Defense versus State

Via Powerline, this is an absolutely fascinating post over at Big Lizards. The thesis is that Presidential administrations can be characterized by whether the Department of State or the Department of Defense is ascendant. Without subscribing to all the editorial comments in the post, it does seem to characterize recent administrations--and the way they are personified in the media--quite well.

Taking the framework a little bit furhter, I think that most elite college campuses are State campuses. Very few, outside of the service academies, would be Defense campuses. And that may explain some of the disconnect between the military and the academy.

Bolten To Replace Card as Chief of Staff

The President announced today that Josh Bolten would replace Andy Card as White House chief of staff. This strikes me as a very good move. The administration achieved its major policy successes with Bolten in the White House as deputy chief of staff. He was underutilized at OMB, given the insufficiently ambitious deficit reduction goals set by the President. (Yes, that's a euphemism.)

Of all the people I met while working in the Executive Office of the President, there were three who impressed me most with their ability to understand complicated policy issues very quickly. Bolten was one. Another was Keith Hennessey, deputy director of the National Economic Council. The other was David Hobbs, director of legislative affairs, who has since moved on to lobbying. So Bush has a very smart guy running the show.

This leaves the directorship of OMB vacant. I wouldn't be surprised if Joel Kaplan, the current deputy director, were promoted from the inside.

That's a Feature, Not a Bug

Yesterday's New York Times ran a front-page story with the headline, "Schools Cut Back Subjects to Push Reading and Math." Like many discussions of the impact of the No Child Left Behind Act, it seems to miss the central element that this was the inevitable consequence of the legislation. Here's an excerpt of interest:

The historian David McCullough told a Senate Committee last June that because of the law, "history is being put on the back burner or taken off the stove altogether in many or most schools, in favor of math and reading."

Some may disagree with this as an objective, but one should not be surprised at the result. The logic runs as follows:

• Reading and math are deemed to be more fundamental skills than other subjects to which class time is devoted in public schools; and
• Some schools can be demonstrated to be inadequate in the outcomes they generate in reading and math; and
• Schools that are so demonstrated are unlikely to have additional financial capacity to expand their programs; so
• Those schools should be devoting more time to reading and math, with other subjects crowded out in whole or in part.

I think we should have been surprised if the law were not having the effect of narrowing the curriculum, but I was surprised that the law was having as pronounced an effect as it is. In general, my view is well summarized by this quote:

"When you only have so many hours per day and you're behind in some area that's being hammered on, you have to work on that," said Henry Lind, the schools superintendent. "It's like basketball. If you can't make layups, then you've got to work on layups."

I'd like to be able to say that every school district should offer a broad curriculum of liberal arts courses including history and music and languages and lab sciences, but some school districts aren't able to do all of that successfully. So given that they won't be at the ideal, where should they be? I think of reading and math as foundational. There's very little use in trying to build on a weak foundation. That doesn't mean I support this sort of federal involvement in primary and secondary education, but it does mean that I don't think the consequences of the law, as they are described in this article, are a source of concern.

The article is well written and of interest. I recommend the whole thing.

Should They Stay or Should They Go?

I think this may be the best protest poster I've ever seen. It captures very well the problem of dynamic inconsistency that plagues any attempt to rationalize or improve the nation's immigration laws. The full article reports on the 500,000 people who protested in Los Angeles against legislation passed by the House that:

[W]ould make it a felony to be in the U.S. illegally, impose new penalties on employers who hire illegal immigrants, require churches to check the legal status of people they help, and erect fences along one-third of the U.S.-Mexican border.

It further quotes the President in a way that illustrates the problem quite succinctly:

"America is a nation of immigrants, and we're also a nation of laws," Bush said in his weekly radio address, discussing an issue that had driven a wedge into his own party.

I start from the basic premise that a nation needs to define its borders and establish the rules for who is a citizen and who is not. Once those borders and rules are set, some people can be identified as being in the country illegally. In order to discourage illegal immigration, the nation's laws must promise severe punishment for those who are so identified. But here's the rub. Once an illegal immigrant has become an otherwise law-abiding resident, the nation should provide as much support to that person as possible. And once the illegal immigrant has a child in this country, all bets are off. Say what you want about the woman in the photo, the kid poking her in the eye is innocent in all of this and we do such children no favors by deporting or jailing their parents.

