Trends

NO SECURITY AFTER ALL

Although government regulation is an acknowledged failure in many areas of consumer interest (e.g., the domains of the CAB, the ICC, the FDA, etc.) few have thought to question the efficacy of government protection of investors, by means of the Securities and Exchange Commission. Until recently, the only scholar impertinent enough to question the SEC's benefits was Chicago economist George Stigler, whose 1964 analysis of the effects of the Securities Act of 1933 raised significant doubts. Last year, however, Stigler's work was considerably extended by Prof. George Benston of the University of Rochester. Prof. Benston has examined in detail the SEC rules requiring periodic disclosure (filing with the SEC) of company financial information. After examining (empirically) every argument in favor of the rules, Benston flatly states that they have had "no measurable positive effect on the securities traded on the New York Stock Exchange. There appears to have been little basis for the legislation and no evidence that it was needed or desirable."

These are serious charges, of course, calling into question one of the primary justifications given for the SEC's existence. To understand why the disclosure rules are of no benefit, and how Benston reached this conclusion, the following examples should prove helpful.

• Benston examined whether the SEC's disclosure system can provide information to investors quickly enough to be useful in making investment decisions. His exacting statistical analysis indicated that by the time the information reaches the public via SEC reports, it appears to have been completely discounted by the market. The strong implication is that insider information is in fact the basis for most price movements in the stock market.

• He examined the famous charge by the SEC that lack of disclosure in 1929 was a principal contributing factor to the success of the "manipulation by massive pool operations" in over 100 stocks. In fact, involvement in pool operations was just as frequent for those companies making disclosures as for those making none. Thus, the operation of pools "owed little to the nondisclosure of accounting data."

• Benston also addressed the argument that absence of the SEC would cause investors to lose confidence and stay out of the market. To test this proposition, Benston compared the statistical "riskiness" of various stocks prior to 1934, and found no difference between those that did and those that did not disclose the type of information subsequently required by the SEC.

In addition to these statistical analyses, Benston (who is himself a CPA, in addition to being an economist) points out several other drawbacks of the SEC's disclosure rules, among them the fact that the SEC's extremely conservative accounting rules actually make some of today's disclosures more misleading than those made voluntarily prior to 1934. He points out that in the 1920's the Stock Exchange itself required all listed firms to be audited, and that competition in selling securities had led the majority to disclose voluntarily such data as their sales and depreciation costs.

Apparently, then, the SEC is little different from the other federal regulatory agencies: irrelevant at best, a costly imposition at worst, justified in the public's mind by economic folklore. Fortunately, that folklore is now being exposed.

SOURCES:
• "Sins of Commission—A New Study Challenges SEC Disclosure Policies," Henry G. Manne, BARRON'S, 20 August 1973.
• "Required Disclosure and the Stock Market: An Evaluation of the Securities Exchange Act of 1934," George J. Benston, AMERICAN ECONOMIC REVIEW, Vol. 63, No. 1, March 1973.

ENDING THE NEW PROHIBITION

Early last October the state of Oregon became the first of the 50 states to repeal its law prohibiting the private possession and use of marijuana. Much to the dismay of critics, Oregon was not overrun with drug-crazed hippies: people still went to work, families stayed together, children remained in school. In short, life continued just about as always, except that hundreds of people avoided the stigma of being labeled "criminal" for partaking of a mild, apparently harmless recreational drug.

There are strong indications that Oregon won't be the last state to "decriminalize" marijuana. In recent months several influential organizations have seconded the recommendation of the National Commission on Marijuana and Drug Abuse that the "new prohibition" be ended. The National Advisory Commission on Criminal Justice Standards and Goals recommended that states "reevaluate" their laws making criminal such victimless activities as marijuana possession and use, gambling, prostitution, adult sexual acts, and pornography. The American Medical Association urges that states not consider marijuana use to be anything more than a misdemeanor. More significantly, the American Bar Association has openly endorsed the removal of all criminal penalties against marijuana possession, as has the National Conference of Commissioners of Uniform State Laws.

In the nation's most populous state, the California Marijuana Initiative is gearing up for a second attempt at decriminalization via a ballot initiative. In the 1972 election the group's decriminalization proposal received 33.5% of the vote. In 1974, the initiative's backers expect to get 40-43%, according to strategist Gordon Brownell, a libertarian and former White House aide. Brownell considers the 40-43% mark as a critical threshold for serious consideration by the legislature. So, apparently, does conservative columnist Kevin Phillips, who considers the California vote as a harbinger of things to come for the rest of the U.S. With Oregon and California showing the way, and prestigious national organizations lending their support, the days of marijuana prohibition may well be numbered.

SOURCES:
• "Marijuana: The Political Future," Kevin Phillips syndicated column, 10 June 1973.
• News items, CRIMINAL JUSTICE NEWSLETTER, Vol. 4, No. 17, 4 September 1973.
• "Grass Grows More Acceptable," TIME, 10 September 1973.
• (THE MARIJUANA REVIEW, Vol. 1, No. 9, September 1973 gives a complete history of the 1972 California initiative campaign and the planned 1974 ballot effort. It is published by AMORPHIA, 2073 Greenwich St., San Francisco, CA 94123.)

THE USURY MYSTIQUE

Probably the oldest form of price control is the usury law, limiting the amount of interest which can be charged on loans. Usury laws stem from the ancient religious prejudice against interest, per se, as evil. In fact, it was not until the 16th century that this prejudice was largely overcome, as part of the emergent "Protestant ethic." Still, the mystique lingers on in the form of usury laws in all 50 states, fixing the maximum price of credit.

