If Washington owns it, it just can’t keep its hands off.

—Senator Lamar Alexander

Twenty-five years ago President Reagan told auto workers in Orion, Michigan, “You’ve demonstrated when the chips are down, what people can do working together freely, rather than at the dictates of some central planner or bureaucratic mandate of government. I happen to believe the last thing your industry needs is the federal government bringing in outsiders to tell you how to run a business.”

Fast-forward to 2009: President Obama fires GM chief Rick Wagoner, the company files for bankruptcy, a government-appointed auto task force calls the shots, and the federal government now owns 61 percent of the new GM.

How did we get to this point and what can we expect from Government Motors?

In its heyday in the early 1980s, GM employed nearly 350,000 workers at 150 assembly plants. It also had a 43.8 percent share of the market. Unfortunately, the good times did not last.

Decades of high labor costs, foreign competition, extensive government regulation, and burgeoning legacy costs steadily reduced GM’s market share to today’s 19.1 percent. A shrinking market means that legacy costs will skyrocket and become unsustainable. Mark Perry at the University of Michigan–Flint estimates that the ratio of retired GM auto workers (plus surviving spouses) to active UAW members was 4.61 to 1 in 2007. Given the state of Social Security, in which fewer workers support a growing retiree population, the phrase “As GM goes, so goes the nation” seems about right.

Given the plummeting market share (averaging 0.85 percent every year), one would think at some point one of the GM chiefs would have taken drastic action to turn things around. One would think wrong. There was no financial incentive to do so. Since the GM board continually rewarded failure with mega-million-dollar bonuses (similar to the practice at AIG), why bang heads to reduce labor rates or eliminate duplicate product lines? GM’s management apparently decided to simply stay the (downward) course, collect their golden parachutes, and hope that the inevitable wreck came on the next guy’s watch.

When time finally ran out for GM in 2008, only two equally bad options appeared to be left for management: bankruptcy or government bailout. As it turned out, there was a third, even more horrible option: a government bailout bankruptcy. When you crawl in bed with the government, it’s not a pretty sight. After the Bear Stearns, AIG, Freddie Mac, and Fannie Mae debacles, it became clear that government money brings some unattractive conditions, including micromanagement, the government’s agenda, and political favoritism.

To oversee the restructuring of GM (and the other auto bailout recipient, Chrysler), the government established a 24-member Auto Task Force, including Obama cabinet members and White House officials. None had any experience in the auto industry. Steven Rattner, an investment banker, was appointed task force leader. According to Neil King of the Wall Street Journal, Rattner “ranked among [New York’s] biggest fund-raisers for Democratic candidates.”

One of the biggest hurdles for the task force was to reduce GM’s $172.8 billion in liabilities and reallocate $82.29 billion in assets to produce a leaner, more competitive company. In normal bankruptcy the secured debt is paid off first, followed by unsecured debt. Anything left over goes to the stockholders. Unfortunately, in this case the GM stockholders came up short. In fact, there was not even enough to pay off all the unsecured debt holders. The U.S. government and UAW came out on top. The chart shows how the debt issue was finally settled.

It should come as no surprise that one of the four parties, the (unsecured) bondholders, balked at the proposed settlement terms. While they were second in the debt held, they came in last with only 10 percent of the common stock, no preferred stock, and no cash. For their objections, they were pummeled by the mainstream media and politicians. What sin did the bondholders commit? They were guilty of “greed” and of being “speculators.” This clearly explained their unwillingness to negotiate in good faith.

Who Are the Bondholders?

Ironically, if we look closely at who these bondholders really are, they don’t seem so ominous, threatening, or evil. As an investment, bonds are unexciting, but they are considered much safer than stocks. While bonds don’t pay that much, the returns are steady. For this reason, they are popular among retirees and working families. This was especially true in the case of GM bonds. According to bond analyst Shelly Lombard, “That’s because unlike most companies that issue debt in large denominations, GM sold many bonds with face values of as little as $25. That made them very attractive to average Americans.” According to the Washington Times, mom-and-pop investors directly accounted for 25 percent of the total. Large banks and investment firms had the rest. But even here, small investors were a major player through their mutual funds and 401(k) retirement plans. Financial-restructuring authority Evan Flaschen said: “The story that hasn’t been told is, this isn’t GM’s union retirees versus the bondholders. It’s retirees versus retirees.”

The government’s treatment of the GM bondholders was simply disgraceful. Investor’s Business Daily said the sordid affair “underscores why GM should have been allowed to undergo a normal bankruptcy—not the politically rigged one that the government forced down all of our throats. A regular bankruptcy would have given GM bondholders first call on its assets. Instead, they literally had money stolen from them.”

At a time when we are trying to restore faith in our financial system, the government chose to run roughshod over the investor class. This near-term political expedient will have long-term negative consequences. Other corporations will have a much harder time raising capital by selling bonds. If American investors get stiffed by the government, how will potential foreign investors view this shabby treatment? Could they be next?

Let the Micromanaging Begin

While many people might say GM did not really have a business model for the past 25 years, can we expect the new one at Government Motors to be any better? After all, there are now 535 members on the de facto board of directors, each making political rather than economic decisions. The recent bizarre treatment of the GM dealerships illustrates this point.

GM planned to eliminate about 2,400 of its 6,000 dealerships. What should have been a pure business decision has, unfortunately, gotten wrapped up in politics. Those dealers slated for closing have appealed to Congress for help. According to CNN, “The push by the dealers to reverse the cuts has garnered strong bipartisan support, especially from powerful Democratic Leaders Financial Service Committee Chairman Barney Frank and House Majority Leader Steny Hoyer.” So far, the Automobile Dealer Economic Rights Restoration Act of 2009 has 250 House and 26 Senate cosponsors. The bill is designed to “re-open profitable dealerships and restore basic fairness.”

The elite class has known all along that the real problem at GM was that it built too many SUVs and light trucks and not enough of the fuel-efficient cars that consumers really want. It now appears that at the new Government Motors environmental considerations will trump business considerations. Congress and the various regulatory agencies, such as the EPA, have been micromanaging the auto industry in the “green” direction for decades with their ineffective and deadly Corporate Average Fuel Economy (CAFE) program. The new CAFE standard calls for all cars and trucks to get 35.5 mpg by 2016. No GM vehicle currently meets the new standard.

Given that the government is now a majority shareholder in the auto industry, expect even more green micromanaging. It has already started. Energy Secretary Steven Chu, who is on the task force, recently said that the Obama administration is thinking about requiring all new cars to run on E-85 gas (85 percent ethanol). This mandate will cost the auto industry $1 billion a year. It is worth noting that E-85 gas is available at less than 2 percent of the gas stations nationwide.

In deciding where to build the new green compact cars that will save the company, the new GM considered the “community impact” and “carbon footprint” of the production facility. Ironically, it ultimately settled on the Orion, Michigan, plant where Reagan had disavowed central planning a quarter century earlier.

