…Those people who worked hard resented those who didn’t.  There was a lot of anger over this, and after three winters of under-production, more than half the original 101 pilgrims were dead, mostly as a result of malnutrition.
After three years of near-starvation and the loss of half the colony, a new experiment was tried. The governor of the colony, William Bradford, had come to suspect that the problem was the absence of private property.  In his now-famous passage on property rights in Of Plymouth Plantation (page 120), Bradford wrote of how he “… assigned to every family a parcel of land, for (their) present use.  This had very good success, for it made all hands very industrious, and much more corn was planted than otherwise would have been by any means.” Bradford wrote that those who believed in communal property were deluding themselves into thinking they were “wiser than God.”  (Doesn’t that sound like Hayek’s concept of the “fatal conceit”?)  He drew up a map and gave each family a plot of land to call its own. Production increased by a factor of five the first year.  As Bradford wrote, “Each family, attempting to better its standing in the community, increased the hours worked on each plot.”The original experiment at Plymouth Colony was communism at its purest form, and centuries later, musician Frank Zappa of the Mothers of Invention said it best. “Communism doesn’t work because people like to own stuff.”How perfect that the very foundation of America was a free market economy! And this was, amazingly, 150 years before Adam Smith wrote about how the greater good results from individuals pursuing their own personal interests. Left to right are Frank Zappa, Adam Smith, Plymouth Colony Governor William Bradford, and Karl Marx.  And how strange that the guy on the left knew more about human nature than the guy on the right.”, November 22, 2015, Excerpt from Mortgage Industry Newsletter

…To accomplish this, the Fed Oversight Reform and Modernization Act of 2015, sponsored by Rep. Bill Huizenga (R., Mich.), should be enacted… The greater the powers ceded to the Fed, the more its activities must be opened up to scrutiny and critical examination. Otherwise, we may soon awake to discover that our central bankers have instead become our central planners.”, Jeb Hensarling, a Republican congressman from Texas, chairman of the House Financial Services Committee,The Wall Street Journal, November 20, 2015

Opinion

Reining In a Sprawling Federal Reserve

The Fed’s greater powers increase the need for close scrutiny of its activities.

The Federal Reserve building in Washington, D.C. PHOTO: KEVIN LAMARQUE/REUTERS

By Jeb Hensarling

Since the 2008 financial crisis, the Federal Reserve has morphed into a government institution whose unconventional activities and vastly expanded powers would scarcely be recognized by drafters of the original legislation that created it. Regrettably, commensurate transparency and accountability have not followed.

Since September 2008, the Fed’s balance sheet has ballooned to $4.5 trillion, equal to one-fourth of the U.S. economy and nearly five times its precrisis level. And after seven years of near-zero interest rates, the central bank’s so-called forward guidance provides almost no guidance to investors on when rates might be normalized. This uncertainty is a significant cause of businesses’ hoarding cash and postponing capital investments, and of community banks’ conserving capital and reducing lending.

Adding to the economic uncertainty, the 2010 Dodd-Frank law granted the Fed sweeping new regulatory powers to intervene directly in the operations of large financial institutions. The Fed now stands at the center of Dodd-Frank’s codification of “too big to fail.” With respect to these firms, the Fed is authorized to impose “heightened prudential standards,” including capital and liquidity requirements, risk management requirements, resolution planning, credit-exposure report requirements, and concentration limits. The Fed is even authorized, upon a vague finding that a financial institution poses a “grave threat” to financial stability, to dismantle the firm. The Fed, in short, can literally occupy the boardrooms of the largest financial institutions in America and influence how they deploy capital.

The Fed’s monetary policy must be made clear and credible, and its regulatory activities must comport with the rule of law and be subject to public scrutiny. To accomplish this, the Fed Oversight Reform and Modernization Act of 2015, sponsored by Rep. Bill Huizenga (R., Mich.), should be enacted. Here are the main parts of the FORM Act, which was passed by the House of Representatives on Thursday.

In regard to monetary policy, the Fed must publish and explain with specificity the strategy it is following. The Fed retains unfettered discretion to choose the rule or method for conducting monetary policy. The FORM Act simply requires the Fed to report and explain its rule, and if it deviates from its chosen rule, why. Economic history shows that when the Fed employs a more predictable method or rules-based monetary policy, more positive economic outcomes result.

Some say this would compromise the Fed’s independence. It would not. The FORM Act merely affects how and when the exercise of its discretionary monetary policy is communicated to the public.

To the extent there is a threat to the Fed’s independence, it emanates from the executive branch. There is a revolving door between the Fed and the Treasury. The Fed chair meets weekly with the Treasury secretary in private, yet is compelled to testify in public before Congress only twice a year. Thanks to members’ leaving office early in their 14-year terms, President Obama has been able to appoint all of today’s Fed governors.

The FORM Act also would compel the Fed to conduct cost-benefit analysis for all regulations it promulgates. Dodd-Frank directed the Fed to publish upward of 60 new regulations, some in conjunction with other agencies. But it did not require the bank to conduct cost-benefit analyses, which other regulatory bodies, such as the Securities and Exchange Commission and the Commodity Futures Trading Commission, must.

The Fed’s failure to carry out cost-benefit analyses has resulted in excessive regulatory burdens—most notably on small banks and businesses—which have harmed the U.S. economy and slowed recovery. Requiring cost-benefit analyses also means Fed regulations would be subject to judicial review, in other words, subject to the unbiased and independent scrutiny that is integral to due process and the rule of law.

The Fed’s authority under Dodd-Frank to stress test the operations of financial institutions it deems “systemically important” allows regulators to essentially dictate the business models and operational objectives of large financial institutions. Yet this process is far from transparent, making it difficult for Congress and the public to assess either the effectiveness of the Fed’s regulatory oversight or the integrity of its findings. The FORM Act will remedy this by providing for public notice and comment on the Fed’s stress-test scenarios and by requiring the Fed to also disclose a summary of the stress-test results that financial institutions have to resubmit if they fail the initial stress test.