Over the years voices of rationality have prevailed in varying degrees in most states, to create "loopholes" in the usury laws for small loans, retail credit, and various business and bank loans. But in most states the usury laws still apply to mortgages. In today's tight money climate, the usury laws are thus wreaking havoc with the mortgage market. The situation is particularly bad in New York, New Jersey, and Minnesota, which are saddled with an 8% interest ceiling. With banks paying 10½ to 11% to get short-term funds, and the prime rate between 9 and 10%, they can hardly afford to loan money out at 8%. None of this jaunts such critics as the New Jersey AFL-CIO. With its usual Neanderthal grasp of economics, the union advocates a forced reduction of mortgage rates to 6%, to "enable people of modest incomes to afford housing."

Nowhere is the comparison between economic naivete and reality more apparent than in Arkansas, where the usury law is part of the state constitution. In Arkansas a 10% ceiling applies to all loans, without exception. In today's market, therefore, credit of all kinds is disappearing in Arkansas. Home mortgages are nearly impossible to obtain, commercial and industrial developments are being cancelled, and bank certificates of deposit are going unsold. Most large finance companies have left Arkansas altogether, while retail merchants have resorted to raising list prices or moving across the border. The comparison is best illustrated in Texarkana, a city of 52,000 which straddles the Texas-Arkansas border. On the Texas side there are 11 new car dealers and 23 used car dealers; the Arkansas side has no new car dealers and three used car dealers. There are 21 furniture and appliance stores on the Texas side, but only six on the Arkansas side; 25 finance companies on the Texas side and none on the Arkansas side.

Despite such evidence, the Arkansas AFL-CIO supports the usury law. "It's one of the finest laws we've ever had," says the state union president. Just the opposite is the view of Edward Penick, president of the state's only bank holding company. Looking to what will happen unless the usury law is repealed, Penick predicts "The average working man looking for a car, mobile home, or boat won't be able to find a loan. The Arkansas usury law, which is supposed to protect the small borrower, is going to be his downfall."

SOURCES:
• "Useless Usury Laws," TIME, 10 September 1973.
• "Arkansas: A Usury Law Dries Up Loan Funds," BUSINESS WEEK, 29 September 1973.

BRINGING IN THE GAS

One of the acknowledged causes of this winter's energy crisis is the federal government's regulation of natural gas prices. Under terms of the Natural Gas Act of 1938, the Federal Power Commission is required to fix the price of natural gas at lower than free market levels, supposedly for the benefit of consumers. In recent years, these below-market prices have been insufficient to finance continued exploration and development, and as a result, U.S. reserves have been dropping and shortages are becoming widespread. The solution to the problem—deregulation—should have been obvious, even apart from economic theory. Available for everyone to see was the fact that producers in the unregulated intrastate markets (e.g. within Texas or Louisiana) have been free to raise their prices, and have continued to bring in new reserves. (Intrastate prices are now twice interstate prices.) The shortages that exist are in interstate gas sales.

To its credit, the FPC has been urging deregulation for several years, and has done what it could (within its legislative constraints) to allow prices to rise. Indeed, on at least one occasion during 1973, the FPC's decision to allow price increases was overturned in the courts. The Commission has allowed large price increases on certain "new" sales, and recently announced that the law gave it no jurisdiction whatever over prices of synthetic gas (e.g. gas produced from coal or naptha), a decision of potentially great future significance.

Despite its sympathy for deregulation, the FPC is limited by its Congressional mandate. And there are intense pressures in Congress to "solve" the gas shortage by extending price regulation to intrastate sales (as proposed in a bill by Senator Adlai Stevenson III). Lee White, director of the Consumer Federation of America, agrees with this view, and even proposes creation of a TVA-type government corporation to compete with private gas producers. White also criticizes the idea of higher prices as a stimulant to increased production, making statements such as "There is absolutely no credible evidence indicating the additional volume of gas that would be produced and available at any price."

But on the contrary, there is considerable evidence indicating precisely that. Two MIT economists, Paul MacAvoy and Robert Pindyck, have constructed a detailed econometric model of the natural gas market, containing explicit policy variables. It simulates both the market for new gas reserves (sold to pipeline companies) and the wholesale market for gas delivered by pipeline. MacAvoy and Pindyck have used the model to evaluate three policy alternatives: deregulation of wellhead prices, more extensive "cost of service" regulation than now exists, and continuation of the status quo (of gradual increases in the controlled prices). The results are dramatic. Under the deregulation alternative, the production shortage would be eliminated in four to five years. This result could not be achieved by continuation of the current policy of small controlled price increases. Moreover, the "more regulation" alternative would increase the size of the annual shortage from the current level of 3 trillion cubic feet to 9 trillion cubic feet per year by 1980. Similar results were obtained by another pair of economists, Robert M. Spann of Virginia Polytechnic and Edward W. Erickson of North Carolina State University. They recommend that deregulation proceed as rapidly as possible, because "It seems better to pay this cost now rather than draw out the process of deregulation, continue to extend the shortage into the future, and run the risk of additional, administratively induced resource misallocations."

The natural gas shortage is a creature of government policy. Whether the shortage is eliminated or exacerbated will also be a matter of government policy. Thus, one acid test of a politician's sincerity regarding the energy crisis is his position on natural gas deregulation.

SOURCES
• "FPC Says Its Control of Coal-Gas Is Limited," AP (Washington), 5 September 1973.
• "The Hot Battle Over Natural Gas Controls," BUSINESS WEEK, 20 October 1973.
• "Alternative Regulatory Policies for Dealing with the Natural Gas Shortage," P.W. MacAvoy and R.S. Pindyck, THE BELL JOURNAL OF ECONOMICS AND MANAGEMENT SCIENCE, Vol. 4, No. 2, Autumn 1973.
• "Joint Costs and Separability in Oil and Gas Exploration," Robert M. Spann and Edward W. Erickson, paper presented at the Operations Research Society of America convention in San Diego, 12-14 November 1973.