I am convinced from having worked on this briefly toward the end of my time at the CEA and from the President's remarks that the administration has its heart in the right place on this and is trying to make some progress on a very challenging issue. There are two parts of the President's rhetoric that I continue to dislike. The first is embodied in this statement from the radio address:

Finally, comprehensive immigration reform requires a temporary worker program that will relieve pressure on our borders. This program would create a legal way to match willing foreign workers with willing American employers to fill jobs that Americans will not do. [Emphasis added.]

That last phrase is a decidedly non-economic statement. Americans will not do these jobs at the prevailing wages. The appropriate response is to let the wages rise, so that the market clears without resorting to workers from abroad. That means that more Americans will do them at the higher wage and that fewer employers will demand the services. That's the way we deal with other markets--I see no reason why we should systematically undermine the wages of low-skilled workers in urban and border areas by refusing to enforce immigration laws. So I disagree with the assertion that reform should involve a guest worker program specifically to allow such jobs to be filled in some exceptional way.

The second issue is whether any reform is perceived is an amnesty. Here's the excerpt from the radio address:

One thing the temporary worker program would not do is provide amnesty to those who are in our country illegally. I believe that granting amnesty would be unfair, because it would allow those who break the law to jump ahead of people who play by the rules and wait in the citizenship line. Amnesty would also be unwise, because it would encourage waves of illegal immigration, increase pressure on the border, and make it more difficult for law enforcement to focus on those who mean us harm. For the sake of justice and for the sake of border security, I firmly oppose amnesty.

Okay, I oppose amnesty as well, for all of these reasons. But if we oppose amnesty, then we haven't addressed the twelve million people who have a version of the story that the woman in the picture is trying to tell.

So, as the House has done, we have to lead with the punishments. I would leave the churches out of it, at least at the start. I would start with extreme fines for employers caught violating the law--fines that are several orders of magnitude greater than any economic benefit that could be gained by hiring illegals at a lower wage than citizens. This applies to large employers and household employment of domestic workers alike. My next targets would be the smugglers who bring illegals to this country and anyone found forging documents that establish citizenship. Jail time, severe and mandatory. I think that laws to deny illegal immigrants access to driver's licenses and other non-essential benefits of citizenship are generally a good idea.

That's about as much prevention as we can do without looking to deport moms with kids. I don't think there is much we can do on that margin, except to deport those who are apprehended if doing so does not jeopardize their children. But most illegals will not likely be apprehended, because they don't break any other laws (and there's nothing beyond lip service about devoting more resources to doing so in the radio address). Those who are here are probably here permanently, unless they leave voluntarily. So there are two more steps we can take.

The first is to work on the border. I have no problem with fences. I am willing to pay taxes to support the increases in border security required to keep as many illegals out as possible. Let the problem get no worse than it currently is. The second is to increase the limits on legal immigration. Who needs the complications of a guest worker program? We are unlikely to enforce the exit requirements, and I see no reason to have two classes of resident formalized in this way. And perhaps a greater pipeline of people coming in legally and enjoying the benefits of citizenship would be the inducement necessary to get those living as illegals to change their status.

Should I Stay or Should I Go?

On Wednesday, we learned of the agreement between General Motors and the United Auto Workers regarding a buyout plan:

G.M., staggering under the weight of $10.6 billion in losses last year, said it would offer buyouts and early-retirement packages ranging from $35,000 to $140,000 to every one of its 113,000 unionized workers in the United States who agreed to leave the company.

When firms are in financial distress, they need to get their creditors--typically private banks and public debtholders--to write down the value of their claims. If existing creditors are willing (or can be coerced) to do this, then the firm faces a better prospect of getting new creditors to help it finance value-enhancing projects. (I am still waiting to see what these might be for G.M.)

In a standard workout from financial distress, the firm enters an agreement with a bank and then makes an exchange offer to its public debtholders to give them new securities in exchange for their old ones, if a sufficient number of them accept. For an exchange offer to work, it typically has to shorten the maturity or raise the seniority of the new debt relative to the old. Those who opt for the exchange have to be able to "get in line" ahead of those who don't in the event that not all of the firm's creditors will be repaid in full. The more workers who take the buyout, the less money will be available in the near future for those who did not take it, in the event that G.M. doesn't recover.

In G.M.'s case, its labor contracts are so costly and so rigid that its unionized workforce resembles a major creditor, and what they have been offered resembles an exchange offer. So each of the 113,000 workers is making an individual assessment of whether they are likely to receive more money by taking the sure payment now or by seeing what uncertain payments they get when G.M. enters bankruptcy or recovers. As a Reuters story points out:

Several union officials said workers who have been thinking about a career change or those worried about the auto industry overall are the ones considering the offers.

