The Bob Zadek Show

Thomas Jefferson observed, "When government fears the people, there is liberty. When the people fear the government, there is tyranny."

Which of those two are we experiencing today? Does the government fear us, or do we fear the government?

Nothing personifies the threat to individual liberties more than the Internal Revenue Service, the agency which enforces the Internal Revenue Code and other federal statutes dealing with taxation. The IRS has just been given funding by the Biden Administration and the complacent congress to hire 87,000 agents to enforce the Internal Revenue Code.

But don't worry. They won’t collect additional taxes from anybody earning less than $400,000 a year (or so they promise).

Ashley Varner is Vice President of Communication and Federal Affairs with the Freedom Foundation – not just a think tank, but a battle tank, taking on Big Unions, Big Government, and anything that threatens our individual rights.

Today, Ashley will help us understand what this additional IRS hiring actually means to us common folk.

The Bob Zadek Show is the country's longest running libertarian broadcast – nationally streamed at 8 AM PT Sundays. Subscribe for weekly transcripts, book summaries and additional resources:

Links and Resources

* freedomfoundation.com

* The Two Faces of Janus v. AFSCME

* A Teacher’s Brave Stand Against Her Union – Rebecca Friedrichs and Terry Pell

Transcript

Bob Zadek: Tell us a bit about the Freedom Foundation.

Ashley Varner: Well, like you said, we're a battle tank. We don't write all that many white papers – not that there's anything wrong with that, but we really see our mission as helping free taxpayer-funded employees in the public sector from union tyranny.

We have seen union bullies up and down the West Coast in particular, all across the country. They get power and they maintain it by taking money out of taxpayer-funded paychecks, siphoning it off to their favorite politicians’ campaign coffers. And it's a vicious cycle. The politicians are bought and paid for. They then give money back to the unions. They grow the government. The government, when it gets bigger, it only means less liberty for you and me. And the cycle continues as it goes.

We stand simply to give people the choice to let them know about their rights. If they are a taxpayer-funded employee, they do not have to pay those union dues. They will be lied to. They will be coerced. They will be bullied. We're here to give them support. We even have a legal team to take on legal action on their behalf.

Bob Zadek: We will not cover in detail the tens of thousands of pages of the Internal Revenue Code. We will cover in some detail what the Biden administration has done to rearm the Internal Revenue Service by building in to current legislation- Yes, it's already been signed- the funding to provide 87,000, give or take, new agents to enforce the statute.

Now first, there is, of all things, a union component in this legislation. Unions are in your crosshairs at the Freedom Foundation. Tell us why in discussing a piece of legislation and appropriation to provide funding for 87,000 new Internal Revenue Service agents, what is the union component of all this? Why must we talk about public service unions in this conversation?

Ashley Varner: Well, because, Bob, government sector employees are the single biggest funder of radical leftist politics in this country, and they have a guaranteed revenue stream because they have a huge workforce. The government workforce is out of control. We've got a bloated government workforce. The vast majority of those people have to pay union dues because they don't know they have an option. That taxpayer dollar, that's your money. That's my money. It's not just given to people by the government. The government doesn't create any money. That's ours. So, we are paying union dues against our will, and all of those dues are then going to be turned into radical leftist politics to take more government control out of our personal lives.

But it starts with union membership. That is why it's so important that unions continually try to grow the government workforce. These 87,000 IRS agents are a guaranteed new crop of people who are going to pay into the union dues campaign coffers.

The Difference Between Public and Private Sector Unions

Bob Zadek: Those unions have an advantage that no other worker has. If they want a raise, all they need to do is to have the legislature enact legislation and they get a job and get a raise and we have no choice. Imagine if a private sector company could enact legislation to compel you to buy their service or buy their product.

Explain to us this incestuous relationship between public service unions – unions who represent workers who work for the government – why those unions have advantages baked into the system that other workers don't have.

Ashley Varner: Sure. It's an important distinction, Bob, the difference between public sector unions and private sector unions because, as you said, a private company has shareholders that they are beholden to. They have customers that they have to provide a product we want to purchase. Even private membership organizations, they have to prove to you that their membership offers you something that you want to pay for. This is the reason that Franklin Delano Roosevelt, that champion of small government – loved private sector unions. FDR was against the public sector unions because he said it was inherently unfair for union representatives to sit across the table from the politicians whose campaigns they directly support without the representation of the taxpayer who funds it all, they're at the table to negotiate. That is the big difference.

“FDR was against the public sector unions because he said it was inherently unfair for union representatives to sit across the table from the politicians whose campaigns they directly support without the representation of the taxpayer who funds it all.”

When the government employees come to the leadership in the House and Senate, they say, "We want to get this inserted into the next omnibus bill – don't forget how much money we gave you. Don't forget that you're in leadership because we bought enough of your member's campaigns to put you in the leadership, to put you over the top. Remember where your money comes from.”

That's why when President Biden was campaigning in 2020, he told several union outfits when he was on the campaign trail, “I'm going to be the most pro-union president this country has ever seen.”

It's one of the few campaigns promises he's actually done quite well. But the unions have power because they can go to the Speaker of the House or the Majority Leader of the Senate or the President or the CDC in the Teachers' Union's case, and they can say, "Remember who put you here, and if you want to keep your position, you're going to do this. You're going to give us this new crop of dues deductions."

The Magnitude of Collusion Between the IRS Union and Democratic Party

Bob Zadek: I suspect you have the statistics, but how active was the Internal Revenue Service Union in drafting and adding these provisions to a piece of omnibus legislation? Was it incidental? Was it moderate? Help us understand what role they played that if one wants to be cynical, this is nothing other than pro-union legislation dressed up as trying to eliminate tax cheating.

Ashley Varner: Bob, that is an interesting question, and it's not something that people have talked about long enough because there's always a new debacle that Congress raises our taxes for or spends billions of dollars we don't have. I would love for us to be able to look into the Freedom of Information Act request to see the kind of communication between the IRS and the Department of Treasury and the leadership in the House and Senate and the Biden administration. That's what is probably going to have to happen in order for us to actually get a better idea.

Much like we found out about the communications directly from the Teachers' Unions to the CDC to keep schools closed longer during COVID, we found direct emails from the CDC asking the Teachers' Unions, how would you like this to be written. We had to get that through a Freedom of Information Act request and several organizations were working on that. It took some time, but I still think that's something that is very important to try to get some FOIA request between the Department of Treasury and the current leadership or the previous leadership in Congress prior to this election in the Biden administration. But you have to think, even if it seems minimal in the amount of emails that go back and forth, the politicians know that 87,000 IRS agents at an average of $800 to $1,000 in dues a year, that's a lot of money that they know is going to go in one direction.

Bob Zadek: What you have just tossed out as a throwaway statistic is that if one does the math, $8,000 in dues times 87,000. We just enacted legislation to provide that much money to a union. That's what we have done. There's not an incidental but a direct relationship between the federal government and the union coffers in forcing the government through a middleman called the union member. But the union member is only a middle person conveying money from the government to the union worker by hiring them and then right back to the union as the union gets their cut. So, we have implicit in that legislation is that long division, that very large number of wealth transfer from the government directly to the unions. For sure, unions made that calculation as they sat around clapping their hands and supporting this legislation.

Ashley Varner: That explanation is absolutely spot on but I only want to correct the math. The average yearly union dues is between $800 and $1,000. Not $8000, just to be very clear. But say it's $900 per federal employee and we've just hired 87,000 people times 900 union dues dollars a year. Yeah, that's a significant amount of money that's being funneled to Democratic campaign coffers through the taxpayers.

Bob Zadek: When you say Democratic campaign coffers, just to state the absurdly obvious point that unions are almost a chapter, a subset of the Democratic Party. Now I say unions, not necessarily union members. Remember, Jimmy Hoffa and Teamsters many, many, years ago were profoundly pro-Republican. So, the union members may vote differently than the union itself, but the union itself, which is more involved in its own prospering and surviving, even though it may not benefit the members, it benefits the union. Those are different benefits.

The union, as opposed to the membership, is profoundly Democratic because the Democrats have been their sugar daddy for oh so many years. So, the unions in general may not be representing the desires of the union members. I know Freedom Foundation and many other organizations, including an organization called the United States Supreme Court, have taken some steps to eliminate the requirement that union members support the unions if the unions are espousing political positions the members don't support, that's a whole other topic. We are not going to cover that today, but that relationship exists.

What 87,000 New IRS Agents Means for YOU

Now, as to this piece, this abomination of tax legislation, the Biden administration has promised, "Don't worry. We will not use any of this money. Any of these 87,000 new agents, we will not assign them the task of collecting taxes or enforcing taxes or auditing taxpayers who earn less than $400,000 a year." Now, I haven't read the whole legislation, nor have you, Ashley. I suspect you have a life, but Biden has made a promise, sort of I'm reminded of, "If you like your private insurance, you can keep it. If you like your private doctor, you can keep it." Remember that representation only a decade ago? Well, now Biden says, "If you like your tax loophole, you can keep it. If you earn less than $400,000." Is that anywhere to be found in the legislation? What is there that anybody can do to enforce that promise in the legislation?

Ashley Varner: That's a very good question, Bob, and honestly, I don't have an answer for you. Again, I haven't read the whole thing and I don't know how many people have. That would be a good research project. But we know the facts here. The past numerous years, whenever we are told that taxes are going to go up, but only on the wealthy, it's not going to impact those under $200,000, those under $400,000, Joe Biden has said a $200,000 figure just in the past couple of years, and we have found that taxes impact everyone. Inflation is a tax on everyone. The $200,000, that impacts every single person. Because when prices go up and businesses have to pass along the cost and then that's why Cardi B is talking about how lettuce has skyrocketed in recent weeks. So, we know not to trust them when they say don't worry because they've given us reasons not to trust them recently.

Bob Zadek: Well, it has been observed that although Biden has represented- a legal word, I don't think it's too strongly- represented none of the money will be used to audit taxpayers earning less than $400,000 a year. That was akin to George H. W. Bush, "No new taxes. Read my lips," and how vacuous that promise was. It was rejected as soon as the legislation was enacted. Well, Biden has made a representation which, of course, nobody can tell if it's true. It's impossible. The IRS doesn't keep those types of records.

But one thing is for sure, there is nothing in the legislation, which is the real acid test, that requires that even a dollar of this new $80 billion expenditure be used to enforce the tax law against rich taxpayers, whatever that may mean. So, if Biden made a promise, his promise is unenforceable, just as Obama's promise, "If you like your doctor, you can keep it." Just like that promise is absurdly unenforceable, has proven to be unenforceable, Biden's promise is unenforceable. If anybody out there in my show listening to this show happens to earn less than $400,000, no, you cannot breathe a sigh of relief.

And we also have some statistics. I'm a graduate of Syracuse University. Syracuse University, an incredibly mediocre college in upstate New York, has an organization called the Transactional Records Access Clearinghouse, TRAC to its friends. Syracuse University's TRAC just released data for fiscal 2022. Just this past year, it just ended. The statistics show that the typical audit by a revenue agent was heavily tilted toward auditing low-income taxpayers. The IRS devotes most of its energy not to wealthy taxpayers, but to low-income taxpayers because it's human nature. That's the low-hanging fruit. It's easy to find lots of money so they can close the file on a taxpayer and show they got some money from the taxpayer, and therefore their statistics go up. Statistics show that human nature within the Internal Revenue Service, human nature demonstrated by their behavior, it's trustworthy that they tend to devote most of their attention to low-income taxpayers.

Now, they will say, "Well, no, no. We start audits on wealthy taxpayers. Here are the numbers." Well, the statistics demonstrated by TRAC at Syracuse have shown that when the IRS says, "We audit wealthy taxpayers," they include as a statistic in that sending out a letter, "Can you come down to visit us or send us some backup data?" They include that to be an audit so they can cook the books. What we have is we have a piece of legislation that, unlike the vacuous unenforceable promise of President Biden, it will produce aggressive enforcement, just a continuation, aggressive enforcement of lower-income taxpayers, which means in effect, those low-income taxpayers end up paying more taxes, obviously. Now, which means it's a tax increase on low-income taxpayers, again violates a Biden promise. Now, Ashley, you are going to chime in and say my favorite thing, which is, "Bob, you're right." So, go ahead.

Ashley Varner: Bob, you're right. You're right. The IRS has been used as a weapon by both parties. They use the tax system to give perks to their favorite voting blocs in the way of subsidies, handouts. They also use the tax system to punish their political enemies. What you just said at the end, when it's going to be a tax increase on lower-income people, part of that is because lower-income people don't have accountants that they pay hundreds of dollars per hour for to go through all of their books to make sure that they find all of the legal loopholes. That's why people were saying Warren Buffett pays less in taxes than his secretary. We just found out that Donald Trump paid less in taxes because he took every available loophole. That's both parties taking advantage of the system based on what kind of accountant help they can afford.

But also, we have seen in the not-very-distant past, the IRS being used as a weapon against who they perceive as their political enemies. Do we all remember Lois Lerner from 2013 with the Tea Party organizations that couldn't get their tax-exempt status because there was a campaign at the IRS to slow roll these organizations so that they couldn't have any measurable impact in the 2012 election? Lois Lerner hasn't paid a price for that today. She had her pension, her golden parachute, and she hasn't been called to Congress to explain anything in years.

Thank you for reading Essential Liberty. This post is public so feel free to share it.

Is it Unpatriotic to Take Advantage of Tax Loopholes?

Bob Zadek: It's interesting that you mentioned. He invites himself to a lot of my shows, former President Trump, and you just crashed my show with your unannounced guest, Donald Trump? But yes, you are correct. Trump's tax returns, in a violation of clearly established norms, his personal tax returns have been made public, albeit with some redactions, but for the most part, made public. There was collective outrage on the left because he paid so little in taxes! For some years, he didn't pay any taxes! Well, he didn't pay taxes because there's no accusation, he broke the law. He didn't hide income. He didn't underreport his cash tips. What he did was he took advantage of provisions in the tax law enacted by our legislature. He took advantage of them the way I take advantage of my $10,000 deduction for home mortgage interest. Is that a loophole? Well, heck no. I'm allowed to do it and I did it, and I pay less taxes as a result.

When these public figures who have substantial income, it's disclosed! that they pay very little in taxes, all they did was take advantage of the law. That's all they did. Now, if they cheated, a different subject but there's not been that accusation. So, to say that wealthy people have loopholes, yes, they have loopholes given to them by the government. They didn't seize them in an authoritarian way. They were given that by the Congress. Anyone in Congress who complains about how little wealthy individuals paying taxes have only themselves to blame, they or their political body enacted the legislation. How is that a reflection on the honesty or the integrity, the patriotism of a wealthy individual to simply take advantage of that which the law allows? Ashley?

Ashley Varner: Wow, that's a good question. I mean, I don't think that it necessarily makes you a more loyal or patriotic person to want to hand the government more money to do with as they please rather than what you would wish. Personally, with my libertarian streak, I think that we should have a lower tax base so that people can afford to give to the charities and the private organizations that they choose, and that you don't have to have two-parent households because they have to have two parents working in order to pay the tax bill that comes at the end of the day. We're sending billions to another country to take care of their border, and we haven't sent any to our own border. 

There are all kinds of things that people across the country of varying political persuasions have been asking for a change in the government, reforms in the government. No one asked for these 87,000 IRS agents unless it came from the unions who wanted to broaden their dues deductions. No one wants this. No one needs another army of tax agents coming after them. It really is, going to your point in the very beginning, is the government afraid of the people, or are they giving the people more reasons to be afraid of crossing the government?

The History of the Income Tax

Bob Zadek: I'd like to spend some time, since we are discussing the federal income tax, and I know Freedom Foundation has resources available to help our listeners understand more, but I'd like to visit for a few moments the history of income tax. It's quite an interesting history, and there are lessons from that history. I start with- I'll share with my listeners, my personal observation, and that is that the founders delivered to us a Constitution in 1787 with a Bill of Rights, even though the Bill of Rights wasn't enacted until 1791, if I'm not mistaken. But the Bill of Rights, which was an amendment to the Constitution, it really wasn't quite amendments as we understand the word, because it was generally understood in the ratifying conventions, certainly in New York and certainly in Virginia and in other states, colonies in the New England that they would not vote to ratify the constitution without a Bill of Rights. So, the Bill of Rights was an add-on, but not quite an amendment. So, I'm going to refer to amendments to the constitution. I exclude the Bill of Rights, and I'll also exclude the Civil War amendments which, in another way of speaking, that was the unfinished business of the founders. The founders knew inevitably there would be something like the civil rights amendments, the 13th, 14th, or 15th amendment. They just concluded, when I could have discussed it on the show, that the country wasn't ready in 1787 to deal with slavery. Okay, that's the starting point.