Finally, the FORM Act places needed constraints on the Fed’s emergency lending powers. Dodd-Frank tried but failed to rein in the Fed’s emergency lending authority. The FORM Act restricts emergency loans to financial institutions only, increases the interest charged on emergency loans, and requires not only a supermajority of Federal Reserve governors but also a supermajority of district bank presidents to approve emergency loans. With these reforms, the FORM Act discourages moral hazard-inducing bailouts of “too big to fail” firms that enrage hardworking taxpayers.

The greater the powers ceded to the Fed, the more its activities must be opened up to scrutiny and critical examination. Otherwise, we may soon awake to discover that our central bankers have instead become our central planners.

Mr. Hensarling, a Republican congressman from Texas, is chairman of the House Financial Services Committee.

…It’s like they are the “wizard” behind the curtain in the Wizard of Oz and don’t want to be exposed (their supposed monetary policy expertise) as a fraud. Think about it, why are the FOMC minutes not disclosed for five years? I think the number one reason is to save the powerful Fed members from embarrassment (and help foster their Wizard of Oz aura). How many people like Mr. Thornton are really interested in reviewing these FOMC minutes five years later (he’s only doing it because it was an extraordinary time)? Not many, so no Fed accountability. Come on, these FOMC minutes aren’t top secret. The disclosure delay should be a year or less. This is America not some totalitarian country.”, Mike Perry, former Chairman and CEO, IndyMac Bank

Selected Excerpts from November 17, 2015, Requiem for QE:

“Contrary to what many have supposed, QE was not the culmination of an intense discussion by the FOMC about the appropriate policy response to the crisis. Rather, QE occurred when the FOMC was forced to abandon its funds-rate operating procedure because it was no longer able to sterilize its lending after the Lehman Brothers bankruptcy announcement. It’s disconcerting that QE;’s theoretical foundations evolved well after the basic structure of the program was finalized–that the so-called “theoretical foundations” were, in fact, ex-post rationalizations. What’s worse is those rationalizations were extraordinarily weak…..the evidence that QE has an economically significant effect on output and employment is nonexistent.”

“Another worrisome aspect of this (QE) episode in monetary policy is that, following its failure to prevent a collapse of credit, the FOMC lost all confidence in the ability of market economies to heal themselves, and subsequently assumed that only monetary and fiscal policy actions could restore the economy’s health. The FOMC’s failure to recognize that economic recovery takes time led it to engage in extraordinary actions, the effectiveness of which FOMC members themselves doubted.”

“QE did have unintended consequences, however. Income was redistributed away from people on fixed incomes and toward better-off investors, while pension funds were forced to hold securities with greater default risk. Other problems may yet materialize: the distorted markets and excessive risk-taking encouraged by QE could lead to renewed economic instability…”

“Ultimately, QE did little good and likely sowed the seeds for future economic problems.”

Requiem for QE, Daniel L. Thornton

…as prices (rates) are distorted by the government below the level that properly compensates for the risk. The private sector can’t compete against these below market (for many) rates and terms. (And I am not even discussing here, how federal deposit insurance distorts free-market banking and the Federal Reserve distorts just about every financial decision and almost the entire economy.) These well-intended government distortions are hindering free market competition and innovation in financial services and free choice and economics tells us that ultimately consumers and institutions will pay for these government distortions in higher regulatory costs (passed through by banks) and higher profit margins for the larger, mostly Too Big to Fail Banks.”, Mike Perry, former Chairman and CEO, IndyMac Bank

Markets

Banks and Fintech Firms’ Relationship Status: It’s Complicated

Disrupters and big lenders, often seen as rivals, are finding some success in playing together

Lenda CEO Jason van den Brand, left, and staff in an astro-carpeted communal meeting area in their office building in San Francisco. PHOTO: BRIAN L. FRANK FOR THE WALL STREET JOURNAL

By Daniel Huang

Joshua Reich co-founded mobile-banking app Simple six years ago with an indirect shot at the nation’s largest lenders: “By not sucking,” he wrote after starting the firm, “we will win.”

That was before he decided to sell his startup to the U.S. unit of Spanish megabank Banco Bilbao Vizcaya Argentaria SA. Now, the West Coast entrepreneur is singing a different tune.

“We had a little bit of bravado back then,” Mr. Reich said in an interview. “But there’s a reality that to be in financial services, you have to work with banks.”

Financial technology—or “fintech”—upstarts have drawn billions of dollars in investments on the premise that they will shake up finance the way Uber or Airbnb have shaken up the taxi and hotel industries. But despite a variety of setbacks ailing big lenders—from billion-dollar mortgage fines to low, profit-sapping interest rates—banking has proved a tougher business to crack.

After years of staking out combative positions, many would-be challengers are rethinking their relationships with the likes of J.P. Morgan Chase & Co., Citigroup Inc. and Goldman Sachs Group Inc.

How the upstarts adjust to the realities of the financial sector will have a significant impact on the success of venture capitalists and other investors who have poured $64 billion into fintech investments since 2010, according to industry tracker Dow Jones VentureSource.

Banks not only compete with the upstarts for customers but also provide some of the key infrastructure they need to grow. The lenders can provide financial startups with capital as well as legions of depositors and expertise in dealing with regulators. Simple, for instance, has more than doubled the number of customer accounts since its acquisition by BBVA Compass, a subsidiary of BBVA, last year and is increasing users at 10% each month. Banks, meanwhile, are hoping for greater access to younger customers.

Those perceived benefits have driven an increase in cross investments between longstanding banks and the new fintech cohort. As of September, the six largest U.S. banks or their clients had participated in 25 fintech investment deals this year, including Prosper Marketplace Inc. and Circle Internet Financial Inc, compared with 26 in the first nine months of 2014 and 14 for the same period in 2013, according to Dow Jones VentureSource.

“The classic narrative is the Silicon Valley firebrand who’s taking on the system,” said Matt Harris, managing director of Bain Capital Ventures, an early Simple investor. In financial services, though, “that’s just not going to be a winning narrative.”

The shift has picked up just in time for fintech’s first major shakeout. Two of the biggest publicly traded fintech stocks, LendingClub Corp. and On Deck Capital, have fallen 49% and 56% this year respectively. Uncertain market conditions led nonbank mortgage lender loanDepot Inc. to postpone its initial public offering this month, while payments startup Square Inc. proposed an IPO price that valued the company about 30% below an earlier funding round.

