the belief that "the human function is activity of the soul in accord with reason" (Nichomachean Ethics, Book I). But his tears must have reflected the thought of how close he had come to accepting a cramped and intolerant view of life and humanity.

Throughout his public career, three ideas were central to Wahid's thinking. First was that true belief required religious freedom. "The essence of Islam," he once wrote, is "encapsulated" in the words of the Quran, "For you, your religion; for me, my religion." Indonesia, he believed, needs "to develop a full religious tolerance based on freedom of faith." Second was his belief that the fundamental requirement for democracy—or any form of just government—is equal treatment for all citizens before the law. Third, that respect for minorities is essential for social stability and national unity, particularly for Indonesia with its extraordinary diversity.

Throughout his career Wahid spoke up forcefully for people with unpopular ideas—even ones he disagreed with—and for the rights of ethnic and religious minorities. He was admired by the Christian and Chinese minorities for his willingness to do so. One of his first acts as president was to participate in prayers at a Hindu temple in Bali where he had earlier spent several months studying Hindu philosophy. Later he removed a number of restrictions on ethnic Chinese and made Chinese New Year an optional national holiday.

Even after leaving office, Wahid's role as a defender of religious freedom was extremely important. Indonesian voters have rejected extremist politics at the polls—and the leadership of the current president, Susilo Bambang Yudhoyono deserves much credit for that. Nevertheless, extremist views and even violent extremism too often go unchallenged. A recent report from The Wahid Insitute (which he founded in 2004) notes that a minority with extremist views, now in control of the Indonesian Ulama Council, has issued religious rulings against "deviant" groups. An even smaller minority that espouses violence, particularly the Islamic Defender Front, has attacked Christian churches and the mosques of the small Muslim Ahmadiyah sect.

Wahid was one of the few prominent Indonesians to defend the rights of the Ahmadiyah or to speak out forcefully against the Islamic Defender Front. Doing so takes courage. But he was always courageous, whether in defying President Suharto at the height of his power or in his personal struggle against encroaching blindness and failing health.

Although optimistic that "true Islam" will prevail, as he wrote in his 2005 op-ed, Wahid did not underestimate the dangers facing the world from an "extreme . . . ideology in the minds of fanatics" who "pervert Islam into a dogma of intolerance, hatred and bloodshed" and who justify their brutality by declaring "Islam is above everything else." This fundamentalist ideology, he said, "has become a well-financed, multifaceted global movement that operates like a juggernaut in much of the developing world." What begins as a misunderstanding "of Islam by Muslims themselves" becomes a "crisis of misunderstanding" that afflicts "Muslims and non-Muslims alike, with tragic consequences."

No one who knew Abdurrahman Wahid can believe that those fanatics who preach hatred and violence speak for the world's Muslims. Even though the extremist ideology represents a distinct minority of Muslims, it is well-financed and well-organized. To confront it, Muslim leaders like himself need, as he wrote in 2005, "the understanding and support of like-minded individuals, organizations and governments throughout the world . . . to offer a compelling alternate vision of Islam, one that banishes the fanatical ideology of hatred to the darkness from which it emerged."

That support includes material support, but it also includes the moral support that comes from international recognition and attention for Muslim leaders who speak out with the courage that Wahid did.

When Wahid was only 12 he was riding in a car with his father, Wahid Hasyim, himself a prominent Muslim leader at the time of Indonesian independence, when the car slid off a mountain road and his father suffered fatal injuries. What Wahid most remembered from that tragic event was the sight of thousands of people lining the roads as his father's casket traveled the 80 kilometers from Surabaya to his burial at Jombang. Overwhelmed by the affection people had for his father, he wondered "What could one man do that the people would love him so?"

As the funeral procession for Wahid himself traveled the same route on the last day of 2009, thousands of mourners, deeply moved, again lined the road. What had he done that Indonesians so loved him? Perhaps the question is answered by the words that he asked to have on his tomb: "Here lies a humanist." That he was and a great one as well. No one can replace him, but hopefully he has inspired others to follow in his path.

Mr. Wolfowitz, a former U.S. ambassador to Indonesia and assistant secretary of state for East Asia, is a visiting scholar at the American Enterprise Institute.

The Real Blackwater Scandal - Another example of prosecutorial abuse in a political case

The Real Blackwater Scandal. WSJ Editorial
Another example of prosecutorial abuse in a political case.
WSJ, Monday, January 4, 2010

No, not as the left would have it, that Blackwater still exists. The scandal is that the Justice Department's case against five former security guards for the military contractor unraveled late last week in what appears to be another instance of gross prosecutorial misconduct, as abusive Justice lawyers went after an unsympathetic political target.

The indictments—which were thrown out by D.C. District Judge Ricardo Urbina in a derisive and detailed 90-page opinion—stemmed from a 2007 firefight in Baghdad's Nisour Square that left 14 Iraqis dead and others wounded. The government contends that five Blackwater guards, who were providing tactical support for the State Department after an IED exploded in the vicinity of a meeting with Iraqi officials, went on an unprovoked killing spree against unarmed civilians. The guards maintain that they came under attack by insurgents and were responding in self-defense to a mortal threat.

