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  Shining a Light on the Federal Reserve’s Foreign Affairs

  Peter Conti-Brown and David T. Zaring

  Throughout its history, the U.S. Federal Reserve has engaged in international diplomacy, outside the bounds of (and sometimes in conflict with) the priorities of the White House and U.S. State Department. In directing monetary policy, the Fed’s primary concern is to benefit the U.S. economy. In the process, the Fed at times acts in concert with foreign central banks, as was the case in setting new bank regulations after the 2008 financial crisis. At other times, the Fed acts in ways that other countries view as detrimental to their economic interests. Either way, the Fed operates with little public accountability and can wind up complicating the work of U.S. diplomats. This issue brief focuses on the questions of whether and how greater oversight of the Fed’s international activities should be pursued. It recommends not an overhaul of the Fed’s structure or the elimination of its role in international affairs but instead calls for greater disclosure of its international activities. The Fed should provide testimony to Congress twice per year on its foreign policies, just as it does for monetary and regulatory policy. This kind of disclosure permits broader discussion of the Fed’s activities without eliminating the benefits of its institutional independence for monetary policy.

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  Improving Future Policy Responses to Foreseeable Bank Risk-Taking

  Joao F. Gomes, Marco Grotteria, and Jessica A. Wachter

  This brief offers new perspectives on the behavior of banks during the financial crisis of 2007-08 and the limited success of unconventional monetary policies in stimulating bank credit to the private sector during the subsequent economic recovery. The common narrative about the financial crisis is that it was caused by a large credit expansion with overly risky loan-granting behavior by banks. We argue, however, that banks actually made optimal financial decisions in the lead-up to the crisis, based on their calculation of their franchise value. The brief explains the mechanics of franchise value—how it led banks to shift their portfolios toward riskier household loans before the crisis, as well as how it dampened the impact of quantitative easing and other novel monetary policies meant to stimulate the investment of capital into the private sector. Policymakers have failed to recognize the role that franchise value plays in all bank decisions. If they wish to devise appropriate fiscal or monetary policies to prevent or mitigate a future crisis, they need to properly account for how franchise value drives the decision-making of bank managers.

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  Identifying Cartels that Use the Illinois Brick Ruling as a Shield

  Serguei Netessine

  “Identifying Cartels that Use the Illinois Brick Ruling as a Shield” looks at a landmark Supreme Court ruling, known as the Illinois Brick (IB) decision, which bars “indirect purchasers” from bringing antitrust suits against upstream product manufacturers. The research suggests the IB ruling not only reduced the costs associated with antitrust enforcement but has the potential to enable firms upstream in the supply chain to engage in collusion through the use of the wholesale price plus fixed fee structure (WPFF). WPFF allows manufacturers to pay a fixed fee to retailers, compensating them for stocking fewer, higher cost items than they would under perfect competition. The fee acts as a disincentive for retailers to level antitrust suits against manufacturers. And consumers, whose welfare is reduced by the collusion, are forbidden from bringing antitrust action by the IB ruling. The incentive to collude is greater when demand uncertainty for a product is higher, the number of retailers in the market is higher, and the number of manufacturers is lower. Public enforcers of antitrust law can use this knowledge to focus their monitoring efforts on firms embedded in the type of supply chain structures described here while using WPFF contracts.

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  The U.S. Needs a National Vision for Housing Policy

  Vincent Reina

  Recent demographic changes—the sharp increase in single-person households, especially among single individuals over the age of 65, as well as racial disparities in homeownership and the increasing cost burden of home rentals—are underscoring the need for a new vision with respect to U.S. housing policy. This Issue Brief

  lays out several policy prescriptions for improving housing affordability and fairness, both for renters and owners: modifying the federal Housing Choice Voucher program as well as local and state land-use regulations; investing in the maintenance of existing affordable housing stock; making good on HUD’s Affirmatively Furthering Fair Housing requirements so as to reduce fair housing barriers; and promoting financing programs for retrofitting existing low-income housing, to increase energy efficiency and reduce overall costs.

