SUMMER 2005 THE FEDERAL RESERVE BANK OF RICHMOND UNDER SCRUTINY Is Sarbanes-Oxley Working as Planned? • Tobacco Buyout • Bankruptcy Reform • Freakonomics • Milton Friedman on Price Controls VOLUME 9 NUMBER 3 SUMMER 2005 COVER STORY Our mission is to provide 13 authoritative information Lights Out: Three years after the enactment of the and analysis about the Fifth Federal Reserve District Sarbanes-Oxley Act, questions are mounting about economy and the Federal unintended consequences for hundreds of U.S. firms Reserve System. The Fifth In an age of stepped-up regulatory scrutiny, more companies are deciding District consists of the the costs of being publicly traded or listed on a major stock exchange District of Columbia, are no longer worth it. That’s not exactly what lawmakers had in mind. Maryland, North Carolina, South Carolina, Virginia, and most of West Virginia. FEATURES The material appearing in 19 Region Focus is collected and Tobacco Buyout: The invisible hand plants first crop developed by the Research For the first time since the 1930s, tobacco growers will enter a market Department of the Federal largely free from mechanisms that restrict supply and guarantee prices. Reserve Bank of Richmond. 22 DIRECTOR OF RESEARCH Redevelopment Boot Camp: Will military-centric commu- John A. Weinberg EDITOR nities find ways to turn barracks and bombing ranges into Aaron Steelman something marketable? SENIOR EDITOR Communities like Blackstone, Va., show that base redevelopment works Doug Campbell best when it uniquely addresses an existing need in the marketplace. MANAGING EDITOR 26 Kathy Constant A Menu of Options: A Richmond Fed economist says that giving BUSINESS WRITERS Charles Gerena financial institutions limited choice about how they are regu- Betty Joyce Nash lated may produce a more stable and efficient banking system EDITORIAL ASSOCIATE What’s the best way to supervise banks? It may be to create a system with Julia R. Taylor incentives that help keep risky banks from declaring themselves safe. CONTRIBUTORS 30 Kartik Athreya Joan Coogan Youth Movement: Blacksburg, Va., and Morgantown, W.Va., Andrew Foerster are counting on their local universities to create more jobs. Eric Nielsen Christian Pascasio Is that realistic? Jennifer Sparger Virginia Tech’s research park has been a boon for Blacksburg. But the ECONOMICS ADVISERS farther away from campus, the fewer the benefits. Andrea Holland 34 Robert Lacy From the Classroom to the Workplace: So, where are the jobs? Ray Owens DESIGN Hiring is up for new graduates but are all degrees created equal? Ailsa Long 35 CIRCULATION Making it on the Reservation: The Eastern Band of the Walter Love Cherokee Indians shares the economic problems that Shannell McCall afflict tribes and rural communities nationwide Published quarterly by the Federal Reserve Bank With pragmatism and a determination to survive, the Eastern Band has of Richmond faced the challenges of federal Indian policy, land use, and rural living. P.O. Box 27622 Richmond, VA23261 www.richmondfed.org DEPARTMENTS Subscriptions and additional copies: Available free of charge 1 Noteworthy/Retail Credit Expansion and Regulatory Overreaction by calling the Public Affairs 2 Federal Reserve/“How Not to Stop Inflation” by Milton Friedman Division at (804) 697-8109. 8 Short Takes Reprints: Text may be reprinted COVER STORY with the disclaimer in italics 10 Jargon Alert/Monopoly below. Permission from the SEE PAGE 13 1 1 Research Spotlight/Why Regulations Fail — Yet Persist editor is required before reprinting photos, charts, and 12 Policy Update/Freer Trade in Textiles Changes Import Sources tables. Credit Region Focus and 39 Economic History/High Tech Down South send the editor a copy of the publication in which the 42 Interview/Robert Whaples reprinted material appears. 46 Book Review/Freakonomics: A Rogue Economist Explores the The views expressed in Region Focus Hidden Side of Everything are those of the contributors and not COVER: necessarily those of the Federal Reserve PHOTOGRAPHY: CHRISTIAN ZACHARIASEN/GETTY IMAGES 48 District/State Economic Conditions Bank of Richmond or the Federal INSIDE COVER: 56 Opinion/The Economics of Bankruptcy Reserve System. PHOTOGRAPHY:PHOTOGRAPHY: AP/WIDE STOCKBYTE/GETTY WORLD PHOTOS IMAGES ISSN 1093-1767 NOTEWORTHY Retail Credit Expansion and Regulatory Overreaction t the turn of the 20th So once again we have an episode of expanding credit century, working Ameri- accompanied by a regulatory response. Among the most Acans had relatively few recent measures, North Carolina has enacted legislation that attractive options for obtaining limits certain practices in the subprime market. At the credit. Often, they took out loans national level, the data that lenders are required to submit with high costs and inscrutable under the Home Mortgage Disclosure Act now must include terms. Worried about this trend, information on interest rates if they exceed a certain spread New Jersey passed the country’s over funding costs. Some advocates have recently