Judge Urbina dismissed the charges because prosecutors misused sworn statements the guards were compelled to make to investigators after the shooting, under the threat of job loss. This was routine practice under military contracting rules, though the statements could not be used in criminal prosecutions. Promptly after the Nisour incident these statements were also leaked to the media, which ran with the narrative of modern-day Hessians gone berserk.

"In their zeal to bring charges against the defendants in this case," Judge Urbina ruled, prosecutors had violated Fifth Amendment protections against self-incrimination by using these compelled statements to formulate their case and ultimately obtain indictments against the guards. The judge calls it "the government's reckless violation of the defendants' constitutional rights."

Because of prior contact with the compelled statements, the Justice Department's entire criminal division had recused itself from the case, which was handed over to national-security prosecutors and later to Assistant U.S. Attorney for the District of Columbia Kenneth Kohl. The veteran Justice public-integrity lawyer Raymond Hulser was eventually assigned to lead a "taint team" to rebuild the case without using the off-limits statements, and he repeatedly warned the trial team that their evidence was "thoroughly tainted."

"By all accounts these prophylactic measures fell well short of expectations," Judge Urbina notes with some understatement. In "direct contravention of the clear directives" of Mr. Hulser, the statements were used to obtain a search warrant against Blackwater, figured into plea discussions, and exposed in testimony to the grand jury, forcing Justice to withdraw the case and present it to a new panel.

In the second round that featured redacted testimony from the first grand jury, prosecutors also excised what Judge Urbina calls "substantial exculpatory evidence." The judge goes on to say that Justice's "inconsistent, extraordinary explanations" for its conduct "smack of post hoc rationalization and are simply implausible," and ultimately "lacking in credibility."

Certainly the shootings at Nisour are a tragedy that strained U.S. relations with the Iraqi government, though the details seem reminiscent of the 2005 incident at Haditha, which the Washington political class played as another My Lai massacre but in reality was the product of the complex, asymmetrical combat conditions in a war zone. The courts martial against all but one of the Marines at Haditha have been dismissed or collapsed.

In this case, too, one question is whether prosecutors felt they could get away with such abusive behavior because Blackwater was such a politically unpopular defendant. The firm had political ties to Republicans, and Democrats and their media allies had made Blackwater a whipping boy to further undermine public support for the Iraq war. (Blackwater is now renamed Xe Services and no longer contracting in Iraq.)

This marks the fourth recent example in which judges have tossed out cases citing Justice Department abuse involving easy political targets. In the last year it has become clear that the ethics conviction against former Alaska Senator Ted Stevens was likely a miscarriage of justice, with prosecutors covering up evidence and trying to keep a witness from testifying.

There's also the vendetta against two former executives at Broadcom in the forgotten political uproar over backdating stock options. That case was thrown out last month after a judge ruled that prosecutors had improperly pressured witnesses and leaked information to the press. Earlier this decade, a federal judge tossed out multiple tax evasion cases against former KPMG partners.

Something is rotten in the culture of Justice, leading ambitious government crusaders to think they can get away with flouting due process when the political winds are blowing hot. Congress and the press corps may be too politically implicated to police this prosecutorial malpractice, so it may be up to the judiciary to apply more stringent sanctions.

Uncertainty and the Slow Recovery - A recession is a terrible time to make major changes in the economic rules of the game

Uncertainty and the Slow Recovery. By GARY S. BECKER, STEVEN J. DAVIS AND KEVIN M. MURPHY
A recession is a terrible time to make major changes in the economic rules of the game.
WSJ, Monday, January 4, 2010

In terms of U.S. output contractions, the so-called Great Recession was not much more severe than the recessions in 1973-75 and 1981-82. Yet recovery from the latest recession has started out much more slowly. For example, real GDP expanded by 7.7% in 1983 after unemployment peaked at 10.8% in December 1982, whereas GDP grew at an unimpressive annual rate of 2.2% in the third quarter of 2009. Although the fourth quarter is likely to show better numbers—probably much better—there are no signs of an explosive take off from the recession.

We believe two factors are behind this rather tepid rebound. An obvious one is the severe financial crisis that precipitated this recession, with many major financial institutions receiving large bailouts from the federal government. The confidence of bankers and venture capitalists has been shattered, at least for a while, and it will take time for them to recover from the financial turmoil of the past couple of years. The household sector also faces a difficult period of financial retrenchment in the wake of a major collapse in home prices, overextended debt positions for many, and high unemployment.

The second factor is less obvious, but possibly also of great importance. Liberal Democrats won a major victory in the 2008 elections, winning the presidency and large majorities in both the House and Senate. They interpreted this as evidence that a large majority of Americans want major reforms in the economy, health-care and many other areas. So in addition to continuing and extending the Bush-initiated bailout of banks, AIG, General Motors, Chrysler and other companies, Congress and President Obama signaled their intentions to introduce major changes in taxes, government spending and regulations—changes that could radically transform the American economy.

The efforts to transform the economy began with a fiscal stimulus package of nearly $800 billion. While some elements served the package's stated purpose and helped to soften the recession's impact, the overall package was not well designed to foster a speedy recovery or set the stage for long-term growth. Instead, the "stimulus" was oriented to sectors that liberal Democrats believe are deserving of much greater federal help. This explains why much of the stimulus money is going toward education, health, energy conservation, and other activities that would do little to soak up unemployed resources and stimulate the economy.