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  Preferred Pharmacy Networks: Health Care Savings on the Margins

  Ashley Swanson

  While policymakers have talked a lot recently about finding a comprehensive fix for escalating health care costs, such as Medicare-for-all, many economists have been exploring the possibility that the answer for excessive health care spending may rest instead in series of smaller adjustments. This issue brief presents research on one such small fix: preferred pharmacy networks. This is a relatively new tool whereby health insurers aim to steer consumers to lower cost “preferred” pharmacies, where insurers are able to negotiate lower drug prices. The research concludes that preferred pharmacy contracting results in a roughly 1 percent decrease in Medicare Part D drug costs among plans utilizing this tool—a fact that should be encouraging to policymakers concerned about reigning in costs, especially in light of other research demonstrating that health care consumers do not shop around for lower priced care. If this practice of “steering” consumers toward lower cost drugs were applied to the entire pharmaceutical industry, the savings could be much greater.

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  Updating the Crowdfunding Narrative

  Gerry Tsoukalas, Simone Marinesi, and Volodymyr Babich

  Policymakers concerned about stimulating small business and entrepreneurial growth need to better understand the dynamics of crowdfunding as a vehicle for that growth. The conventional wisdom is that raising cash through crowdfunding always benefits entrepreneurs. But that is not the complete picture. In reality, there are ways in which entrepreneurs, as well as VCs looking for new investments, may actually be left worse off after a successful crowdfunding campaign. This issue brief examines the potential pitfalls of a successful campaign. These include a moral hazard problem that comes into play when entrepreneurs explore both crowdfunding and venture capital investment, which can lead to a breakdown in negotiations between entrepreneurs and VCs, leaving the VC without a potentially lucrative project and the entrepreneur without the VC’s essential financial support, expertise, and guidance. While the brief focuses on reward-based crowdfunding platforms, the pitfalls described herein likely apply as well to peer-to-peer lending, real estate, and equity-crowdfunding platforms too.

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  The Policy Barriers to Marijuana Banking

  Peter Conti-Brown

  Although cannabis-related businesses have thrived in the localities that have legalized marijuana as a consumer product, the industry has suffered from crippling uncertainty, in the form of limited access to the banking system. The cannabis industry thus has been forced to operate in a cash-intensive “gray market,” which is a problem. An entire industry conducting all of its business in cash cannot be fairly taxed or regulated and, historically, has been associated with lawlessness—everything from security concerns, transportation and currency problems, money laundering, and cash hoarding. This brief reviews and analyzes the issues that surround marijuana banking and offers several policy options for addressing the tension between federal enforcement and state sovereignty as it related to marijuana banking.

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  State Foreclosure Law: A Neglected Element of the Housing Finance Debate

  Brian D. Feinstein

  Proponents of robust mortgage finance regulation would do well to look to the states, and specifically to the regulatory effects of state-mandated judicial foreclosure. Judicial foreclosure, which is authorized in almost half of U.S. states, requires that lenders seeking to foreclose on a mortgage file an action in state court. This not only provides borrowers with a forum for holding lenders accountable for their behavior and obligations, but puts the onus on the lender to show that the requirements for foreclosure have been met. It also aids borrowers by delaying the foreclosure process and allowing them to remain in their homes for longer periods while in default. In this brief, Professor Brian Feinstein empirically examines the effects of judicial foreclosure on lender behavior and mortgage costs for consumers. The findings indicate that judicial foreclosure alters lender behavior in ways that are beneficial to borrowers, and that mirror regulatory goals. Lenders exhibit greater caution in loan-approval decisions and offer fewer subprime loans. These results are amplified for lower-income borrowers. Importantly, the costs imposed on lenders by judicial foreclosure do not appear to get passed on to borrowers in the form of higher rates.

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  Cryptocurrency Competition and the U.S. Monetary System

  Jesus Fernandez-Villaverde

  Advocates of cryptocurrencies such as Bitcoin believe that having currency competition will help achieve the economic objective of price stability. This Issue Brief summarizes research that explores whether competition among privately issued fiat currencies can actually produce price stability. The research finds that in most cases, a system of private monies does not deliver price stability. And even when it does, it always is subject to self-fulfilling inflationary episodes, and it supplies a suboptimal amount of money. Although there is no economic reason to curb the use of cryptocurrencies at the moment, it is important to review key regulatory issues that policymakers need to consider now, before the use of cryptocurrencies becomes even more widespread.

