Category Archives: Big Govt

‘What’s the Worst That Can Happen?’

John Kerry makes a revealing statement in the form of a question.
May 20, 2014 7:22 p.m. ET

Secretaries of State may want to stop making statements in the form of questions, à la “Jeopardy.” First Hillary Clinton declared “what difference at this point does it make?” regarding the reasons that four Americans died in Benghazi. Then on Monday John Kerry told graduates of Boston College that even if he’s wrong about climate change, it won’t cost a thing.

“The solution is actually staring us in the face. It is energy policy. Make the right energy policy choices and America can lead a $6 trillion market with four billion users today and growing to nine billion users in the next 50 years,” Mr. Kerry said in his commencement address, referring to climate change. Then came the odd poser.

“If we make the necessary efforts to address this challenge—and supposing I’m wrong or scientists are wrong, 97% of them all wrong—supposing they are, what’s the worst that can happen?” Mr. Kerry said. “We put millions of people to work transitioning our energy, creating new and renewable and alternative; we make life healthier because we have less particulates in the air and cleaner air and more health; we give ourselves greater security through greater energy independence—that’s the downside.”

So the “downside” of addressing climate policy is more jobs, cleaner air, more energy security, and we save the planet too. Makes you wonder why there aren’t already 100 Senate votes for this miracle. Perhaps that’s because the “energy policy” Mr. Kerry is talking about includes vast new political control over the economy, starting with taxes and limits on carbon energy, subsidies for his favored energy sources, and new and costly regulations on much of the American Midwest, South and West.

The “worst that can happen” is that we spend trillions of dollars trying to solve a problem that we can’t do anything to stop; that we misallocate scarce resources in a way that slows economic growth; that slower growth leads to less economic opportunity for Boston College grads and especially the world’s poor, and that America and the world become much less wealthy and technologically advanced than we would otherwise. All of which would make the world less able to cope with the costs of climate change if Mr. Kerry is right.

‘What’s the Worst That Can Happen?’ –


The Investors at War With Political Power

Rather long, but folks – we need to start paying attention to “the government of ours’ which ‘managers’ of which are more and more thinking they can do as they wish.
How a once-obscure federal agency targeted two brothers, and what happened when they decided to fight back in the age of Obama.
By JOSEPH RAGO CONNECT May 2, 2014 6:45 p.m. ET West Chester, Pa.

There’s a quote hanging on the wall of Rich Gates’s office, here in a suburb west of Philadelphia: “No person, in any culture, likes to be bullied. No person likes living in fear because his or her ideas are different. Nobody likes being poor or hungry, and nobody likes to live under an economic system in which the fruits of his or her labor go unrewarded.” President Obama, in his book “The Audacity of Hope,” meant those words as inspirational; for Mr. Gates, they are ironic.

Late last summer Mr. Gates and his identical-twin brother, Kevin, learned in a letter from the government that they were being accused of having manipulated electricity markets, a serious fraud violation. After a three-year investigation, federal energy regulators had concluded that two of their investment partnerships, known as Powhatan and Huntrise, had “profited, intentionally so” from sham power trades. The Gates’s reply to the 28-page document, in its entirety:

“Your preliminary findings make no sense. Should you choose to proceed with a public notice against Powhatan and/or Huntrise, please be advised they will respond publicly and forcefully.” The Gates brothers debated whether the second sentence was redundant. By then, they had decided they wouldn’t be bullied any longer.

The brothers went public with an earth-scorching campaign against their treatment by the Federal Energy Regulatory Commission, or FERC. They’ve released hundreds of pages of internal documents that aren’t normally disclosed during an ongoing investigation, and FERC is not pleased. This is not supposed to happen, and never has.

Rich Gates says he was “completely dumbfounded” by FERC’s legal and financial reasoning. “We wanted to go open kimono,” Kevin Gates adds, “and just provide full transparency into the process to the public at large.”

The Gates case offers a rare glimpse into FERC’s prosecutorial method and the workings of the larger regulatory state in the Obama era. Since 2009, the commission has transformed itself from the boring regulator nobody ever heard of into a fearsome scourge of Wall Street and U.S. business. To great political acclaim, FERC’s Office of Enforcement has pursued everybody from big financial institutions like Barclays BARC.LN -1.33% and Deutsche Bank DBK.XE +0.03% down to individual traders and even Maine paper mills, making market-manipulation charges much like those lobbed at Powhatan and Huntrise.