In terms of discouraging a rapid recovery, other government proposals created greater uncertainty and risk for businesses and investors. These include plans to increase greatly marginal tax rates for higher incomes. In addition, discussions at the Copenhagen conference and by the president to impose high taxes on carbon dioxide emissions must surely discourage investments in refineries, power plants, factories and other businesses that are big emitters of greenhouse gases.

Congressional "reforms" of the American health delivery system have gone through dozens of versions. The separate bills passed by the House and Senate worry small businesses, in particular. They fear their labor costs will increase because of mandates to spend much more on health insurance for their employees. The resulting reluctance of small businesses to invest, expand and hire harms households as well, because it slows the creation of new jobs and the growth of labor incomes.

The administration also indicated early on that it would take a different approach to antitrust policy, reversing a 30-year trend toward more consumer-based interpretations of antitrust laws. Likewise, the installation of a pay "czar" in Washington is scary, even though his activities are so far confined to companies that received substantial bailout assistance from the Treasury. Perhaps as a next step, Congress will decide that executive pay is too high generally and levy special taxes on bonuses, or impose other controls over executive compensation—as the British and French have done. Congress is also considering major new regulations on consumer financial products.

In its efforts to combat the financial crisis and recession, the Fed created over $1 trillion of excess reserves at banks through various bailout programs and open market operations. When banks draw on these reserves for loans to businesses and households, there is a potential for the money supply to grow rapidly, possibly producing a substantial inflation. How hard the Fed will fight inflationary pressures through open market sales and other actions that raise interest rates is a significant source of uncertainty about future inflation and about the potential for monetary policy tightening to choke off the recovery.

The uncertainty about monetary policy has important political dimensions as well. The Fed now faces greater political pressures than at any other time in the past quarter century, as seen from the grilling the Senate Banking committee gave to Fed Chairman Ben Bernanke in deciding whether to approve his reappointment. These pressures may intensify greatly if, and when, future Fed actions to restrain inflation conflict with politicians' desires to prop up housing and the major government enterprises enmeshed in housing finance.

Even though some of the proposed antibusiness policies might never be implemented, they generate considerable uncertainty for businesses and households. Faced with a highly uncertain policy environment, the prudent course is to set aside or delay costly commitments that are hard to reverse. The result is reluctance by banks to increase lending—despite their huge excess reserves—reluctance by businesses to undertake new capital expenditures or expand work forces, and decisions by households to postpone major purchases.

Several pieces of evidence point to extreme caution by businesses and households. A regular survey by the National Federation of Independent Businesses (NFIB) shows that recent capital expenditures and near-term plans for new capital investments remain stuck at 35-year lows. The same survey reveals that only 7% of small businesses see the next few months as a good time to expand. Only 8% of small businesses report job openings, as compared to 14%-24% in 2008, depending on month, and 19%-26% in 2007.

The weak economy is far and away the most prevalent reason given for why the next few months is "not a good time" to expand, but "political climate" is the next most frequently cited reason, well ahead of borrowing costs and financing availability. The authors of the NFIB December 2009 report on Small Business Economic Trends state: "the other major concern is the level of uncertainty being created by government, the usually [sic] source of uncertainty for the economy. The 'turbulence' created when Congress is in session is often debilitating, this year being one of the worst. . . . There is not much to look forward to here."

Government statistics tell a similar story. Business investment in the third quarter of 2009 is down 20% from the low levels a year earlier. Job openings are at the lowest level since the government began measuring the concept in 2000. The pace of new job creation by expanding businesses is slower than at any time in the past two decades and, though older data are not as reliable, likely slower than at any time in the past half-century. While layoffs and new claims for unemployment benefits have declined in recent months, job prospects for unemployed workers have continued to deteriorate. The exit rate from unemployment is lower now than any time on record, dating back to 1967.

According to the Michigan Survey of Consumers, 37% of households plan to postpone purchases because of uncertainty about jobs and income, a figure that has not budged since the second quarter of 2009, and one that remains higher than any previous year back to 1960.

These facts suggest that it was a serious economic mistake to press for a hasty, major transformation of the U.S. economy on the heels of the worst financial crisis in decades. A more effective approach would have been to concentrate first on fighting the recession and laying solid foundations for growth. They should have put plans to re-engineer the economy on the backburner, and kept them there until the economy emerged fully from the recession and returned to robust growth. By failing to adopt a measured approach to economic policy, Congress and the president may be slowing the economic recovery, and thereby prolonging the distress from the recession.

The authors are economists at the University of Chicago. Messrs. Becker and Murphy are also fellows of the Hoover Institution of Stanford University. Mr. Davis is also a visiting scholar at the American Enterprise Institute.

How Abdulmutallab got on the plane - was granted Fourth Amendment reasonableness rights

Intelligence Is a Terrible Thing to Waste. By L. GORDON CROVITZ
President Obama doesn't need an investigation to figure out how Umar Farouk Abdulmutallab got on a Detroit-bound plane.
WSJ, Monday, January 4, 2010

Intelligence about terror threats rarely comes on such a silver platter: A Nigerian banker went to the U.S. Embassy in Lagos to warn that his son had fallen under "the influence of religious extremists based in Yemen" and was a security risk. This came after months of U.S. intelligence intercepts about al Qaeda plans for an attack using a Nigerian man. Umar Farouk Abdulmutallab paid for his ticket with cash and didn't check any luggage.