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  The Missing Pieces of the Economic Debate Over Immigration Reform

  Exequiel Hernandez

  To the extent that immigration reform is discussed in terms of economics, the debate tends to focus exclusively on labor issues-specifically, how immigrants affect jobs and wages for native citizens. But to understand the economic effects of immigration, and thus develop sounder policies, policymakers need to consider how immigration affects all three core components of economic growth: not just labor, but capital and innovation too.
  
  In the Penn Wharton Public Policy Brief, "The Missing Pieces of the Economic Debate Over Immigration Reform/whr.tn/2vmKbK8>," Professor Exequiel Hernandez discusses new research showing that immigration produces gains for the U.S. economy with respect to capital and innovation. Immigrants help to attract investment from foreign firms and significantly increase bilateral trade flows between the U.S. and their home countries. Immigrants also account for roughly a quarter of all U.S. entrepreneurs. They not only generate novel businesses and inventions, but also introduce novel ideas that U.S. citizens develop further to create new products and companies of their own.
  
  Just as importantly, labor, capital, and innovation are all interrelated. Policies that target one growth component (such as labor) can carry unintended negative consequences for the other two, and result in undesirable economic outcomes.

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  Regulating Initial Coin Offerings (ICOs)

  David Hoffman

  Research led by the University of Pennsylvania Professor David Hoffman presents legal literature’s first detailed analysis of the inner workings of Initial Coin Offerings (ICO). Startups are using the novel funding mechanism with increasing frequency. In 2017, an estimate 370 ICOs raised around $6.2 billion, and by July 2018, an additional 430 ICOs had raised almost $17.2 billion. ICOs come with the promise of a “smart contract”, or an automated contract that governs real world relationships where before a legal document would have been employed. Human oversight is supposed to be unnecessary because the embedded code ensures proper governance. But do ICOs actually deliver what they promise? Hoffman’s team examines the white papers of the 50 top grossing ICOs from 2017 and compares the promises made to the underlying code. ICO investors face a unique set of concerns, three of which are addressed in detail: will promotors restrict the supply of their cyryptoasset, will they restrict the transfer of cryptoassets according to a vesting or lock-up plan, and do promotors retain the power to modify the smart-contract code governing the tokens sold? The findings are stark: ICO software code and ICO investor disclosures often did not match. While ICOs are a potentially powerful financial innovation, this failure of self-governance reveals opportunities for policymakers consider options to protect consumers and help the ICO market mature.

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  Antitrust in 2018: The Meaning of Consumer Welfare Now

  Herbert Hovenkamp

  Modern antitrust policy follows the consumer welfare principle (CWP), the proposition that antitrust policy should encourage markets to produce high output consistent with sustainable competition, and low prices. The market dominance of giant firms such as Amazon, however, is opening the door to a reevaluation of this antitrust standard, particularly from a new antitrust “movement” that has economic goals, such as protecting small businesses and controlling runaway profits, that can be at odds with promoting low prices. Penn Law and Wharton Professor Herbert Hovencamp evaluates the merits of three antitrust frameworks within the context of the law and economic history. While he acknowledges that business can cause harm to the lives of Americans in ways that extend beyond inflating prices—i.e., creating barriers to market entry, stifling innovation, controlling information, or limiting wages—he argues that the CWP remains best positioned to respond to antitrust problems, although it would benefit from technical improvements.

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  The Policy Trajectories of Autonomous Vehicles

  John Paul MacDuffie

  Autonomous Vehicle (AV) technology promises to dramatically reduce deaths and economic losses from crashes caused by human error, increase mobility for those with disabilities, and revolutionize the auto industry. Yet legislation to facilitate oversight of the development and deployment of AVs is stalling in Congress. Professor John Paul MacDuffie offers a primer on AV technology policy, and discusses strategies for addressing safety and other public concerns while still facilitating AV innovation in the private sector.