My conclusion, almost all of the amendments, the structural amendments to the Constitution, such as the income tax as the 17th amendment, which provided for the direct election of senators contrary to the founder's wishes, and those two amendments followed each other income tax and 17th amendment, most of the amendments made the Constitution worse. That's my premise. I haven't done a math count, but that's my starting point. I'll exclude also women's suffrage as part of the Civil Rights amendment until later. That fixed a problem that had to be fixed, obviously.

But as to issues like the income tax, the income tax was expressly- not by implication, not by reading between the lines, was expressly forbidden by the founders. They feared giving the federal government the excessive power it would have if it could directly tax the people. The power to tax in the Constitution was only the power to levy a tax which was borne equally by the states so that you couldn't have a different tax rate. You had to have each state paying, in effect, the same system of taxation. That's the starting point. That worked fine. There was a temporary income tax during the Civil War. It existed for a short period of time. Then, it was promptly repealed.

The first permanent income tax in 1913 required the Constitution to be amended. The founders were so fearful, they made it unconstitutional. Not generally known that we needed the 16th amendment to the Constitution to make the income tax constitutional. So, embellish that if you would, Ashley, because I know you and your organization have commented quite a bit on that. Tell us about the early history of this, at that time, somewhat radical and very modest proposal to tax a handful of Americans to tax their income.

Ashley Varner: Yes, well, I mean, the obvious thing is our founders would be appalled to see the tax system we have today, what the IRS is doing today, the fact that the government spends so much of our money on projects that they never foresaw the government doing. To your point about the Bill of Rights, the first ten were negative rights that the government couldn't do. They were protections for the people against the overreach of the government, so many of the amendments that came after that, like you said, taking out the Civil Rights amendments. But like the 16th amendment, the 17th amendment, prohibition, they then became things that the government was encroaching upon us. The 16th amendment is a perfect example. I mean, the founders fought a revolution for less than what the IRS does to us on a regular basis. The 3% tax on tea, or maybe I don't have that percentage correctly, but amongst other things that the king was doing, we knew that we did not want a government who could demand so much money from us without giving us the proper representation for how they were spending that money.

They also understood that a progressive tax inevitably leads to a war by the poor against the rich. That's how they pit our two groups against one another. It's fueled by politicians who claim that successful people didn't build that, or they don't pay their fair share and that we should tax the rich. I am glad that you brought up the fact that we actually repealed the first income tax after the Civil War was over, but the Supreme Court actually struck down the second income tax that was established. They struck it down in 1895 because they said that it needed to be a tax that was equally borne by the people. So, to your point, from 1895 when the Supreme Court struck down the second federal income tax to 1913, I guess they had to come up with different percentages. But that first income tax levied a 1% tax on personal income greater than 3%.

At first- I have some notes here to help me get it right, but one of the people who was discussing the income tax said, "Well, I'm okay with passing a tax that is above $4,000 income because nobody here has a $4,000 income." That's where it began in the very early days of our politicians discussing an income tax because they saw it starting to encroach even then. "Well, nobody here is going to have to pay for that. So, we'll let the upper income; upper echelon people carry the heavier burden."

It only took one generation to hike the taxes sky high, and I'm sure you have it here, but under President Roosevelt, he hiked the income tax to 79% of your income and then later to 99%. He wanted to go after a 99% income tax. That is insane. It never would have passed muster with our founders.

Bob Zadek: Of course, the tax the rich concept, it has the clear implication that there's something inherently improper about the very concept. Elizabeth Warren and AOC abhorred the very concept that there are- and Bernie Sanders, of course, that there are rich people, and the income tax is the tool by which people who are successful get punished. I invite the audience, if you want to go on a flight of fancy, just imagine what would the country be like without an income tax. Remember, our country had a period of great economic growth. Growth is a word that's abhorred these days. It's not, in eyes of many people, a legitimate goal in itself, mere economic growth. But of course, economic growth gives us a better standard of living, a healthier standard of living, a happier standard of living, and the like, of course. Somebody has to invent the stuff that makes our life better, and that's growth.

But we never enjoyed, except perhaps in a period of time after World War II, such sustained economic growth as the period after the Civil War and until the income tax, and in the first few years after we had an income tax. There was sustained growth. Somehow, this country managed to enjoy economic growth, which means a better standard of living, longer life expectancy, all that comes with it without an income tax. So, it's not an absurdity to imagine a world without an income tax, without punishing the activity of earning money. Because remember the core principle of taxation, the more you tax something, the less you have of it. Therefore, the more that you tax income, the less income that's produced. Well, who suffers? Where does the money come to hire people? It comes out of earnings, comes out of income. Do we want a life without income and therefore without growth? The message of an income tax is, "Let's tax the activity of earning money." It's like less tax breathing and make people cut their breathing in half and we'll have more money. That's the concept of income taxation.

So, here we are with the Biden administration, allocating 80 plus billion dollars to the Internal Revenue Service. The reason I asked Ashley to join us for this hour is because the Internal Revenue Service is special in a bad way, in my opinion. What makes it special? It is the only federal agency that has its goal, taking property from people who did nothing wrong. It's the only agency that does that. We are allocating huge amounts of our treasure to an agency whose sole purpose is to take away property lawfully obtained by citizens who broke no law. Of course, we have other agencies. We have law enforcement agencies who punish people and protect us from somebody else doing us harm or our property. But somebody else earning money is not a threat to me. And yet, we are giving money to the one agency that has as its purpose taking property from people who did nothing wrong.

I think that's what the founders feared the most. That's the tax collector, that's what it does. There are plenty of other taxes where the tax is paid voluntarily. Sales tax, when I go to a restaurant and I get the check and there's a little number at the bottom for sales tax, doesn't make me resent the restaurant. It doesn't make me wish I hadn't eaten there. I understand, I make a decision to buy a meal or a car, and I make a decision knowing full well there's a tax for doing that. It's an excise tax. It's a tax on activity. You don't want to pay the tax? Don't do the activity. I think, Ashley, the evil- evil is not too strong a word, of an income tax is it's a tax that takes property away from people who did nothing wrong other than crash into a piece of legislation whose only purpose is to take property.

Ashley Varner: Well, once again, you're right, Bob. I also want to say to add insult to injury, the taxes that have to be raised in order to pay for those new 87,000 IRS agents are going to be used as political speech when they are funneled to government employee unions. It's going to benefit one party because the IRS Union is part of the Department of Treasury Union, and it gives 100% of its donations in the last several cycles to the Democrat Party. The Democrats are not necessarily known for wanting to give tax breaks or lower taxes, but they also want to grow government in order to grow government employees, to grow their union coffers that then benefit their campaigns. It's again the vicious cycle.

I'm just very fond of reminding everyone within my listening voice, this is your money. This is your money, Bob. This is my money. This is everyone in your audience's money because the government does not create money. They may print money, but they don't actually create money that is gained, that is created by you and me. When they spend millions and billions of dollars of our tax dollars, they're taking it out of our mouths and spending it eventually for their own political purposes whether or not we agree with that political speech.

Bob Zadek: This is in effect- and the Supreme Court has spoken on this. This is in effect taxpayers in our country are, in effect, forced to give money, albeit indirectly, so that another organization can promote a political system that we oppose. Imagine if a statute was passed that required every American to give $200 to the Democratic Party or Republican Party. And this legislation, Ashley, as you have pointed out, in effect does that. There's no question that that's exactly what this legislation does.

Ashley Varner: You're right, Bob. That's why the Freedom Foundation is so passionate about helping people understand. If you work for the government and you don't want to pay these union dues, which amounts to political speech in your name with your paycheck, you don't have to pay it. The Supreme Court weighed in 2018 and said, "Union dues are political speech. Public sector employees should not be compelled to fund union activity against their will." But so many people don't know that because the unions certainly aren't going to tell them. So, the Freedom Foundation has taken it upon ourselves to try to reach out to every government employee in the country.

To your point about Democrat or Republican, we hear from Democrats all the time who may be union members. They tell us, "I may support Planned Parenthood, I may support the ACLU. But why don't I get to choose how much of my money to give to that organization rather than having the union take it out of my paycheck before I even get to see it and then give it to the organization?"

So, it really does run across the political gamut. We just have people, in times of inflation, they want to keep more of their dollars so that they can buy more groceries and put more gas in their car, or they're not political at all and they just don't care or don't want to pay attention, so they don't want their money to go to it. Or they might even be on the left side of the aisle but they say, "Meh, I'd rather decide how much to write on that check."

Bob Zadek: The case that Ashley referred to in 2018, most of my listeners will know this, the Janus case. The Janus case was decided by the Supreme Court in 2018, which held that only with respect to public service unions, think Teachers' Unions, public service unions, the union members who are required by the employer through legislation to join the unions as a condition of employment. That means it's the government acting. The government therefore was prohibited under Janus to compel union members to pay dues to the extent that those dues support political speech they don't oppose.

Those of you who really follow the Supreme Court will remember the Janus case followed a very interesting case called Friedrichs, Rebecca Friedrichs. Rebecca was on my show in about 2016 with her lawyer.

She was about to go to the Supreme Court. She was a teacher in Southern California, and she brought the first case. It was quite interesting because she brought a case on the same principle, compelled speech, and it was about to go to the Supreme Court. You may recall that the Supreme Court heard an argument. It was very clear that the Supreme Court was going to decide 5-4, Scalia was on the Court, against the union. Scalia, as you recall, died in an accident visiting in Texas. Therefore, the Supreme Court was then tied 4-4 on the Friedrich case. The case was then sent back down because the Supreme Court couldn't decide. So, the Janus case, a very interesting story, was then brought up by those people who opposed compelled speech. The Janus case was kind of Friedrichs II, and that held, as Ashley said, 5-4 that you could not compel public service workers. This doesn't apply to the private sector, at least not yet, but it does apply to public service worker unions. Now, was Freedom Foundation involved at all in the Janus case directly?

Ashley Varner: We were not. It was Mark Janus. He was a public employee out of Illinois. So, we were not involved with Mark. We have worked with him since then, but since June 2018, people kind of anticipated that this was the way the Court was going to go. So, we had a national campaign ready to go, and we started the Freedom Foundation. freedomfoundation.com started in Washington state and then we have since moved into Oregon and then California and we’ve since moved across the country. But since Janus in 2018, we've helped 132,000 people leave their unions, stop paying dues, and that has cost the unions $267 million that the government employees, taxpayer-funded employees, get to keep in their own pockets.

Bob Zadek: You go, Freedom Foundation, you go. Thank you for that well-deserved plug on the Freedom Foundation. As we wind down, one postscript on the Biden legislation that allocates $80 billion in legislation that has been signed. The Republicans, if they can get their act together, a big if, the Republicans in the House, which have control over the purse, do have the power. Whether they exercise it intelligently or not remains to be seen but they have the power since they can appropriate the money that's been budgeted for the IRS, and they can direct the IRS on how to spend and how not to spend the $80 billion. So, there is hope even though the legislation has already been enacted.

By the way, as to the great majority of our listeners who make less than $400,000 a year, if you think you're home free, remember that during the Biden administration, there was another underreported bit of legislation that requires anybody being paid more than $600 a year through cash apps such as Venmo now must report and Venmo must report. Can you imagine how many people out there don't get $600 a year on Venmo? Everybody will have to report their transactions to the IRS and Venmo will report.

Do you think the IRS might be using those reports to assess taxes against those people? If the answer is a reluctant yes, which segment of the population, the under $400,000 crowd or the over $400,000 crowd is more likely than not to be paid through Venmo? I doubt you mentioned Warren Buffett, that Warren Buffett gets substantial income through his Venmo account, just as I doubt you mentioned Donald Trump, I don't know about him so much, but he probably doesn't either. So, here we have yet another piece of legislation that is 100% targeted toward those people least able to protect themselves.

Ashley, you at the Freedom Foundation are truly doing God's work in trying to protect us from the leviathan of the Internal Revenue Service. How can our audience follow the work of Freedom Foundation, can support you, can become active, and can volunteer to work for you for free because you're doing such important work?

Ashley Varner: Well, thank you so much, Bob. This has been a true pleasure. freedomfoundation.com, we've got a donate page there at the top if you'd like to help us. We have over 80 cases against labor unions right now that won't let people stop deducting dues. And we do that for free. We do not charge our clients. 80 cases against unions get pretty expensive. So, if you wanted to donate to that cause, freedomfoundation.com. We have an email. Sign up for an email, get our weekly updates so that what we're doing. Follow us on Twitter and Facebook. If you're a government employee, optouttoday.com. It's an interactive map. You click on your state, you click on your union. It self-populates a letter that you send to your union saying, "I want to opt-out of dues. I don't want to be a member anymore." We will help follow up with you on that, free of charge again.

Bob Zadek: Thank you so much, Ashley Varner of the Freedom Foundation, for sharing your thoughts with us on this really ugly portion of the Inflation Reduction Act, inaptly named, of course. Thank you so much for the work of the Freedom Foundation for helping us level the playing field. Thank you so much. Especially, thank you to my listeners for giving us an hour of your very valuable time. We hope you have found it worthwhile.

Ashley Varner: Thank you.

This is a public episode. If you'd like to discuss this with other subscribers or get access to bonus episodes, visit www.bobzadek.com/subscribe

Ashley Varner of the Freedom Foundation on the financial boon to the Democrats; Looking around today, do we see evidence that the government fears the people? Why should they?Remember when Lois Lerner targeted Tea Party freedom activists as head of the IRS? She retired with a full pension and never bore any consequences for weaponizing the agency she led against ideological opponents.More recently, the Biden administration was fearless enough to pass the so-called “Inflation Reduction Act,” which included a provision for hiring 87,000 new IRS agents. To quote Jefferson again, in his complaints against the Crown, “He has erected a multitude of New Offices, and sent hither swarms of Officers to harrass our people, and eat out their substance.”They say the new agents will “mostly provide customer service,” and that we need to spend $80 billion in order to raise $200 billion in new revenue. Does anyone believe those claims?But there is another sinister feature of the move to bolster the most reviled of all bureaucracies. The IRS represents the single largest federal public sector union lobby, and 100% of its political contributions go to one party (guess which). Ashley Varner of the Freedom Foundation joins me this Sunday to discuss the perverse nature of public sector employee unions, which can lobby the government for direct pay raises – all at taxpayer expense. Varner will explain how the vicious cycle of political privilege is perpetuated by public sector unions and their boosters in government.The Freedom Foundation is a “Do Tank” based in Washington State that is leading a national movement of workers who are opting out of their union dues.We’ll also discuss the unresolved IRS scandal of 2013, and the broader problem of public sector union influence – including the teachers union and their figurehead, Randi Weingarten. Finally, I’ll talk about what the founders would have said about our current tax system, especially the Income Tax.

This is a public episode. If you'd like to discuss this with other subscribers or get access to bonus episodes, visit www.bobzadek.com/subscribe

We all remember the bank bailouts of 2008, but almost nobody talks about the more recent COVID bailouts. $50 billion here; $25 billion there – pretty soon we're talking about real money. The airlines were one of several industries that enjoyed special treatment from the federal government on the grounds that they constituted an "essential business." What would happen if the airports shut down completely? Sounds scary.

But the airline industry was never at risk of disappearing, notes Veronique de Rugy, a senior research fellow at the Mercatus Center at George Mason University. In a series of policy briefs co-authored with air travel guru Gary Leff, de Rugy shows the colossal waste of taxpayer dollars that took place while no one was paying attention. Rather than re-organizing under Chapter 11 bankruptcy laws, as businesses do all the time, inefficient airlines were able to keep paying dividends to their shareholders while less privileged businesses went under permanently.

Now, politicians like Bernie Sanders are criticizing Southwest airlines for the debacle of its holiday cancellations (and he has a point):

But what else should we expect from an industry that makes money whether it performs well or not?

The Bob Zadek Show is the country's longest running libertarian broadcast – nationally streamed at 8 AM PT Sundays. Subscribe for weekly transcripts, book summaries and additional resources:

Veronique de Rugy is a nationally syndicated columnist who has frequently testified before Congress on the effects of the fiscal stimulus, debts, deficits, and the regulation of the economy — aka crony capitalism.

Veronique and I discuss the underreported—almost stealth—but massive bailout of the airline industry, which was part of the in aptly named COVID relief legislation. Veronique will explain the Faustian Bargain, which the airline industry has made with Washington, whereby the airlines sold to Congress—and for a substantial amount of money—voting control of their boards of directors. You thought it was immoral or if not illegal to buy the right to vote? Think again.