“Time humbles you,” said Ben Milne, co-founder of Dwolla, a digital payments platform that also linked with BBVA this year to offer real-time money transfers. Working with banks, he says, is the difference between running a sustainable business and “just another venture-funded experiment.”

Brett King, CEO of mobile-banking app Moven, wrote in 2010 that “the death of retail banking is here.” Now, Mr. King counts meetings with potential bank partners among his biggest priorities. Last year, Moven was tapped by Toronto-Dominion Bank in Canada and the New Zealand unit of Australia’s Westpac Banking Corp. to provide mobile capabilities for their customers.

“If I have my disrupter’s hat on all the time, they will just see me as the enemy,” Mr. King says of his more traditional rivals.

Even staunchly antibank firms need to play ball with banks. Lenda, an online mortgage lending platform launched in San Francisco three years ago, doesn’t deal directly with banks, but its loans often pass through a bank before reaching investors.

“If I get my way, we take over the entire mortgage business from them and do it the right way,“ says CEO Jason van den Brand. But for now, ”we have to play in the sandbox until the day we get big enough and are able to bypass the banks completely.”

At Bank of America Corp.’s annual Technology Innovation summit each fall, around 16% of the more than 230 startups that have attended went on to sell their services to the bank.

“It’s too simple to say all these banks are stupid,” says Qasar Younis, a partner at the Silicon Valley seed fund Y Combinator.

Some fintech firms, though, remain skeptical of bank overtures. Lenda has turned down banks’ offers to invest in the company, instead picking backers that include venture firms Winklevoss Capital and 500 Startups. Many of the firm’s 12-person staff had their own bad experiences working with banks before the crisis. Other fintech executives are concerned that banks will join with startups long enough to steal their ideas and then eventually stifle their business prospects.

The complex relationship was underscored recently when J.P. Morgan and other large banks temporarily cut off the flow of information to some popular websites and mobile applications that aggregate consumer financial data. The banks cited the need to manage heavy server traffic and the security on their websites. The financial aggregators have maintained their sites are secure.

Mr. van den Brand, shown in Lenda’s office in San Francisco, has said he’d like to take over the entire mortgage business from banks. PHOTO: BRIAN L. FRANK FOR THE WALL STRE FOR THE WALL STREET JOURNAL

Still, banks can no longer ignore fintech companies. Citigroup this summer brought Chief Executive Michael Corbat and other executives to meet San Francisco-area fintech executives at an exclusive club in the city’s financial district. “We recognize the need to be strongly connected with what’s happening outside,” said Deborah Hopkins, CEO of Citi Ventures, Citigroup’s venture-capital arm.

“There were no events five years ago that banks were inviting [fintech firms] to,” Dwolla’s Mr. Milne says. “Now, the banks are paying for lunch.”

Last year, BBVA paid $117 million for Simple and has so far granted the tech firm near-complete autonomy, from separate human-resources staffers to branded company T-shirts. Mr. Reich has also kept his CEO title, reporting directly to the Simple’s board, which includes BBVA executives.

“We want to keep away the antibodies that could crush a startup,” says Jay Reinemann, executive director of BBVA Ventures Group.

Simple turns away more than 70% of requests by global BBVA executives to visit, says Enrique Gonzalez, BBVA’s liaison between the two firms. “The main criteria is to let in those who can really add value to the relationship,” he said.

When a team of BBVA bankers and lawyers recently stopped by Simple’s headquarters in Portland, Ore., they got to know their colleagues by playing arcade games in the office common room and sampling craft beers at the Oregon Brewers Festival.

“We’re a little younger and nerdier,” said Simple spokeswoman Krista Berlincourt. “But I like to think of us as one fantastic extended family.”

—Peter Rudegeair contributed to this article.

November 17, 2015, Charles R. Kesler, The Wall Street Journal

Opinion

When the College Madness Came to My Campus

The student protests are about power. And now that leftists have it, what good to them is free speech?

McKenna Auditorium on Claremont McKenna College campus in California. PHOTO: IMAGE COURTESY OF CLAREMONT MCKENNA COLLEGE

By Charles R. Kesler

Claremont McKenna College was once deliberately out of step with academic fashion. I used to tell prospective students and their parents, liberal or conservative, that one of the best things about CMC was that it refused to enforce the little catechism of political correctness. Regardless of political beliefs on campus, I assured them, students did not have to worry about speaking up in class or being persecuted for their opinions.

That is now very much in doubt. Last week the turmoil stirred at Yale and the University of Missouri swept my campus. A coalition of self-proclaimed “marginalized” students presented a catalog of “microaggressions” they had suffered, demanding new forms of “institutional support” in compensation. Demonstrators, who included both CMC undergrads and a few unfamiliar, skulking adults, denounced the dean of students and humiliated her in an open-air trial. Two students went on a hunger strike. Within days, Claremont McKenna—a place I have been proud to call my employer for more than three decades—surrendered ignominiously. How and why did it happen?

Founded in 1946 in a quiet town about 30 miles east of Los Angeles, Claremont McKenna College set out to make sense of a world shattered by depression, war and totalitarianism. The first classes consisted almost entirely of demobilized GIs from World War II, who found familiar the Quonset hut classrooms then in use. The school focused its curriculum on politics and economics, with a healthy skepticism about the latest New Deal-style nostrums and a high regard for the lessons of America’s constitutional experience.

Claremont McKenna never set out to be a true-blue conservative school. But it insisted that students hear conservative as well as liberal arguments, and its faculty eventually included some of the best students of Milton Friedman, James Buchanan and Leo Strauss. Their visibility, and the college’s promise to provide a genuine diversity, a diversity of reasonable ideas, meant that the college soon acquired a conservative reputation.