FERC’s most notable scalp so far is a $410 million settlement last year with J.P. Morgan JPM -0.37% that happened to land amid the London Whale and mortgage securities political pile-on. The White House thinks well enough of the enforcement division’s work that the administration wants to promote its director, Norman Bay, to FERC chairman.

The problem is that no one understands what FERC’s definition of “market manipulation” is, only that, like Justice Potter Stewart, Mr. Bay knows it when he sees it. Though the financial stakes for the Gateses aren’t high in the scheme of things—$4.7 million in allegedly ill-gotten profits, by FERC’s reckoning—the brothers think that their reputations are worth defending. Alone among FERC’s targets, they’re doing what they promised, publicly and forcefully.

“This particular adventure began in 2008 when we cold-called Alan Chen, ” Kevin Gates says. Dr. Chen was a Houston energy trader with a Ph.D. in power engineering, and his strategy appealed to the Gates brothers. They and their friends and family set up a fund, Huntrise, which would reflect Dr. Chen’s plays.

The fund was a side investment for their personal portfolios. Their day jobs are managing a midsize advisory firm called TFS Capital. Rich Gates is among the heroes of Michael Lewis’s “Flash Boys,” and the Securities and Exchange Commission considers him a Dodd-Frank whistleblower for his role in exposing some high-frequency trading practices.

The trades on FERC trial are less exotic. Megawatts can be bought and sold like any other stock or commodity in about half the country where competitive wholesale power has replaced the old state utility monopolies. Dr. Chen was trading in a large regional market called PJM Interconnection, a transmission grid organization that covers all or most of 13 mid-Atlantic states out to Ohio.

He was placing bets on the spread between the day-ahead and real-time price of electricity, focused on rare but very profitable events that could not be known in advance. Think of a batter swinging for a home run on every pitch even if he strikes out most of the time.

Then one day in November 2009, Dr. Chen received a surprise reimbursement from PJM, retroactively paying him an honorarium for some of his past trades. He was the beneficiary of a running debate within FERC over “fairness” and who should pay for the fixed costs of electric transmission.

FERC favors the bafflingly complex over the straightforward and efficient, but to oversimplify, all buyers and sellers pay various tariff charges to participate in PJM. The process is designed to collect more of these up-front fees than transmission costs in practice. “Basically there’s a big pot of money left over that PJM has to allocate,” Kevin Gates explains.

This redistribution largely had gone to grid operators that physically flowed power through the transmission lines. But then FERC decided that since traders like Dr. Chen were also required to prepay the tariff charges, they deserved to be cut in on the rebates too. He realized—it takes a doctorate in the sciences to understand the formula’s technicalities—that at certain predictable geographical hubs in PJM and at certain predictable times, the rebates would be significant and higher than the tariff charges. As it turned out, the system would sometimes pay him to make trades.

“We liked the investment to begin with, that’s why we had money with Alan,” Kevin Gates says. “Now we have this tailwind. We were collecting rebates in addition to the normal exposure we were getting. Therefore the natural, logical response is, let’s increase our exposure.”

Another way of putting it is that since the cost of swinging was lower, the Gates brothers could try for more home runs. Around this time they founded Powhatan and ramped up their trading volume over six months in 2010. Of the Gates brothers’ initial $2 million investment, Dr. Chen lost over $400,000 in the first two days, though he went on to grow the investment to $7 million in a matter of weeks.

That drew the ire of FERC’s enforcement division, which began demanding information and taking depositions in fall 2010. At first, the Gates brothers tried to adhere to the insider playbook and hired an attorney from White & Case, a D.C.-based law firm that does frequent business in front of FERC. The insular Washington energy bar trafficks in political connections, but those aren’t so useful for clients who maintain their innocence.

Things started to turn for Kevin Gates, he recalls, during his second full-day deposition with the lead FERC enforcement lawyers on the Powhatan matter, Steven Tabackman and Thomas Olson. “I would suggest that it was intimidation tactics, aggressive behavior, which I guess is natural for a federal prosecutor, maybe what you would expect,” he says. “But there were also a lot of questions asked and behavior that suggested to me that we were seeing the world very differently and—I would suggest—they didn’t know what they were talking about.”