President Obama has said that his decision to take a majority stake in GM was unavoidable and that it would be temporary. This remains to be seen. However, we have been down this road before. In 1971, the federal government became the majority shareholder in Amtrak. This too was unavoidable and was to be temporary. Amtrak has been a ward of the state ever since; costing the taxpayer $2.6 billion a year to operate.

I fear that the new slogan in America will be, “Is this any way to run an auto company?”

Related posts:

1. Political Bankruptcies: How Chrysler and GM Have Changed the Rules of the Game
2. Stealth Expansion of Government Power
3. Government-Mandated Fuel-Efficiency Standards

Edison’s words may have been true in the 1800s. Today, however, we have plenty of rules, thanks to the U.S. Congress. Some are so bizarre that you have to question the judgment of those who come up with them. One rule in particular is probably causing Edison to spin in his grave. His most famous invention, the incandescent light bulb, a mainstay in every American household for over a hundred years, has been banned by an act of Congress and will be replaced with the government-approved compact fluorescent light (CFL) bulb.

U.S. Rep. Jane Harman announced in a 2007 news release that her provision “bans Thomas Edison’s favorite oldie, the 100-Watt incandescent, by 2012, and will phase out inefficient light bulbs by 2014. By 2020, it requires that all light bulbs be 300 percent more efficient than today’s incandescents.”

Unfortunately, the federal government’s ban on products that happen to work just fine is nothing new. In writing about government-mandated products, I have noticed remarkable similarities in each case. They proceed through four phases and the light-bulb mandate is no exception.

Phase 1: Bureaucrats, “consumer advocates,” and environmentalists trumpet how wonderful the new product is. The extensive hoopla surrounding it can be boiled down to just two claims: big savings for the consumer and benefits to the environment.

The Department of Energy (DOE) and the Environmental Protection Agency (EPA) began to promote CFLs in 1999 with their “Change a Light, Change the World” program. The DOE’s and EPA’s promotional (lobbying?) efforts were directed at members of Congress and governors, plus state and local officials, to encourage their constituents to participate. In 2006 then-Secretary of Energy Samuel Bodman said: “Here’s a simple step we can take to preserve energy resources, save money and help the environment.” This is the typical approach that the government uses to influence the marketplace. The government never states that its chosen prod-uct is better.

The “big savings” never refers to the retail price. This is because the government-endorsed products are always more expensive than the consumer-endorsed alternatives. A 75-watt incandescent bulb at my local Kroger store costs 22 cents. The 20-watt CFL (advertized as equivalent to the 75-watt bulb) costs $5.49–25 times more expensive. A three-way incandescent bulb (50-100-150 watts) costs $1.25. A three-way CFL (12-23-32 watts) costs $13.12. That’s ten-and-a-half times more expensive. So when the government, environmentalists, and consumer advocates talk about big savings, they are obviously not talking about the upfront cost. They mean the operating cost over the life of the product. CFLs are advertised to last up to ten times longer than the incandescent bulb and use 75 percent less energy.

In the not-too-distant past, patriotism was exploited by the government to elicit a desired response from its citizens. Today, it is environmentalism. This has become our de facto state religion. When the government says that we need to do something because it is good for the environment, we are expected to take it on faith. We are not to question the government’s motives or logic for taking away our freedom of choice, but are expected to feel good about forgoing our selfish consumer desires because there is no higher calling in this country than saving the environment.

Rejected by Consumers

Phase 2: Consumers weigh the advantages and disadvantages of this wonderful product and decide that it is not really that wonderful after all.

CFLs have been on the market for some time, but so far consumers have not been impressed. Besides being expensive and strange looking, the light quality doesn’t seem to please people. They are not as good for reading as incandescent bulbs are, for example. Many also complain that the bulbs flicker and buzz. Dimming the intensity of CFLs also poses a problem. It would appear that consumers have a very clear choice: They can pay more for the new inferior government bulb or pay far less for a superior existing product. This might help to explain why CFLs made up only 5 percent of the light-bulb market last year, according to H. Sterling Burnett of the National Center for Policy Analysis.

I have been trying one of these bulbs above the sink in our kitchen. When I get up in the morning to make coffee, I flip the switch—but the light doesn’t really turn on. It starts off with a faint glow that gradually brightens for two to three minutes until fully illuminated. To get the lighting I want I must also turn on the light over the stove (one of those bad incandescent bulbs) because it brightens immediately. So now I am using two lights instead of one. Because turning the CFL on and off is so annoying, it is the one light in the house that we tend to leave on all the time. Why not? It’s so cheap! This situation is analogous to what happened when the government imposed CAFE fuel-efficiency standards: People drove more.

Mandated by Government

Phase 3: Hating to have their recommendations ignored by the ignoramus class, the miffed elitist class takes steps to mandate their beloved product.

Here is a question that never gets a direct or honest answer: If these economical and environment-friendly products are so wonderful, why is it necessary to outlaw competing products? The unsaid answer appears to be: The government, consumer advocates, and environmentalists know what’s best for the consumer.

As Ed Feulner, president of the Heritage Foundation, put it, “It’s only inferior or unnecessary products that require congressional intervention to survive. Useful or innovative products thrive on their own.”

When Rep. Harman introduced the bipartisan ban on the Edison light bulb, she said, “Only 10 percent of the power used by today’s incandescent bulbs is emitted as light, while the other 90 percent is released as heat.” Let me see if I have this right. Here in Michigan, where we have long, cold winters, the incandescent light bulbs in our family room actually help keep my wife, daughter, and me warm while we watch TV and read. Since the lights in the rest of the house (except for the light over the sink) are all off, why is this considered a problem? In the summer, when it gets dark later, we hardly use the lights. So I fail to see why this issue demands heavy-handed congressional intervention.

The Energy Independence and Security Act, signed by President Bush in 2007, contained the incandescent ban, but it also included a Consumer Awareness Program, authorizing $40 million to help consumers make energy-efficient lighting “choices.” Thus as the government takes away our freedom of choice, it also spends our money to convince us that we really have a choice.

Bad Product

Phase 4: It becomes clear that the consumer’s reluctance was justified. The product is in fact bad. But it doesn’t matter because the old product that worked has been outlawed.

The DOE guidelines for CFLs suggest that they be left on for at least 15 minutes after they are turned on, prompting Andrew Ferguson of the Weekly Standard to comment, “Odd, isn’t it—an energy-saving device that you’re not supposed to turn off?” It turns out that the lifespan of a CFL depends on how many times you turn it on and off. Failure to keep the light on causes the bulbs to burn out just as fast as the Edison bulbs. There go those big savings. So try to get in the habit of not turning off the lights after using the bathroom, a closet, or the laundry room. However, plan to come back 15 minutes later to turn off the light.