Links and Resources

* Veronique de Rugy, Reason Archive

* Moral Hazard: Airline Edition | National Review June 3, 2021

* The Economic Case against a Second Airline Payroll Bailout, Mercatus Study

Transcript

Bob Zadek: Veronique, welcome to the show this morning.

Veronique de Rugy: Thank you for having me.

Bob Zadek: Now, Veronique, the bailout, as I said in my introduction, has been underreported. I dare say, if you were to do a search bailout of the airline industry, you would not immediately find all of the legislation that was embedded in and an important part of the various Biden administration democrats only voting for it, COVID relief legislation. I don't recall ever hearing about the airline bailout. First of all, tell us the headline of how the COVID relief legislation amounted to a bailout of the airline industry and the magnitude, and then we will drill down and take it apart and see if it made any sense.

Veronique de Rugy: Yeah. So, the only thing I will correct from what you've said is that actually, it was quite bipartisan. Unfortunately, when it comes to bailing out and cronyism, Republicans are as terrible as the Democrats. They do it for different reasons, but the result is the same. So, as part of the Care Act, which was the first big, massive COVID relief bill, there was a $25 billion bailout which took the form of-- There were some tax relief, there were some loans, and there were some grants. They were done in a name mostly like the payroll protection program, if you remember, for companies in the name of actually trying to give an incentive for airlines to not furlough or fire their workers. And so, we got this massive bailout. And then, it was going to be for six months. It was an enormous amount of money for six months.

There were two other ones. Another $25 billion and another one was $15 billion, I think. Each time they were done, again, in the name of companies, airlines saying, "Well, the money you gave us was all great, but it's been six months now and the economy hasn't recovered, it hasn't reopened, people are still not flying as they used to, and we think we're going to be bailing out. We're going to be furloughing or we're going to be getting rid of people."

Another argument that was used and I suspect we're going to cover this later on, is the argument for keeping all these workers employed. Even though no one was flying or very few people were flying, was this notion that when the economy would recover, then the airlines would be ready to go. There'd be no gap between not flying and flying full time. That would help the economy recover. So, that's pretty much the layout of the land. I think altogether, it was close to $70 billion going to airlines. By the way, it is a tradition now almost that at every emergency, every crisis, the airlines are almost the first one with their hands out asking for a bailout.

How much did we spend per job saved?

Bob Zadek: Now, an interesting statistic. You probably have it at your fingertips. If not, we can pass over it is, if we start with the premise, this was done, so that there is continuity of employment. Of course, they could have laid off the workers and then pulled them back, but the workers would have found other jobs, different careers. And building an airline from scratch from a labor standpoint would be a challenge. So, there is something to be said for continuity. And the context I want to put this in, one can calculate how many jobs were preserved and how much did it cost. And then, with the complex device of long division, we can then calculate how much we spent per job to save the job. Do you happen to have that relationship handy?

Veronique de Rugy: So, it's complicated only because there were three different bailouts and each time the numbers were different. Also, the airlines are not super transparent about what they ended up doing. What I can tell you, the second bailout, for instance, the companies were saying, “If you don't give us a bailout, we're going to be furloughing." I think it was like 30,000 people or something like this.

Now, if you look at the average salary, actually, if you just assume like, let's say $100,000 a year, which I think is a little high. It's a little high for an average. But pilots make a lot of money and then there's a lot of people who don't make a ton of money. But to be conservative, let's say, $100,000 a year, this was a bail out for six months. So, $50,000 per employee to prevent furloughing them. And you multiply by $30,000 and then immediately you can see the $25 billion is at least 10 times more than what the airlines needed.

In the study that my colleague, Gary Leff and I wrote, we explain why airlines shouldn't be bailed out or, at the very least, certainly not bailed out from the get go. And then, we explain why the second bail out was just complete nonsense. In part, we were making the argument and we had the correct numbers. Basically, if you did this calculation, the bailout that would have been needed to actually keep these people employed would have been something like $2.5 billion and they ended up getting $25 billion as opposed to $2.5 billion. So, that means that basically, they were getting a lot of money in order for the companies to continue paying employees that they had no intention of furloughing. Hence, this is why we always say bailout of shareholders, it has nothing to do with employees.

The Nonexistent Crisis

Bob Zadek: Now, it's interesting that you mentioned bailout of shareholders, because that was exactly where I was about to go, as I was going to ask you the question where the answer, I think, would be a bit obvious to our listeners, but I'd like to hear it from your point of view as an economist. So, you're quite right. The money is a wealth transfer from the government, from all of us to the shareholders. Now, when shareholders invest in an airline, presumably, at least the theory is, you invest in a company, because you know there are risks and there are rewards. You have made or somebody has made for you a calculation that buying stock in Delta Airlines, the benefits outweigh the detriments, the risks. To some degree, either specifically or generally, one of the risks is, something could happen existential that will affect the airline's performance. It's built into the equation, more or less. Those of us who would like to think we have faith in the allocation of capital through the capital markets, we say, "Why are we bailing out shareholders since all that's happened is a risk that, whether they knew it or not, they were assuming it happened?" And so, there's a bailout.

Now, speak a little bit more about that about what that does, that kind of a bailout. And, of course, Veronique, I suspect you're going to mention moral hazard along the way. But I'll start with a question for which you will give, I think the audience will profoundly benefit. What's wrong, as a matter of policy, putting aside the fact the math doesn't work, as a matter of policy, our government trying to protect the airlines from this existential threat that nobody caused? Isn't there a public benefit that "justifies" the expenditure?

Veronique de Rugy: Yes. The answer is no. Let me answer your question and why I think it is no. First, it is not the role of the government at a principal level to actually go and bailout private companies, big or small. In the case of airlines, they had a lot of options that were available to them in case they hadn't been bailed out before they would have to actually close the airline altogether. In fact, they did, but they would have been able to tap into their enormous assets to tap into the capital market. By the way, the capital market was functioning quite well because of the intervention of the Fed. They could have actually filed for bankruptcy and they can still fly during bankruptcy. Airlines have done it many times and got out on the other side stronger. 

They could have tapped into their enormous mileage program, which basically would have allowed them to, again, tap into an enormous amount of capital. There were a lot of things that could have been done by the airlines. And in fact, it should have been done by the airlines, who, by the way, I had had the 10 years before the pandemic. Their best profit ever. And so, they were flushed. And the capital market was, again, thanks to the Fed, was ready to lend. They were able to tap into those capital assets, use their own assets, declare bankruptcy. There's just a lot of things they could have done.

Now, the other thing is, this notion that somehow any airlines who cannot sustain an emergency like this one would come to disappear, means some sort of catastrophe for the US that justifies the government stepping in. By the way, I checked the number, and it was $54 billion over the course of three bailouts. It was supposed to be $75 billion, but in the end, it was $54 billion that justified that enormous amount of money for really, actually, really big in rich companies is nonsense. When a company has to close down, it doesn't mean that there won't be any planes to fly in the US. This company is going to be bought by another company. Their assets are still going to be there and bought by other. A new company will emerge and all will be fine. The disappearance of a weak airline, that certainly does not mean that Americans won't be able to fly, there will be no more American Airlines. It's nonsense.

Now, I think there's a much more credible case, at least, for some level of bailout originally, simply because the government shut down the economy. But still in this case considering how many different steps were available to airlines before they had to really sustain any source of real damage, I still think that even that argument is weak. I would say that, again, arguments for bailouts are always done in the name of workers. "Oh, we need to do it to preserve workers." But all that it's doing really in the end, because it is stepping in. The government is stepping in in place of the shareholders who, as you've said, are calculating risk and investing in the airlines. For the most part, they're actually doing pretty well with their investments and it's their job when you invest somewhere, it's not just in an asset. It's not just for when times are good. It's also when times are bad. That's the assessment of the risk because the government steps in and basically takes the burden away from shareholders, effectively what you're really doing is you're bailing out the shareholders from their basic responsibility. By the way, it is worth saying that the government is also bailing out creditors. Everyone compromises in light of the emergency about how much they're going to get, one, from what they're due, and the other one in order to save a company they have shares in.

The Beauty of Bankruptcy

Bob Zadek: Now, you said bankruptcy. Probably some, perhaps not a whole lot, but some. To some of our listeners, bankruptcy sounds scary. There's an air of finality to it. It sounds like something will go away. You were quite clear in your statement of a few minutes ago that the bankruptcy of an airline itself doesn't mean the airline goes away. That would be extreme and profoundly unlikely. Remember, General Motors went bankrupt. There wasn't an interruption of even five minutes of anybody being able to buy or do business with General Motors. No one even knew about it in their daily life. And that was wow, General Motors. So, a bankruptcy is kind of invisible to the public. The public would not have a flight cancelled. Some uneconomic flights may be cancelled, that's a good thing. But the audience should not be intimidated or frightened by the threat, threat being the wrong word, of a bankruptcy. It's an adjustment.

Veronique, as you have pointed out, all it means is creditors who extended unsecured credit to the airlines, they made a credit judgment that the sale was worth the risk. Well, they bet wrong, and they will get less, maybe a lot less than what they are owed. But their customer will survive and the customer will place more orders. So, bankruptcy is just the jiggling around of losses-- 

Veronique de Rugy: Yeah, especially in this case. There are two types of bankruptcies. There's the one that are like the final terminated-- [crosstalk]

Bob Zadek: Chapter 7 liquidation.

Veronique de Rugy: Yeah, Chapter 7. And then the Chapter 11 is one where basically, a company declares bankruptcy and the point of declaring bankruptcy is to be able to restructure the company that at this point is not effective. It has problem, it is not making profits for whatever reason and to restructure it. So, it comes out of this fire stronger. That's the whole point of the bankruptcy. You go through bankruptcy, because you've made some bad business decisions. Sometimes you have to go through bankruptcy, because there's a pandemic, a one in a hundred years pandemic and no one is flying. Even though, by the way, it was one of the most frustrating thing about the no one is flying thing is that actually the safest place to be indoors was actually in a plane, because it had the best air purifying.

Actually, I flew a fair amount during the pandemic, and I was really impressed about how safe it felt. So, yeah, people are really worried. Even if you were to go through a bankruptcy, for the purpose of actually closing down the airlines. So, this happens a lot. There are a lot of airlines in the US-- Who remembers Pan Am? Who remembers Frontier?

Bob Zadek: Eastern.

Veronique de Rugy: Eastern. There's just a lot of companies.

Bob Zadek: TWA.

Veronique de Rugy: Exactly. It does not mean that those assets still exist. Are going to be picked up by existing companies or new companies. It doesn't mean usually you're totally right. Consumers will see nothing. It certainly doesn't mean that all of a sudden, the US doesn't have an airline. It certainly, by the way, even assuming that there are disruptions to consumers, ultimately, it beats sending taxpayers money to this airline in order to preserve it, in spite of the fact that obviously it's not working out. Preserving airlines for the sake of preserving airlines is actually a money losing endeavor.

Bob Zadek: As you have pointed out, when an airline goes into bankruptcy, even if a bunch of them go into bankruptcy, the big loses ought to be management. They were the ones who didn't properly plan and the ones who ought to lose their job and sometimes do are existing management. So, the bailout done under the name of protecting workers. The workers are the least at risk. Of course, somebody will buy those assets. They are capital intensive. Somebody's going to buy the planes and the gates and the repair facilities and the hangars. Somebody is going to buy them as a going concern. And they are going to keep the workers, of course, without the workers, there's no company. So, the bailout protecting the workers, that gives political cover. They're not protecting the workers, they're protecting management.

Veronique de Rugy: Yes. In fact, also we haven't talked about moral hazards, which you mentioned earlier on, but that's another thing that ends up-- What happens when airlines are bailed out over and over again without ever having to try to navigate through an emergency on their own. It means that the managers and the presidents of these airlines actually will run the airlines during good time as if they will be bailed out the next time around. In fact, there was a very telling press conference, I blogged about it at some point at National Review of the head of Delta, who was telling investors-- There was an investors meeting and he was telling investors, he said, "Here's what we've learned during this pandemic. Effectively, what we've learned during the pandemic is that airlines are worth investing in, because government will always bail us out."

When you think the government is always going to bail you out, it means that you never need to plan for times of emergency. It means you never need to put money aside. You just don't need to have a plan. What it means is effectively, you are privatizing all the benefits and the gains from running a business like an airline, but you are socializing the cost, since the airlines will not be the one having to shoulder whatever happens in the bankruptcy and whatever cost emerges from an emergency, because taxpayers will pick up that tap. That is not just unfair, it creates real distortions in behaviors that are just incredibly unhealthy.

Essential Liberty is a reader-supported publication. To receive new posts and support my work, consider becoming a free or paid subscriber.

The Money Always Comes with Strings Attached

Bob Zadek: When I introduced the topic this morning, I mentioned what I described as the Faustian bargain that the airlines made with government and how they sold. The statement I made was, they in effect gave the government a seat on the board of directors. So, the government always, if they put money in, they get to call the shots. It's true in health are. Since the government in effect provides healthcare, the government gets to decide who lives and who dies, because it's their money. Okay. Now, tell us what the airlines from a management standpoint gave up. What they gave up or what they lost as they sold out to the government? Give us some of the headlines of how the government now took control over management decisions on the airlines.

Veronique de Rugy: So, for some of the bailouts, if I remember correctly, some of the shares of the airlines were turned over to Treasury. But Senator Warren wanted way more. She wanted, basically, a much bigger control of government over the airlines. She wanted to make sure that airlines were going to cap executive pay that there'd be no stock buyback. There were just a whole progressive list of things that she wanted. I'm against the bailouts, but I'm also against government taking over and telling companies how to run their business, if only because this is a very dangerous spiral with the worst of both world where you end up with not just the company being bailed out, but also the government calling the shots at just very fundamental level. And so, it was just super unhealthy as always, but she didn't get what she wanted.

Bob Zadek: Now, just to expand upon that, I believe the bailout did contain some restrictions on buybacks, as you had mentioned. Buybacks are sort of jargon, just so our listeners understand what that's all about. Buyback is a very simple step. A corporation makes a decision for business reasons that this is a good time for it to use some of its money to go into the stock market and buy its own shares and put it in Treasury. It does so to prop up the share price, it does so, so that existing shareholders get a higher dividend, it's easier to sell stock in the future, but it's a business judgment that the directors make. But it's part of managing a company. To the progressives, that's nothing other than, in their narrow tunnel vision, a transfer of wealth to people who don't need the money. So, they say no-- [crosstalk]

Veronique de Rugy: What they would prefer is that money-- if the company has money, which is part of the belief is that companies are always sitting on an enormous amount of money that they won't share with workers. What they would want with that money is that the company pay worker more, give more benefits, and all of that. They always see stock buyback as something that is taken away from workers. Of course, workers' wages and total compensation is set mostly by productivity, but Democrats just don't want to hear this. They think that, if there's money left independently of the productivity of workers, they should be getting more. And so, everything else that this money is used for, no matter what the reason, they see it as going away as-- basically, some unfairness to workers who they assume all the time are unfairly treated.

Bob Zadek: Veronique authored with Gary Leff, a name Veronique mentioned earlier. A series of three installments of a thorough policy brief. It was written for Mercatus Center where Veronique teaches part of GMU, George Mason University. It's very current. It was written in September. The last installment was in September. It was entitled "The 2020 Bailouts Left Airlines, the Economy, and the Federal Budget in Worse Shape Than Before." If you are interested in this topic and what we are talking about, I commend that quite readable three installment paper. It will tell you so much, not only about the airline industry, but beyond that the relationship between private business, government and bailouts, and Veronique's conclusions apply equally well to the bank bailout. Indeed, it's a mirror image. Everything we're talking about could have been discussed with the bailout of the banks in 2007, 2008. It was the same bargain.

Moral Hazard & the Socialization of Losses in a “Free” Market

The banks gave up control of a lot of their business. They gave up Dodd-Frank, big banks like it, small banks don't in exchange for in effect a guarantee that they will never fail. Now, the same bargain is made by the airlines. Veronique, you use the phrase socializing losses. I want to build upon that a little bit, because how profoundly an anti-free market that concept of socializing losses is. It's a phrase you and I use all the time, but help the audience understand a bit, what that simple phrase of socializing losses means to all of us who would prefer there to be a free-er market?

Veronique de Rugy: Um. [pause] Ugh, it's a big question, right?

Bob Zadek: Right. [chuckles]

Veronique de Rugy: What do you want me to start with, because we can take-- [crosstalk]

Bob Zadek: Well, just explain the concept, what that means to socialize losses and the big picture effect, the negative effect upon investing allocation of risk in the capital markets and the like.