Mr. Gates was asked to leave the room and sat in the hallway while his lawyer conferred with the feds. The lawyer emerged to relate what the FERC enforcement team had proposed: “Kevin’s a businessman, isn’t he? He knows that it’s cheaper to settle than it is to fight this investigation.” Right then, Mr. Gates says, “I realized that we had a big problem on our hands. This was unlike anything we’d ever seen before at a regulatory agency.”

The Gates brothers fired the white-shoe practice and brought on Bill McSwain of Drinker Biddle, a Philadelphia-area lawyer who “didn’t interface much with FERC. He also used to be a Marine sniper, so he had a different approach to the world.” Mr. McSwain introduced himself to FERC by calling their conduct contrary to “established law, as well as common sense,” and that was one of his subtler letters.

Ultimately FERC claimed that Powhatan was making trades merely to harvest the PJM rebates, not transactions that had a legitimate economic purpose or generated real value. FERC calls them “wash trades.”

Yet FERC doesn’t seem to understand the difference between a wash trade and a washing machine. By definition wash trades make no money and entail no risk—a trader makes near-simultaneous purchases and sales of the same security. They can be self-dealing or used to trick another investor or inject bad information into the market. As Rich Gates put it, “Alan Chen’s trades were very different. They were spread trades that were designed to make money by themselves, they didn’t benefit some other entity, they weren’t designed to deceive. They were designed with the sole purpose of making money.”

More to the point, the Gates brothers make a compelling argument about due process. FERC debated the transmission rebates, vetted the consequences, and then wrote rules that opened the PJM rebates to traders. The commission itself had expressly predicted in a 2008 ruling that if arbitrageurs “can profit from the volume of their trades,” they “may make trades that would not be profitable based solely on price differentials alone.”

In other words, even if the Gates brothers were trying to amass rebates and nothing else, that was not illegal or illegitimate at the time, and FERC never gave fair notice suggesting otherwise. Instead, years later, the commission decided that it didn’t like the outcomes that it anticipated from the incentives it created, and decided to selectively punish some investors ex post facto. If in hindsight FERC thinks the results of obeying its rules are undesirable, then the commission should either make better rules or else give investors like the Gates brothers a public-service medal for exposing its own mistakes.

FERC did end up changing the rules, again. The rebates for traders stopped. But the assault on Dr. Chen and the Gates brothers has continued. FERC even views their efforts to exonerate themselves as compounding the original offense, such as it is.

The Gates brothers hired as consultants an all-star roster of experts in power and securities law to independently examine the facts of the case. They include Harvard’s Bill Hogan and Richard Tabors, formerly of MIT, who were the architects of the electric-deregulation movement. Another is Craig Pirrong of the University of Houston, probably the world’s leading authority on commodity-market manipulation. With their own credibility to maintain, not one supported FERC.

One of the experts, Susan Court, FERC’s former enforcement director, had “a very short meeting” with her successor, Mr. Bay, as a gesture of good faith. She informed him of what the Gates brothers were up to. Ms. Court reported that Mr. Bay “was very upset and taken aback.” Perhaps he let that cloud his judgment, Kevin Gates says.

The brothers concluded, Mr. Gates continues, that “we can’t communicate effectively with the FERC,” so they’d try to persuade “our neighbors, our investors, our business partners.” They’ve uploaded all of their case files and correspondence to a public website, Mr. Gates says that, “It’s never good as a money manager or even just a citizen to have your name in the paper as a market manipulator, but we know we’re not going to settle.”

FERC still hasn’t brought public charges or formally closed the investigation. The Gates brothers have filed Freedom of Information Act requests for records relevant to their case so that they can disclose more, and they’re more or less daring FERC to sue. The brothers seem like they’d be delighted to vindicate themselves in a court of law.

Still, their treatment does raise troubling questions about Mr. Bay’s fitness and competence to lead the larger Federal Energy Regulatory Commission. Congress gave FERC market-manipulation oversight powers with teeth—including penalties of $1 million per day per violation—only in 2005, but those powers did not receive a real work-out until Mr. Bay joined FERC in 2009. He was formerly U.S. attorney for New Mexico.