And while CFLs that are left on may last ten times longer than incandescent lights, no one is saying that they will fully perform for that long. A Department of Energy study found that after 40 percent of the advertised service life, a quarter of the CFLs started to become dim bulbs. If you don’t mind having dim bulbs for 60 percent of the service life, then CFLs should make you happy.

While these mandated lights may be great for the environment, they are not so great for humans. In some people they trigger headaches or even migraines because of the nearly imperceptible flickering. The BBC reported that the bulbs can also increase the risk of seizures in people with epilepsy. According to the Winnipeg Free Press, the United Kingdom’s Health Protection Agency recommends that people be no closer than about a foot from these lights for more than an hour a day. The ultraviolet radiation emitted by CFLs is like direct sunlight on bare skin. Thus the government is mandating that we all have miniature sun lamps throughout our homes.

But maybe the government light bulb is not really good for the environment after all. It turns out that the each CFL contains five to ten milligrams of mercury. Mercury is one of the most toxic substances on earth; it can cause serious health problems, including nerve and kidney damage. The mandate will result in millions or billions of CFLs ending up in landfills where the mercury will leach out to contaminate the soil and groundwater.

So how do CFLs fit with the EPA’s recommendation that we purchase mercury-free products? It explains that the amount of mercury in the bulbs is much smaller than the amount in old-fashioned thermometers (which are disappearing from households) and watch batteries. Both statements may be true; however, I have never had a thermometer or watch battery explode, shatter, or break the way a light bulb does. It was also my choice to have, or not to have, a mercury-filled thermometer or watch battery. The EPA’s final defense is that the health and environmental risks of CFLs are insignificant compared to the risk presented by the mercury put out by coal-burning power plants.

So what happens if a CFL next to my daughter’s bed breaks? According to the EPA guidelines, I am to: 1) open the windows and evacuate the room for 15 minutes; 2) shut off the heating or air-conditioning system; 3) carefully scoop up the glass using stiff paper and place it in a glass jar or sealable plastic bag; 4) after vacuuming, wipe the canister and put the bag or debris in a sealed plastic bag; and 5) throw away clothing or bedding that comes in contact with the broken glass or the mercury-containing powder. I must not wash contaminated clothing or bedding because mercury fragments may also contaminate the washing machine or pollute the sewage.

Has this convinced you that the health and environmental risks of CFLs are minor?

As a result of the Energy Independence and Security Act, we will be forced to buy new light bulbs for every room in the house that are more expensive, of lower quality, dangerous to our health, and bad for the environment. Given this government mandate, the consumer has three options. The first is to go out and buy up all the old-fashioned Edison bulbs before they become illegal. The second option is to try to get a family discount on hazmat suits. The final option is to just say no to dim bulbs. U.S. Rep. Michele Bachmann has proposed the Light Bulb Freedom of Choice Act. She is facing extensive opposition from the green lobby, big government, and consumer groups. Sadly, fighting for freedom in this country has become an uphill battle.

Related posts:

1. Washington’s Centrally Planned Heating and Cooling
2. Perspective: Soviet Keynesians
3. Opportunity Cost and Hidden Inventions

That article was tantamount to heresy among those who devoutly believe in anthropogenic (manmade) global warming. A physics professor responded, “Heberling’s commentary is the latest in a long list of junk-science commentaries about climate change. Heberling, who is not a scientist, but rather the president of a small business school, repeats several old and misleading ideas.”

Of course, Al Gore, the Nobel laureate who has made global warming his cause, is not a scientist. He has a B.A. in government. For the record, I have a B.S. from Cornell University, where I took courses in physics, chemistry, geology, and meteorology. However, this makes little difference because my sin was to downplay the severity of global warming, and too many people and organizations are tied financially to the “crisis.”

As MIT atmospheric physicist Richard Lindzen puts it, “Ambiguous scientific statements about climate are hyped by those with a vested interest in alarm, thus raising the political stakes for policymakers who provide funds for more science to feed more alarm to increase the political stakes. Indeed, the success of climate alarmism can be counted in the increased federal spending on climate research from a few hundred million dollars pre-1990 to $1.7 billion today.”

The Government Accountability Office says that for over 15 years the federal government has funded programs to study the earth’s climate and to reduce emissions of carbon dioxide and other greenhouse gases linked to climate change. A review of the number of government agencies and the amount of government money devoted to “climate change” is staggering. Nine of the 15 cabinet-level departments receive significant funding for climate-change activities. A 2007 White House press release boasted, “The President has devoted $37 billion to climate-change-related activities since 2001.” The U.S. Global Change Research Program, which has 13 federal agency participants, has made the largest scientific investment in climate change research at $20 billion over a 13-year period. The federal organizations with the largest budgets devoted to climate-change activities include NASA, the National Science Foundation, the Department of Energy, and the National Oceanic and Atmospheric Administration.

For those who embrace big government and centralized planning, the global-warming crisis has been a godsend. Under the mantra “preventing global warming,” government has greatly expanded into our daily lives. Mandates have superseded consumer choice in the areas of energy, transportation, and appliances. For example, when compared to the traditional light bulb, the new government-mandated compact fluorescent light bulb is far more expensive, loaded with mercury, and takes time to illuminate. To compensate for this delay, consumers leave the lights on. How does this help the environment or curtail global warming?

And the Horse You Rode In On

Given the billions of federal dollars at stake, it is not surprising that there would be resistance to any free flow of ideas that might question the crisis. If we don’t have a crisis, then we won’t need the government to ride in on a white horse throwing billions around to save us. It therefore becomes imperative to squelch or marginalize dissent. Name-calling, shooting the messenger, and the use of such show-stopper statements as “We have consensus” and “The debate is over” usually do the trick.

In the name-calling category, we find the following epithets: “climate-change denier,” “flat-earth advocates,” and “tools or stooges of Big Oil.”

Jeff Kueter of the Marshall Institute says that scientists who challenge global warming “are quickly labeled as having received money from the petroleum industry. The media consider their findings and their opinions to somehow be tainted because they’ve got a financial relationship.” Why is there never any suspicion in the other direction, when a researcher has a financial relationship with the government and its agenda for more regulations, more mandates, a carbon tax, and the nationalization of the energy sector? Why don’t the media ever call such a researcher a “tool of big government”?

What about the consensus we hear so much about? Gregg Easterbrook expresses the mainstream sentiment: “The consensus of the scientific community has shifted from skepticism to near-unanimous acceptance.”

The late author Michael Crichton had this response:

I regard consensus science as an extremely pernicious development that ought to be stopped cold in its tracks. Historically, the claim of consensus has been the first refuge of scoundrels; it is a way to avoid debate by claiming that the matter is already settled. Whenever you hear the consensus of scientists agrees on something or other, reach for your wallet, because you’re being had. Let’s be clear: the work of science has nothing whatever to do with consensus. Consensus is the business of politics. Science, on the contrary, requires only one investigator who happens to be right, which means that he or she has results that are verifiable by reference to the real world. In science consensus is irrelevant. What is relevant is reproducible results. The greatest scientists in history are great precisely because they broke with the consensus. There is no such thing as consensus science. If it’s consensus, it isn’t science. If it’s science, it isn’t consensus. Period.