Yet a headline in the Washington Post summed up the current state of our intelligence: "Uninvestigated Terrorism Warning About Detroit Suspect Called Not Unusual."

President Obama promises to investigate what went wrong, but there's no big mystery. He should simply review testimony put in the public record in early December, before the Christmas Day incident. Sen. Joe Lieberman's Homeland Security Committee heard an explanation of how U.S. intelligence agencies decide when to put suspected terrorists on a watch list or a no-fly list.

Timothy Healy, the head of the FBI's Terrorist Screening Center, explained the unit's "reasonable suspicion" standard like this:

"Reasonable suspicion requires 'articulable' facts which, taken together with rational inferences, reasonably warrant a determination that an individual is known or suspected to be or has been engaged in conduct constituting, in preparation for, in aid of, or related to, terrorism and terrorist activities, and is based on the totality of the circumstances. Mere guesses or inarticulate 'hunches' are not enough to constitute reasonable suspicion."

If this sounds like legalistic language, it is. Indeed, a quick Web search was a reminder that this language is adapted from Terry v. Ohio, a landmark Supreme Court case in 1968 that determined when Fourth Amendment protection against unreasonable searches allows the police to frisk civilians or conduct traffic stops. In other words, foreign terrorists have somehow now been granted Fourth Amendment reasonableness rights that courts intended to protect Americans being searched by the local police. Thus was Abdulmutallab allowed on the airplane with his explosives.

The difference between law-enforcement procedures and preventing terrorism could not be clearer. If a well-respected banker takes the initiative to come to a U.S. embassy in Nigeria to report that he thinks his son is a terrorist, we expect intelligence officers to make "hunches," such as that this person should have his visa reviewed and be searched before getting on a plane. Information is our defense against terrorism, but evidence of terror plots is often incomplete, which is why intelligence requires combining facts with hunches.

The result of prohibiting hunches was that Abdulmutallab was waved through. Information about suspected terrorists flows into a central Terrorist Screening Database, which is then analyzed by the Terrorist Screening Center, where FBI agents apply the "reasonable suspicion" standard to assign people to various watch lists including "selectee" lists and the "no-fly" list. It's at this point where an approach based on domestic law enforcement trump prevention, undermining the use of information.

Aside from concluding that we are misapplying a reasonableness test, the Abdulmutallab investigation likely will conclude that information in the databases of the National Security Agency, CIA and State Department weren't properly mined to connect dots. His name went onto the list of 400,000 people who might have links to terror, but not the list of 14,000 subject to multiple screenings before boarding an airplane or the list of 3,400 people who are not permitted to fly.

The Obama administration has leaned toward treating terrorism as a matter for domestic law enforcement, such as trying terrorists in civilian courts instead of in military tribunals. But this legalistic culture also undermined intelligence in the Fort Hood case in November. The FBI knew that Maj. Nidal Malik Hasan had been exchanging emails with a Yemen-based imam with ties to the 9/11 hijackers. The agency, operating by the standards of domestic law enforcement instead of applying information to prevention, surmised that the "content was explainable by his research" and failed to warn the Army of its potential risk.

In contrast, British authorities last May denied Abdulmutallab the right to re-enter the United Kingdom, where he had been president of an Islamic Society while in college. In Britain, domestic intelligence is the job of M15, which unlike the FBI has no power to arrest or responsibility for criminal prosecutions. Instead, it is free to focus on gathering intelligence, making hunches and preventing wrongdoing. The British ban on Abdulmutallab didn't require any FBI-like "reasonable suspicion" test.

After 9/11, the key political issue that went unresolved was what Americans expect from their intelligence agents. We send the mixed message that we want them to prevent attacks, but only if they operate under strict restrictions based on rules crafted for domestic law enforcement.

We have a choice. We can limit how information is used or we can allow smart use of information to prevent attacks. If we continue to choose to limit how information can be used in our defense, we shouldn't be surprised when our defenses fail.

The Biggest Losers - Behind the Christmas Eve taxpayer massacre at Fannie and Freddie

The Biggest Losers. WSJ Editorial
Behind the Christmas Eve taxpayer massacre at Fannie and Freddie.
WSJ, Monday, January 4, 2010

Happy New Year, readers, but before we get on with the debates of 2010, there's still some ugly 2009 business to report: To wit, the Treasury's Christmas Eve taxpayer massacre lifting the $400 billion cap on potential losses for Fannie Mae and Freddie Mac as well as the limits on what the failed companies can borrow.

The Treasury is hoping no one notices, and no wonder. Taxpayers are continuing to buy senior preferred stock in the two firms to cover their growing losses—a combined $111 billion so far. When Treasury first bailed them out in September 2008, Congress put a $200 billion limit ($100 billion each) on federal assistance. Last year, the Treasury raised the potential commitment to $400 billion. Now the limit on taxpayer exposure is, well, who knows?