proposed first small loan laws in 1914. expanding credit card disclosure requirements to include, Like similar measures to follow for example, the time it would take to repay the bill while just in other states, the New Jersey making the minimum payments. Improved disclosure can legislation included requirements strengthen consumers’ understanding of financial products that lenders who charged more and increase the odds of consumers getting the product that than the legal interest rate for banks be licensed and that bor- is best for them. But to the extent that increased disclosure rowers be informed about the precise terms of their transaction. requirements are simply a prelude to other measures that More than any other effort in the early 1900s, small loan laws would reduce the availability of credit, we should be wary. were credited with helping to protect poor borrowers from When weighing measures designed to protect borrowers, price gouging. we should always keep in mind the inherent trade-off between We have witnessed a similar pattern over the past preventing adverse effects for some and limiting the avail- 100 years. When new forms of retail credit have become ability of credit to others. The evidence suggests that available, there has often been a political response, ranging constraints on allowable interest rates are counterproductive from disclosure rules for installment lenders in the 1920s to and generally reduce consumer well-being. While some curbs on payday advances in the 1990s. Sometimes these policies that carefully target truly abusive practices are responses have been driven by populist aversion to financial warranted, the broader risk is of a regulatory overreaction institutions; sometimes by sound economic principles. that stifles much of the benefit of the technology-driven Occasionally, they have been counterproductive. expansion in consumer credit. It is important to remember these lessons of history. One thing I think everybody can agree on is the usefulness The United States is currently experiencing what can of educating consumers about managing their financial arguably be called a revolution in retail consumer finance, affairs. Financial institutions depend critically on their one of the greatest credit expansions in history. And with it customers’ trust, and trust is built on their understanding the we are encountering the anticipated policy responses. While difference between a legitimate financial transaction and one in general we would expect that regulations ought to adapt that is too good to be true. Beyond that, an electorate that to changing credit market practices, there is a very real has a broad appreciation of the efficiency of credit markets danger here of regulatory overstep. It’s important to will have an easier time sorting out when any particular remember that, on the whole, the expansion of retail credit policy proposal is truly in its interests. has been tremendously beneficial. Limiting this expansion The United States has arguably the most efficient retail might have the undesirable effect of preventing the people credit markets in the world. We should avoid regulatory most in need of credit from obtaining it in the first place. actions that would threaten a system that has served so many Over the past 15 years, technological advances have people so well. reduced the cost of gathering, processing, and retaining consumer account information. These savings have been passed along to borrowers in the form of lower lending rates. Credit cards, which used to be available almost exclusively at high interest rates, are now offered at lower rates to a JEFFREY M. LACKER broader market of creditworthy customers. PRESIDENT The upshot is that more people today can afford to FEDERAL RESERVE BANK OF RICHMOND borrow. Because credit allows people to choose a spending pattern that is smoother over time than their income stream, Editor’s Note: This article is based on a speech given on June 14, 2005, at the the expansion of retail credit over the last two decades has annual meeting of the North Carolina Bankers Association. To read the yielded positive net benefits for American consumers. speech in its entirety, please visit our Web site: www.richmondfed.org Summer 2005 • Region Focus 1 FEDERALRESERVE How Not to Stop Inflation BY MILTON FRIEDMAN EDITOR’S NOTE: High and rising in- et me turn to my topic for This analogy is suggestive but does flation can tempt policymakers to enact tonight, “How not to stop not go far enough. If you broke the inflation.” As you know, the word thermometer, that would neither quick “fixes,” such as wage and price L “inflation” has a great many different make it hotter nor do any other harm. controls. But as Milton Friedman argues in meanings and people attribute different It would just simply prevent a signal this speech, delivered in February 1966 to conceptions to it. What we mostly of the rising temperature from being the Detroit chapter of the University mean by it, and what I shall mean by it, seen.