One of the biggest tragedies of consensus science is the chilling effect it has on those who fall outside of this consensus. “Scientists who dissent from the alarmism have seen their grant funds disappear,” Lindzen says. “It’s my belief that many scientists have been cowed not merely by money but by fear. Alarm rather than genuine curiosity, it appears, is essential to maintaining funding. And only the most senior scientists today can stand up against this alarmist gale and defy the iron triangle of climate scientists, advocates and policy makers.”

Threat Level Whatever

The problem with public policy based on alarmism is that it’s hard to sustain. There are three reasons for this. The first is overselling the crisis. The general public has become numb and cynical about the endless barrage of ills all tied to global warming. (Even the disappearance of the Loch Ness Monster has been attributed to it.)

The second reason is clear and convincing evidence to the contrary. This is what did in the last climate-change crisis. A New York Times headline on May 21, 1975 blared: “Scientists Ponder Why World’s Climate is Changing: A Major Cooling Widely Considered to be Inevitable.” But it was hard to continue the hype about global cooling when it got hot outside. While the current global warming debate may be over, Mother Nature is, unfortunately, not cooperating. Contrary to the infallible computer climate-model predictions (which I call high-tech crystal balls), global temperatures peaked ten years ago, in 1998. There was no appreciable temperature increase for the next eight years. However, for the last two years the temperatures have actually fallen. The past two winters have been brutally cold. This painful realization may help to explain the sense of urgency in Congress to pass climate-change legislation–right now! Rep. Henry Waxman said at the opening of the 2009 congressional hearings on global warming that he plans to move “quickly and decisively” to push through climate legislation before Memorial Day (Or does he mean before it gets even colder?)

The final reason is that the alarmist crisis gets run over by a real crisis. With the financial turmoil, the housing crisis, the stock-market crash, and rising unemployment, it is hard to get excited about global warming. In the January Pew Public Survey Poll, global warming came in 20th out of 20 on the list of Top Priorities for America. The top five were: the economy, jobs, terrorism, Social Security, and education.

The global-warming crisis was tailor-made to simultaneously advance the agendas of the environmentalists, big government, and those who vilify the oil industry and business in general. There is far too much at stake to have this crisis die peacefully. As a result, there will be extensive efforts to keep it alive. For starters, the phrase “global warming” is being used less frequently (if at all). It’s been replaced with the nebulous, but error-free, “climate change.” Given that the earth’s climate has been changing for millions of years, “climate change” covers all bases (both warming and cooling). The problem with this approach, however, is that the public won’t buy it. It is hard to get excited about the dangers of “climate change.”

Be prepared for more talk about “energy security” and “energy efficiency.” This will lead to more government-mandated products and less consumer choice. There will still be a push for a carbon tax–or a cap-and-trade scheme, President Obama’s preferred policy. However, without the global-warming hysteria, this will be a harder sell.

Carbon dioxide will continue to be demonized as a “greenhouse gas.” Even though it is harmless to humans and is needed by all plant life, it will be called a toxic pollutant by the media, militant environmentalists, and politicians. Yet carbon dioxide makes up less than 4 percent of all greenhouse gases. Water vapor accounts for 95 percent.

Shut Off the Alarmists

What’s to be done? First, we should abandon all efforts and discussions related to cap-and-trade, carbon offsets, carbon footprints, and carbon taxes, which would never go away if implemented and won’t measurably change the temperature.

Second, we should stop government from funding climate change science. As John Tierney of the New York Times writes: “[Government] officials running the agencies have their own agendas . . . which can be [met] by supporting research demonstrating that there’s a terrible problem for the agency to solve.” Climatologist Patrick Michaels states, “[N]o one ever received a major research grant by stating that his or her particular issue might not be a problem after all.”

Third, we should demand that lobbyists for expanded government power disclose their financial backers.

Finally, we need to accept that climate change, both global warming and global cooling, will continue. Ironically, of the two we should wish for warming. Mankind has prospered in warming periods because agricultural production increased at higher latitudes and elevations. The opposite was true with global cooling. I’ll take global warming over another Ice Age. My request to Washington: Please don’t pass legislation to make Michigan any colder than it already is.

Related posts:

1. Higher CO2, More Global Warming, and Less Extinction?
2. Climate Confusion: How Global Warming Hysteria Leads to Bad Science, Pandering Politicians, and Misguided Policies that Hurt the Poor
3. Global Warming and the Layman

“Once you lose your freedom to fail, you also lose your freedom to succeed and you cease to be a free society.” —U.S. Rep. Jeb Hensarling of Texas

In March 2008 the investment banking firm Bear Sterns failed and the federal government quickly stepped in. The public was inundated with the phrase “too big to fail” (TBTF) by the financial news media. You had to go back to 1998 for the last time it was used so often. In that year the troubled hedge fund Long-Term Capital Management had $4.6 billion in losses. The Federal Reserve stepped in to orchestrate a restructuring deal to avoid bankruptcy. With this government intervention, the precedent was established for future calls for help. In 1999 Kevin Dowd, writing for the Cato Institute, stated: “[T]he intervention implies a return to the discredited doctrine that the Fed should prevent the failure of large financial firms, which encourages irresponsible risk taking. . . .”

An institution is deemed “too big to fail” if its collapse would be expected to create a devastating ripple effect throughout the economy, creating a “systemic risk.” When this occurs the government is expected to provide some form of assistance. This can vary from a guaranteed loan, where management and stockholders get off scot-free (as with Chrysler in 1979), to guaranteeing the assets of a failing bank, to facilitating an outside takeover (Bear Stearns). In the event of an outside takeover thousands of employees could be shown the door and stockholders left with pennies on the dollar. Since the public only notices that it is paying the bill, it has a hard time discerning these subtle differences. As a result, the term “bailout” is used broadly to describe any form of government financial intervention to assist a crashing TBTF company or its creditors.

Too Big to be Free-Market

There are no clear guidelines on who is (or what constitutes) TBTF. As a result the “systemic risk” scare is ad hoc and apparently meant to be taken on faith. Any large company can claim it is vital to the health of the economy because its failure would have a domino effect on suppliers. Other firms can pick up the slack and even acquire the assets of the failed firm, but this is usually ignored.

TBTF is problematic because it indirectly influences how companies are managed. If there is a real, or implied, government safety net should things “head south,” management might be inclined to take on more risk for greater profit. This illustrates the concept of “moral hazard,” an insurance term. If you are insured, you may be less cautious. TBTF is actually a state of mind that afflicts the senior management of our largest corporations. If they think they are TBTF, even if they aren’t, they still behave as if they are. This is the crux of our current financial problem.