Veronique de Rugy: Not even talking about airlines, talking about any company operating in the marketplace. What they're trying to do is to maximize their profits. And in order to guide them, in order to do this, they basically have to produce something that consumers want. That's the goal. That's the basic thing. Guiding a lot of their decisions is basically the ability to actually look at prices, the prices that emerge in the market. These prices are just a remarkable reflection of millions of pieces of information about scarcity, about demand, about supply of all sorts of things. And so, companies use this. If they fail to deliver, they will go under. That actually is part of the free-market information cycle, if you want. The assets will be redirected towards, actually, activities that are less likely to fail. People who are investing and looking at what's happening are saying, "You know what? I'm not going to invest in this company, because prices are falling for the goods that this company is selling. Maybe it means this is a no brainer." When a company fails, it's a clear indicator that actually resources could be used somewhere else.

The problem when the government steps in and says, "You know what? It doesn't matter that consumers don't really want to buy this good. It doesn't really matter that investors that this company is actually doing such a poor job that it's going to fail, but we're going to bail them out." It's keeping a lot of this capital, a lot of these resources, it's keeping them in an activity that is just not effective.

The other thing that it does that very few people think about is that, effectively, when the government invests in a particular activity, that alone sends a signal that this is maybe actually a safe investment. What you end up seeing with subsidies and loan guarantees to different activities, you end up seeing capital that would have not actually gone to these areas suddenly shift and go to the subsidized company. Basically, it distorts the essential signal that everyone is looking at, that's the price system for all sorts of things. Basically, it create a lot of mal investments. Basically, signaling to company, to investors, "Oh, we should invest in this," even though without the government, actually that company would be failing. Or, it's preventing other company to come in and compete with that company and provide consumers with better product.

Bob Zadek: As you were explaining it, Veronique, I imagined a very simple hypothetical. Two homeowners living side by side on expensive real estate, expensive homes right on the coastline. One homeowner says, "I have to protect my investment and my family, and I will buy flood insurance. It's very expensive, and it means I don't get to go on vacation quite so much and maybe my lifestyle is a bit lower, because I'm spending money on insurance." The neighbor says, "What a fool? I'm not going to waste money on flood insurance. The government would never allow me to lose money. They will come in as they have in the past." So, therefore, I ask you between those two homeowners, which homeowner is the one whose behavior you would respect more? Who is a better money manager? 

Well, you would like to think the homeowner with the insurance is more prudent. But in reality that homeowner is punished for making the right economic decision, because he has less money, while the homeowner next door who makes an imprudent decision, a bad decision on theory that there will be a bailout. Take that very simple example and say, which one would you rather have managing your airline?

Veronique de Rugy: But you can actually go a step further. You can go a step further, which is now that the government has bailed out those homeowners without insurance, what it signals for future homeowners is that actually, it is worth not only taking the risk to build a home in a flood zone, but that they shouldn't be taking insurance either since the government is going to bail them out. You have a double whammy of bad decisions that are being made. It goes on and on and on to the point. And, of course, builders are excited about this. They lobby the government to say, "Please do bail out people, because we want to be building big homes in flood zones." And then, it reaches a point where effectively for the government to step away and let all these irresponsible homeowners face the consequences of being in a flawed zone, now that the government is not going to bail them out is so big that no politicians will dare doing it. And you have a bad system that is maintained in perpetuity. That's a lot of the problem that come with government bailing out or government interfering with the market place in the first place.

Certainly, all of these intervention, they distort that price signal that tell people whether it's risky, whether it's safe, whether it's worth investing, whether it's worth consuming, whether it's worth building, whether it's worth hiring, all of this. By the way, the government does it with the labor market and wages. The government interferes everywhere. Ultimately, what it does, it distorts the price system and it distorts this essential signal that allows a complex economy made of exporters-importers, consumer, producers, often those people are the same, and investors, and stock owners, and all of this to actually function.

Bob Zadek: When you were describing all the things that are wrong with the bailout, what I also found myself thinking about, and because it's in the news again is our relationship to farming. When I say "our" I mean our government's relationship to farming. Whenever farmers suffer losses due to an existential natural disaster or whatever, the government is right there with a farm bailout, because it is an essential industry. The reason I thought of it is because just this morning in The Wall Street Journal was an article about wheat prices are high because of Ukraine, whatever it is, and farmers are raking in the money. I didn't see that government was saying, "Okay, since we socialize your losses, and we'll bail you out with a farm bill--" Why doesn't government take the excess profits when times are good? It's a ratchet, which is only one way and the same thing happens.

You mentioned in the beginning of our show how the airline industry had come off a decade of monumental profits. They were loaded with money. Well, one of the things to do with the money is to either buy insurance or do whatever you have to do as a planner to say to yourself, "It's not always going to be this good. Let's put some money away." They didn't see the need to do it because of the hope realized by the bailout. 

Now, you took a lot of time, you and Gary Leff in putting together this three-installment policy brief. As we start to reach the closing part of our show, is the country worse off because of the bailout only, because the federal government has $54 billion less or are there other residual detriments in addition to the pure loss of $54 billion? Not that that's not a lot of money. Of course, it is. But how else are we worse off as a country economically big picture by dint of the bailout besides simply the money?

Veronique de Rugy: The money is bad, because especially since we don't have the money, it means that basically, they borrow the money. Borrowing the money, especially as interest rates are going up is a problem. We have $31 trillion in debt right now. All of this is a problem. In my opinion, the biggest problem is one that we've talked about and that is the moral hazard that it creates. Basically, airlines have learned that from now on forever and ever-- By the way, they're not the only ones. Individuals have learned that next emergency they're going to be getting a check from the government, no questions asked, whether they work or not. They'll be getting a check in the mail. The companies that are non-airlines are going to have learned that it's very likely that they are going to be giving them the ability to borrow money either at very low cost or then the money will be forgiven whether they needed to get rid of their workers or not.

Then, airlines will learn, once again, that the government will step in and they will be able to make an enormous amount of money during good times precisely, because they will tell their shareholders and investors, "Invest in us, because you will never have to shoulder the cost of us during the next emergency." These type of expectations of government bailout, in my opinion, not only is it corrupting the corporate moral, honestly, where basically companies think, and shareholders and investors think that it's totally normal for them to line their pockets when times are good and they're going to be bailed out when times are bad. So, that's the problem. But it is really changing effectively the behavior. And I have to say that we run the risk of this type of behavior is one of the reasons why people are upset about capitalism. When people don't like cronyism, they don't turn against the government, which really is the one responsible. If the government didn't give the money, companies could ask for it and ask for it, it wouldn't happen. So, ultimately, the government is the source of the bailout, the one we should blame. But they blame companies for being greedy and that's a real problem. Corporate welfare, cronyism, however you want to call it is the biggest threat. [crosstalk]

Is Lending Better than a Blanket Bailout?

Bob Zadek: I live my life in the world of business credit. That's my world. It's been my world for half a century. Therefore, I jump to, given that the government can't stop itself from giving $54 billion to the airlines. Let's assume that. Stop me before I give again. They can't stop. It's baked into the system. This is very rhetorical, Veronique. Why couldn't you accomplish all the goals and lend the money to the businesses, make loans under terms that the governments sort of a lender of last resort and at market rates? Now, if I say that, then a corporation would probably say, "Might as well borrow it from my bank," which is exactly the answer I want them to say. So, all of these grants, if the government feels compelled for whatever reason to give the money to business, why can't it be a loan? Now, that's my last question I was looking forward to asking you. Would you be a tiny bit happier if the money was lent or does that not do anything to fix the problem?

Veronique de Rugy: No, I think any government involvement means moral hazard, no matter what form it takes. Look, there's just a lot of government loan guarantees program, where actually a bank lends the money, but in case the company can't pay-- [crosstalk]

Bob Zadek: Student loans.

Veronique de Rugy: Yeah. Even like you take the Export-Import Bank, so the bank extend the money to a foreign company and the taxpayers are backing that loan.

Bob Zadek: SBA loans.

Veronique de Rugy: Yeah. SBA is the same way and then the company will buy US products. So, what ends up doing is that the decision to who gets those government loans, who get those loans that are subsidized, that are better terms, that are-- If you default, taxpayers are paying for it. First, the banks are much less careful about how they lend the money. And second, the government picks winners and losers. Listen, there's a reason why it's always the airline being bailed out. At the time where they were talking about the second bail out or maybe it was the third bail out, now I can't remember. Do you remember? So, they were something like it was something 30,000 employees that were going to be furloughed with the airlines? Congress was all up in arms that this needs to be prevented. Meanwhile, all the movie theaters employees were getting fired. That was something an enormous amount, like four times or five times more than anyone in the number of reported number of airline employees that may be furloughed. And no one cared about this. Why is this? Because the airlines have a relationship with politicians. 

So, ultimately the government decides which companies live and die. It's totally unfair. It's done for political reason. It means that you have to be involved and have some sort of lobbying branch and be always sure that you're pleasing politicians, so they will be there for you when times are rough. [crosstalk] No, I'm not.

Bob Zadek: That's the system. We have run out of time, Veronique. Thank you to Veronique de Rugy for sharing with us the results of her research on the 2020 bailout by the federal government. I hate even to say the word of the airline industry and all the evils that befall us as a result.

Veronique's paper, The 2020 Bailouts Left Airlines, the Economy, and the Federal Budget in Worse Shape Than Before is available at the Mercatus Center at George Mason University. Veronique, thank you so much for returning to our show and for sharing your thoughts. And thanks to Gary as well. Thank you so much.

Veronique de Rugy: Thank you. Thank you so much, Bob.

This is a public episode. If you'd like to discuss this with other subscribers or get access to bonus episodes, visit www.bobzadek.com/subscribe

This week’s returning guest, Professor Richard Epstein, teaches law at NYU School of Law, where he founded and heads the Classical Liberal Institute, run through the university.

Richard is also a senior fellow at the Hoover Institution and a senior lecturer at the University of Chicago. With his extensive background and knowledge in both economics and law, he's the ideal guest to discuss with me the newly enacted California FAST Recovery Act, which seeks to socialize the entire California fast food industry by putting it under strict governmental control. Other states are looking with curiosity, and perhaps envy, at what California has done so that they can follow the lead. It is really ugly.

In light of the nationwide implications and unprecedented broad reach of this legislation, Richard and I will discuss the act and the impact of labor laws on our economic life in America.

Links

* California’s Fast-Food Fumble | Hoover Institution California’s Fast-Food Fumble

* The Libertarian | Hoover Institution

* New California Law Forces Fast Food Restaurants to Think Fast | The Regulatory Review

* Richard Epstein joins my show to discuss the California pig case

* Say Goodbye to Bacon?. Professor Richard Epstein on… | by Bob Zadek | Medium

* West Virginia v. United States – Halt The EPA’s Takeover Of Energy Markets | Hoover Institution Halt The EPA’s Takeover Of Energy Markets

Transcript

Bob Zadek: Richard, welcome back.

Richard Epstein: Well, it's always good to be with you, Bob.

What is the FAST Act?

Bob Zadek: Now, Richard, the FAST Act, California legislation, was recently signed into law by the Governor. It's an acronym for the Fast Food Accountability and Standards Recovery Act. I must say it's an art form how they can find these acronyms for this insidious legislation. The FAST Act seeks to capture the entire fast-food industry and bring it under tight governmental control. First of all, what does it do?

Richard Epstein: Well, I think the first thing to say about the statute is indeed a fast one. What it purports to do is much more modest than it turns out if you start to read the details in terms of what it does do. Well, the first thing it does is to make a series of findings about the systematic forms of abuse that you see inside the fast-food industry. This is de rigueur for any and all efforts to impose regulation on it because you have to have a villain in order to regulate. What's interesting about it is they don't give you any particulars as to why it is that the particular act that they're doing is actually curing any situation.

Fast food is a booming industry. There are large numbers of people who want to get into it. Huge numbers of consumers. Most of the workers and most of the consumers in this industry tend to be not upper-middle-class people but lower-middle-class people both on the job and on the food side. There's every sign that the market seems to be working reasonably well.

It turns out the FAST Act is essentially a combination of forces by progressives who generally believe in the socialization of the economy. But more importantly, the driving force behind this situation turns out to be unions. Their effort is to try to figure out a way in which they can gain a foothold in this particular industry.

“It turns out the FAST Act is essentially a combination of forces by progressives who generally believe in the socialization of the economy. But more importantly, the driving force behind this situation turns out to be unions.”

The Structure of the Fast Food Industry

To go back to the origins of this, the way the fast-food industry is organized is that you have central purveyors who set standards. These are franchisors. What you have is a large number of individuals who are franchisees. The way the division of power starts to work is the franchisors, well, they set the menu, they set the trade dress and they kind of give you everything that you need to know so that the consumer who is interested in making sure that when they go from one company outlet to another company outlet is going to get a standard fare. It's the arches of McDonald's, it's whatever other kind of logo that you want to see. You have to have that degree of control. Otherwise, it turns out the quality differentials become enormous. Each franchisee will try to play off the reputation created by others. So, in the end, there'll be a giant prisoner's dilemma game in which people will start to cheat on quality and vary in service so by the time you're done, it will be an inferior fault. That's why you need the franchise law.

But the franchisee knows that when it comes to running a particular outlet, he or she has no particular advantage over the person who's on the ground. So, the distribution of authority then goes that if you're starting to look at the employment relationships, the leases, and so forth, some of the borrowings in order to get the thing done, it's the franchisee who takes the lead on this stuff. This has huge consequences for the way in which labor markets are organized.

If each franchisee is a separate employer, then the only way that you can unionize is to find a way to go branch by branch, outlet by outlet in an effort to persuade those workers to do it. They're going to be, in general, very reluctant to do that. The reason they are so is they understand that if it's a popular franchise, they're going to be other branches that are going to be located fairly close. They decide to vote to unionize. That's going to raise their wages, which in turn will probably have to have exerted pressure on the prices that have to be charged to cover those things. So, there's a danger of losing market share. There's a danger of another franchisee from the franchisor coming into the market. There's a danger that they'll lose to a rival franchise that sells the same kind of product.

Well, the labor people are fully aware of all this. One of the provisions that I'm going to start with is not the most dramatic provision. The one which says, "Oh, we can raise the wages that we choose up to $22 an hour over the current $15 and change that it now is," but what they say is, "You're going to be exempt from all of these requirements to be unionized." Essentially, what happens is we are treating the statute as a big club which will force you to go into a unionization agreement which you won't want to leave because it turns out staying out, being subject to the FAST requirement, is a more onerous and hateful thing for you than is unionization.

There's going to be a huge fight over this, Bob, because as far as I can tell, question about the balance between union and nonunion shops is something which is set exclusively by the National Labor Relations Act which says that workers have the right to join a union and collectively bargain if they choose and they have the right to stay out. If this is a federal right, what's going to happen is they're going to come back and say the state cannot put its basically heavy thumb, make it an elbow, on the scales in order to direct you in the way of unionization so that the statute has to fall to the extent that it has this kind of component. This is going to have to be litigated. It will take place in two stages. One is there'll be some kind of challenge that will be made before the National Labor Relations Board to which the answer is this is a Biden operation. I don't think they've made a single ruling since they've taken over which has been anti-union and they've basically taken a lot of other things which have been relatively fixed for a long period of time and have expanded the authority of the board and have increased the rights of unions as against anybody else.

That means it's going to have to go to the courts. If you're going to go in California, the 9th Circuit is a kind of an iffy place. There's some liberal and some conservative judges. So, this issue is going to end up in the Supreme Court, and the prediction is it will follow a conservative-liberal line, and the conservatives will essentially vote to strike this thing down along with other kinds of cases they have. In connection with the unionization of public workers in a case called Janice and so forth, the Supreme Court said that the state is going to be subject to certain very powerful restrictions so that you're not dragging people to support a union if their free speech right wishes to do something else.

Bob Zadek: Just to summarize and to emphasize, if you will, this is nothing other than a tool to enable unions to gain membership in an area of the economy where up to now, they haven't tried that hard. They've tried a bit but it's unsuccessful for structural reasons. They can't get the job done. So, since they cannot achieve increase in union membership the way that the law now provides, they go to the California state government and the governor, Governor Newsom, they say, "Give us a club so that workers in the fast-food industry will have no choice but to join a union," because it's the classic "your money or your life", not really a good choice.

Richard Epstein: Yes.

The Unelected Council

Bob Zadek: The statute, I was surprised a bit that wasn't higher on your list to mention, because that to me was 19th-century European labor relations in 21st-century California. Just because it's so scary and it's so, if you will, un-American, tell us about the council that the statute sets up.