The story also notes that employee reactions are mixed:

Reactions to GM's buyout offers, announced on Wednesday, varied among workers, with younger employees worrying about their future because the offers would not include health benefits, and some older ones getting ready to retire.

But some senior GM workers might just refuse to go.

Terry Brumley, 63, who works at the Corvette plant in Bowling Green, Kentucky, has been with GM more than 40 years.

"I'm not taking the money. I can raise a garden, go to dinner with my wife and go fishing, and still have a job. So why should I retire?'' he asks, adding that he sees himself working for at least another 10 years.

And, to show some of the problems with getting in the habit of offering buyouts, consider:

"Members of high seniority are very interested,'' Eldon Renaud, president of the United Auto Workers Local 2164 in Bowling Green, Kentucky, said. "There were a lot of people that were ... holding on to see if there was going to be a buyout offer.''

On this sort of dynamic inconsistency, more later.

Bradley Belt, We Hardly Knew You

Via my former partner in crime, Phill Swagel, I learn that Bradley Belt, executive director of the Pension Benefit Guaranty Corporation, has submitted his resignation. To find out why, you could read the letter and get to the phrase "the time has come to pursue other opportunities." Or you could read his remarks to the National Association of Business Economics from ten days ago. Everything up to the statement "But there is hope ..." constitutes one of the best expositions of why we face these troubles in the defined benefit universe. My tenure in DC overlapped very briefly with Belt's, and I wish him well.

The shorter version of Belt's remarks is that the entirety of pension regulation is set up to distort and minimize the impact of economic conditions on the firm's reported pension liabilities. He takes particular aim at smoothing of asset and liability values:

And thus we come to another figment of imagination in pension-land—smoothing. “Smoothing” is a seductive marketing word. It conveys the sense that we are sparing investors from the rude jolt they would receive if pension losses were reported at full value and saving companies from the terrible burden of repairing pension deficits as quickly as they were created.

In the accounting context, smoothing allows companies to show pension losses to investors in small slivers over time rather than all at once. This helps make a company’s reported earnings look smoother as well, which is to say, more divorced from economic reality. But if we have learned anything from recent economic history, it is that attempting to manage reported earnings leads to trouble. Going back a few years further, would we have avoided the need for an S&L bailout if we had allowed thrifts to smooth interest-rate spikes over a several year period? Would the economic reality of their asset and liability mismatch have been any different? In the pension context, it should be a wake-up call when the deputy chief accountant of the SEC derides smoothing for its potential to render financial statements “meaningless.”

But as problematic as smoothing may be in the pension accounting context, in some ways it is even worse in the pension funding context.

Under the pension funding rules contained in ERISA and the Internal Revenue Code, a company can skip needed contributions to its pension plan on the grounds that “smoothed” assets and liabilities make the plan look well-funded. When followed by a corporate bankruptcy, this policy of ignoring economic reality and failing to make needed contributions can lead to devastating losses of retirement income for long-serving employees.

On the asset side, the funding rules allow companies to use values smoothed over five years. The only constraint is that the market value of the assets cannot be more than twenty percent different than the so-called “actuarial” value of assets. In practice, this means a pension plan with $1.2 billion in liabilities and $1.2 billion in “actuarial” assets may not be fully funded but rather $200 million short of what’s needed to pay promised benefits. If I tried to pay my bills with the “actuarial” value of my bank account, I’d be bouncing checks left and right—which, unfortunately, is what some companies are doing with their pension plans.

If anything, the situation is even more perverse on the liability side. Companies are permitted to calculate the present value of their pension liability using the four-year average of a corporate bond index. It should go without saying that interest rates from four years ago have absolutely nothing to do with the value of the pension liability today (or tomorrow). This is akin to driving down the highway at a high rate of speed looking only in the rear-view mirror.

Still, I can understand why plan sponsors want the flexibility afforded by smoothing the discount rate. It is a fact of life that pension liabilities are extremely sensitive to movements in interest rates. If the discount rate drops by one hundred basis points, that can easily drive up liabilities by ten percent or more. Better to “smooth in” that rate drop slowly over time to avoid unpleasant hiccups in the plan’s funded status. Of course hiding the volatility doesn’t mean it isn’t there.