Mr. Bay expanded the Office of Enforcement to some 200 staffers from 20 a decade ago, bringing in the likes of Mr. Tabackman, who was most recently a partner at Butzel Long Tighe Patton, where from 2002 to 2005 he was a consultant to the legal-defense team of 9/11 conspirator Zacarias Moussaoui.

These former criminal prosecutors and litigators have specialized in retroactive punishments for conduct that was legal at the time. Most of these cases never go to court and end with settlements against politically disfavored defendants like J.P. Morgan (that one, like Powhatan, was led by Mr. Olson). Most companies roll over because their future business interests depend on preserving good regulatory graces and favorable FERC rulings. The Gates brothers are unusual in that their livelihoods are elsewhere, but the illogic, intimidation tactics and erosion of due process in their investigation are typical.

The larger point is that the Gates case shows Mr. Bay and FERC are really undermining the electricity markets in the name of defending them. Ad hoc settlements win political plaudits, but because companies usually neither admit nor deny wrongdoing, the settlements set no meaningful or coherent legal precedents. Aside from mind readers and fortune tellers, no one can know what the rules—or, rather, what FERC’s subjective backward-looking interpretation of market manipulation—will be, depriving the markets of liquidity and price discovery. “Shooting random people for following the law,” says Rich Gates, “that sets the markets and the world back.”

Mr. Rago is a member of the Journal editorial board.

The Weekend Interview: The Investors at War With Political Power –


The Troubling Numbers in the Obama Budget

I think the key item Galston brings up is that in the past much Federal spending contributed to infrastructure improves – these provided a real multiplier impact. Spending on consumption.. not at all.
When he was governor of New York, Mario Cuomo famously remarked that “You campaign in poetry; you govern in prose.” To which he might well have added, “And you budget in numbers.” Although President Obama’s fiscal 2015 budget is professedly aspirational, its numbers reveal—as its prose does not—the path on which our country is now embarked. Americans of every persuasion should ask themselves whether this is the path they want.

In the decade between 2014 and 2024, if the president’s budget became law, spending for defense and nondefense “discretionary” programs—the outlays subject to annual appropriations—would barely budge. By contrast, Social Security spending would rise by $644 billion, Medicare by $350 billion, and Medicaid by $243 billion. During that same period, interest on the government’s debt would nearly quadruple to $812 billion, from $223 billion, becoming the third-largest line item in the budget.

Corrected for inflation, the differences are even more dramatic. While discretionary spending would fall by more than 20%, Social Security, Medicare, and Medicaid would increase by more than 20%, and debt payments would nearly triple.

Here’s the third, perhaps most revealing, view of what’s happening. The president’s budget projects that federal spending in 2014 will be 21.5% of GDP, not much different from today’s share. But the composition of that spending changes radically. In the fiscal year ending October 2013, in the aggregate we spent 10.8% of gross domestic product on Social Security, Medicare, Medicaid and interest payments combined. By 2024, that total would rise to 13.5%. In contrast, we spent 3.8% of GDP on defense in 2013, with that spending projected to drop to 2.3% in 2024. Meanwhile, nondefense discretionary spending would fall to 2.2%, from 3.2%. Even with these reductions, the debt stabilizes as a share of GDP only because revenues rise by 2.6 percentage points of GDP over the next decade.

This trajectory is not peculiar to Mr. Obama’s budget. The Congressional Budget Office’s baseline projections, which reflect current policy, show a very similar pattern over the next decade. Even if the president’s proposals were accepted in full, they would change the country’s path only marginally.

So what? Maybe that trajectory is right for us, or at least better than the feasible alternatives. I doubt it, and here’s one big reason why. As many analysts (including the president’s own representatives) have pointed out, discretionary spending is slated to fall to its lowest share of GDP in more than half a century. If that were to happen, we would put at risk both national security and the economy.

Early signs of these problems are already emerging. Given the realities of personnel costs in the all-volunteer armed forces, tough budget targets can be met only by reducing troop levels significantly. Given the importance of cutting-edge technology to the military, qualitative superiority can be maintained only by reducing the number of weapons systems procured.

Worse, local considerations and the quest for short-term political advantage give members of Congress perverse incentives to resist the least-damaging cuts, such as closing redundant military bases. Defense Secretary Chuck Hagel’s recent force-reduction proposals are the harbinger of even deeper and less popular cuts in the future. Forget about the two-war doctrine. The question a decade hence is whether we’ll be able to wage even one.