In an ideal free-market environment, entrepreneurs would be willing to take on risk based on an expected return. Since returns are never guaranteed, the entrepreneur’s willingness to take on risk is tempered by the potential downside (a loss), if things don’t pan out. While the rewards for extremely risky investments may be great, so too are the penalties. In severe cases the company could go bankrupt. As a result, this risk/reward/loss relationship in the free market would force rational behavior into the business decision-making process.

TBTF companies are no longer on their own to succeed or fail. With TBTF we now have the government in the game—not so much as another player but as a non-neutral referee ready to step in if the game gets too rough. What’s more, TBTF companies operate under a different set of rules from merely mortal ones. In 2004 Gregory Mankiw, then chairman of the President’s Council of Economic Advisers, said, “Expecting a government bailout if things go wrong creates an incentive for a company to take on risk and enjoy the associated increase in return.”

So if you are (or think that you are) TBTF, there is little or no perceived penalty to counterbalance risky behavior. With a guaranteed—or at least an implied—government safety net, the sky is the limit when it comes to risk-taking. The siren song of big returns (with little or no risk) becomes irresistible—and you no longer operate in a free-market environment. According to Thomas Sowell, “The hybrid public-and-private nature of these activities amounts to ‘privatizing profit and socializing risk’ since taxpayers get stuck with the tab when high-risk finances don’t work out.” In other words, it is a travesty to say or imply that our current crisis stems from market failure.

Mixed Signals

What makes the TBTF phenomenon so difficult to follow (and understand) is that there is no official list of “too big” companies put out by the Treasury Department. The taxpayer only finds out that a company is on the list after the company fails.

The tab to the taxpayer for bailing out Bear Stearns is $29 billion and counting. What remained of Bear Sterns’ assets, along with government guarantees, were transferred to JPMorgan Chase. The next TBTF firm to run into trouble was the investment bank Lehman Brothers Holdings Inc. Although conventional wisdom held that Lehman, with $615 billion in debt, was TBTF, this time the Fed said no.

These mixed signals about what was and what was not TBTF sent the financial markets into a tailspin. Some federal policymakers and many in the financial news media saw this as the beginning of the credit “crunch.” (In fact, while credit standards have tightened, money is still being lent for all kinds of loans.) It was no longer prudent to do business with any “troubled” bank. Since no one knew which banks the government would or would not bail out, inhibition set in.

The next TBTF firm to ask for federal help was the world’s biggest insurance company, American International Group Inc. (AIG). Not wishing to mishandle another TBTF firm, the Fed quickly agreed to lend $85 billion to AIG in September to avert bankruptcy. The following month AIG came back to the Fed asking for an additional $37.8 billion, citing liquidity problems. The Fed’s response: No problem. But are you sure $123 billion will be enough? AIG is intricately involved in America’s money-market funds. In November AIG came back and said: “On second thought, could you make that an even $150 billion?” The government response: Fine, but only on one condition, and you may find this to be exceedingly harsh. We absolutely insist that your top 70 executives not get any bonuses this year. AIG’s response: “You drive a hard bargain, but we have a deal.”

As a result of this action, the government now owns 80 percent of the company’s assets.

In September the federal government took over two more TBTF firms. The quasi-governmental Fannie Mae and Freddie Mac own or guarantee about 40 percent of the nation’s mortgages. This bailout will cost the taxpayer $200 billion. Egged on by influential members of Congress, Freddie and Fannie blatantly abused their government-sponsored-enterprise (GSE) designations, and no two firms better exemplify the “moral hazard” argument. Since they were chartered by Congress, many believed their mortgage-backed securities were guaranteed by the federal government. Then-Fed chairman Alan Greenspan told Congress in 2004: “The Federal Reserve is concerned that Fannie Mae and Freddie Mac were using this implicit reliance on a government bailout in a crisis to take more risks, in order to multiply the profitability of subsidized debt.” When housing prices started to tank we found out that this was exactly what was going on.

Bad Medicine and a Hail Mary

One would think that with all of the government oversight these TBTF events would not keep popping up. Since the government doctor has utterly failed to prevent this disease, why should we think the same government doctor suddenly knows how to cure the disease now that it has metastasized throughout the economy?

The Treasury, with the help of Congress, has thrown a $700 billion “Hail Mary” called the Troubled Asset Relief Program (TARP). Whether or not this bailout “restore[s] confidence in our financial system” (Treasury Secretary Henry Paulson) remains to be seen. Judging by the stock market, the early results are not good. Ironically, the first step of the plan was to identify publicly the banks that are really TBTF by buying their preferred stock. Nine TBTF banks, which account for 50 percent of all U.S. deposits, will get half the $250 billion earmarked for banks and thrifts. These include JPMorgan Chase, Wells Fargo, Citigroup, Bank of America (plus Merrill Lynch, which is being acquired by BoA), Goldman Sachs, New York Mellon, Morgan Stanley, and State Street. The bailout bill also includes a provision for the FDIC to offer an unlimited guarantee on bank deposits in business accounts that do not bear interest. For individual depositors, the FDIC insurance limits will increase from $100,000 to $250,000. How do these actions reduce the “moral hazard” problem? The last time the individual deposit insurance limit was raised—from $40,000 to $100,000 in 1980—we had the S&L crisis, which ended up costing the taxpayer $150 billion.

Being on the official TBTF list has its pros and cons. On the positive side, you can’t fail. The government guarantee is no longer implied. It’s real. But being on the official TBTF list has a severe downside: additional regulation. The government will be very close at hand to make sure that our biggest banks become and remain stodgy. In other words: We’re from the government and we’re here to make sure that your risk level remains in the “safe zone.” In October New York Senator Charles Schumer, a member of both the finance and banking committees, wrote Paulson demanding that “banks receiving capital eliminate their dividends, restrict executive pay and stick to safe and sustainable, rather than exotic, financial activities.” Given the makeup of the new Congress and administration, expect even more intrusive micromanaging of our financial institutions—but that is only to be expected if the Treasury becomes a stockholder. From now on innovation will be discouraged, downplayed, or slow-rolled by the government. As a result of these rescue actions, our entire financial system has effectively become nationalized.

A Troubling Cultural Shift

The most troubling aspect of the ever-increasing number of government bailouts is the subtle change overtaking the entire country. The mindset of companies and individuals today is shifting away from self-responsibility. We blame everyone else for our mistakes and look to others (the taxpayer) to come to the rescue.