Richard Epstein: What happens is the labor movement not only has the strong pro-union stuff in terms of trying to get the organization going but what they do in this particular case is it's not just a minimum wage law that's passed and so forth. What they did is they set up a council which has 10 members, 8 of whom are appointed by the governor and one each by the head of the assembly and by the Senate. The interesting feature about these appointments is that the governor just makes them for everybody. If you start looking at the composition that you're talking about, it's really quite strange. There are two people who were put on this council by the Governor whose job is to be fast food advocates for workers. They're not workers themselves, they're just political. Then, it turns out there's supposed to be two representatives of employers and two representatives of franchisees that get you to four, but the governor appoints those and there's nothing which says that he's going to appoint people who actually care about what franchisees believe. He's going to point to somebody who's a rogue inside the business and not representative of everything else.

You then add these people and essentially, as best I can tell, at the very best, you've got a six or four majority in favor of whatever it is that the labor unions want. In some cases that vote could actually go to be and nothing if in fact the employer guys start the cave because they're appointed by the governor who can move them. Well, I mean, the first thing that you wanted to ask is, can you possibly do this kind of delegation to the governor? There is a recent move in a federal constitutional law saying that a non-delegation doctrine, which had been left for dead many years ago, is in fact something that you seriously have to take into place.

What this particular doctrine says is if it's something that looks to be legislation, that has to be decided by the legislature. The standard verbiage formulation is that the legislature has to set out the outlines of the statute, and then what happens is the governor or administrative agency can throw in the detail. Well, there's no outline that said, in this particular case, it's not as though what the statute says is that when it comes to these particular situations, there are 14 kinds of things that you have to find and list what they are. Then, what happens is the governor or the administrative agency can put together various guidelines as to how you submit information to a central body that addresses these kinds of questions. There's absolutely carte blanche. It also turns out it gets even odder. They have local councils as well. There is some thought, "Ah, the reason you need local council is because if you look at the wage profile that's going to be in Fresno compared to that in San Francisco, the same $22 minimum wage which will make the most modest effect in San Francisco where the market wage is already at $22 or very close to it." But it could be devastating in the central counties where the market wage is probably something around 13 or $14, and this will just drive everybody out of business.

They were afraid of allowing these local variations. So, what happens is these local councils can only recommend things to the center. They can't decide themselves and that then gets you into this terrible kind of situation, what happens when the central body manages to get inconsistent recommendations from different councils who have different local agendas? My view is that this is a classic case as to why administrators fail. If they decide to do local variations, they're going to become so intimate that they're going to be completely essentially [unintelligible 00:13:10] that they're going to be completely unworkable. On the other hand, you have a single standard, it's going to fit so badly with so many cases that it's going to result in enormous kinds of situations. So, you got a dilemma. You can't do it locally and you can't do it nationally. The correct answer is you ought not to do it at all. But if you're a labor guy, all of these things are just small details. So, what you will do is you will get this stuff, put it at the center, come up with some kind of a recommendation, and then defend it fiercely, claiming that a delegated authority is entitled to a presumption of death.

Now, at the federal level, given this huge delegation, I think there's some belief that this one will not survive that kind of situation. Essentially, what's happened is the governor is told he can make the law by appointing people who can disappoint or remove from office anytime he wants, and that's a huge kind of delegation. We know by the way, there's nothing in the statute which prevents the governor from speaking to members of his particular council and expressing the views that he would like them to follow under these cases.

There's a case in which there was a much more modest delegation, and the Supreme Court barely upheld it 5:4. It was a kind of an odd case because virtually everybody believes that the challenge is coming back again in a different form, but a slightly different kind of case. This would be a perfect illustration to do this. Also, there's another development of the Supreme Court, in what is perhaps the single most important long-term case decided in the very controversial 2021 term. It's not the abortion cases which deals with abortion. It's a case called West Virginia v. United States. The so-called issue in that case is called the Major Questions Doctrine. What it means is that there's a really big question about the way in which an industry or a business ought to be structured and there is no deference given to an administrative agency, the legislature has to speak for itself in terms that have a reasonable degree of clarity to them.

In the West Virginia case, what happened is there was a provision which says that you can implement certain kinds of technical improvements that have demonstrable elements of success. What the Obama administration wanted to do and in a kind of strange way, the Biden administration wanted to do is to say, "The way in which we make sure that we use the best systems of emissions reduction is to require these plants not just to produce oil and gas, but to make sure that the mix of fuels includes a healthy dose of both wind and solar energy." What the Supreme Court quite sensibly said, in my view, is it's one thing to tell people how to put baffles or noise reducers on different kinds of equipment. It's another thing to try to redirect the energy from one source of energy to another source of energy. You can't do it by administrative regulation.

That's what they're trying to do in this case. They're trying to completely transform this particular industry into something that's utterly unrecognizable. The consequences of this stuff are going to be amazing. There's not a single shred of evidence that anybody at any time asks the question of what this would do to levels of employment, levels of firm profitability, levels of consumer prices. It's all taken on faith. Then, they're supposed to implement this and they can have a huge variation in what it is that they turn out to do. So, I think the statute is basically subject to this.

To give you a historical situation, there was a case called the Wolff Packing Company involving the state of Kansas in the early 1920s. What the case did was to set up a kind of an industrial council or board to oversee various kinds of firms in the meat packing business in order to be able to schedule wages for particular kinds of services and so forth. The United States Supreme Court actually struck that down, claiming that using these sorts of industrial courts is essentially just a total abuse of the entire administrative process. I think that cases like that which have been pretty much on the back burner in the last 100 years are likely to come back again when you're talking about this stuff. What you said is, A, is this a horror story? Yes. The question is, is this a horror story that will survive? Here, the parallel is what I said to you earlier about the union preference, the antiunion- rather the pro-union [unintelligible [00:17:34] is that it's going to be preempted by federal law. There's going to be a similar challenge in this particular case that is not going to work. It turns out that it's just not going to happen.

So, I think in effect that the statute is- first of all, I think it might well be beaten back by a referendum. If you get 1000 people to sign it and then you start to figure out who in the state is going to benefit from it, there are a lot more people that have had their lives made miserable than those who will be helped by it, I think it's likely to go down. But even if it survives there will be constitutional challenges and those constitutional challenges will seek a preliminary injunction. If what I said is correct, they're likely to get it. So, you'll see at least several more years of postponement before this dreadful statute is put into effect, if it's put into effect at all.

Essential Liberty offers a review of current events through the time-tested principles of limited government & individual freedom. Subscribe for weekly podcasts, edited transcripts, & book summaries.

A Solution in Search of a Problem

Bob Zadek: A few observations. The chief sponsor, legislative sponsor of the FAST Act is Lorena Gonzalez. Those of you who are junkies on this stuff may remember that Lorena Gonzalez was the sponsor of the statute which California enacted which declared war on the gig economy. Remember, my friends, when California enacted legislation, it was basically focused on Lyft and Uber. On, others were captured as well where Lorena Gonzalez's statute sought to declare that the status of Uber and Lyft drivers and other industries as well was not independent contractors setting their own hours and working but rather that of employees that had to be treated as employees with profound cost implications, work rule implications, and the like. It was a declaration of war against the entire gig economy well flushed with the success of that bill even though it's been watered down and affected by California's Prop 22 which said, "Not so fast, folks. We don't like that statute." But Lorena Gonzalez is at it again and she was the chief sponsor of the FAST Act. That might tell you something about the source.

Number two, this is the most classic case of finding something that's not broken and then fix it. As Richard said in his observation, in his comments a few moments ago, the fast-food industry both in California and nationwide, it absolutely works. It delivers a product that people like at a cost they're willing to pay. It provides entry-level jobs more so than most other industries in the country, and we are desperately in need of entry-level jobs. The franchisees are able to pay a lot more than the minimum wage. In fact, the wages in the fast-food industries [unintelligible [00:20:42] something no more complicated than supply and demand of labor, the wages in the fast-food industry have been above the minimum wage, mostly around the country simply as a fact that there aren't enough workers. That's the way it's supposed to work.

So, we have an industry that delivers a quality product. There's no complaint about that. Customers want it. The food is readily available. The restaurants are clean. The workers get entry-level jobs. Everything is working exactly the way it's supposed to for all of the components. Yet, here we have an entire rejiggling of a system, a complex system that works beautifully. Find something that's not broken and fix it. The legislation has only one purpose as Richard said. It's a gift to the unions who could not find a way to force workers to join a union by having them vote so the unions had to go to the thinly disguised compulsion of a statute where it's your money or your life.

So, Richard, do I overstate the case about the industry? I don't want to sound like I'm some passionate follower of the fast-food industry, although they are my primary vendor when it comes to food, but that's a different subject.

Richard Epstein: Well, I think the answer is I'm sure you could find pockets of places where things don't work particularly well. You're running a very complicated industry with huge numbers of independent points of authority. Some of these franchises are extremely adroit. So, when you talk about a franchisee, you're not talking about a guy who simply runs one outlet, they thought to run 15 to 20 outlets and able to borrow on existing franchisees to expand elsewhere. Then, you may get somebody who's a really terrible franchisee who can't survive. But that's essentially part of the success. The key element in the franchise business is if you fail, you go out of business. If you go out of business, you're not going to basically have a very strong role to play.

The thing about markets is that you start with, say, a market in which 50% of the people were terrific and 50% of the people were terrible, all of whom were untested, and you go through several iterations, by the time you get to the second, the third one, the ratio is shifted. The successful guys have a much larger share of the market. They're up to 70%, 80% or 90%. The unsuccessful guys are holding on by their fingertips, and that pressure turns out to be relentless. So, I think the right way to put this is that markets, you don't want to be Pollyannaish about them, but what you want to stress is that they have immense self-corrective capacities in terms of the fact that they reward the right things, not the wrong thing. Whereas the moment you start talking about the governor's type of stuff and the special committees, all of a sudden, you're no longer designed to figure out how it is that you manage to please your customers and your supplier. What you now are trying to figure out is how you play games of flirtation with the various regulators to get what you want. It turns out that what's going to make it much more difficult is people who have bad performances are going to be propped up by the statute in some particular kind of way and good people are going to be driven out of the market so that what happens is whenever you have a regulatory system, the nature of the entrepreneur in it goes.

To give you an illustration, take rent control, it's a classic divide. Now, landlords in New York and landlords in Chicago, I've lived in both cities, Chicago is not a rent-controlled city. What happens? You've got large numbers of people and twice a year, basically in March and October, leases start to turn over and somebody who's in a big apartment and the kids have gone away, they give up that lease and they rent a smaller apartment in the same neighborhood. Landlords are essentially very attentive to what their tenants need. The tenants are pretty clear that they have to supply references and records in order to make sure they get it. You go to New York City, and it turns out, well, the tenants are there for life unless you could pry them out with a hammer and tongue, and you get a very different kind of landlord. These are landlords who know how to use the legislative process. These are landlords who are prepared to make life miserable for tenants by cutting off services in one form or another in an effort to get them out. So, you get the cult of a landlord in a place like New York which you would never get in Chicago.

What happens is the moment you introduce a system of regulation, the people who move into that industry are those people who are comfortable employing all of the levers that are needed to survive in a regulated economy. So, the quality of the merchant starts to go down. That's the thing that you really have to worry about. The pressures are always upward in a market economy for better services. They're always downward in a regulatory economy where Lord knows what it is going to start to move these things.

So, Robert, basically you are Pollyannish but Pollyannish with a legitimate purpose. There's no question if you were trying to take the long-term trend of the ways in which these industries have worked, the franchise industry has been one of the great successes in the history of American innovation. And it's not just in fast food. It's also in other kinds of services that one starts to deal with as well. So, the more you understand about how this thing operates, the less willing you are to interfere with it.

I might add that to go at the federal level again, in the Obama administration, there was an effort which was beaten back to try to make sure that the franchisees essentially were working pawns of the franchisors so that anytime they committed some kind of mistake, the franchisor, the McDonald's or the Wendy's or whatever it is, could be tagged with an unfair labor practice. They tried to put something like that in this bill, and the defendants, the manufacturers or the restaurateurs, managed to get that provision out. They're working on this again in Biden administration to try to do it, and it's a total disaster. Because what happens is the franchisee only works well when they have profit and loss responses. The moment you start to say that every time he commits a mistake, the national chain is going to be responsible, then at that point the national chain is going to have to exert greater control over what the franchisee does, which gets rid of all the right economic incentives on the downstream part of the market.

What happens is you take a company like McDonald's and so forth, this is what they do. They keep essentially franchise-owned outlets, 4% or 5% say of the market, and they do this for testing new innovations and so forth. Every time they do the studies in terms of long-term success, what they realize is that the franchise model dominates the wholly owned model, which is just used for very specific purposes, like trying to figure out what new kinds of products ought to be put into the market this, that, or the other week, but none of these companies want to expand beyond that particular situation. We do see essentially the progressive mood that every form of business is essentially ill concentration. If you want to look further, the labor board has become absolutely hopeless under the current administration. The FTC and the justice department think that anytime you acquire a company, you engage in anticompetitive activities, and they have been a menace on the market. The SEC has done one dumb thing after another.

So, what you're looking at today is the general economy in which progressive states on the one hand and the federal government on the other, are pushing us to what will be a kind of systematic recession. Because there's no way that these businesses can survive if they're constantly pumped in one form or another by a set of people who always think they know how to run somebody else's business better than the people who own these businesses do. The point about socialism is the one that you always made. "If it's my money, I'm going to watch it. If it's your money, to quote Margaret Thatcher, I'm willing to spend your last time on my particular purposes. And if you go about bankrupt, I'll find another target and bankrupt them as well."

So, the long-term trend that we have in this thing is very ominous. You have a governor who's absolutely oblivious to all of this stuff. They put out press releases saying, "Well, the people who benefit from these statutes are really just wonderful people. We love them all." They never asked who was going to be hurt by these statutes. If they started to do that, they could then explain why it's not all that difficult. They'd get a million signatures in California against this kind of statute.

Is the FAST Act Constitutional?

Bob Zadek: You are a very strong expert in the area of labor relations, business labor relations. So, when you speak about labor relations, the audience is hearing something from somebody who has spent their life studying that body of law. You mentioned if the California legislation finds its way to an appellate court or to the Supreme Court, the Supreme Court could easily find the legislation to be unconstitutional or violative of federal law, at least under the Labor Relations Act itself, in that it doesn't give workers the right to vote on unionization, it coerces them. It struck me as rather perverse that legislation, the National Labor Relations Act, which was designed to give unions a leg up at the bargaining table, it was very pro-union in its enactment, and that was the reason is now the very statute that may be the final nail in the coffin of this legislation.

The second point I want to just mention and have you speak to it, Richard, is the legislation also makes a distinction in its coverage. It defines the types of establishments both by size and number of units. There is speculation now, maybe more than speculation, that the fact that it treats different restaurants differently may trigger a constitutional issue about equal protection.

Richard Epstein: Yeah, well, let me just take the first point first, which is the question about the purpose of the National Labor Relations Act. It's hard for people to imagine today just how central to American politics, labor relationships were in the first third of the 20th century, going even past the war. 1935, the Wagner Act was passed, and it had only one set of unfair labor practices, and that was unfair labor practices committed by employers against employees, and there was also no public union coverage in that particular statute. Then, the courts get to this, and some of them start to interpret this thing in ways that are very expansive to the statute. The second world war is over. 1946 is a huge transformation in American politics in which the FDR New Deal Democrats essentially get absolutely wiped off the face of the globe in both the Senate and the House, and a series of statutes that passed designed to limit the power of unions, including the Taft-Hartley Act, whose key provisions in many ways, which is trying to create a parallel set of unfair labor practices applicable to unions as against their workers or against employers.

In that statute, what they said is not the right only to organize, but the right not to organize. That's why the preemption argument if you force people to organize by threatening them with something in the way in which the statute does, if they don't organize, it's going to be difficult.

I think what happens is the current version of the National Labor Relations Act is designed by Republican influence not to repeal the whole statute which I have championed for the last 40 years or more. In fact, the student note I wrote in 1967 was an antiunion piece. I'd just come back from England in 1966 where I studied law at Oxford. You can see, as eventually became the case, that labor unions were going to bring England down to an impossibly low position until Margaret Thatcher took office in 1979. That's how bad it got. So, I think that the whole problem turns out to be there.