The firms have made clear that they may only be able to pay the preferred dividends they owe taxpayers by borrowing still more money . . . from taxpayers. Said Fannie Mae in its most recent quarterly report: "We expect that, for the foreseeable future, the earnings of the company, if any, will not be sufficient to pay the dividends on the senior preferred stock. As a result, future dividend payments will be effectively funded from equity drawn from the Treasury."

The loss cap is being lifted because the government has directed both companies to pursue money-losing strategies by modifying mortgages to prevent foreclosures. Most of their losses are still coming from subprime and Alt-A mortgage bets made during the boom, but Fannie reported last quarter that loan modifications resulted in $7.7 billion in losses, up from $2.2 billion the previous quarter.

The government wants taxpayers to think that these are profit-seeking companies being nursed back to health, like AIG. But at least AIG is trying to make money. Fan and Fred are now designed to lose money, transferring wealth from renters and homeowners to overextended borrowers.

Even better for the political class, much of this is being done off the government books. The White House budget office still doesn't fully account for Fannie and Freddie's spending as federal outlays, though Washington controls the companies. Nor does it include as part of the national debt the $5 trillion in mortgages—half the market—that the companies either own or guarantee. The companies have become Washington's ultimate off-balance-sheet vehicles, the political equivalent of Citigroup's SIVs, that are being used to subsidize and nationalize mortgage finance.

This subterfuge also explains the Christmas Eve timing. After December 31, Team Obama would have needed the consent of Congress to raise the taxpayer exposure beyond $400 billion. By law, negative net worth at the companies forces them into "receivership," which means they have to be wound down.

Unlimited bailouts will now allow the Treasury to keep them in conservatorship, which means they can help to conserve the Democratic majority in Congress by increasing their role in housing finance. With the Federal Reserve planning to step back as early as March from buying $1.25 trillion in mortgage-backed securities, Team Obama is counting on Fan and Fred to help reflate the housing bubble.

That's why on Christmas Eve Treasury also rolled back a key requirement of the 2008 bailout—that Fan and Fred begin shrinking the portfolios of mortgages they own on their own account, which total a combined $1.5 trillion. Risk-taking will now increase, so that the government can once again follow Barney Frank's infamous advice that the companies "roll the dice" on subsidies for affordable housing.

All of which would seem to make the CEOs of Fannie and Freddie the world's most overpaid bureaucrats. A release from the Federal Housing Finance Agency that also fell in the Christmas Eve forest reports that, after presiding over a combined $24 billion in losses last quarter, Fannie CEO Michael Williams and Freddie boss Ed Haldeman are getting substantial raises. Each is now eligible for up to $6 million annually.

Freddie also has one of the world's highest-paid human resources executives. Paul George's total compensation can run up to $2.7 million. It must require a rare set of skills to spot executives capable of losing billions of dollars.

Where is Treasury's pay czar when we actually need him? You guessed it, Fannie and Freddie are exempt from the rules applied to the TARP banks. The government gave away the game that these firms are no longer in the business of making profits when it announced that the CEOs will be paid entirely in cash, though it is discouraging that practice at other big banks. Who would want stock in the Department of Housing and Urban Development?

Meanwhile, these biggest of Beltway losers continue to be missing from the debate over financial reform. The Treasury still hasn't offered its long-promised proposals even as it presses reform on banks that played a far smaller role in the financial mania and panic. Senate Banking Chairman Chris Dodd (D., Conn.) and ranking Republican Richard Shelby recently issued a joint statement on their "progress" toward financial regulatory reform, but their list of goals also doesn't mention Fannie or Freddie.

Since Mr. Shelby has long argued for reform of these government-sponsored enterprises, their absence suggests that Mr. Dodd's longtime effort to protect Fan and Fred is once again succeeding. It would be worse than a shame if, having warned about the iceberg for years, Mr. Shelby now joins Mr. Dodd in pretending that these ships aren't sinking.

In today's Washington, we suppose, it only makes sense that the companies that did the most to cause the meltdown are being kept alive to lose even more money. The politicians have used the panic as an excuse to reform everything but themselves.

A tax increase that will cause many seniors to lose private benefits

ObamaCare on Drugs. WSJ Editorial
A tax increase that will cause many seniors to lose private benefits.
The Wall Street Journal, page A10, Jan 02, 2009

Democrats are starting to mash together the Senate and House health-care bills, all of the negotiations taking place in secret. One reason to keep quiet is so voters don't discover items like the Senate's destructive change in the way retiree health benefits are taxed. This is a revenue grab that will cost many retirees their private drug benefit coverage, with knock-on harm for the federal budget and financial markets.

When the Medicare prescription drug benefit was created in 2003, one concern was that businesses that provided private drug coverage for seniors would dump them into the new taxpayer-funded plan. So Congress created a modest tax subsidy—equal to 28% of the total cost of a drug plan—to encourage employers to maintain coverage for retirees who would otherwise enroll in Medicare. On average, this subsidy will cost the government about $665 per person in 2011, according to the Employee Benefit Research Institute, while the same Medicare coverage would run about $1,209.

Currently, the $665 a business gains by providing benefits—and keeping one senior off Medicare—is not taxed. By instead treating the subsidy as income taxed at the 35% corporate rate, Democrats expect to raise about $5.4 billion for ObamaCare—and while that's a pittance in the scheme of a new multitrillion-dollar price tag, it's also based on a static tax analysis that is surely wrong.