When it comes to handouts and bailouts the government is no longer simply on the slippery slope—it’s in free-fall. Every bailout makes it harder to say no when the next TBTF request comes forward. Aren’t the Big Three automakers too big to fail as well? In many people’s eyes the answer is yes. At the end of September Congress approved a $25 billion low-cost loan package to help the automakers and their suppliers modernize their facilities so as to be “more green.” But this wasn’t enough. General Motors CEO Rick Wagoner, whose company was hemorrhaging cash, sought another $10 billion in federal assistance the next month to help finance the merger of GM and Chrysler. However, this request was denied. Then in November the Big Three found sympathetic ears from the big two in Congress, House Speaker Nancy Pelosi and Senate Majority Leader Harry Reid, for yet another $25 billion “bridge” loan for the Big Three. The Bush administration ultimately dished out $17.4 billion from the $700 billion TARP fund to assist GM and Chrysler. It also handed the problem of deciding the long-term future of the bailouts to the Obama administration, which had already expressed support for a bailout package. (Notably, the several profitable foreign-owned automakers with facilities in the United States weren’t looking for help.)

It shouldn’t need pointing out that the “too big to fail” doctrine fundamentally changes the nature of a market economy, which when free is a profit-and-loss system. Not only does the doctrine reward error, sloth, and inefficiency, it deprives other, more competent entrepreneurs of the scarce resources they need to serve consumers. Who knows what products and opportunities would arise if the free market, not politicians, determined who had access to capital?

Related posts:

1. ‘Too Big to Fail’ Banks Could Be Downsized
2. Nationalization of the Mortgage Market
3. Too Big to Fail?

When Big Government calls for investigations to look into the “obscene profits” of Big Oil, this is always a crowd-pleaser. However, we rarely hear about the results of these investigations because they almost always implicate Big Government as the primary reason for the high prices and price spikes.

Another Big Government strategy to address high gas prices is to propose legislation that outlaws “greed” and “price gouging.” Big Oil has become the poster child for “free-market failure.” In reality, the petroleum industry, as it now exists, is anything but free market. A case could be made that it is one of the most regulated industries—if not the most regulated—in the United States. Decades of federal, state, and local government micromanagement of the petroleum industry have helped to create the mess we are in. The phrase “perfect storm” has been overused, but it helps to explain why we have gas at $3.99 a gallon. While “greed” is easy to understand, there are many interrelated facets of this problem that are not so easily understood.

The United States is no longer the primary customer for petroleum. Americans now have to compete for petroleum on the world market with people in the emerging economies of India and China. To no surprise, the Economics-101 concepts supply and demand come into play, driving up the cost of petroleum. What further complicates the situation is the weak U.S. dollar relative to other currencies. This helps to explain why oil is over $120 a barrel.

We could alleviate our supply problems by developing domestic sources of petroleum through privatization and free markets. The Arctic National Wildlife Refuge in Alaska has an estimated ten billion barrels of oil. Unfortunately, the Big Government/Big Green coalition has declared the reserve off-limits. The continental shelf could provide us with another 85 billion barrels of oil. But this plus the Florida and California coasts are off-limits because of environmental concerns.

The high price of gasoline now makes synthetic fuel derived from coal an attractive alternative or supplement to petroleum. The environmentalists are blocking it because it has an unacceptable carbon footprint. China, however, does not see this as a problem. The Chinese are spending billions to develop coal as a fuel.

If we can’t use domestic oil, what will the Big Government/Big Green coalition allow us to do? Their number one answer is “burn food.” But that pesky supply-and-demand issue keeps coming back to complicate things. Burning food in addition to eating it drives up the price. This is an inevitable outcome when you have people, livestock, and automobiles competing for limited supplies of food. If we continue down this ridiculous path, there is only one plausible outcome. We will have no choice but to develop more and more pristine wildlife habitat for agriculture. How long will Big Green allow that?

As it turns out, burning food as a fuel is not very efficient. Corn-derived ethanol yields 35 percent less energy than gasoline. So as the percentage of ethanol in gasoline goes up, miles per gallon will go down. Translation: Our demand for gas has gone and will continue to go up thanks to this government-promoted biofuel program.

We have not built a new oil refinery in the last 30 years, although existing ones have been expanded and updated. But 24 refineries have closed since 1995. For many of the marginal facilities, it was just too costly to comply with the burgeoning level of environmental regulations. Between 1994 and 2003 Big Oil spent $47.4 billion of their profits not to build new refineries, but rather to simply bring the remaining ones into environmental compliance.

To address the refining-capacity shortfall, there have been endless calls to build new refineries. This has become next to impossible because we now adhere to the BANANA philosophy. This stands for Build Absolutely Nothing Anywhere Near Anyone. BANANA has replaced NIMBY (Not In My Back Yard). According to the Tucson Citizen, a company in Arizona sought a permit in 1998 to build a refinery in Mobile, outside Phoenix. This would be the first new refinery built domestically since 1976. Five years later, the state of Arizona determined that the proposed location would not be in compliance with the ozone standards. The company then agreed to build the refinery near Yuma. Two years later, in 2005, the final permit was issued. This was seven years after the original request. Barring any further Big Government/Big Green roadblocks, we may have the first new U.S. refinery in 2011.

However, don’t expect a big rush to build many other new refineries. Through government biofuel and fuel-efficiency programs, the politicians have mandated a 20 percent reduction in our use of refined gasoline over the next ten years. Why would Big Oil increase the supply (by building more refineries) to meet a decreasing demand for gasoline? It should come as no surprise that many of the plans to build new refineries or to further expand existing ones have been put on hold. Government incentives and disincentives (in this case) really work.

Fewer Refineries Mean Fewer Options

Since building new refineries is not really a viable option for Big Oil, we are putting all of our eggs (gasoline production) into fewer and fewer refinery baskets. When the remaining refineries go offline due to accidents or routine maintenance, or to incorporate environmental changes, the impact on the entire nation’s fuel system could be both profound and immediate. Translation: price spikes.

Gasoline-price volatility is further exacerbated by government regulations that call for different types of gasoline in different parts of the country at different times of the year. We have winter gas and summer gas. There is Chicago gas and California gas. This means that entrepreneurs can’t readily move gasoline from where it is less scarce to where it is more scarce. We also still have the requirement for reformulated gas (RFG) in many areas even though the additive MTBE was determined to be dangerous to the environment. (Is that ironic? See my “Government-Reformulated Gas: Bad in More Ways than One,” The Freeman, September 2003, http://tinyurl.com/5kkrb5.)

As to be expected, the politicians’ “solutions” are nothing of the kind. Once again, some call for a windfall-profits tax. That’s a terrible idea on many levels, but suffice it to say here that it won’t raise supplies or lower prices. And what about the three-month gasoline-tax holiday being called for? It might bring prices down a bit—or it might not. And no doubt, the government will try to make up the revenue in other ways. All in all, the idea is an expedient, near-term, and unsatisfactory proposal. What we need is a long-term regulation holiday.

The next time you fill up your tank, don’t direct your wrath at Big Oil—they appear to be price takers. Direct it at Big Government and Big Green.