Now, the second problem that you're asking is a slightly different one, and you called it an equal protection problem, but there's going to be another way in which you could think about it as well. What you noted is essentially this is only trying to attack big franchisors, people with 100 units or more franchisees. But what's so odd about the statute is that if you have 100 units outside of California and 1 unit inside California, the California unit is going to be subject to that particular statute because they count things out of state. So, there's going to be this whole crazy fault pattern of advantages and disadvantages that you're going to have to sort out. Well, that's good enough. So, what happened is the protection clause says these are arbitrary distinctions between different kinds of franchisees, they're not equal protection, what you have to remember is if you go back to the American constitutional framework on the equal protection clause, if you're talking about race, the level of scrutiny is very strict. If you're talking about sex, they raise more than one eyebrow. There's, at the very least, intermediate scrutiny. We talk about economic affairs, the level of scrutiny is so low that in many cases it's just a joke to say that you could ever find a violation of the Equal Protection Clause insofar as it relates to differences between different kinds of economic organizations.

But there's another element in this case and it's not clear how it will play out, which is called the Dormant Commerce Clause. If you start looking back to the way in which the Constitution was organized, it's pretty clear that we were not capitalist in the sense we never used a word which wasn't in existence back in 1789. But there was a very strong set of beliefs that you were trying to make sure that the United States, even though it had strong states, would have an open national economy for the movement of goods and services across state boundary lines. This thing basically was dormant until 1824 when a case called Gibbons and Ogden gets proposed. At this point, you see the outlines of doctrine called the Dormant Commerce Clause. What that doctrine starts to say is if Congress doesn't do any legislation but there's a state statute which imposed an impediment to the free movement of goods and services across state lines, then the very fact that the Commerce Clause takes over the area means that those statutes can be struck down.

So, the issue is going to be is this kind of crazy quilt situation going to so disorganize the relationship back and forth against state lines that this Dormant Commerce Clause doctrine is going to deal with and it's not a clean fit one way or another. The doctrine is in somewhat of a disarray today and there are many conservative judges who think that it's not really textual in the strong sense of the word. So, the originalists like Thomas and Scalia who are on the court are reluctant to extend it but there are cases right now before the Supreme Court involving, of course, California with the-

Back to Pigs

Bob Zadek: You are going to talk about Richard, you're going to talk about the pig case. You actually joined us on my show to discuss the California pig case and it's amazing how on this one hour, we've gone to- [crosstalk]

Richard Epstein: Back to pigs.

Bob Zadek: Back to pigs, exactly right.

Richard Epstein: Well, because what happens is the State of California says you can't sell within the State of California, pigs that are slaughtered and prepared elsewhere outside the state that don't meet California standards for justice and fair play. This is the so-called extraterritorial effect. I think the Dormant Commerce Clause arguments are stronger there than here. It is interesting to note that if you look at the liberal press, 100% of them are in favor of strong extraterritorial impact. So, the question is, is there a labor issue lurking in the background? What do you think the answer is? You better believe it. How do I say that? Well, what this statute says is, "We will not admit because of our moral judgments, perfectly safe meat, pork that has been slaughtered elsewhere because it offends our sense of moral." Now, what you do is California is going to say, "We will not allow anybody to sell goods and services if they're made by in a right-to-work state or if they're made essentially by a nonunion firm." Can they do that?

I think the Dormant Commerce Clause says you absolutely cannot do anything like that. Indeed, one of the issues left over in the pork case is exactly that one. The unions and the state had this brief trying to explain why everything was hunky dory. And when it came to the hypothetical about the Right-to-Work Act, they just punted. They don't want to face that their strategy is exactly correct. "Don't bother me with hard cases. Let me win the case having to do with the pigs first." I think they will lose but, boy, that is a very tricky judgment. "After I win that case, we can figure out whether or not I could work the extension."

So, the real thing is whether or not the courts of California and the legislature of California can buy its huge position in these markets essentially dominate the ways in which things are done in other states. There's a huge battle about whether or not they have that particular power. There's a very long and learned debate over court about the extent to which different companies may or may not be able to adapt their assembly lines so that they can supply both California and the non-California market without a very high price increase. The case may well be remanded to see whether or not the price increase that was posited by the industry, something close to 10%, is that a true number or is it a false number? One of the things about it is when you do as much law as I do, you're very cautious about making predictions about the actual dollar impact of these statutes. It takes a lot of very close empirical work. But you can see what the pattern on all of this kind of thing is.

Of course, there's also going to be imitation. You find a series of other states that are liberal. What you've done by passing the California statute and by developing regulations on how it works and by withstanding a constitutional challenge, say, you're lucky on all of those things, there's somebody in New Jersey who says, "Well, we'll just basically borrow the whole California kitten caboodle and put it into law here. It's going to be much slower for us to introduce this statute because all the difficulties and all the constitutional issues have been ironed out in our favor before we got into this particular situation." So again, it's exactly the same kind of situation. The issue in all of these particular cases is whether or not when you start doing these kinds of things, what you can do is you can kind of lever up and constantly expand the scope of the situation.

There are rough studies today which indicate that the American public, generally speaking, is about 70/30 in favor of the union, which is a huge working majority. I think it is one of the worst judgments that you could possibly imagine. Of course, many of the people who are doing this are not employers. If you ran the actual same survey on the question of how employers feel about that, the survey would come out about 99 to 1. There's not a single employer who would voluntarily yield to the sorts of restrictions that are imposed by the National Labor Act if they did not face some government sanction. All of them know that this stuff is poisoned and generally speaking of workers and the firm are faced with a firm which has less flexibility in the long run, what will happen is they will lose out themselves. They will get short-term monopoly profits but that will so basically cripple the way the firm works that its market share will start to shrink and then these workers will find that they're on a short lease, high wages for a short period of time. You remember what the number of workers was when we looked at this stuff, Bob, back in 1979? How many workers there were in General Motors? Remember the number?

Bob Zadek: A little less than a million or around a million.

Richard Epstein: About half a million people by that time. When they went bankrupt, they had 42,000 people working for them. The only way that this can happen is that you end up lopping off unit after unit. You lose to foreign competition in one form or another.

Bob Zadek: Or machines.

Richard Epstein: Well, machine, whatever it is, people will find ways to do this. And automation of course is a constant threat, and you will see more automation taking place in the fast-food industry. I have the following. This is a form of age discrimination. Guys like me, I have never been able to figure out how to use all this stuff. My 12-year-old grandson, my 8-year-old grandson, they've been working with these machines since birth. I started out life with an Underwood typewriter back in 1955 in which the keys would get stuck when you type a word too fast. And so, they're much better at doing all of these things. But in the end, what happens is they will force you into systems that are better off than a market than the regulatory system but worse than a market kind of system.

I think most of the American public, essentially their support for unions is abstract in the sense that they believe powerful employers should not be able to drive into the dust terrible employees. If you actually ask them, "Well, do you want a union in your particular factory?", oftentimes, the answer is really quite the opposite. What the unions have done is to try to make the rules in every way, shape, and form possible to favor them in union elections. They're allowed to take cards and not to return them. They have a quickie election so that the vote has to be made very quickly after the thing is done. It's amazing how much change, i.e., damage can be done by the National Labor Relations Board.

The first thing that will happen if the Republicans take over in 2024 is that when it comes to the new members of this thing, it will be three, two Republicans, and all the stuff that the Democrats put into place will be undone. And when the Democrats come back in, the cycle is going to run in another way, which is another reason to say you don't want any industry to beholden to the regulatory situation, because the shifts in sentiments in one direction or another make another element of uncertainty.

You're doing a business plan and you're trying to figure out how to expand the factory or network. You want to run a ten-year plan. You can do that with your investors and all the rest of it, but you can do it with your regulators, and they may turn over two or three times between the state, the federal, and the local one. It's just a terrible mistake. As we start to lurch into a depression- or not a depression, I think it's more likely to be a recession, all of us are going to start to see this happening.

The big change intellectually because we're coming to the end of the hour is when I started teaching and taking this in law school in 1968 or so, you couldn't find anybody who had the hard-line views that I had on labor relations. Now, it turns out the intellectual forces are much more heavily divided. There are large numbers of people who think that the problem about the labor law is that they basically organize the most efficient form of cartels imaginable. Labor unions, which create rigidity, job [unintelligible 00:44:05] situations, all sorts of collateral consequences that harm individual people, shutting down school systems, buses, and all the rest of that stuff. And that they should regard it as a very dangerous set of institutions. That has been my view consistently since 1968. Looking at this statute, I don't see any reason why I should change my mind.

The Folly of the National Labor Relations Act

Bob Zadek: Richard, as I recall, when the National Labor Relations Act was enacted, almost your first sentence today was you recited the necessary findings which the legislature made in California, I believe, this is really from memory, the findings were that I'm paraphrasing "It's in the best interest of the country to have strong unions," something like that. And I said, "Where is that written? How could that be a finding? How could that finding govern union management relations for almost a century?"

Richard Epstein: What happens is if you go back and you read the National Labor Relations Act, there was a long history of judicial situations in which they said any effort on the part of the government to require individual firms, either at the federal or the state level, to unionize was an interference with freedom of contract. There was a decision in 1908 called the Dare by Justice Harlan which took that position. There was a more elaborate and actually more effective version of the same thing by Mahlon Pitney in a case called Coppage and Kansas, which was decided in early 1915. Essentially, you couldn't force unions on anybody. By the time you got to the 1920s and so forth, the New Republic, then a serious, very powerful situation, people like Felix Frankfurter was so strongly pro-union that it was only a question of time as to when these earlier cases would topple.

They started the topple in 1926 with the passage of the Railway Labor Act. That was applied to railways only because there was no question that the federal government had jurisdiction over things under the narrow version of the Commerce Clause. Then, 1930 comes and you see a book written by Felix Frankfurter and Nathan Greene called The Labor Injunction, which was very strongly pro-union. Norris-La Guardia gets passed in 1932. Then, what you do is you get the National Labor Relations Act after a couple of failed attempts in 1937 which completely undoes the structure that had been put together in these earlier cases.

What happens is they made a series of findings. There was no "actual" freedom of contract between management and work. What's the meaning of the word 'actual'? What they said is they couldn't prove that these contracts were coercive. The employers were often in a competitive industry. Wages were rising at that particular time. So, It's a philosophical belief that the moment you have an employee, there's an inequality of bargaining power, which means that the worker has no choice. Well, somehow or other, you have to reconcile that with the consistent rise in wages that took place during the entire period in which workers were oppressed. There's a fine book by a man named Gordon about the rise and fall of the economic system. What happens is, without question, the single greatest improvement in human well-being took place between the period of, roughly speaking, 1870 and 1940 at a time when labor laws were extremely hostile to you.

It's not an accident, it turns out it's a reason. You start putting these things into place and you slowly start to shut down the way in which the system is going to operate. So, after the war, you have unions and they get a little bit more powerful, the big one, but it's almost an equilibrium, but things slow down a bit and it's never been able to reproduce the level of growth that we've had in that particular period. There are a whole variety of other reasons that explain some portion of it. But make no mistake, if you were talking about the basic constitutional framework, you're a classical liberal, I'm a classical liberal, the period of time in American history that was closest to that frame of mind was the pre-New Deal period extending roughly from the end of the Civil War to the Second World War. That's where all the progress started to take place. But if you start reading everybody, what they say is all you did was just the endless amount of exploitation and the rest of it.

I'll give you just another illustration. There's always the argument, the moment you have market economies, safety is going to be thrown to the winds in the search of profit. Well, turns out these firms have a reputation. You start flying planes that drop regularly out of the sight, even if you don't have to pay a single dollar in damages, the loss to reputation exceeds so much the cost of prevention that they go in exactly in the opposite direction. If you start looking at records with respect to air safety on the one hand and vehicle safety on the other, all of these things improve mightily during this particular period when it turns out that you get these genius progressive economists saying none of this could possibly ever happen. It's all a kind of a big mistake.

Understand the following. If employers are not liable to workers for accidents, and they have a new device, are they going to use it? Yes, they are. Why are they going to use it? Because then they get better working conditions, they can get higher productivity and pay lower wages because they don't have to pay a premium for accidents. Also, if they are liable for the injuries, as they sometimes were in this period, they're going to put it into place because the cost of putting in superior equipment is less than the cost of paying damages.

Well, put both hands of it together. Doesn't matter what the liability rules are like. If you're running a business in which you have a close consensual arrangement with workers, it's going to be in your interest to make sure that this thing starts to run better. The real thing that you worry about is whether or not your safety devices are going to have to be approved by some federal board before they can start to be put into place. Or whether or not you can change work rules which have an intimate relationship to safety without going through some kind of a union procedure.

So, what happened is the old model worked perfectly well, and the great intellectual puzzle is why is this thing going to be destroyed in the New Deal period if it was so successful? The one-sentence answer, if I could give it to you, the macro situation completely deteriorated. Smoot-Hawley with respect to tariffs, massive deflation under Hoover. By the time you got done, those changes were so big, people said, "Well, the way we fix that is to get rid of all the bad breaches of American capitalism." What we did is compounded the felony. The only way you could get rid of deflation is through reinflation. The moment you reinflate, there's some people who are going to be caught in the downs and the ups, and they're going to be in a very bad situation. This is what the Biden administration doesn't understand at all, is you don't want to ever let this train run off the rails. Because if it does, there's no easy way to get it back on the rails without creating all sorts of collateral damages in the end.

So, what we have to do today is to try to make sure that statutes like the one you are talking about, the California Fast Food Act, never see the light of day because the damage that it will wreak will last long beyond the period of its repeal if it is repealed. That's why I take such a strong stand on it. It is to me a source of great sadness that popular sentiment is running in favor of practices, I think, which in both the short and long run would be regarded as utterly destructive.

Bob Zadek: Every time anything in our country is reformed, what is being reformed is something else that the government did. The reform is always fixing another statute and it goes on forever. Richard, thank you so much for sharing your thoughts and thank you to my friends.

This is a public episode. If you'd like to discuss this with other subscribers or get access to bonus episodes, visit www.bobzadek.com/subscribe

This is a public episode. If you'd like to discuss this with other subscribers or get access to bonus episodes, visit www.bobzadek.com/subscribe

We all remember the bank bailouts of 2008, but almost nobody talks about the more recent COVID bailouts. $50 billion here; $25 billion there – pretty soon we're talking about real money. The airlines were one of several industries that enjoyed special treatment from the federal government on the grounds that they constituted an "essential business." What would happen if the airports shut down completely? Sounds scary.But the airline industry was never at risk of disappearing, notes Veronique de Rugy, a senior research fellow at the Mercatus Center at George Mason University. In a series of policy briefs co-authored with air travel guru Gary Leff, de Rugy shows the colossal waste of taxpayer dollars that took place while no one was paying attention. Rather than re-organizing under Chapter 11 bankruptcy laws, as businesses do all the time, inefficient airlines were able to keep paying dividends to their shareholders while less privileged businesses went under permanently.Now, politicians like Bernie Sanders are criticizing Southwest airlines for the debacle of its holiday cancellations (and he has a point)But what else should we expect from an industry that makes money whether it performs well or not?

This is a public episode. If you'd like to discuss this with other subscribers or get access to bonus episodes, visit www.bobzadek.com/subscribe

It’s said that the way to a man’s heart is through his stomach. The State of California has repurposed this adage lately, finding ways to remake the country in its own progressive image through the food industry. The last time Professor Richard Epstein joined the show, we took up the “pig case” aka NPPC v. Ross. The Supreme Court is now deciding whether California can foist its values on the rest of the country through regulations that would impact pork producers nationwide. Based on oral arguments in October, it looks like it will be a close call. Meanwhile, a new battle has been brewing over fast food restaurants and other franchises in the Golden State. Governor Newsom signed the FAST Recovery Act (AB 257) into law on Labor Day, celebrating the bill’s dramatic minimum increase from $15 to $22 for fast food and other franchise workers. Organized labor cheered, but the bill has now been put on hold until voters can weigh in by referendum in 2024. We can hope that voters will see through the bill’s lofty promises for workers to the harms of minimum wage increases for workers, employers, and consumers alike. Even the Washington Post called the bill “ham-handed.” Professor Epstein joins me to review the economic case against the minimum wage. However, this is not like normal minimum wage legislation. The FAST Recovery Act also gives sweeping new powers to the state – and “Emperor Newsom” in particular – to regulate every aspect of thousands of businesses in California that qualify as large franchises. Such powers were unthinkable for the Founders, but Epstein points out that the courts have increasingly deferred to state authority since the New Deal Era. The FAST Act takes the administrative overreach that has become common and goes a step fruther – consolidating that power into the governor’s hand. Beyond the possibility of overturning the law by citizen vote, Epstein sees a larger opportunity to challenge its constitutionality on equal protection grounds – setting a precedent for similar cases of power grabs by state executives. The battlelines have been drawn. To quote an old Union hymn, Which Side Are You On? Team Liberty or Team Newsom?