As for the president’s 2015 budget provisions for investment, the fine print tells the story. The document trumpets Mr. Obama’s commitment to research and development, but the numbers don’t back it up. Corrected for inflation, overall spending for R&D is flat, while funding for basic research actually declines by 2%.

That last figure is especially troubling because basic research doesn’t lend itself to being precisely targeted: By definition, we don’t know where the next big breakthrough in medicine, information, energy or other sectors will occur. We might get lucky, of course. But history suggests that if we want to increase the pace of path-breaking innovation, boosting the overall level of investment is essential. And history confirms what economic theory predicts. Without vigorous public participation, the private market will not produce an adequate amount of basic research—especially in a hypercompetitive global market.

Short-term thinking in the service of political advantage is hardly a new phenomenon. In the past, however, the U.S. has been able to balance such thinking with programs that helped build a better future for everyone—the long list includes land-grant colleges, interstate highways and the postwar explosion of publicly funded scientific research that has transformed the world.

If we want to move from today’s slow growth and wage stagnation to a path of vigorous growth and job creation, there’s no choice. We must embark on a new generation of public investment that responds not to the demands of today but to the needs of tomorrow. The challenge is stark. If we cannot summon the will to mobilize new resources for investment, we condemn ourselves to decline at home and abroad.

William A. Galston: The Troubling Numbers in the Obama Budget –


A Good Time for Housing Reform

If Congress cannot address and issue like this, then it is truly dysfunctional. Please, someone tell me why I’m wrong??
The prospects for progress on Capitol Hill this year are few, but one possibility is reform of federal housing policy. With home prices rising and the economy growing, now is a good time to pare back the government support that has too often led to unsustainable housing booms and taxpayer busts.

Consider the Obama Administration’s latest report to Congress on the Federal Housing Administration. The Department of Housing and Urban Development noted last month that the FHA has a negative $1.3 billion net worth, and that’s after a $1.7 billion Treasury capital infusion in September to offset losses. FHA insures more than $1 trillion in loans and has now missed its federally mandated 2% minimum capital standard for five years.

This is hard to do amid a housing recovery, even for the government. FHA wasn’t caught up in the subprime hurricane as Fannie Mae FNMA -4.07% or Freddie Mac FMCC -3.18% were in the pre-2007 boom years. Instead, FHA expanded its high-risk book of business right as everyone else was getting out.

As HUD Secretary Shaun Donovan euphemistically put it, “the substantial role FHA was forced to play” to keep housing credit flowing during the bust inflicted “considerable stress.” Uh huh. Delinquency rates on FHA’s 2007, 2008 and 2009 books stand at 26%, 26% and 19%. Taxpayers will now have to pay for those homeowners who were induced in part by FHA subsidies to buy more home than they could afford.

The Obama Administration’s response to FHA’s troubles has been to pile higher fees on new borrowers. Along with rising housing prices and the quiet shuttering of FHA’s reverse-mortgage business, this has helped FHA’s finances improve from awful to merely rotten, but it may not be enough to right the books soon.

It’s hard to know how deep the FHA’s red ink goes. The agency’s fiscal health is an estimate based on 30-year forecasts of mortgage prepayment rates, unemployment rates, house prices and inflation rates that no private insurer would use. Do you know what unemployment will be in 2044?

Even the actuaries disagree on the scope of the problem. FHA’s go-to firm, Integrated Financial Engineering Inc., thinks the agency’s single-family home insurance program is worth negative $7.9 billion but could make money by the end of the fiscal year. Summit Consulting and Milliman Inc., more conservative outfits, think the right number is negative $10.6 billion and the business will remain in the red next year, adding that forecasts are “subject to significant variability.”

Whatever the real number, the main goal should be not to repeat the mistake. The underlying problem is that the FHA’s woes derive from a policy of public risk and private profit, which is what blew up Fannie Mae and Freddie Mac.

In a better world, Congress would slowly work off the FHA’s portfolio and get out of the housing subsidy business. Short of that, Texas Republican Jeb Hensarling has a proposal to spin off FHA from the Department of Housing and Urban Development, make it a stand-alone agency, focus its mission on low-income and first-time home buyers, and subject it to the same accounting rules that private lenders have to meet. How about starting there?

A Good Time for Housing Reform –