Related posts:

1. Gasoline Prices : Why So High Last Spring?
2. High Gasoline Prices Are Your Fault? It Just Aint So!
3. Rising Prices: The Markets Way of Conserving Oil

Geothermal energy is derived from heat beneath the earth’s surface and is used to drive steam turbines and heat pumps. Unfortunately, sites capable of producing geothermal energy are rare. Operational geothermal facilities are found in just four western states: California, Utah, Nevada, and Hawaii. Geothermal power plants need sufficient magma close to the surface to heat the surrounding rock and water. The best potential new sites are frequently on federal park lands or in protected wilderness. This complicates, and in many cases even precludes, development. Do we really want to use Old Faithful in Yellowstone National Park as a green-power source?

While geothermal energy is “free,” extraction is extremely expensive since developers are frequently required to drill up to a mile or more underground. The remote locations require extensive infrastructure (roads and power lines) and large amounts of cooling water, which is at a premium in the arid west. Various forms of pollution also complicate geothermal energy production. This includes groundwater contamination (thermal and toxic), gas emissions (hydrogen sulfide—which produces a rotten-egg smell, ammonia, and methane), and the mineral-rich discharge sludge that contains mercury and other heavy metals. Closed-loop systems that re-inject all the fluid and gas waste back into the ground will minimize the environmental impact. However, these environmental precautions make the cost of operation far more expensive than gas-fired power plants.

Hydroelectric power, which would seem to be an ideal source of green power, has unfortunately fallen from grace. This dam-derived power source disrupts river ecosystems by hampering (or preventing) the migration of some fish species. As a result, a number of leading environmental groups no longer promote hydro as a legitimate green-power candidate. In fact, they want to dismantle hydroelectric dams in order to return rivers to their natural pristine state.

Biomass energy involves the burning of plant material. For some reason, environmentalists find the burning of recent plant material to be acceptable, but the burning of aged plant material in the form of coal to not be acceptable. For biomass to be anything more than a cottage industry of “gee whiz” token pilot projects, large tracts of land would have to be dedicated to growing green power. Will these tracts come from areas previously used for food crops or will this require additional habitat destruction?

Solar power is inexhaustible (especially when the sun shines). It doesn’t pollute and best of all—it’s “free.” Most solar-power advocates will gloss over the fact that to produce one megawatt of electricity would require covering up to 17 acres of pristine land with solar panels. This compares with 1/25th of an acre for one megawatt of electricity produced by fossil fuels. In other words, to be an advocate for solar power, you must at the same time be an advocate of . . . “sprawl.” In Michigan solar energy is not practical because of our many cloudy, rainy, and snowy days. How many environmentalists does it take to remove the snow from 17 acres of solar panels in the middle of winter? Bottom Line: Solar energy, even though it is “free,” still costs consumers four times more than electricity derived from fossil fuels.

Wind power, just like solar power, is inexhaustible (so long as the wind blows). It doesn’t pollute and again, it’s “free.” Unfortunately, wind is not available on those hot, humid dog days of summer when energy demands peak. The same is true for those quiet (read: windless) bone-chilling winter nights here in Michigan.

While environmentalists loathe a lone cell-phone tower on a hill, they are surprisingly enamored with acre upon acre of wind tower “sprawl” on what were unspoiled vistas. To produce the same amount of energy as a conventional gas-fired power plant, wind farms would need 85 times more area. To its credit, however, wind power is far more economical than solar power. It is only twice as costly as electricity generated from fossil fuels.

However, the most troubling aspect of wind power from an environmental perspective is not sprawl, but the devastating impact it has on bird populations. According to the U.S. Fish and Wildlife Service, between four and five million birds are killed annually in collisions with the 45,000 communication towers (cellular, radio, telephone, and television) located across the country. Many environmentalists and politicians support the “Wind Energy Initiative” that calls for obtaining 5 percent of our electricity from wind turbines by the year 2020. However, to achieve this goal we will need to erect over 132,000 wind-power towers. Do environmentalists and politicians view the additional 12–15 million bird deaths per year as an acceptable tradeoff to meet the green-power goal?

An analysis of the bird deaths caused by the existing communication towers suggests that the additional 12–15 million bird deaths from wind turbines is a conservative estimate. When compared to a communication tower, the cross-sectional surface area of a wind turbine is far more deadly to birds because of those rotating “sling blades of death.” A 295-foot-tall wind turbine can be viewed as a “communication tower” with an additional bird-killing surface area of 21,113 square feet. That is an area about half (44 percent) the size of a football field.

It is interesting to note that the primary objection that environmentalists have with petroleum exploration and development in the Arctic National Wildlife Refuge (ANWR) is that it may harm wildlife. Environmentalists instead propose an alternative form of energy that is guaranteed to destroy wildlife by the millions—year after year after year. Defending such hypocrisy serves to reinforce what Kermit the Frog said over 30 years ago: “It’s not easy being green!”

Bad for the Consumer, Taxpayer

If at this point you are starting to have trouble distinguishing between good green power and bad brown power, here is an easy way to keep the two straight. If the power in question requires taxpayer greenbacks to stay afloat, it is definitely green power. Consumers have no idea how expensive green power really is, because the true costs have been hidden by politicians using massive taxpayer subsidies and other preferential treatment. Over the past 30 years federal, state, and local governments have spent between $30 bilion and $40 billion promoting renewable energy through grants, subsidies, production credits, accelerated depreciation, publicly funded research, and tax credits. And what do we have to show for this massive taxpayer investment? Today, green power makes up roughly 2 percent of total energy usage in this country.

While geothermal energy, wind, and sunlight are free, capturing this energy and transporting it from remote, sparsely populated areas to where the people actually live is a costly undertaking. For wind power the ideal lower-cost sites will be developed before higher-cost sites. Consequently, the costs and the NIMBY (not in my backyard) factor will dramatically increase as we expand wind-energy generation in the future. Wind may be considered an infinite resource; however, the land on which to capture this wind is a finite resource. Where are we going to put all those 132,000 wind-turbine towers? We could start with the Hamptons or Martha’s Vineyard and see what happens.

When utility customers are surveyed asking if they would be willing to pay more for green power to help the environment, there is always an overwhelming and enthusiastic positive response. However, when customers are then asked to actually sign up and pay extra, the euphoria disappears. Among the 85 utilities that offer their customers the option to pay extra for green power, the participation rate rarely exceeds 3 to 6 percent, with the majority being around 1 percent. In 1996 Traverse City (Michigan) Light & Power installed a wind generator near Lake Michigan. Under their voluntary green-pricing program, customers could expect to pay from 17 to 23 percent more for their electricity. The electric bill for Dick Dell’Acqua’s Omelette Shoppe & Bakery in Traverse City went from $1,600 to $1,900 a month after signing up.