Without these (and other) smoothing mechanisms, the argument is made that companies won’t be able to “predict” their pension contributions and won’t be able to budget accordingly. This is a particularly fascinating line of reasoning. How can a CFO of an airline possibly function without being able to “predict” future oil prices? Or the CFO of an auto manufacturer with respect to steel prices? Or the CFO of a multinational enterprise that has to deal with currency fluctuations? Or, perhaps most similarly, a bank or insurance company CFO whose business is especially sensitive to changes in interest rates?

Ah, say the inhabitants of pension-land, but our obligations are “long term.” These benefits are going to be paid out over decades, so there’s no need to value the liability based on what interest rates are doing today.

Nonsense. I want to know the market value of my house today even if I have a thirty-year mortgage and plan to live in it for another thirty years—it affects my net worth and my ability to borrow. Moreover, there’s always the chance that I may have to sell my house earlier than I expected.

Similarly, workers and retirees need to know the funded status of the pension plan today even if the benefits are going to be paid out over thirty years. Not only should it affect their planning for retirement, but there’s always the possibility that their company may go bankrupt and turn its pension plan over to the PBGC. I can assure you: At that point a liability calculation based on interest rates from the year 2002 is utterly meaningless and misleading. Yes, most pension obligations are long term. But, there have been more than 160,000 standard terminations of fully funded plans over the past thirty years. There have been 3,600 terminations of underfunded pension plans. Ask the participants in these plans whether these are necessarily long-term obligations.

The argument that something other than the current market values of assets and liabilities should be reflected on corporate financial statements is bizarre. I suppose it comes from an idea that a corporation should not have to suffer the consequences of reporting the impact of return volatility in its pension funds because ... it is doing the world a favor by sponsoring the pension. Paraphrasing Belt, that's "nonsense." It is only doing the world a favor if it does bear the consequences of that volatility. Those consequences should drive it to fully fund its liabilities and duration match its assets and liabilities (e.g., in a heavily bond rather than equity portfolio). Only then would it really be doing the world a favor and merit the substantial tax advantage of the pension relative to other forms of compensation.

More on pensions tomorrow, focusing on the GM/UAW deal.

In Memoriam, James O. Freedman

The Dartmouth community lost James O. Freedman, its President from 1987 to 1998, yesterday after a 12-year bout with non-Hodgkins lymphoma. The article in The Dartmouth characterizes his contribution to Dartmouth succinctly:

Freedman was a staunch advocate of intellectualism, ethnic diversity and gender parity at the College, while orchestrating an extremely successful capital campaign during the 1990s.

He was one of only a few presidents of the College who had no prior connection to it. But he managed to move it in a positive direction by, in the words of Sandy McCulloch '50, who was chairman of the College's board of trustees at the time Freedman was hired, "refocus[ing] on what we're in business for." It is a less ambitious agenda than that of a Summers or even a Hundert, who were hired to take their institutions in a new direction, but I am grateful for the effort, since it ultimately brought me to Dartmouth during that time.

Pass the Spittoon, Pension Reform Edition

For the trouble of having to wade through all of the details of the pension reform bill now being gutted in House-Senate conference, Mary Williams Walsh gets a Voxy. I remember working on the early stages of this reform effort while at CEA. It started out simply enough:

With a strong directive from the Bush administration, Congress set out more than a year ago to fashion legislation that would protect America's private pension system, tightening the rules to make sure companies set aside enough money to make good on their promises to employees.

Enter the Congressional porkfest, and what do we now have?

Then the political horse-trading began, with lawmakers, companies and lobbyists, representing everything from big Wall Street firms to tiny rural electric cooperatives, weighing in on the particulars of the Bush administration's blueprint.

In the end, lawmakers modified many of the proposed rules, allowing companies more time to cover pension shortfalls, to make more forgiving estimates about how much they will owe workers in the future, and even sometimes to assume that their workers will die younger than the rest of the population.

On top of those changes, companies also persuaded lawmakers to add dozens of specific measures, including a multibillion-dollar escape clause for the nation's airlines and a special exemption for the makers of Smithfield Farms hams.

As a result, the bill now being completed in a House-Senate conference committee, rather than strengthening the pension system, would actually weaken it, according to a little-noticed analysis by the government's pension agency. The agency's report projects that the House and Senate bills would lower corporate contributions to the already underfinanced pension system by $140 billion to $160 billion in the next three years.