The cost of offering drug benefits will rise by about $233 per retiree, making Medicare a far more attractive option for businesses. Private drug coverage is already on the decline, but Verizon, Xerox, Boeing, Metlife, Caterpillar and other companies are already warning that they may be forced to cut benefits. (Consider this another reward for the Business Roundtable's decision to promote ObamaCare.)

As more employers drop drug coverage, Congress won't be dispensing as many subsidies with the one hand that it can tax with the other, so revenue will fall. The retirees who lose private benefits will simply move onto Medicare, so public drug spending will also rise. The American Benefits Council, which represents the largest employers, estimates the tax will be a net loser for the government if just one out of four retirees is crowded out of private coverage.

That $233 may not sound like a lot, but under an accounting rule established in 1990, companies are required to report and expense their long-term retiree health liabilities on their financial statements, including actual paid claims and certain future payments. The deferred losses from the tax change thus must be immediately reflected on their balance sheets, which would take a huge bite out of reported earnings in 2010. Given the shaky economy, not to mention the political uncertainty that Washington continues to generate, is this really the best idea?

This is merely one example of how careless Democrats have been about the details as they dash to pass ObamaCare, even as they behave as if the results of their major changes to the health market will match perfectly with their perfectly unrealistic rhetoric.

"One of the things I've learned is that the Econ 101 approach to life where all that matters is the direct financial incentives or penalties is just wrong," Obama budget director Peter Orszag said in December. "Not to say that it doesn't matter, but exclusive focus on rational, perfectly optimizing behavior is just not, not where it's at."

When even the budget scorekeeper spurns economic incentives, you know pure politics is in charge. We suspect the White House will discover soon enough that everyone is a lot more rational, and a lot smarter, that it presumes.

Why the Health-Care Bills Are Unconstitutional. - If the government can mandate the purchase of insurance, it can do anything

Why the Health-Care Bills Are Unconstitutional. By Orrin Hatch, J Kenneth Blackwell and Kenneth Klukowski
If the government can mandate the purchase of insurance, it can do anything.
The Wall Street Journal, page A11, Jan 02, 2009

President Obama's health-care bill is now moving toward final passage. The policy issues may be coming to an end, but the legal issues are certain to continue because key provisions of this dangerous legislation are unconstitutional. Legally speaking, this legislation creates a target-rich environment. We will focus on three of its more glaring constitutional defects.

First, the Constitution does not give Congress the power to require that Americans purchase health insurance. Congress must be able to point to at least one of its powers listed in the Constitution as the basis of any legislation it passes. None of those powers justifies the individual insurance mandate. Congress's powers to tax and spend do not apply because the mandate neither taxes nor spends. The only other option is Congress's power to regulate interstate commerce.

Congress has many times stretched this power to the breaking point, exceeding even the expanded version of the commerce power established by the Supreme Court since the Great Depression. It is one thing, however, for Congress to regulate economic activity in which individuals choose to engage; it is another to require that individuals engage in such activity. That is not a difference in degree, but instead a difference in kind. It is a line that Congress has never crossed and the courts have never sanctioned.

In fact, the Supreme Court in United States v. Lopez (1995) rejected a version of the commerce power so expansive that it would leave virtually no activities by individuals that Congress could not regulate. By requiring Americans to use their own money to purchase a particular good or service, Congress would be doing exactly what the court said it could not do.

Some have argued that Congress may pass any legislation that it believes will serve the "general welfare." Those words appear in Article I of the Constitution, but they do not create a free-floating power for Congress simply to go forth and legislate well. Rather, the general welfare clause identifies the purpose for which Congress may spend money. The individual mandate tells Americans how they must spend the money Congress has not taken from them and has nothing to do with congressional spending.

A second constitutional defect of the Reid bill passed in the Senate involves the deals he cut to secure the votes of individual senators. Some of those deals do involve spending programs because they waive certain states' obligation to contribute to the Medicaid program. This selective spending targeted at certain states runs afoul of the general welfare clause. The welfare it serves is instead very specific and has been dubbed "cash for cloture" because it secured the 60 votes the majority needed to end debate and pass this legislation.

A third constitutional defect in this ObamaCare legislation is its command that states establish such things as benefit exchanges, which will require state legislation and regulations. This is not a condition for receiving federal funds, which would still leave some kind of choice to the states. No, this legislation requires states to establish these exchanges or says that the Secretary of Health and Human Services will step in and do it for them. It renders states little more than subdivisions of the federal government.

This violates the letter, the spirit, and the interpretation of our federal-state form of government. Some may have come to consider federalism an archaic annoyance, perhaps an amusing topic for law-school seminars but certainly not a substantive rule for structuring government. But in New York v. United States (1992) and Printz v. United States (1997), the Supreme Court struck down two laws on the grounds that the Constitution forbids the federal government from commandeering any branch of state government to administer a federal program. That is, by drafting and by deliberate design, exactly what this legislation would do.

The federal government may exercise only the powers granted to it or denied to the states. The states may do everything else. This is why, for example, states may have authority to require individuals to purchase health insurance but the federal government does not. It is also the reason states may require that individuals purchase car insurance before choosing to drive a car, but the federal government may not require all individuals to purchase health insurance.