As the faculty expanded, however, it grew more hostile to the college’s original mission. The past two presidents encouraged the place to keep up with the spirit of the times. Now the examples of the University of Missouri and Yale have proved inspirational. Mizzou taught administrators that if they want to keep their jobs, they need to grovel early and often. Yale showed undergraduates that no matter how prestigious the college, the same rules applied, and that unloading F-bombs on professors, an act of incivility that once would have merited expulsion, is a trump card.

Unlike the hypothetical Halloween costumes that prompted the imbroglio at Yale, the dress-up that fanned the troubles at CMC actually happened. Two young women donned sombreros, ponchos and fake mustaches. A photo went up on someone’s Facebook page. Add this to a simmering controversy: After an aggrieved Mexican-American student complained that she felt out of place on campus, the dean of students wrote a poorly worded email pledging that the college was “working on how we can better serve students, especially those who don’t fit our CMC mold.”

On Nov. 10, Hiram Chodosh, CMC’s president, electrified the campus with an email saying he felt “very upset” about the Halloween-costume calamity. Remarkably, he called for a “sit-in in my office” to discuss things—perhaps the first time, as noted by historian Steven Hayward, that an administration ever called a sit-in to denounce itself. About 40 students showed up (of more than 1,200 in the student body). At 1:54 a.m. they emailed around a “Call to Action” with a list of demands and complaints of the students’ “feeling a strong pressure to assimilate and an inability to fully express their racial, ethnic, sexual, gender, and religious identity.”

That afternoon, President Chodosh replied with his own memo, announcing steps to satisfy the protesters, including two additional administrative positions on “diversity and inclusion”; a safe space to support new programming on the “campus climate”; “pro-active measures” to increase diversity in faculty hiring; and a “day of dialogue” in the spring, in preparation for which the administration “will provide in-depth facilitator training to faculty and staff in how to manage difficult conversations.” If not a complete embrace of the students’ demands, it came close.

Whatever the wisdom of his concessions, there was no disputing their efficiency. In 24 hours he agreed to measures that his administration had been discussing with the same students, it emerged, for seven months. Within 48 hours, the dean of students had resigned and a rump session of the faculty had issued its own statement calling for “diversity training for faculty,” ideally by next semester, and a thorough re-evaluation of the curriculum. The statement was quickly endorsed by 102 of my colleagues (a majority). I voted “no,” as did others, but somehow the dean of faculty did not report the number of those opposed.

The problem on campuses is that the elder members of the old New Left, and their spiritual descendants, are finding it impossible to object to the demands of the new New Left. In 1964 campus protesters kicked off the Free Speech Movement at Berkeley. Today’s students don’t have free speech high on their agenda, to put it mildly.

During the outdoor struggle session at CMC last week, an Asian student volunteered that she had once heard “go back to your home” shouted at her by a black person. “We should not distinguish people by their race or gender or anything. Black people can be racist,” she said. “I just mean that we have to look at people individually.” The crowd moaned disapproval and a young woman took back the bullhorn. Someone yelled that “racism is prejudice with power,” a shibboleth of the new New Left. Someone else shouted, “How is that relevant to the college failing to provide a space for people of color?”

That is what the protests are about: reordering campus in the name of the “marginalized” and their sponsors in the faculty and administration, whose turn has come to enjoy their own reign of intolerance. When the leftists lacked power, they embraced free speech. Now that they have power, they don’t need it.

Mr. Kesler is a professor of government at Claremont McKenna College and the editor of the Claremont Review of Books.

… — an increase of more than 40%. “It has understated pension debt dramatically,” said Joe Nation, a professor at Stanford’s Institute for Economic Policy Research, of CalPERS’ current estimate. “They’ve been able to convince a lot of people things are OK when they aren’t.”…Currently CalPERS says it is short about $117 billion for pensions already owed to government employees. That debt was calculated by assuming it would earn an average of 7.5% on its investments for decades into the future.That hole would deepen more than 50% to $178 billion if the rate of 6.5% was used instead, according to Nation’s calculations.”, Melody Petersen, “CalPERS may lower its return target; taxpayers may have to contribute more”, The Los Angeles Times, November 18, 2015

“Does CalPERS really have either the moral authority or management chops to lecture private sector companies about their corporate governance? I don’t think so. It seems to me that they need to focus solely on getting their own house in order, especially fiscally.”, Mike Perry, former Chairman and CEO, IndyMac Bank

CalPERS may lower its return target; taxpayers may have to contribute more

The pension fund has already warned cities that they are in the midst of a six-year span in which pension payments will rise 50%. The new plan will add even more to those costs. Above, CalPERS offices in Sacramento. (Carl Costas / For The Times)

Melody Petersen

Experts have warned for years that the state’s largest public pension plan has overestimated how much its investments will earn, leaving taxpayers to pay billions of dollars more than expected.

Now the board of the California Public Employees’ Retirement System is reconsidering. As soon as Wednesday, the fund’s board could approve a plan that would slowly reduce to 6.5% the current 7.5% it says it expects to earn on its investments.

For taxpayers, that seemingly small change is significant.

Consider the average California Highway Patrol officer who now earns $105,000. Taxpayers currently contribute $47,000 a year for that officer’s pension.

If calculated using an expected investment return of 6.5% instead, according to CalPERS documents, the taxpayer contribution would be $68,000 — an increase of more than 40%.

“It has understated pension debt dramatically,” said Joe Nation, a professor at Stanford’s Institute for Economic Policy Research, of CalPERS’ current estimate. “They’ve been able to convince a lot of people things are OK when they aren’t.”

Nothing will happen immediately. The pension agency’s staff says it has designed the plan to soften the blow.

If the board approves the plan as expected, payment calculations won’t change significantly for years, the staff says.

Under the proposal, the rate would be reduced slowly by tiny increments. Getting to 6.5% could take 20 years.

Many experts believe that even the 6.5% estimate is too optimistic.

The average corporate pension plan now uses a rate of 4% to determine how much money needs to be contributed, according to a recent study by Milliman, a consulting firm.

This year, after several years of double-digit returns, CalPERS earned just 2.4%.

A move by CalPERS, the nation’s largest retirement fund, could lead to similar changes by government plans across the country.

CalPERS covers 1.7 million employees and retirees of the state government as well as those of cities and other agencies across California.

