Streetwise Professor

April 24, 2023

Redistribution in the Worst Way–By Messing With Prices

Filed under: Economics,Financial crisis,Politics,Regulation — cpirrong @ 5:53 pm

“Equity” is one of the three legs of the iniquitous DIE gallows. It is a driving force behind a variety of policy proposals, two of which have surfaced in recent weeks. They illustrate the fundamental depravity of such “equitable” policies generally.

The first is the Federal Housing Finance Agency’s policy to reduce rates and fees for homebuyers with low credit scores who put down relatively little on a house, and to raise them for those with higher scores, especially those who make a downpayment of between 15 and 20 percent of value. In other words, good credits are being forced to subsidize bad credits. In the words of the FHFA director, this is intended to “increase pricing support for purchase borrowers limited by income or by wealth.”

In other words, it is a purely redistributive policy. And excuse me, but where have I seen this movie before? Oh, that’s right. During the last financial crisis, which was in large part the consequence of policies designed to, well, “increase pricing support for purchase borrowers limited by income or by wealth.”

It isn’t rocket science to figure out where this will go. More low credit quality households will buy houses they can’t afford. A loss of a job, or a downturn in the real estate market, or one of myriad of other things means that they won’t be able to repay the loan, resulting in default, foreclosure, and a credit loss to the lender. Most likely followed by class action law suits alleging predatory lending.

Wealth redistribution via housing policy and housing finance policy has always been a bad idea plagued by unintended–but totally predictable–consequences. But it’s like a bad drug, and one that the United States government just can’t quit for long.

The other policy, smaller in scale but similar in design comes from California. There the three major state regulated utilities have proposed implement two part tariffs, consisting of a fixed monthly fee and a per unit usage charge. The fixed fee will be based on income, with low income households paying $15/month and higher income households paying as much as seven times that amount. Further, the utilities will reduce the rate per kwh.

Now you can make an economic case for a two part pricing structure in an industry (like electricity) with high fixed costs, but that doesn’t appear to be the motive here: instead, it is an attempt to use electricity tariffs to redistribute income and wealth. It is also somewhat ironic that California, which faces chronic electricity shortages and constantly strives to reduce consumption because climate change is introducing a policy that encourages consumption. I am sure that will work out swell.

If you believe in redistribution, there are better and worse ways to achieve that objective. The better ways are through lump sum transfers or something like the negative income tax. The worse ways are through messing with prices. It’s fair to say that the worst ways are through messing with prices.

And that’s exactly what these two policies will do. The FHFA policy messes with the price of credit. The California electricity policy messes with the price of power.

Messing with prices distorts decisions on a variety of margins.

For example, distorting the price of credit (i.e., charging borrowers rates and fees that do not reflect default costs) encourages overborrowing by those with poor credit and underborrowing by those with better credit. As we saw in 2006-8, such policies can have systemic consequences. Even absent systemic consequences, they will lead to greater financial distress costs, deadweight bankruptcy costs, reduction in housing values due to the effects of foreclosure, etc.

Both policies also increase effective marginal tax rates, which distort labor supply decisions. In California’s case, the redistributive policies represent one more straw on the camel’s back of those debating where to locate, and due both to the direct effects and the signal sent regarding the extractive nature of California policies will add to the exodus of the middle class from the state.

The means by which these redistributive policies are being imposed is also pernicious. This is redistribution via regulatory fiat. The administrative state is already too large and too unaccountable. Giving it a license to redistribute income and wealth–or to engage in more such redistributive schemes–in the name of “equity” will result in a proliferation of such ghastly schemes, and the deadweight costs they entail due to their distortions of prices. Make elected politicians make the case for and take responsibility for redistributive schemes rather than delegating them to the unelected and the unaccountable. Especially those who can only implement redistributive policies through destructive distortions in the prices of the goods and services they regulate.

The United States desperately needs pro-growth policies, not redistributive ones–not least because growth is essential to prevent a debt crisis. These redistributive policies are decidedly anti-growth.

They are also divisive, and are being implemented at a time where social divisions are already acute.

I wish I could say that these two policies were outliers. They are not. They are representative of today’s strongest policy current: the Biden administration’s “whole of government” plan for “environmental justice” is another. Such policies are a recipe for stagnation, and taken collectively and together with lavish government spending bear the seeds of future economic crises. And not far into the future either.

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  1. You’l be lucky to achieve stagnation or, at least, to achieve it for long. Bad times are just around the corner.

    Comment by dearieme — April 25, 2023 @ 7:44 am

  2. Extending cheap credit to the uncreditworthy and denying it to the creditworthy. What could possibly go wrong?

    There’s a lot of this lunacy about. Warehousing covid patients in crowded hospital wards with windows that don’t open, and no clue of how to treat them. So they reinfect each other just as they are beginning to recover. Thus releasing the evolutionary pressure on a novel disease to become milder. That’s another.

    It’s almost as if the government, faced with a policy choice, will always choose the stupidest.

    Comment by philip — April 25, 2023 @ 1:23 pm

  3. As the Grumpy Economist posted recently, if you want to subside something, pass a law,write a check so everyone knows what’s going on. DC would rather hide their thefts.

    Comment by The Pilot — April 26, 2023 @ 7:37 am

  4. Cambridge Dictionary says something like equity is the value of a company, real estate or else, equally distributed among shareholders. If the focus is not on value creation, then there’s not much to ditribute. Even if someone says it’s okay to apply it to consumer prices, the examples exactely don’t distribute equally or by share.

    But America seems to be a big diverse country. Guess it was in autumn 2017 when I visited New Hampshire. There were low real estate prices, good average incomes with no state income tax. Houses could be bought without equity or small downpayment also, but then the buyer needed to pay an equity insurance on top of the annuities.

    But it did make sense to finance like this instead of paying rent, they could build equity like this, starting with an own house at a young age, that could be sold when one needed a bigger house.

    That made sense to me, low reasonable real estate prices, good incomes, low taxes, the possibility to buy, finance and own a house and therefore build equity instead of paying somebody else a rent, and a low hurdle with a low or no downpayment and combined with an equity insurance for the missing downpayment.

    Comment by Mikey — April 28, 2023 @ 3:15 am

  5. @dearieme. I fear you are correct, but we’ll have the UK for company. So there’s that.

    Comment by cpirrong — April 30, 2023 @ 3:26 pm

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