This hardly exhausts the list of constitutional problems with this legislation, which would take the federal government into uncharted political and legal territory. Analysts, scholars and litigators are just beginning to examine the issues we have raised and other issues that may well lead to future litigation.

America's founders intended the federal government to have limited powers and that the states have an independent sovereign place in our system of government. The Obama/Reid/Pelosi legislation to take control of the American health-care system is the most sweeping and intrusive federal program ever devised. If the federal government can do this, then it can do anything, and the limits on government power that our liberty requires will be more myth than reality.

Mr. Hatch, a Republican senator from Utah, is a former chairman of the Senate Judiciary Committee. Mr. Blackwell is a senior fellow with the Family Research Council and a professor at Liberty University School of Law. Mr. Klukowski is a fellow and senior legal analyst with the American Civil Rights Union.

The States and the Stimulus - How a supposed boon has become a fiscal burden

The States and the Stimulus. WSJ Editorial
How a supposed boon has become a fiscal burden.
The Wall Street Journal, page A10, Saturday, January 2, 2010

Remember how $200 billion in federal stimulus cash was supposed to save the states from fiscal calamity? Well, hold on to your paychecks, because a big story of 2010 will be how all that free money has set the states up for an even bigger mess this year and into the future.

The combined deficits of the states for 2010 and 2011 could hit $260 billion, according to a survey by the liberal Center on Budget and Policy Priorities. Ten states have a deficit, relative to the size of their expenditures, as bleak as that of near-bankrupt California. The Golden State starts the year another $6 billion in arrears despite a large income and sales tax hike last year. New York is literally down to its last dollar. Revenues are down, to be sure, but in several ways the stimulus has also made things worse.

First, in most state capitals the stimulus enticed state lawmakers to spend on new programs rather than adjusting to lean times. They added health and welfare benefits and child care programs. Now they have to pay for those additions with their own state's money.

For example, the stimulus offered $80 billion for Medicaid to cover health-care costs for unemployed workers and single workers without kids. But in 2011 most of that extra federal Medicaid money vanishes. Then states will have one million more people on Medicaid with no money to pay for it.

A few governors, such as Mitch Daniels of Indiana and Rick Perry of Texas, had the foresight to turn down their share of the $7 billion for unemployment insurance, realizing that once the federal funds run out, benefits would be unpayable. "One of the smartest decisions we made," says Mr. Daniels. Many governors now probably wish they had done the same.

Second, stimulus dollars came with strings attached that are now causing enormous budget headaches. Many environmental grants have matching requirements, so to get a federal dollar, states and cities had to spend a dollar even when they were facing huge deficits. The new construction projects built with federal funds also have federal Davis-Bacon wage requirements that raise state building costs to pay inflated union salaries.

Worst of all, at the behest of the public employee unions, Congress imposed "maintenance of effort" spending requirements on states. These federal laws prohibit state legislatures from cutting spending on 15 programs, from road building to welfare, if the state took even a dollar of stimulus cash for these purposes.

One provision prohibits states from cutting Medicaid benefits or eligibility below levels in effect on July 1, 2008. That date, not coincidentally, was the peak of the last economic cycle when states were awash in revenue. State spending soared at a nearly 8% annual rate from 2004-2008, far faster than inflation and population growth, and liberals want to keep funding at that level.

A study by the Evergreen Freedom Foundation in Seattle found that "because Washington state lawmakers accepted $820 million in education stimulus dollars, only 9 percent of the state's $6.8 billion K-12 budget is eligible for reductions in fiscal year 2010 or 2011." More than 85% of Washington state's Medicaid budget is exempt from cuts and nearly 75% of college funding is off the table. It's bad enough that Congress can't balance its own budget, but now it is making it nearly impossible for states to balance theirs.

These spending requirements come when state revenues are on a downward spiral. State revenues declined by more than 10% in 2009, and tax collections are expected to be flat at best in 2010. In Indiana, nominal revenues in 2011 may be lower than in 2006. Arizona's revenues are expected to be lower this year than they were in 2004. Some states don't expect to regain their 2007 revenue peak until 2012.

So when states should be reducing outlays to match a new normal of lower revenue collections, federal stimulus rules mean many states will have little choice but to raise taxes to meet their constitutional balanced budget requirements. Thank you, Nancy Pelosi.

This is the opposite of what the White House and Congress claimed when they said the stimulus funds would prevent economically harmful state tax increases. In 2009, 10 states raised income or sales taxes, and another 15 introduced new fees on everything from beer to cellphone ringers to hunting and fishing. The states pocketed the federal money and raised taxes anyway.

Now, in an election year, Congress wants to pass another $100 billion aid package for ailing states to sustain the mess the first stimulus helped to create. Governors would be smarter to unite and tell Congress to keep the money and mandates, and let the states adjust to the new reality of lower revenues. Meanwhile, Mr. Perry and other governors who warned that the stimulus would have precisely this effect can consider themselves vindicated.

