The Hunger Games: Amazon Edition

photo by SounderBruce

The New York Law Journal published commentary of mine, The Hunger Games: Amazon Edition. It opens,

Last week Amazon finally announced that New York and Northern Virginia would be the sites of its planned major expansion. While many are caught up in the excitement of Amazon bringing 25,000 high-paid jobs to both metropolitan areas, it is worth thinking through the costs that beauty contests like this one impose on state and local governments. Amazon extracted billions of dollars in concessions from the winners and could have extracted even more from some of the other cities courting them.

It is economically rational for companies to create such Hunger Games-type competitions among communities. These competitions reduce their costs and improve their bottom lines. But is it economically rational for the cities? As long as governments are acting independently, yes, it is rational for them to race to the bottom to secure a win. So long as they are a bit better off by snagging the prize than they would have been otherwise, they come out ahead. But the metrics that politicians use are unlikely to be limited to a hard-nosed accounting of costs and increased tax revenues. Positive buzz may be enough to satisfy them.

Consider Wisconsin Governor Scott Walker’s deal with Foxconn. Just over a year ago, he was touting the $3 billion state subsidy for FoxConn’s manufacturing plant. This was the year leading up to his hard fought election fight, a fight he ultimately lost. His public statements focused on Foxconn’s promise to create 13,000 jobs. While that was a lot of jobs, it was a hell of a lot of subsidy—more than $230,000 per job, more than six times the largest amount Wisconsin had ever paid to subsidize a promised job. Walker got his campaign issue, FoxConn got its $3 billion and Wisconsin residents got … had. The $3 billion dollar subsidy has grown to over $4 billion at the same time that Foxconn is slowing down its investment in Wisconsin. So now taxpayers are subsidizing each job by well over $300,000 each. Nonpartisan analysts have determined that it will take decades, at the earliest, for Wisconsin to recoup its “investment.”

Likewise, hundreds of millions of dollars are thrown at stadiums and arenas even though economists have clearly demonstrated that those investments do not generate a positive financial return for the governments that provide these subsidies. Fancy consultants set forth all of the supposed benefits: job creation, direct spending by all of the people drawn to the facility, indirect spending by those who service the direct spenders. This last metric is meant to capture the increase in restaurant staff, Uber drivers and others who will cater to the new employees, residents and visitors to the facility. But as has been shown time and time again, these metrics are vastly overstated and willingly accepted at face value by politicians eager to generate some good headlines. They also ignore the opportunity cost of the direct subsidies—monies spent on attracting a company is money that can’t be spent on anything else. While we don’t know what it would have been spent on, it is likely to have been public schools, mass transit, roads or affordable housing in many communities.


Monday’s Adjudication Roundup

Are Billions Enough?

Jenner & Block has issued the Citi Monitorship First Report. By way of background,

The Settlement Agreement resolved potential federal and state legal claims for violations of law in connection with the packaging, marketing, sale, structuring, arrangement, and issuance of residential mortgage-backed securities (RMBS) and collateralized debt obligations (CDOs) between 2006 and 2007. As explained below, in the Settlement Agreement, Citi agreed to pay $4.5 billion to the settling governmental entities, acknowledged a statement of facts attached as Annex 1, and agreed to provide consumer relief that would be valued at $2.5 billion under the valuation principles set forth in Annex 2.2 As part of the Settlement Agreement, [Jenner partner] Thomas J. Perrelli was appointed as independent monitor (Monitor) to determine Citi’s compliance with the consumer relief and corresponding requirements of the Settlement Agreement. This is the first report assessing Citi’s progress toward completion of those obligations. (3, footnote omitted)

Because this is the first report, much of it sets the stage for what is to come. I was, however, struck by the section titled “Impact of Relief Provided:”

To evaluate fully the impact of the relief that is the subject of this report and authorized under the Settlement Agreement would require a variety of activities not contemplated by the settlement and not easily achievable (e.g., interviews with individual homeowners). Isolating the effect of this settlement, the National Mortgage Settlement, and other RMBS settlements from the broader housing market is also difficult.