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  The Other Side of a Merger: Labor Market Power, Wage Suppression, and Finding Recourse in Antitrust Law

  Ioana Marinescu

  Labor market concentration can worsen after a merger takes place, and this heightened concentration can negatively affect wages. The focus of antitrust analysis, however, has been on the prices of consumer products, not the wages of laborers. New research indicates that, on average, labor markets are highly concentrated, and that higher concentration is associated with significantly lower posted wages for new jobs. This brief uses existing economic tools to develop a model for evaluating labor market concentration and its effects, to determine if a merger will run the risk of anticompetitively suppressing wages, employment, and output. Regulators can use this model to apply antitrust principles to labor markets, as a basis for antitrust enforcement.

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  Bright Lines: How Regulatory Asset Thresholds Change the Banking Industry

  Allison Nicoletti, Michael Iselin, and Hailey Ballew

  One of the key features of the Dodd-Frank Act is that it imposes specific and costly regulatory requirements on banks that cross the threshold of having more than $10 billion in total assets. Anecdotal accounts have suggested that this threshold has led to increased consolidation in the banking industry. This brief provides new statistical evidence of that phenomenon. Banks that approach the $10 billion threshold are significantly more likely to engage in an acquisition, pay more for that acquisition, and acquire bigger target banks than similar banking institutions did prior to Dodd-Frank. To the extent that policymakers are concerned with further consolidation in the banking industry, these findings should be of interest as they continue to evaluate current regulations and develop new ones, which might include the use of bright line asset thresholds.

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  Policy Options for Improving the Resilience of US Transportation Infrastructure

  Gina Tonn Ms., Jeffrey Czajkowski, and Howard Kunreuther

  Despite the vulnerability of America’s aging infrastructure to costly disruptions from man-made and natural disasters, infrastructure insurance under-utilized. On average, only 30% of catastrophic losses in the past 10 years have been covered by insurance. Most infrastructure project managers have relied instead on taxpayer-funded federal aid when disaster strikes. But it doesn’t need to be this way. In this brief, Gina Tonn, Jeffrey Czajkowski, and Howard Kunreuther use technical reports and input from infrastructure managers to outline steps that policymakers can take to help maximize the use of infrastructure insurance for providing financial protection, encouraging investment in loss mitigation measures, and limiting the current reliance on taxpayer dollars.

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  Regulating Robo Advisors: Old Policy Goals, New Challenges

  Tom Baker and Benedict Dellaert

  Financial “robo advice”—an automated service that ranks or matches consumers to financial products—has gained significant attention in the investment industry and on the Hill, but there has not yet been a consensus on how to regulate these new services. Robo advisors often are on par with and can exceed the standards of human advices, but they don’t fit into the category of fiduciary, and therefore won’t be held to the same regulatory standard that humans advisors are. Nonetheless, they are subject to systemic risks and the potential for abuses that can hurt consumers. Professors Tom Baker and Benedict Dellaert offer a regulatory trajectory to follow as the technology of robo advisors continues to develop and expand.

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  The Presidency, Congressional Republicans, and the Future of Financial Reform

  Peter Conti-Brown

  This brief examines the tension between the Republican ideological commitment to curbing executive power and the opportunity Republicans now have for Trump to dominate the direction of financial regulatory reform. The discussion will focus on three key policy outcomes that Republicans have sought during the last six years: reforming the Federal Reserve, overhauling the Consumer Financial Protection Bureau, and changing the way in which the nation’s largest financial institutions are designated and regulated.

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  The Economic Realities of Replacing the Affordable Care Act

  Hanming Fang

  Using simulations based on a new economic model, this brief empirically examines the pivotal mechanisms of the Affordable Care Act, such as the individual mandate, employer mandate, and premium subsidies, to inform the debate over repealing and replacing the Affordable Care Act. The research suggests that the ACA, if left intact, in the long run significantly reduces the uninsured rate. The simulations also suggest that the employer mandate is not a crucial pillar for the success of the ACA. The analysis indicates it is the premium subsidy, rather than the employer mandate or the individual mandate, that is crucial for the success of the ACA, in terms of expanded coverage. The brief concludes with a look at the key elements of the main legislative proposals Congressional Republicans have offered to replace the ACA, including the American Health Care Act.