Two excerpts from the article say it best:

"It takes a better economist than me to understand how reducing contributions by that much is going to protect benefits and put the system on a sounder footing," said Jeremy I. Bulow, an economist at Stanford University.

That's actually funny, since there are no demonstrably better economists than Jeremy Bulow. And then we have the author's own attempt to make sense of this:

Someone must pay for this. Currently, the pension agency finances itself in part through the insurance premiums that companies are required to pay into the system. Raising the premiums to support pilots or help other victims of corporate bankruptcies, some companies in other industries are starting to say, would be unfair.

This is the contemptible legislative impulse to favor the special interest over the general interest. Read the whole thing and be amazed at how unprincipled the House and Senate are being.

The President has been losing credibility on several issues related to finances as of late. He could get some of it back if he would simply VETO this monster and send it back to the sty. If for no other reason, he should do it to show respect for the many people in his administration who worked diligently on a much better blueprint for reform.

For my own views on how to reform the defined benefit pension system, see these earlier posts.

Academic Reformers Beware

On my trip through Cleveland, I learned that the cold and blustery weather from the Charles River has moved west to Lake Erie and has claimed yet another university president:

Dr. Edward Hundert may be leaving the president's office at Case Western Reserve University, but the many problems that led to his resignation remain.

Hundert, who resigned Wednesday night, will stay at his post until Sept. 1. That means he will have to address the university's $40 million budget deficit and deal with other issues that led to the faculty's no-confidence vote against him earlier this month.

Here's how it played out:

Lawrence Krauss, a physics professor who led the charge for the no-confidence vote, said he thought Hundert would eventually resign but was surprised by the timing of his decision.

[...]

Hundert came to Case in 2002 from the University of Rochester, where he was the dean of the medical-dental school. He immediately embarked on a quest to mold the university into "the world's most powerful learning environment."

The Vision Investment Plan was his blueprint for catapulting the university into the spotlight. The plan involved spending $181 million over five years with the understanding that the university would have to spend more than it took in. However, when research money and donations declined, the university started to take on more debt than projected.

Hundert's tenure started to unravel when Krauss - upset over the university's fiscal problems and emboldened by Summers' resignation - called on the Arts and Sciences faculty to take a no-confidence vote. He cited among his concerns the university's budget deficit, turnover in central administration, a downturn in fund-raising and the administration's lack of openness.

The March 2 vote went against Hundert 131-44. By a slimmer margin, 97-68, the same faculty expressed a lack of confidence in Provost John Anderson.

I have a bit more sympathy for the Case Western faculty, but there are some similarities in the two cases. Consider: University needs new leadership with bold ideas. University trustees hire someone with bold ideas to lead. President begins to implement vision, meeting with mixed success. Trustees look to stand by troubled president. Faculty seize upon some early setbacks to impeach with a vote of no-confidence.

I'll venture to guess that this pattern will repeat several more times outside the for-profit sector in the coming years.

Social Security Reform Lecture

I'll be giving a lecture this evening in Cleveland about Social Security Reform. For those in the area, the details are:

Date: Thursday, March 16th
Time: 7:30 p.m. Refreshments, 8:00 p.m. Lecture
Place: University School, Lower School Campus, 20701 Brantley, Shaker Heights
Cost: $8 for non-students; free for students
More Info: Kent Mann

Hope to see you there.

The End of Winter

Winter is my term for teaching at Dartmouth. For me, teaching crowds out blogging in two ways. The first is time. Teaching pushes everything else aside, blogging included. The second is that teaching and blogging scratch the same itch--the desire for two-way communication of ideas. After today's exam, I expect the frequency of posting to pick up. In the meantime, here's the funniest idea that was communicated to me this Winter:

In Jerusalem, a journalist heard about a very old Jewish man who had been going to the Wailing Wall to pray, twice a day, everyday, for a long, long time. So she went to check it out. She went to the Wailing Wall and there he was!

She watched him pray and after about 45 minutes, when he turned to leave, she approached him for an interview. "I'm Rebecca Smith from CNN. Sir, how long have you been coming to the Wall and praying?"

"For about 60 years."

"60 years! That's amazing! What do you pray for?"

"I pray for peace between the Christians, Jews and the Muslims. I pray for all the hatred to stop and I pray for all our children to grow up in safety and friendship."

"How do you feel after doing this for 60 years?"

"Like I'm talking to a fucking wall."

Tell me about it.