One question frequently asked is whether the relief provided to borrowers and for which Citi has received credit would have been provided in any event (e.g., is this really additional?) On this question, the answer is mixed. Given ordinary accounting practices, loans for which foreclosure does not make economic sense are frequently written-off by financial institutions. In that circumstance, however, the banks may not release liens as a matter of routine, leaving borrowers with an ongoing burden and impeding potential efforts to redevelop the property. To get credit under the Settlement Agreement, Citi was required to release the lien, thus giving an additional benefit to the homeowner to allow him or her to make a fresh start and to remove any legal obstacles from the transfer of the property. (17, footnote omitted)

As I have noted before, it is hard to truly assess the restorative and retributive impacts of the ten and eleven digit settlements of litigation arising from the financial crisis. Are individuals appropriately helped? Are wrongdoers appropriately punished? Are current actors appropriately deterred?  I find it bizarre that it is so hard to tell even when settlements are measured in the billions of dollars.

Fannie and Freddie’s Debt to Treasury

Larry Wall of the Federal Reserve Bank of Atlanta has posted one of his Notes from the Vault, Have the Government-Sponsored Enterprises Fully Repaid the Treasury? It opens,

Have U.S. taxpayers been fully compensated for their bailout of the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac? The Treasury is reported to have argued that “the value of Treasury’s commitment to the GSEs was “incalculably large,'” with the implication that it could never be repaid. Richard Epstein, the Peter and Kirsten Bedford Senior Fellow at the Hoover Institution [and who discloses that he consults “with several hedge funds with positions in Fannie and Freddie”], responded that “the level of the Treasury commitment was not ‘incalculably large’: it was $188 billion, all of which will shortly be repaid.” The significance of Epstein’s argument is that if Treasury has been fully compensated for its bailout of Fannie and Freddie, a case can be made that the future profits of the two GSEs should go to their private shareholders.

As an accounting matter, one could argue that Epstein is correct; the dividends equal the amount of Treasury funds provided to the GSEs. And as a legal matter, the issue may ultimately be resolved by the federal courts. However, as an economic matter, the value of the government’s contribution clearly exceeds $188 billion once the risk borne by taxpayers is taken into account.

In this Notes from the Vault I examine the value of the taxpayers’ contribution to Fannie and Freddie from an economic perspective. My analysis of these contributions is divided into three parts: (1) the GSEs’ profitability prior to the 2008 conservatorship agreement (bailout), (2) the value of the taxpayer promise at the time of the bailout, and (3) support of new investments since they were placed in conservatorship. (1)

The article goes on to explain each of these three parts of the taxpayers’ contribution and concludes,

The claim that the taxpayers and Treasury have been fully repaid for their support of Fannie Mae and Freddie Mac is based on an accounting calculation that does not withstand economic analysis. The claim that Treasury’s commitment has been fully repaid attributes no dividend payments to Treasury starting in 2012, attributes no value to the government guarantee to absorb whatever losses arose in the pre-conservatorship book of business, and arguably reflects Treasury setting too low of a dividend rate on its senior preferred stock. Moreover, the profits that are being used to pay the dividends did not arise from the contributions of private shareholders but rather entirely reflect risks borne by the Treasury and taxpayers. Thus, the Treasury claim that the value of the aid was “incalculable” is an exaggeration; the value surely can be fixed within reasonable bounds. However, the implication of this claim, that the GSEs cannot repay the economic value on behalf of their common shareholders, is nevertheless accurate. (2)

This article offers a useful corrective to the story one hears from those representing Fannie and Freddie’s shareholders. They have constructed a simple narrative of the bailout of the two companies that ignores the way that the two companies’ fortunes have been intrinsically tied to the federal government’s support of them. That simple narrative just nets out the monies that Treasury fronted Fannie and Freddie with the payments that the two companies made back to Treasury.  After netting the two, they say, “Case closed!” Wall has demonstrated that there are a lot more factors at play than just those two.

I would also highlight something that Wall did not: the federal government actually determines the level of profits that Fannie and Freddie can make by setting the fees the two companies charge for guaranteeing mortgages. So, the federal government could wipe away future profits by lowering the guaranty fees. And wiping away those profits would make those outstanding shares worthless.

So the question remains: what is the endgame for the investors who have brought these lawsuits?