This is a public episode. If you'd like to discuss this with other subscribers or get access to bonus episodes, visit www.bobzadek.com/subscribe

Not long ago, many businesses competed to extend credit to consumers through unsecured lending, auto loans, home mortgage loans or installment sales. Sadly, true competition is no longer.In today's consumer lending environment, businesses are nothing other than agencies of federal and, to some degree, state governments acting under the veneer of a private business. They have an unholy alliance with government.The industry promised, "We will do your political bidding. We will give you political cover, so you can carry out the social policies you wish. In exchange, Mr. Government, you will make sure we never lose any money."That pact has been honored by both parties to the detriment of us – naive consumers.Todd Zywicki helps us understand how we got here, where we go from here, and how to spot it when it happens.

Guest: Todd Zywicki, Professor of Law at George Mason University School of Law and co-author of Consumer Credit and the American Economy.

Not long ago, many businesses competed to extend credit to consumers through unsecured lending, auto loans, home mortgage loans or installment sales. Sadly, true competition is no longer.

In today's consumer lending environment, businesses are nothing other than agencies of federal and, to some degree, state governments acting under the veneer of a private business. They have an unholy alliance with government.

The industry promised, "We will do your political bidding. We will give you political cover, so you can carry out the social policies you wish. In exchange, Mr. Government, you will make sure we never lose any money."

That pact has been honored by both parties to the detriment of us – naive consumers.

Todd Zywicki helps us understand how we got here, where we go from here, and how to spot it when it happens.

Subscribe to the country's oldest libertarian broadcast – nationally streamed at 8 AM PT Sundays – for weekly transcripts, book summaries and additional resources:

Further Listening/Reading

* GMAC/Ally Financial

* Redlining (a libertarian perspective from Neal McCluskey)

* Usury ceilings in Arkansas

* Operation Choke Point

* ESG & the Political Pollution of Capital Markets

TRANSCRIPT

Bob Zadek: Consumer credit is a huge element of our domestic economy. Listeners have a personal self-interest as consumers of credit in the form of home mortgage loans, auto loans, payday loans, unsecured credit card debt, and so on.

Our economy would be in the dumpster the additional buying power given to consumers, because they can spend more than what they are earning in the past week or in the past month.

How important is the extension of consumer credit is in our economy?

Todd Zywicki: That's really the theme of our book that you mentioned, Consumer Credit and the American Economy.

In many ways, the history of America in the past century is the history of consumer credit. Most people don't appreciate that the great migration to the suburbs after World War II was fueled by consumer credit. When people left their apartments in the city and moved out to Levittown, they took out a mortgage, and they needed a car and furniture. That was all funded by car dealers, department stores, furniture stores, and appliance companies. People weren't paying cash for that three-bedroom house with the new Buick in the driveway.

That has continued since then. Consumer credit is a powerful vehicle for consumers to be able to acquire goods and then use them. Think about something as humble as a washing machine. That may be the best investment you ever make in your life.

“[T]he great migration to the suburbs after World War II was fueled by consumer credit.”

The alternative to buying a washing machine is schlep into the laundry mat every weekend with a pocket full of quarters – sitting there waiting for your clothes to wash.

We don't appreciate that these are capital goods – whether cars, houses, or student –that it makes sense for consumers to buy on credit as a form of an investment as well a form of savings as an alternative to renting, etc.

It fuels the economy and it really empowers consumers to make their lives better.

A Brief Primer on Consumer Credit

Bob Zadek: We could break down the consumer credit economy into three classes of the providers of credit:

* The lenders

* The businesses, remember them, and then,

* The government.

As we all know from the student loan crisis, government is the 8-billion-pound gorilla in the area of consumer credit – both directly and as a lender. When they're not the lender, the government is the board of directors of all the lenders, telling them how to do it. They are there one way or the other.

So, we have government butting into private lending, and we have the loan sharks, since the demand for consumer credit will always be there. If that demand is not met by A) businesses or B) government, it will be met by the street. One way or another, consumers will of necessity – not of choice – find a way to get the money they need to go about with their lives.

We start with the past – private lenders – even though those days are over.

Tell us how far away from the activities of a private lender we are today.

The activities of being a private lender and making a profit are easy. You're making loans. That's the product.

I have a lifetime of lending and representing lenders. As I learned when I first ventured into lending, you don't have to be that smart to make a loan – you don't have to be a genius to get a total stranger to take your money. Getting paid back is a bit trickier. You’ve got to know what you're doing. If you're a private lender, you're in the business of making loans to people who will pay it back, and in the ideal world of the marketplace, if you price your product higher than one of your competitors, you will not have any business. A lender has to price the product in a way that they make a profit or else they will fail.

“[Y]ou don't have to be that smart to make a loan… Getting paid back is a bit trickier.”

Profit = Income - Expenses. One of the business expenses of a lender is bad debts, because if somebody doesn't pay you back, that becomes an expense. A lender, in running the business, must manage the expense of bad loans.

Lenders make loans to people who will pay it back at a price that's lower than the competition. Pretty straightforward stuff. But that doesn't happen anymore.

The Distortion of Consumer Credit by Government

How far from that idyllic main street model are we today with consumer lending and why has government chosen to become as involved as they are in a consumer service?

Todd Zywicki: That's a great question – why does the government put their hands so much on finance when they don't design cars?

They don't design blue jeans, but they feel perfectly comfortable designing a lot of the terms and conditions of loans.

We understand why consumers use consumer credit. The demand side of the equation is to acquire what we can think of as capital goods. It makes sense to have a mortgage on a house, for example. It doesn't make any sense to save up for a house, pay rent while you're doing it, and then buy a house in cash.

Same with the car. People don't appreciate this, but one of the main reasons why General Motors overtook Ford as the largest auto dealer, was not just because of the superiority of their cars, but in the 1920s, General Motors rolled out the “GMAC plan” which allowed people to drive the car while they were paying for it. Otherwise, you could save up for the car but in the meantime, you had to take the bus.

The other reason people use credit is to deal with emergency, short-term fluctuations between income and expenses. That's the demand side.

The supply side basically consists of two things: the first thing is bad debt. If you have more bad debt, then you would lose money. The other thing is just the cost of lending.

A lot of the cost of lending is unrelated to the size of the loan. So, for example, it doesn't cost a hundred times more to make a $30,000 car loan as opposed to a $300 payday loan. You've got overhead. You've got operating expenses, employees, electricity, all that stuff. This is why small dollar loans just are more expensive than say a credit card loan – they're smaller, and they have high loss rates. It all makes sense from an economic perspective, but people just switch off their economic thinking about this.

Over time we've seen that a lot of this has migrated away from traditional sorts of credit to financial institutions. Back when we had usury regulations, that kept ordinary consumers from getting access to a lot of good credit – whether it was car loans or credit cards or whatever.

For example, Arkansas in the 1970s had very strict usury ceilings. Consumers, basically, couldn't get a credit card in Arkansas. It was also the pawn shop capital of America. Pawn shops were three times more prevalent in Arkansas, because people have a demand for credit but not a supply. You can't wish away a need for credit. If consumers can't get credit through organized competitive markets, they still need credit.

Tony Soprano isn't just a myth. In the 1960s, for example, there was a Senate report 1968 that said that loan sharking was the second largest revenue source of the mafia. It was estimated around 1970 by an FBI agent that there was about $10 billion a year in illegal loan sharking which is in today's dollars is about $69 billion. The entire payday loan industry in America today – online and brick-and-mortar – is about half that: $34 billion.

That's what we had with strict usury regulations that stifled competition and consumer choice. We learned in the past that whenever the government got involved by imposing these usury regulations, or imposing price controls, would get a black market. The loan sharks would take over.

Eventually, they moved away from usury regulations, but what they've done in many ways is worse – they have gotten their tentacles into the supply side of lending in a much more intensive way to try to control the other terms and conditions even if they leave the prices alone.

The Folly of Prohibition & Usury Laws

Bob Zadek: You mentioned Arkansas and pawn shops. Pawn shops are, of course, lenders. That's what they do. It's dressed up as you are selling something, with a right to buy it back at a higher price. The higher price is the interest. So, it's a loan secured by a guitar.

The pawn shop rates were somewhere around 128% per annum, although they don't lend itself to a precise calculation. So the Arkansas politicians back in the day could proudly boast, "We are protecting our consumers from paying too much interest," but the consumers were simply sent to 128% per annum transaction, because it was illegal to lend them the same money at 42%, which was usury. Go figure.

Of course, the reference to organized crime or even disorganized crime loan sharking is a common story. We all know that. Prohibition – whether narcotics, opioids, gambling – whenever government prohibits an activity that people are determined to do, the people will always do it, except they do it underground, which means the cost of doing it underground is higher.

There is no such thing as prohibiting an activity people want to do. You cannot legislate morality. If you regulate the price of something or ban its purchase and sale, and people want to do it, they will find a way to do it. Government will only succeed in only converting people into criminals just because they want to do something that doesn't hurt anybody else.

If you're a private business, you are torn. You want to make as many loans as you can. But more importantly than making a loan, is getting it back. Therefore, you want to manage all your expenses, including the expense of not getting it back, the bad debt expense.

Which means if you're a lender, you are determined to lend money to as many people as you can so long as they can pay it back. Therefore, you set the interest rate as high as you possibly can, but the market dictates that if you're making too much money you will draw competitors which will cause the price to come down. So, the marketplace puts the brakes on how much you could charge.

Give us some examples of how government has mandated to a lender that they increase their bad debt expense because that accomplishes a social goal. What happens to the marketplace for lending?

Todd Zywicki: They can pass all the laws they want, but they can't repeal the law of supply and demand and they can't repeal the law of unintended consequences. There's a supply and demand. There's a market here just like there is for anything else. You start fiddling with the pricing in that market and you're going to end up drying up the market – meaning people won't be able to get access to credit or some people, or you're going to get the products repriced.

For example, every credit card basically used to have annual fee on it. Now, why was that? It was because you couldn't charge a market rate of interest. Lenders would compensate by just charging you a fee in order to have a card– $40 or whatever. People who paid off their bills every month were subsidizing those who didn’t.

Most people would be familiar with the example of the Community Reinvestment Act during the financial crisis, and the requirement that banks do a certain amount of political lending to favored groups by the government. We know that those loans had a higher loss rate and that those loans end up washing through the system.

The Community Reinvestment Act: A Case Study in Market Distortion

Bob Zadek: The Community Reinvestment Act started in Chicago as an experiment. It was the first big example of requiring regulated lenders, aka banks, to make loans that a bank might not otherwise make. Tell us the effect of that legislation.

Todd Zywicki: It has become the model for subsequent political interventions into the financial system. The Community Reinvestment Act is intended to solve a prior problem the government caused, which is the problem of redlining. Redlining was the idea that there were certain neighborhoods that banks wouldn't lend to, which were predominantly minority neighborhoods. Now, where were the so called red lined neighborhoods? Where did that come from? It came from the federal government's housing agencies basically identifying certain neighborhoods as being high-risk neighborhoods, which were basically defined by their racial demographics.

In a competitive market you don't get that – regulating banks telling them where they can lend. We ended up with decades of federal government discriminatory housing policy that created disparities in the market. The way they decided to make up for that was basically to tell banks that they had to start making loans in a lot of those neighborhoods without applying the same underwriting standards that they apply to other customers. Government policy that creates red lighting and creates a racial discriminatory market followed up by another government policy that is designed to rectify the prior government policy by now turning those into favored neighborhoods where people are subsidized and then you end up with these issues of bad debt.

Bob Zadek: Banks are required to go to Washington and seek favors all the time. A bank wants to acquire another bank. They need approval. The approving agency will say, "Not so fast to Ms. Bank. Before we give you a consent that you want to make more money, let's see how you're doing on making loans to our politically favored groups. If you have a low rating for CRA, then we just may say no." 

So, there's a lot of coercion because of regulation. banks have no choice but to make loans to borrowers they otherwise wouldn't make a loan to for credit reasons, not for racial discrimination. Or, they would make a loan, but they would charge a higher rate than the government permits them to make, which means the bank expenses go up.

Well, if the bank's expenses go up and the bank is determined to make a profit, what must they do? They must raise their rates, which means all you listeners are now paying a quarter of a point more for your home mortgage to cover the increased bad debt expense, which a bank incurs because they are ordered to do so. So, notice what has happened: It's been a wealth transfer. By dint of CRA type legislation, consumers who pay their loans promptly are paying a higher rate of interest to underwrite and subsidize the cost of consumers who don't. It's insidious, but it's profound. 

But CRA in that dynamic is not alone, is it?

Todd Zywicki: No, not at all. This has become increasingly common by the federal government. A good example of this was during the financial crisis. The government basically took over Ally Financial – they had a majority stake in Ally Financial, the former General Motors financing arm. Ally wanted to become a bank holding company and it needed approval from the Federal Reserve. Basically, the CFPB held it up and extorted a settlement out of the company for discrimination with very questionable evidence to support it. The company has said subsequently that they were basically bullied into it. They used this leverage of discrimination.

We're now seeing that in the wake of everything that happened with George Floyd, this is spreading.

The idea is to conscript private banks to carry out this social policy and use this idea of wealth redistribution through the financial system. They use banks as a piggybank to accomplish things that the government doesn't want spend money on or take credit for directly.

Bob Zadek: Government decides to take money from one group to give it to another group. They know how to do that by direct legislation and call it “The 2023 Wealth Transfer Act”, but that's politically uncomfortable. The government is far too insidious to do it directly. 

Essential Liberty is a reader-supported publication. To receive new posts and support my work, consider becoming a free or paid subscriber.

A New Target: Credit Rating Agencies

You have called attention to another aspect of consumer lending which is becoming socialized: the credit rating agencies. I dare say the perception is that there's some objective evaluation of how you have behaved as a debtor. But it's far darker than that and getting much worse. What is happening in the area of this boring area of credit ratings?

Todd Zywicki: This is an under the radar issue that people really need to know about. Now, why do I say that? Because it turns out our modern credit reporting system in this country and credit rating agencies is a miracle. I'm not understating it when I say it is a miracle. We talked about the migration to the suburbs, we talked about the American dream. What really fueled that was the adoption of these modern credit rating agencies – these ways of collecting information.

Prior to the widespread use of credit reports and credit ratings, you could get a loan if you played golf with the bank manager. But the Ordinary Joe – the immigrant, the new guy – who was a good reliable person who worked hard and could pay their bills but weren't connected had no way of proving their credit worthy status. Credit ratings enabled the ordinary person to prove that they were creditworthy.

In fact, the great growth in the use of credit rating agencies came about with the passage Equal Credit Opportunity Act. Women were the ones who primarily lobbied for greater use of credit reporting. The accuracy of credit reporting is most important to people who are on the periphery. The young people, who don't have connections; people who don't have experience; people who can't to be able to show that they can be trusted to get a mortgage, to get a car loan etc. We're seeing more of these political assaults on credit rating agencies designed to politicize them to redistribute wealth. But in the long run, it ends up undermining the accuracy and the value of those systems which ends up interfering and harming those who supposedly are being helped the most by this.

Bob Zadek: The credit rating agencies only have their service purchased if it is proven to be accurate. Large consumer credit granters have a way of relating bad debt losses to credit ratings. There are a few credit rating agencies. If you find that one agency's rating produces a higher loss ratio than another's, you will determine the credit agency has a bad algorithm. Their methodology is wrong. So, the proof is in the pudding. Now, governments once again have discovered that credit rating agencies can be used to give credit – which means money – to recipients who might not deserve it so long as the method of rating the borrower can be manipulated.

Todd Zywicki: There is this irony, which is that they want to say that banks are these greedy guys, yet at the same time, they don't want to make loans to valuable customers because of discrimination. One of the persistent issues is that there are chronic differences in the credit scores between whites and minority borrowers. 

Or more precisely, Asians have better credit scores on average than whites, and blacks and Hispanics have credit scores that are not as good. A lot of people said, "Well, that's just evidence of systemic racism," and that we need to manipulate the credit scores so they all come out to be the same. That basically means taking what are these electronic systems, these algorithms that are designed specifically to identify what variables will best predict whether somebody will pay their loans and reconfigure them, so that they make it possible for racial redistribution within the system.

One other example that people haven't focused on is a desire to fiddle with the reporting of medical debt. This is part of a long-term effort to move to a single payer healthcare system by basically making it really difficult to bill and collect medical debt over time. If we want to have a debate over single payer health care, let's do that, but let's not do it through the back door by basically making doctors and healthcare practitioners unable to collect debt for services.

Bob Zadek: You could just as well have been talking about admissions policies in major universities. It's the same conversation. It's the objective examination which doesn't let enough of a politically favored group. Therefore, the problem must be in the selection process. Now, of course, university admissions systems are far from objective. There's a lot to be criticized in admissions policy. This is not a love song towards admissions policies, but it's the same process: You start with the result. We need to change the result. 