Nation, a former Democratic state legislator, praised CalPERS for beginning to lower the rate.

He said that by overestimating expected investment returns, CalPERS and other pension funds have hidden the true cost of public worker retirements.

Currently CalPERS says it is short about $117 billion for pensions already owed to government employees. That debt was calculated by assuming it would earn an average of 7.5% on its investments for decades into the future.

That hole would deepen more than 50% to $178 billion if the rate of 6.5% was used instead, according to Nation’s calculations.

Looked at in another way, the debt for pensions already owed to workers would rise from more than $9,000 for each California household to $14,000.

Cheryl Eason, CalPERS chief financial officer, said the fund has no intention of seeing the liability rise to that level. CalPERS has already announced other increases to the amounts governments must pay for pensions with the goal of reducing the debt to zero, she said.

Contributing to the shortfalls is a large hike in pension benefits that state legislators voted to give public workers in 1999 when the stock market was booming.

CalPERS lobbied for those more lucrative benefits. In a brochure, the fund quoted its then-president, William Crist, saying the pension-boosting legislation was “a special opportunity to restore equity among CalPERS members without it costing a dime of additional taxpayer money.”

Under those increased benefits, a highway patrol officer could retire at 50. He was promised 3% of his highest salary for every year on the job, with a maximum of 90%.

Already many California cities have been forced to cut services ranging from police patrols to library hours to cover fast-rising payments to CalPERS. Skyrocketing retirement costs were at least partly to blame for the bankruptcy filings of three California cities in recent years, including Stockton and San Bernardino.

The cuts to government services to pay CalPERS may have just begun. The pension fund has already warned cities that they are in the midst of a six-year span in which pension payments will rise 50%. The new plan will add even more to those costs.

“This is going to be pretty tough for a lot of cities,” said Rudy Fischer, a council member in Pacific Grove, where pension costs are expected to soon consume as much as 30% of the general fund — up from 20% today. “We aren’t able to do the sidewalk repairs and fix the street lights as much as we want to.”

The quiet seaside community of 15,000 is now considering allowing developers to build at least one new hotel to help raise the money needed to pay its pension bills.

In a slide presentation to the board in May, CalPERS staff estimated that taxpayer rates for pensions would rise an additional 6% to 20% over the next decades under the plan.

To make the change easier for cities, the incremental rate reductions would only be made in years of superior investment returns when governments’ finances should be stronger.

Public employees hired in 2013 or later must also pay more for their pensions under the plan. But the vast majority of employees are exempt from any increase in their personal contributions.

CalPERS staff said they proposed the plan to reduce the risk of a devastating financial loss if the stock market plunges again. It requires the fund to slowly begin moving more money into safer investments such as bonds, which earn lower returns than stocks.

Nation said the exaggerated expected investment returns have allowed governments to promise workers pensions at levels that aren’t sustainable.

“The public pension system model is all about pushing costs to the future,” Nation said. “No one has been paying attention. Now it’s caught up with them.”

…Look, sophisticated institutional investors didn’t start buying U.S. single family homes until 2011-2013, or so. So why in the world did FHA encourage Americans to take out these risky home loans while home prices were falling, especially when they knew it might cause them tens of billions in losses (and did cause them to become insolvent and need a taxpayer bailout)? I think they were thinking more about the industry and the economy, than the interests of these individual homeowners. And then on top of that, FHA, as a monopoly government guarantor of higher-risk mortgages, raised their fees way beyond borrower risks (for mortgages made in 2011-2015). This allowed FHA to rapidly recapitalize itself by charging these homebuyers (many with lower-incomes and little net worth), thousands of dollars more than they deserved to pay (relative to their risk). In writing this, I am intending to show that FHA (our government) doesn’t make any better decisions than private sector mortgage lenders. In fact, if private sector mortgage lenders made FHA’s decisions from 2007-15, they would likely have been sued by both the government and private plaintiffs for consumer fraud and abuse. CFPB where are you? Nowhere, because the CFPB, assumes the government is good and its only the private sector that is bad, and so it does not enforce its rules on FHA, VA, Fannie, Freddie, or the federal student loan program! P.S. I wrote a lot about FHA and this issue on my blog back in 2013. Check it out.”, Mike Perry, former Chairman and CEO, IndyMac Bank

“The FHA ultimately paid the cost of offering mortgages when others wouldn’t. In 2008, it reported that its reserve ratio stood at about 3%, but as the housing market deteriorated, the agency didn’t have the funds needed to cover expected losses. In 2013, the FHA needed a $1.7 billion taxpayer infusion, its first bailout in 79 years. As the crisis deepened, the FHA raised the fees it charges borrowers several times from less than 0.6% to 1.35% by 2013.”, Joe Light, “FHA Meets Minimum Reserve Requirement for First Time Since 2009”, The Wall Street Journal, November 17, 2015

U.S.

FHA Meets Minimum Reserve Requirement for First Time Since 2009

Recovery prompts calls for Federal Housing Administration to draw more first-time home buyers

The Federal Housing Administration, which insures mortgage lenders against losses, has a capital reserve ratio of 2.07%. The ratio is above the minimum threshold required by law for the first time since 2009. PHOTO: ROGELIO V. SOLIS/ASSOCIATED PRESS

By Joe Light

In another marker of the housing market’s swift recovery, a government agency that just two years ago required its first taxpayer-funded bailout said on Monday its reserves were back in line with federal requirements.

The Federal Housing Administration, which backs low-down-payment mortgages popular with first-time home buyers, said its insurance fund’s net worth at the end of September was $23.8 billion, up from a year-earlier level of $4.8 billion. Its capital reserve ratio, which by law is required to stay above 2%, rose to 2.07%, the first time it met the threshold since the start of the agency’s 2009 fiscal year. The ratio measures how much in reserves, as a proportion of its loan guarantees, the FHA would have on hand after covering expected losses.

Since the financial crisis, the FHA—part of the Department of Housing and Urban Development—has played a critical role for potential homeowners on the margin of qualifying for a mortgage. With the private subprime-mortgage market largely gone, the agency offers some of the easiest terms available, letting borrowers with a credit score as low as 580 make a down payment of as little as 3.5%.