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  Before International Tax Reform, We Need to Understand Why Firms Invert

  Michael Knoll

  A wave of corporate inversions by U.S. firms over the past two decades has generated substantial debate in academic, business, and policy circles. The core of the debate hinges on a couple of key economic questions: Do U.S. tax laws disadvantage U.S.-domiciled companies relative to their foreign competitors? And, if so, do inversions improve the competitiveness of U.S. multinational firms both abroad and at home? This brief, summarizes both old and new research that views these questions through the lens of corporations’ global effective tax rates (ETRs), and finds that the stronger case seems to be that U.S.-domiciled corporations are often tax-disadvantaged and that they can improve their competitive position by inverting. Additional evidence also suggests that U.S. MNCs can increase their after-tax cash flow by inverting. Inversions indicate that something is fundamentally wrong with the tax system. The brief concludes by discussing two feasible paths forward for reform.

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  Why Taxing Carbon May Not Make the World More Green

  Serguei Netessine and Sam Aflaki

  Although taxing carbon is an idea that enjoys significant support among policymakers and business leaders, new research indicates that carbon taxation can actually cause energy investments to gravitate away from the cleanest energy technologies. This counterintuitive finding reflects two key characteristics of energy markets: the worldwide increase in renewable energy sources whose output is intermittent and variable; and greater market liberalization, which has made the spot driving of electricity more volatile. The intermittency of renewable energy sources requires backup generation, typically from generators using fossil fuels. The dynamics of market liberalization amplify this negative effect of intermittency. Policymakers need to take steps to reduce intermittency by supporting storage technologies or setting monetary incentives to increase renewable generation capacity investment.

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  An Updated Look at Student Loan Debt Repayment and Default

  Laura W. Perna, James Kvaal, and Roman Ruiz

  Over 41 million Americans now owe more than $1.2 trillion in outstanding federal student loan debt. Policymakers are considering a number of amendments related to federal student aid programs in the context of the Higher Education Act reauthorization. In addition to providing a snapshot of key data related to student loan debt that all policymakers should consider, this brief discusses recommendations for facilitating repayment and curbing defaults on student loans, including: protecting students from low-performing institutions; encouraging use of forbearance and deferment mechanisms; and strengthening income-driven repayment options.

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  Addressing Personal-Income-Tax Manipulation with Tools from Psychology

  Alex Rees-jones

  In order to better understand the tax manipulation decision-making process—both legal uses of tax deductions and illegal tax evasion—this brief looks at the impact of gain/loss framing. Analysis of tax data confirms that tax decisions are influenced by “loss aversion.” For instance, taxpayers are more likely to pursue tax reduction activities when they make a loss smaller, as compared to when they make a gain larger. The brief looks at tools that policymakers have at their disposal for both deterring tax evasion and making exiting tax incentives maximally effective. The brief discusses instances when such gain/loss framing interventions might be deployed, and provides estimates around the size of the revenue responses they may generate. The author estimates that if tax filers who face losses experienced the lower motivation to manipulate shown by those facing gains, annual tax revenue would increase by $1.4 billion. Even attempts at marginal interventions, though smaller in predicted effects, might be financially worthwhile.

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  The Issue at the Heart of America’s Great Unbanking

  Lisa Servon

  Consumer protection regulation targets services like payday lenders under the presumption that these services can be predatory and associated with high costs. Yet an increasing number of Americans are utilizing such alternative financial services and joining the ranks of the “unbanked” and “underbanked.” Altering this status quo and promoting greater middle-class stability will require that policymakers foster innovation in the development of high-quality, transparent, and consumer-oriented financial services within the mainstream banking system.

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  Lessons for Policymakers and Regulators on the (Predictable) Future of the Digital Economy

  Kevin Werbach

  The next stage in the evolution of the digital economy involves the creation of what can be called the “Internet of the World”—an expanding web of transactions, anticipated today by on-demand platforms such as Uber and Airbnb, that eventually will occur across trillions of networked devices and penetrate every sphere of human activity. This brief looks at the many legal questions raised by these novel services, in particular, at the regulatory classification of on-demand services, as well as the application of antitrust provisions, the imposition of taxes and fees, and the assignment of liability to these new platforms.