How do we change the result? 

We fiddle with the criteria. 

But when you fiddle with the criteria of who can pay back a debt, that's nothing other than saying the credit rating policy discriminates against people who don't pay their debts. Well, yes, that's the purpose. So, that's what's going on in credit ratings.

Explain to our listeners why they should care how it will adversely affect somebody who gets sufficient credit and goes about their business life, their commercial life borrowing what they need at whatever rate the market will charge. Why should they care about the government fiddling in underground garages, if you will? 

Todd Zywicki: Let me make clear, first, that like many other areas of our history, there was racial discrimination in the financial system. But the important point to recognize is that discrimination was a by-product of government regulation that came about because of government policies by housing authorities that pushed for redlining. That came about as a result of things like usury regulations that made it impossible for lower income people generally, but specifically minorities to be able to get access to credit. That came about because of usury regulations that made it impossible for personal finance companies to be able to operate in cities. 

But the answer is not to create more government regulation. The answer to that has always been the private market. It has always been banks, it has always been private lenders looking to identify untapped markets of credit worthy borrowers to whom they could lend money and get paid back.

Why does it matter? Because when some people don't pay their loans, the rest of us have to pay for it. In order to make a loan, you need to either be able to price the risk effectively or you need to reduce your risk of loss. That means either you raise interest rate or other cost, or you have to just not lend to some people. And in particular, who loses? People who have the weakest credit reports – people who have the weakest credit rating are the ones who end up losing. As a result, they are the ones who end up in hand of the loan sharks.

Operation Choke Point

Bob Zadek: Banks used to be truly private businesses, operated as a private business. The government has learned from none other than Lenin and Marx that all you need to do as a government is control the financial system and you control the entire country. That's all you need. You don't need a lot of armed weapons and you don't need a force. 

That process started with reducing the number of banks. It's easier to control a smaller number of banks than a larger number of banks. Of course, the banking system used to have perhaps 15,000 or 16,000 banks. Now, we're down to less than half of that. Many people believe, including me, that's not an accident or just mere consolidation. That's a matter of policy, because it's easier to control a few large banks than a zillion small banks.

On top of that, the government, which now ensures the deposits, has a stake in the solvency of the banks. The governments have a tool which is they require banks to behave in a way that doesn't threaten them. The usual tool government uses is they determine that an activity of the bank jeopardizes their reputation and in doing so, it threatens their solvency. 

All of that, Todd, is an introduction to Operation Choke Point, which we thought had gone away, but it has not.

Todd Zywicki: We live in a different world here. Those of us who consider ourselves libertarians have always thought in terms of this binary that goes back for centuries, which is that you've got private business on one hand, you've got public government on the other, and that the threat to liberty in some sense comes from the government and not from the private sector. 

But now, in the world of the administrative state, that binary distinction doesn't really hold anymore. Banking is in many ways the apotheosis of the regulatory state. Banking is so intertwined with the government – starting with deposit insurance and that becomes the lever for everything that comes after – that it gives the government the ability to exercise all these informal tools over the government.

They particularly use a power called supervision, which is basically the government can go in, and inspect your books and records, and basically determine whether or not you're running the bank in what they consider to be a safe and sound manner. That has been expanded over time now to include things like ESG that many people are aware of. 

What many people are less aware of was the Operation Choke Point. Operation Choke Point was an initiative during the Obama administration, where the banking regulators without any authorization from Congress, ended up basically telling banks they should not lend to these legal businesses. These were payday lenders, firearms dealers, etc. These were fundamentally just businesses that were unpopular with the Obama administration.

Bob Zadek: It included dating services.

Todd Zywicki: They weren't just controversial. They weren't dating services. But notably, it didn't include say, abortion clinics. A lot of organizations that could be thought of as controversial, but they just didn't think of it. What they used was this idea called reputation risk. Our friend, John Allison, who was, of course, the President of BB&T Bank for a long time and later president of the Cato Institute refers to it as “regulation by raised eyebrow,” which is the banks look at you and say, "Do you really need to have that particular client in your bank?” whether it's a payday lender or a firearms dealer or whatever. 

Most of the time, the banks just knuckle under, and most people don't even know about it, and all of a sudden, people have their bank accounts cancelled. Well, that eventually got out.

Cancel Culture in Banking

Bob Zadek: It got outed and then the FDIC or the OCC denied doing it. I did a show last week on the Dear Guidance letter from the Department of Education. It's the same thing. "No, we didn't tell banks what to do. We just casually express an opinion. We're not crazy about bank accounts for gun dealers," even though it's a lawful activity and bankers got the hit. 

You and I thought was dead, but you have pointed out it surfaced again. Government using bank accounts as a weapon to attack citizens who are not breaking any law is not limited to the US. There are examples in Nigeria, China, and Iran. Tell us about what's going on internationally about weaponizing a deposit account.

Todd Zywicki: I call it cancel culture comes to banking. Banks are now depriving private citizens, churches, and non-profit organizations of bank accounts. The Alliance Defending Freedom, for example, a number of religious liberties organization has had a number of their clients lose their bank accounts over time. Mike Lindell, the My Pillow guy, lost his bank account for being too controversial on various issues. But this is increasingly becoming a weapon used by authoritarian governments to prevent dissent.

In Canada, for example, people may recall that Justin Trudeau used this power to stop the Canadian truckers from protesting against vaccine mandates, which is he froze their bank accounts – frozen to the extent that people couldn't even use their own bank accounts to post-bail. 

A judge let this one person have bail, but she couldn't access her bank account to actually pay for it. You could easily see how this could lead to de facto taking away constitutional rights, if you have a right to a lawyer but you can't pay for it. The Chinese have done this. Iran right now has announced that women who protest the mandatory hijab rules will get two warnings and after two warnings, they're going to get their bank accounts frozen if they continue to persist in not covering their face in public. Why did they call it Operation Choke Point? Because they know they can choke off the air you need to breathe. And that's why they're leveraging bank accounts.

Bob Zadek: This is Bob Zadek thanking Todd Zywicki for sharing with us his thoughts, as set forth in his book, Consumer Credit and the American Economy. It is scary how our government has weaponized something as benign and ordinary as consumer credit and access to banking. It scares the heck out of me, because it's insidious. Nobody knows about it if somebody knocks on your door in a SWAT uniform. But when your banker is performing the same function as a SWAT team surreptitiously, that makes me fear for our country. 

Todd, thank you so much for sharing your thoughts with us.

This is a public episode. If you'd like to discuss this with other subscribers or get access to bonus episodes, visit www.bobzadek.com/subscribe

Two-term SEC Commissioner Paul Atkins is the chief executive of Patomak Global Partners – a New York and DC-based financial services consultancy. Paul served as a member of the congressional oversight panel for TARP (remember that?), was a partner at PricewaterhouseCoopers, and an attorney with Davis Polk.

Today's topic we can subtitle as “Financial markets meet Environmental Social Governance (ESG),” which sounds rather benign, but it's far from it. Imagine you're seeking the best physician to cure a serious medical condition. What's the likelihood you'll ask the prospective physician her opinion on immigration, cash bail, or criminal justice reform?

The Bob Zadek Show is the country's longest running libertarian broadcast – nationally streamed at 8 AM PT Sundays. Subscribe for weekly transcripts, book summaries and additional resources:

As Paul will explain, financial regulation is forcing the politics of ESG into our financial markets, resulting in lower yields for all of us and the misallocation of capital.

Links & Resources:

* Patomak Global Partners

* ESG trends and impacts on public pensions, Reason Foundation Webinar, September 23, 2022

* A Friedman doctrine: The Social Responsibility Of Business Is to Increase Its Profits, Sept. 13, 1970 - New York Times

* ESG-focused institutional investment seen soaring 84% to US$33.9 trillion in 2026, making up 21.5% of assets under management: PwC report, 10/10/22

* Engine No. 1.

Transcript/Summary

Bob Zadek: Tell us the statutory historical purpose of the SEC, so we can understand the context for ESG investing.

Paul Atkins: The SEC is a government agency that was created back in 1934, in the wake of the 1929 stock market crash. Congress, in the new FDR administration, enacted a series of statutes trying to govern the securities markets and bring disclosure to them for transparency. The SEC was created as a specialized agency to be a regulator of the public financial markets, and also as an enforcement agency. It has a whole big regulatory rulebook that governs brokers, asset managers, and other parts of the infrastructure of trading securities here in the United States.

So, the SEC does not do quality control on how good and investment is, but rather makes sure that when decisions are made by the investing public, they have the best information available. Is that a fair summary?

Yes, sometimes SEC is a bit schizophrenic as to how it approaches these things. But Congress wanted to try to make sure that the information in the marketplace is accurate, and that public companies provide material information to investors, so that they can make their investment decisions. It’s not to require companies to disclose every possible thing, because that's impossible, but to disclose material information that is accurate.

What is the relevance of those three words to investment: Environmental, Social, and Governance? Why are we talking about this current buzz phrase?

This is an amalgam of a lot of different ideas that have been percolating in investment circles for a few decades.

It’s odd that these three things are thrown together, because environmental obviously has to do with the disclosure and investment, and what we now call “sustainable companies” or “sustainable products,” and that itself has a very squishy meaning.

The social aspect is what we've seen over the last few years when people talk about equality, or equity, or anti-discrimination issues.

And finally, governance has to do with how a company is run – the roles and interactions between the shareholders, the board, and management. There's a long history of how public companies are governed, the rights of shareholders, the duties of directors, and then how management interacts with that. Basically, the investors invest money in the company. They have their representatives – the board of directors – who are meant to oversee management and the company. Then management is, of course, the hired help. So that's the governance aspect.

More and more institutional investors are using some or all of these various criteria as filters for their investment decision making.

You can trace this back in the ‘70s, when several states directed their pension plans to screen out so called “sin stocks,” like no tobacco, no alcohol, no gambling, etc. A lot of religious-oriented groups did the same thing. Then in the ‘80s, there was the issue about South Africa divestment. In the 2000s, there was a movement by states, again, to screen out their Iranian investments, or even fossil fuels, depending on the state. But ultimately, it didn't have much of a real effect in the financial markets.

Now, especially after COVID, and during that time with the George Floyd issues, this ESG investing by the private sector has grown to where investors are putting pressure on public companies to change their business models to deal differently with workers and so on. These institutions are looking to invest in “good companies” rather than the undesirable ones.

ESG, so far, sounds a little bit vague. Show us how politicized investment through the large institutional investors profoundly and negatively affects each and every listener to our show.

If you think the government is bad at spending ‘other people's money,’ that's what we're talking about here.

Back in the ‘80s and ‘90s, public markets looked different than they do now. More than half of all the money that was invested in the US stock market was held by individual investors – normal folks who putting money into the stock market through their brokers.

Today more like 78% of the total amount of money held in the US markets is held by institutions.

When annual shareholder meetings come up for the stocks held by these various funds, somebody has to vote the proxies. You're not doing that, because it's not you who own that share of stock of the company, but it's the fund that you've put money into. So it’s Vanguard or Fidelity – there's a portfolio manager, or a committee, or somebody who is deciding how those proxies are voted.

Over time, there are people who are much more politically inclined – these politicized shareholder activists, I'll call them – putting pressure on public companies through these shareholder proposals to try to sway the company policy with respect to either businesses that they go into, or products that they issue, how they treat their workers, etc., and they are pressuring other investment managers to vote their way as well.

For example, there are these groups out there who are trying to pressure oil and gas companies to get out of the oil and gas business.

Saul Alinsky, back in the ‘70s, was the first one who recognized the power of swaying corporate management through the use of shareholder proxy process. That has had some very serious and long-range effects.

Americans hold the right to vote as being quite important. When we vote for members of the House of Representatives, we are voting for people to represent our best interest. It’s the same thing in corporate governance: we don't get a vote in controlling officers and employees of the corporation, but we vote for the people who will represent us in those elections.

These representatives are not voting in our best interest, and may not reflect our views. Do I overstate my case?

People who are putting their money into large ETFs or mutual funds are unwittingly powering an ideological strategy by folks who maybe don't share your outlook or your goal of having financial returns to fund your retirement, your college fund for your kids, your health needs, etc.

They are more interested in doing “good” with the money.

The telling part is the behind-the-scenes strong-arming – almost mafia-type tactics – where people representing these big investment managers meet with corporate management, and say, “We're going to vote against you at the upcoming shareholder meeting if you don't do X, Y, and Z.”

It's a growing type of pressure being put on these various companies to try to have them follow these various type of ideological standards. Ultimately, it cuts down on the returns that investors get. If you're saving for retirement or just saving in a mutual fund, you will have less money in the future, because all of this stuff costs money, and of course a lot of the sustainability investment is riskier than others sorts of investments.

Tell us what happened with Exxon, when activists – who were not concerned about maximizing profits but other goals – actually got to be on the Board.

A couple years ago, Exxon's returns were not doing that well.

Energy prices were very low, and so Exxon was facing pressure from these institutional investors saying they should get out of oil and gas because it's bad for the environment. They wanted Exxon to go down to alternative sorts of energy paths.

This one single-purpose hedge fund was put together called Engine No. 1. They ran what we call a short slate of directors against the other directors that were being put up by the nominating committee. Some of the large investment management funds – in particular BlackRock, State Street, and Vanguard – switched their normal voting. They usually voted with management, but this time they voted for the short slate of insurgent directors who actually won.

That was quite a big boost in investment management circles and it got the whole discussion going about ESG.

Exxon obviously has been around a long time. It prides itself on always paying a dividend. Unlike some other companies, it has a lot of individual investors still holding its stock. Some 90% of the individual investor group voted with management, whereas the institutional investors – voting with other people's money – appointed that insurgent slate of directors.

So whose interests are being represented here? Ultimately, it's the investors who are putting money into it, who will either get the benefit or pay the price of those decisions.

People who are usually on the left have figured out that they can actually do things through the private sector – through these investment managers – to put pressure on companies to achieve “net zero” by whatever arbitrary dates people are now talking about – 2030 or 2050.

Isn't there a market for an investment fund that says, “We pledge to make our investment decisions on a purely economic basis, and we have no interest in doing anything other than increasing the return”?

There are some that are emphasizing that right now, and making a point that they’re not going to engage in that sort of ideological screening of investments or twist companies’ arms behind closed doors to advance their ideology.

However, it's in the interests of these investment managers to push the whole ESG investment process because they can charge higher fees. There was a PwC survey that said 78% of investors are willing to pay a 3-5% premium to invest in ESG.

If you want to do that there should be full transparency and proper disclosure about all this. The fiduciary duty of these pension managers and other financial managers to their investors, should be in violet there.

“People who are usually on the left have figured out that they can actually do things through the private sector – through these investment managers – to put pressure on companies to achieve ‘net zero’ by whatever arbitrary dates people are now talking about – 2030 or 2050.”

That's where the controversy is coming from now with state financial officers, for example, in the red states. 26 of them have been putting contrary pressure on some of these investment management firms [to stop ESG investments].

Florida, for example, has taken money away from management by BlackRock for just this reason.

People need to be aware of how your money could be used, and to ask questions of your investment manager, where you're looking to see how your money's being used by your various funds.

Nothing in this show is expressing an opinion about ESG as goals. I’m agnostic on that. The point of this show is about who gets to decide how your money is used. This is about financial democracy. It's your money, and a stranger should not be permitted to further their social goals with your money.

I agree. First of all, ESG investing, like you say, may be fine. If you like that, God bless you – put your money into that. But be aware that your money could be used in ways that you don't necessarily want it to be. So ask questions.

ESG investing is dangerous because it uses made-up metrics. It's ideologically driven, and could be against your own interests. It distorts markets by denying capital to legitimate types of productivity, and it could cut down on innovation competition – again, to your detriment, because investing into solid products that have a market need is the essence of investing in the marketplace.

Ultimately, ESG is about pushing social and environmental policies through means other than our Constitutional political process. This is all about power, and all about trying to get to ulterior motives down there. So if you're not on board with that, please be aware that you have a lot of power through where you place your money. Just ask your advisors or look at the statements behind the investment manager that is running your fund to see if they're talking about ESG principles.

People talk about ideology 24/7 nowadays. It’s unfortunate that it's invaded the investment management industry. Ultimately, it’s detrimental to investors, and people could be hurt long term – whether you're spending money more on higher fees for the ESG funds, or through compounding of interest. That really hurts after 20, 30, 40 years of saving and investment.

This is a public episode. If you'd like to discuss this with other subscribers or get access to bonus episodes, visit www.bobzadek.com/subscribe