Tackling Insurgency

Tackling Insurgency. By K C Dixit
IDSA, Dec 29, 2009

Military operations must aim at creating a sense of security by preventing insurgent depredations on the people, and forcing misguided elements to seek an honourable negotiated settlement. Our conventional training philosophy, which is based on dehumanizing a man, motivating him with an ardent regimental spirit and building in him a very specific image bordering on arrogance and flamboyance, is not ideally suited to carry out counter-insurgency operations. Thus, changes in attitudes are mandatory to achieve the primary objective of winning over the hearts and minds of the people. But sudden transitions are always difficult to manage, since it will often mean discarding conventional military wisdom. In fact, military hawks usually term it as appeasement or a live and let live approach adopted by weak-kneed commanders. Hence, reorientation training for counter insurgency environment is mandatory both for political masters and the army.

Even at the tactical level, there is scope for refinement. It must be remembered that during the conduct of operations, tactical successes are necessary to retain initiative, to maintain morale and motivational levels of own troops and to force the insurgents to remain always on the run. But if tactical operations are executed in an uncontrolled manner, they directly contribute to the achievement of insurgent strategy of creating a sea of hostility. Thus, there exists a contradiction. We must accept that fighting back is a fundamental human instinct, and even soldiers will retaliate in self defence if their own survival is threatened by insurgents and their supporters, notwithstanding clear directives to field commanders to attempt apprehension of hostiles first, and open fire when hostiles resist or attempt escape. Anyone will retaliate, if their own survival is at stake. Therefore, it must be emphasized during training that security forces are carrying out extremely delicate tasks under serious tactical constraints. Patience and perseverance are the prime requirements in such scenarios. Also security forces must develop consummate, calculative and deft, tactical, psychological and political sophistication to come up with correct answers to numerous unforeseen situations that can crop up in an insurgency environment; be it during ambushes, or search operations, or interrogation of hostiles or their supporters, or innocent civilians. Unfortunately, it is unrealistic and impractical to produce templates for application.

We need to re-confirm if employment of army using conventional concepts and infantry tactics but with restrictions on the use of fire power is the only answer? Obviously, the answer to the problem, particularly in the initial stages of insurgency, is the first step and must start with the identification of the problem and accurate visualization of pattern of insurgent operations to include their initial, intermediate and final objectives. Furthermore, their capabilities must be accurately reviewed and tasks likely to be executed correctly identified. Of course, the overall aim of all clandestine and subversive activities would be to expand their influence over people by attraction or coercion with a view to assert their credibility in the minds of masses and to gain initiative in the military field. Expressed in terms of tasks, all insurgent activities include: guerilla operations to acquire military capability and ascendancy, recruitment to expand politico-military base, tax and ration collection to sustain expanding capability, selective killings to coerce non-partisans to extend support and political initiatives to gain and widen external and internal support. Perforce, security forces’ tactical operations must be designed to combat such insurgent activities with least inconvenience to the people and contain insurgency. Therefore, counter insurgency operations automatically include: population control and denial, psychological operations, civic action programmes and search, ambush and raid missions to isolate and capture insurgents and destroy their camps. In such a complex situation, conduct of uncontrolled operations usually results in real and contrived excesses and loss of credibility. Thus, ironically excessive use of military force by uninitiated commanders and troops will always be counter-productive and must never be attempted.

To amplify further, general cordon and search operations are usually counter-productive and need to be replaced by selective cordon and search operations conducted on the basis of real time actionable intelligence, to prevent causing avoidable harassment and humiliation to people. Furthermore, excessive employment of road opening parties, convoy escorts and other security measures, particularly curfew restrictions, though defensive by nature, are not only counter-productive but also offer lucrative targets to the insurgents to inflict casualties and achieve their overall strategy. Therefore tactical operational activity should only be directed at insurgents and their active collaborators/ sympathizers with least disturbance caused to neutral and friendly people. Of course, intelligence capability will be the most vital Key Result Area to conduct such operations. Logic automatically dictates employment of special forces, operating from designated firm bases, to launch surprise strikes aimed at capturing maximum number of insurgents and arms or destroying their camps, vis-à-vis conduct of large scale and un-controlled operations during the initial stage. However, during later stages of insurgency, if guerrilla activity gets widespread, there is a need to move into open conventional warfare. In both situations, the army will be forced to counter insurgent activity adopting conventional tactics with restricted fire power, but once again supported by a psychological warfare effort. The overall object will continue to remain winning over the hearts and mind of the people.

Commanders and troops must understand that they are operating in a ‘No Win’ situation and their overall aim will always remain achievement of a more perfect peace. It simply implies that there is no such thing as a quick military victory. Conduct of counter-insurgency campaigns will invariably extend over a number of years. None should attempt to achieve ‘quick-end’ results, particularly by excessive use of force. Excessive use of force is counter-productive and must be avoided. Patience, perseverance, warmth and genuineness must be displayed by totally committed, dedicated and motivated leadership at all levels. Undeniably, counter-insurgency environment demands a very high order intellectual acumen unimagined ever before in conventional setting. Since it is a ‘No Win’ situation, performance evaluation may not be based on head count of number of insurgents captured/ destroyed and weapons captured or on number of hearts and minds won over. At the same time there is no room for ‘Zero Error’ or ‘live and let live’ approach to the problem. Such is the nerve racking complexity of the problem that the need for ensuring correct type of mental conditioning at all levels assumes vital significance. Fighting insurgency in this backdrop tends to create tremendous pressure on the minds of security forces’ personnel due to contradictory requirements and as such needs to be addressed appropriately at various levels.