In a speech Monday, HUD Secretary Julián Castro said the FHA’s decision to lower mortgage costs this year contributed to the rapid growth in home prices and sales: “Today, the housing market is better off because of our actions.”

The report added fuel to recent pushes by some in the real-estate industry for the FHA to again cut the cost of mortgages it backs. In January, the agency lowered the annual premium it charges a typical borrower to 0.85% from 1.35%, a move the White House and HUD said would enable homeownership for many first-time buyers.

After the speech, Mr. Castro pushed back on calls for the FHA to reduce costs again. “It’s premature to talk about any kind of additional changes,” he said.

The FHA ultimately paid the cost of offering mortgages when others wouldn’t. In 2008, it reported that its reserve ratio stood at about 3%, but as the housing market deteriorated, the agency didn’t have the funds needed to cover expected losses. In 2013, the FHA needed a $1.7 billion taxpayer infusion, its first bailout in 79 years. As the crisis deepened, the FHA raised the fees it charges borrowers several times from less than 0.6% to 1.35% by 2013.

HUD officials said Monday their primary concern now is persuading lenders to issue mortgages to borrowers who qualify under FHA guidelines. Because of fears of lawsuits and other hefty penalties for making mortgage-related mistakes, many lenders eschew qualified borrowers with shakier credit histories, and the FHA is in the midst of an effort to mitigate those worries.

Now that its reserves meet the legal requirement, some in the real-estate industry repeated calls for more fee cuts.

“It will be hard for the FHA to keep excess reserves at the expense of families making $50,000 or $70,000 a year,” said Brian Chappelle of Washington, D.C.-based Potomac Partners LLC, a consulting firm for mortgage lenders and others in the industry.

Brooke Anderson-Tompkins, chairwoman of Community Mortgage Lenders of America, a trade group for community-based lenders, said that with its improved health, the FHA should consider reducing premiums again and taking other steps to ease mortgage access.

“To see positive results is good news, not only for we as small community lenders but for families across the nation,” Ms. Anderson-Tompkins said.

The FHA’s finances far outpaced what was forecast last year in large part because of an unexpectedly large increase in the value of its reverse-mortgage business, which allows seniors to get cash out of their homes. That portfolio is heavily influenced by the forecast of home prices and interest rates made by the independent actuary who compiles the report for the FHA. The value of the reverse-mortgage business rose $8 billion more than forecast, compared with a $900 million decrease in the previous year.

David Stevens, a former FHA commissioner and now president of the Mortgage Bankers Association, cautioned against the likelihood of more fee cuts. “If I was looking at the program and were still responsible for it, the fact that you can have swings upward in [the reverse-mortgage business] in one year and similar swings to the downside in the next means I would not be overly confident in the position I stand in today,” he said.

Mr. Castro also would likely face significant opposition from some Republicans if he chose to cut premiums again.

Lowering premiums would discourage private capital from taking a greater role in mortgage lending, said former Congressional Budget Office director Douglas Holtz-Eakin, who now runs a center-right think tank and has acted as an economic adviser to many Republicans. “To declare victory is to ignore the lessons of the crisis,” he said.

…This has resulted in stock price inflation that has kept equity valuations aloft even as quarterly corporate earnings results have begun to show signs of weakness. As these misallocated investments stream back into the fixed-income markets once the Fed starts raising rates, the supply-demand imbalance will drive up prices and push down yields faster than the Fed can raise them. Essentially, every time the Fed introduces any additional yield into the marketplace, it will be immediately swallowed up by retiree (or near-retiree) investors who need to de-risk their portfolios. This is another unintended consequence of the Fed’s quantitative easing. For retirement-age investors, it will be critical to seize the opportunity of increasing interest yields to de-risk their portfolios. But for equity and corporate credit investors, the result might very well be a prolonged period of subpar returns. For central bankers, it will be a hard lesson in how much easier it is to add monetary accommodation than it is to remove it……Seven years of near-zero interest rates has created a serious problem for retirees and those nearing retirement.”, Michael Thompson, chairman of S&P Investment Advisory Services, “How the Fed Has Warped the 401(k), November 17, 2015

Opinion

How the Fed Has Warped the 401(k)

Older workers seeking returns have piled into stocks. When interest rates finally rise, watch out.

PHOTO: GETTY IMAGES

By Michael Thompson

Seven years of near-zero interest rates has created a serious problem for retirees and those nearing retirement. When interest rates finally start to rise, the rest of the investment marketplace—and the Federal Reserve—will feel the pain.

In place of the Treasurys and investment-grade corporate bonds that had been the hallmark of retirement investment strategy for decades, current retirees, and those soon to retire, have resorted to investing in equities and high-yield corporate bonds to generate the returns they need to avoid outliving their nest eggs.

A recent report from Fidelity Investments found that 11% of its 401(k) account holders aged 50-54 had a staggering 100% of their retirement assets invested in stocks. All told, 18% of the firm’s retirement account holders in that age bracket had a stock allocation at least 10 percentage points or higher than recommended. That figure increased to 27% among people ages 55-59. But with 10-year U.S. Treasury yields averaging 2.3% over the past five years, retirement-age investors have had few alternatives.

However, once the Federal Reserve finally starts raising rates, investors will begin reallocating their portfolios into more age-appropriate risk profiles. The large-scale unwinding of those “risk on” allocations will result in the inability of the Fed to dictate the shape of the yield curve.

The investment committee at my firm estimates that roughly $1.3 trillion in retiree assets are currently misallocated into equities based on the historic 16-year average price-to-earnings ratio for the S&P 500. This has resulted in stock price inflation that has kept equity valuations aloft even as quarterly corporate earnings results have begun to show signs of weakness.

As these misallocated investments stream back into the fixed-income markets once the Fed starts raising rates, the supply-demand imbalance will drive up prices and push down yields faster than the Fed can raise them. Essentially, every time the Fed introduces any additional yield into the marketplace, it will be immediately swallowed up by retiree (or near-retiree) investors who need to de-risk their portfolios.

This puts the Fed—and the Bank of England and Bank of Japan, which are both in a similar situation—in the unenviable position of having the yield curve flatten even as they continue to raise rates.

Meanwhile, a steady exodus from equities and corporate bonds will cause valuations to fall more in line with fundamentals, which have not supported the high valuations we’ve seen over the past several years.

In all, my firm anticipates that the overnight federal-funds rate will need to reach about 3% before this supply-demand imbalance is normalized. That could take several years.

This is another unintended consequence of the Fed’s quantitative easing. For retirement-age investors, it will be critical to seize the opportunity of increasing interest yields to de-risk their portfolios. But for equity and corporate credit investors, the result might very well be a prolonged period of subpar returns. For central bankers, it will be a hard lesson in how much easier it is to add monetary accommodation than it is to remove it.

Mr. Thompson is chairman of S&P Investment Advisory Services.

…You can’t, in the long run, keep telling your base that government bureaucrats are invariably incompetent, evil or both, then say that the Fed, which is, when all is said and done, basically a government agency run by bureaucrats, should be left free to print money as it sees fit.”, Paul Krugman, “Republicans’ Lust for Gold”, The New York Times, November 14, 2015

“Krugman, once again you distort and lie. Don’t believe me, read Mr. Friedman’s famous 1967 speech entitled: “The Role of Monetary Policy” in blog posting #73 below, for yourself. It is very clear that Mr. Friedman was just as concerned about The Federal Reserve making mistakes in judgment, with respect to its awesome monetary powers, as he was with any other centralized, government bureaucracy. The modern Fed has completely gone against Friedman’s monetary teachings. The modern Fed hasn’t targeted monetary aggregates for years, as Friedman strongly advised and yet does peg interest rates and the rate of unemployment for long periods, as he strongly advised against. If Friedman saw the modern, Greenspan/Bernanke/Yellen, Fed which has clearly been the source of much economic instability in recent decades, I believe he just might have advocated for “hard money” pegged to gold or at least the Taylor Rule, and he certainly would have supported “auditing the Fed.””, Mike Perry, former Chairman and CEO, IndyMac Bank

 November 4, 2013 – Statement 73: “The first and most important lesson that history teaches about what monetary policy can do….and it is a lesson of the most profound importance…is that monetary policy can prevent money itself from being a major source of economic disturbance.” Milton Friedman 

Here are three excerpts from Friedman’s, The Role of Monetary Policy:

“Unaccustomed as I am to denigrating the importance of money, I therefore shall, as my first task, stress what monetary policy cannot do. From the infinite world of negation, I have selected two limitations of monetary policy to discuss: 1) It cannot peg interest rates for more than very limited periods; 2) It cannot peg the rate of unemployment for more than very limited periods.”

“Let us assume that the monetary authority tries to peg the ‘market’ rate of unemployment at a level below the ‘natural’ rate….As in the interest rate case, the ‘market’ rate can be kept below the ‘natural’ rate only by inflation. And, as in the interest rate case too, only by accelerating inflation.”

“How should monetary policy be conducted? The first requirement is that the monetary authority should guide itself by magnitudes that it can control, not by ones that it cannot control. If, as the authority has often done, it takes interest rates or the current unemployment percentage as the immediate criterion of policy, it will be like a space vehicle that has taken a fix on the wrong star. No matter how sensitive and sophisticated its guiding apparatus, the space vehicle will go astray. And so will the monetary authority.”

“My own prescription is still that the monetary authority go all the way in avoiding such swings by adopting publicly the policy of achieving a steady rate of growth in a specified monetary total…I myself have argued for a rate that would on average achieve rough stability in the level of prices of final products, which I have estimated would call for something like a 3 to 5 per cent per year rate of growth in currency plus all commercial bank deposits or a slightly lower rate of growth in currency plus demand deposits only. But it would be better to have a fixed rate that would on average produce moderate inflation or moderate deflation, provided it was steady, than to suffer the wide and erratic perturbations we have experienced.”

The Opinion Pages

Republicans’ Lust for Gold

Paul Krugman

It’s not too hard to understand why everyone seeking the Republican presidential nomination is proposing huge tax cuts for the rich. Just follow the money: Candidates in the G.O.P. primary draw the bulk of their financial support from a few dozen extremely wealthy families. Furthermore, decades of indoctrination have made an essentially religious faith in the virtues of high-end tax cuts — a faith impervious to evidence — a central part of Republican identity.

But what we saw in Tuesday’s presidential debate was something relatively new on the policy front: an increasingly unified Republican demand for hard-money policies, even in a depressed economy. Ted Cruz demands a return to the gold standard. Jeb Bush says he isn’t sure about that, but is open to the idea. Marco Rubio wants the Fed to focus solely on price stability, and stop worrying about unemployment. Donald Trump and Ben Carson see a pro-Obama conspiracy behind the Federal Reserve’s low-interest rate policy.

And let’s not forget that Paul Ryan, the new speaker of the House, has spent years berating the Fed for policies that, he insisted, would “debase” the dollar and lead to high inflation. Oh, and he has flirted with Carson/Trump-style conspiracy theories, too, suggesting that the Fed’s efforts since the financial crisis were not about trying to boost the economy but instead aimed at “bailing out fiscal policy,” that is, letting President Obama get away with deficit spending.

As I said, this hard-money orthodoxy is relatively new. Republicans used to base their monetary recommendations on the ideas of Milton Friedman, who opposed Keynesian policies to fight depressions, but only because he thought easy money could do the job better, and who called on Japan to adopt the same strategy of “quantitative easing” that today’s Republicans denounce.

George W. Bush’s economists praised the “aggressive monetary policy” that, they declared, had helped the economy recover from the 2001 recession. And Mr. Bush appointed Ben Bernanke, who used to consider himself a Republican, to lead the Fed.

But now it’s hard money all the way. Republicans have turned their back on Friedman, whether they know it or not, and draw their monetary doctrine from “Austrian” economists like Friedrich Hayek — whose ideas Friedman described as an “atrophied and rigid caricature” — when they aren’t turning directly to Ayn Rand.

This turn wasn’t driven by experience. The new Republican monetary orthodoxy has already failed the reality test with flying colors: that “debased” dollar has risen 30 percent against other major currencies since 2011, while inflation has stayed low. In fact, the failure of conservative monetary predictions has been so abject that news reports, always looking for “balance,” tend to whitewash the record by pretending that Republican Fed critics didn’t say what they said. But years of predictive failure haven’t stopped the orthodoxy from tightening its grip on the party. What’s going on?

My main answer would be that the Friedman compromise — trash-talking government activism in general, but asserting that monetary policy is different — has proved politically unsustainable. You can’t, in the long run, keep telling your base that government bureaucrats are invariably incompetent, evil or both, then say that the Fed, which is, when all is said and done, basically a government agency run by bureaucrats, should be left free to print money as it sees fit.

Politicians who lump it all together, who warn darkly that the Fed is inflating away your hard-earned wealth and enabling giveaways to Those People, are always going to have the advantage in intraparty struggles.

You might think that the overwhelming empirical evidence against the hard-money view would count for something. But you’d only think that if you were paying no attention to any other policy debate.

Leading political figures insist that climate change is a gigantic hoax perpetrated by a vast international scientific conspiracy. Do you really think that their party will be persuaded to change its economic views by inconvenient macroeconomic data?

The interesting question is what will happen to monetary policy if a Republican wins next year’s election. As best as I can tell, most economists believe that it’s all talk, that once in the White House someone like Mr. Rubio or even Mr. Cruz would return to Bush-style monetary pragmatism. Financial markets seem to believe the same. At any rate, there’s no sign in current asset prices that investors see a significant chance of the catastrophe that would follow a return to gold.

But I wouldn’t be so sure. True, a new president who looked at the evidence and listened to the experts wouldn’t go down that path. But evidence and expertise have a well-known liberal bias.

A version of this op-ed appears in print on November 13, 2015, on page A35 of the New York edition with the headline: Lust for Gold.

…They are not supposed to be “deeply moral,” to use Mr. Munger’s words, but deeply pragmatic about making their shareholders money by increasing the market value of the assets they control—and usually not because they are filled with agape for shareholders, but because they are shareholders themselves. There are other players in the game—customers, competitors, regulators, the tort system—in charge of adjusting the terms of acceptable behavior in light of changing public standards and moods. Voilà, a highly workable economic system.”, Holman W. Jenkins Jr., “What Would Jesus Short?”, The Wall Street Journal, November 14, 2015

Opinion

What Would Jesus Short?

Charlie Munger and Bill Ackman trade barbs over the morality of each other’s investments.

Bill Ackman, chief executive of Pershing Square, at the New York Stock Exchange, Nov. 10. PHOTO: BRENDAN MCDERMID/REUTERS

By Holman W. Jenkins, Jr.

Were the Wharton School of Business to offer a course on how prominent investors should go about criticizing the morality of each other’s stock portfolios, the one-word syllabus would be: don’t.

And when it came to the case study of superinvestor Bill Ackman, the two-word advice would be: shut up.

That said, Charlie Munger started this week’s embarrassing war of words. The famous investing partner of Warren Buffett called an embattled Ackman holding, Valeant Pharmaceuticals, “deeply immoral” because its business model rests on buying the rights to drugs and sharply raising their prices. This criticism perhaps seems a tad odd given that Mr. Buffett is always praising businesses with competitive “moats” that create pricing power. But Mr. Munger also used the word unsustainable—and may prove right if Valeant’s behavior invites new competitors or federal regulation of drug prices.

The 91-year-old Mr. Munger leavened his critique with approving statements about Valeant, but the 49-year-old Mr. Ackman apparently was not appeased.

At an event at the Museum of American Finance honoring Mr. Buffett, by the account of those present, Mr. Ackman was calm and smiling, but nevertheless responded like a 5-year-old taking vengeance by smashing a rival’s favorite toy. He attacked a core Buffett holding, Coca-Cola, charging that the soft-drink maker has “probably done more to create obesity and diabetes on a global basis than any other company in the world.” He added: “Coca-Cola is a company that I wouldn’t own.”

It should probably be added that Coca-Cola has been around for 130 years, and the obesity crisis is of more recent vintage. What’s more, Coke will happily sell customers Diet Coke, and is no more responsible for America’s bad eating habits than GM is for its bad driving habits.

Mr. Ackman has produced some stunning successes as well as some failures as an activist investor, but he is best known lately for his short-sale of Herbalife, which he calls a pyramid scheme. He says any personal profits from his Herbalife crusade he will donate to charity. Doesn’t that last part niggle at his investors just a bit? Wouldn’t they be happier if he were in it for the financial reward rather than moral vindication?

And where exactly is Mr. Ackman’s investment thesis taking his investors if he’s more concerned with which products consumers should buy than which products they actually choose to buy?

Mr. Munger’s real offense was likening Valeant to the 1960s go-go conglomerate IT&T, implying that Mr. Ackman had been taken in by a market fad. Mr. Munger did not mention Mr. Ackman and perhaps failed to suspect his words would be received as a stinging rebuke from a legend. But the result has not been productive for either man. Mr. Ackman finds himself queried in the New York Times for the “morality” of his own investments in junk food and companies that engage in tax minimization. Mr. Buffett, who wasn’t even a participant in their argument, finds his numerous hypocrisies cataloged in a Journal story playing off the Munger-Ackman “morality” debate.

It may be time to recall that CEOs and fund managers are not Jesus. They are not supposed to be “deeply moral,” to use Mr. Munger’s words, but deeply pragmatic about making their shareholders money by increasing the market value of the assets they control—and usually not because they are filled with agape for shareholders, but because they are shareholders themselves.

There are other players in the game—customers, competitors, regulators, the tort system—in charge of adjusting the terms of acceptable behavior in light of changing public standards and moods. Voilà, a highly workable economic system.

Vanity in a professional can be an asset right up the point where it occludes professional judgment. Mr. Munger might have satisfied himself with explaining why Valeant’s strategy was self-defeating without dragging morality in. Mr. Ackman has a long career ahead of him. His investors might appreciate some sign that he hasn’t lost sight of Job One.