Since the consumer is not voluntarily buying into green power, it should not be surprising that our elite class wants to take away our freedom of choice. Across the country at the local, state, and federal levels there are efforts to mandate green power. Sixteen states (Arizona, California, Colorado, Connecticut, Hawaii, Iowa, Maine, Maryland, Massachusetts, Nevada, New Jersey, New Mexico, New York, Rhode Island, Texas, and Pennsylvania) have “Renewable Portfolio Standards” (RPS) that require varying percentages of green power in their energy mix. Three other states (Illinois, Minnesota, and Pennsylvania) have RPS-like programs that are not quite as onerous as the other 16.

A common theme in each RPS is to have the mandated percentage of green power increase over time. California is required to produce 20 percent of its electricity through green power by 2017. In Nevada state law requires 15 percent by 2013. The New York RPS requires 25 percent by 2013.

In the majority of the RPS programs, government-owned municipal utilities have aggressively (and successfully) lobbied for exemption from their own state’s costly and unrealistic green-power requirements. This raises a question: If green power is so wonderful, why are government utilities allowed to opt out? At least under the green-pricing programs, consumers had a choice. Under state RPS programs, consumers who have the misfortune to be served by investor-owned utilities are forced to pay a hidden and unconscionable energy tax. Do the elite ever think about the poor or the elderly on fixed incomes when they impose “good for the environment” taxes?

A National Tax Coming?

Those of us who are lucky enough to live in the 31 RPS-free states are not out of the woods just yet. Even if our state legislatures are able to resist the siren song that “mandated green power is good for the environment,” our federal legislators are hard at work trying to impose a national RPS energy tax. In October 2003 a national-RPS provision was pulled at the last minute from the energy bill. Had this been included, we would have seen a mandatory 1 percent green-power requirement in 2005. The requirement would then have risen to 10 percent by 2019.

Last year bipartisan legislation was introduced again to establish a federal RPS energy tax. This legislation seeks to mandate a 20 percent green-power requirement by 2025. As in most of the state RPS programs, this national mandate would exempt government–owned utilities from this costly and unreachable goal.

Given that 30 years of central planning and $40 billion of taxpayer money have done little to facilitate the growth of green power, perhaps we should now consider an alternative consumer-friendly approach. It is time to permanently remove the government-subsidized training wheels from green power. Let the marketplace, not the government, determine what types of energy will be the winners and the losers. Considering the numerous problems associated with green power, a market-based solution will, ironically, be good for both the consumer and the environment.

Related posts:

1. Re-Thinking Green: Alternatives to Environmental Bureaucracy
2. The Sustainable–and Young–Hydrocarbon Energy Age
3. Wasting Energy on Energy Efficiency

As happens so often, the results of the fuel-efficiency program were opposite of the stated objectives. By reducing the per-mile cost of driving, it became economical to drive more. Forget carpooling and public transportation. The significant savings in MPG (114 percent improvement for cars and 56 percent improvement for light trucks) were more than offset by an increase in the per capita miles driven (through more leisure driving and living farther away from the workplace). So instead of seeing a drop in oil consumption, there was a significant increase. In 1975 U.S. consumption of oil was 14.4 million barrels per day. Today, we consume 18.7 million barrels per day. Given this revelation, it should not come as a surprise that oil imports did not decrease as predicted but increased. In 1975, before CAFE, we imported 37 percent of our petroleum requirements. According to the government’s Monthly Energy Review of July 2005, with CAFE we now import 64 percent. CAFE neither reduced America ’s use of foreign oil nor lowered our consumption of gasoline. 

Even if the masses had done what the elite class wanted (that is, drive less), it is unlikely the results would have been much better. Conventional wisdom assumes that most of a barrel of petroleum becomes gasoline for automobiles. Actually, gasoline accounts for less than half (44 percent) of the petroleum end-products. Some of the other end-products include: petrochemicals (such as plastics), jet fuel, diesel fuel, kerosene, propane, and home heating oil. 

When the CAFE standards took effect in 1978, the initial impact was benign. Because of the high gas prices, consumers already strongly preferred high-mileage cars. There was no need for a mandate because consumers and the auto industry were responding to market conditions. In 1981 prices peaked at an inflation-adjusted $3.07 a gallon. After that, real gas prices started to plummet. By 1986 they had fallen to the lowest levels in 30 years. As a result, American consumers were abandoning the small cars for their true love: Big Cars. Unfortunately, Phase II of CAFE was just kicking in. The federal government was now pulling the auto industry and the consumer in opposite directions. By law the auto industry would be punished if it provided products that the consumer wanted. The industry had no choice but to pursue the following suicidal strategy: Overcharge for the big cars consumers demanded in order to restrict sales, and give away the small cars that consumers didn’t want in order to encourage sales. 

Unfortunately, consumers responded to this shell game in a way that neither the government nor the auto industry wanted. They stopped buying cars. The large-car market has effectively been replaced by pickup trucks, SUVs, and minivans. The light-truck market, which is not subject to the same CAFE restrictions as cars, has gone from 28 percent of the market in 1987 to over 55 percent today. This consumer rebellion also resulted in the following CAFE irony: The fuel-economy average for all vehicles dropped from 26.2 MPG in 1987 to the 24.4 MPG today. 

It would be hard to find a more anti-consumer, anti-business, anti-jobs, or anti-American piece of legislation. The CAFE laws forced the Big Three auto industry to unilaterally surrender its strong suit, the large-car market, and go head to head against the small-car strong suit of the Japanese manufacturers. This was no contest. In 2004 the top four selling cars were are all Japanese: Toyota Camry, Honda Accord, Toyota Corolla, and Honda Civic. 

To make compliance even more difficult, each of the Big Three American automobile companies actually have to meet two sets of CAFE standards, one for domestically produced cars and one for foreign-made cars. In other words, the U.S. companies could not use their high-MPG foreign-produced cars to offset  low-MPG domestic cars. Since the large cars were more likely to be produced in the United States , the domestic-fleet target of 27.5 MPG was all but unreachable. To avoid fines for producing cars that the consumer wanted, the auto industry had four options: 1) downsize the large cars, 2) stop production of large cars, 3) move large-car production overseas, or 4) make the domestic large cars “foreign” by outsourcing at least 25 percent of the parts. If all this seems insane, that’s because it is. 

Besides being ignorant of economics, our elite class does not know much about engineering. They assume that the auto manufacturers are deliberately hiding the technological silver bullet that will enable cars to get phenomenal gas mileage. While a few known engineering changes could make marginal improvements, the only proven way to make substantial gains in miles-per-gallon efficiency is to reduce the weight of cars. This is accomplished by both making the cars smaller and by replacing steel parts with plastic parts. The average weight of new cars has dropped by an average of 1,000 pounds since CAFE became law. While lighter cars get significantly better gas mileage than heavier cars do, this comes with a price. There is an unavoidable tradeoff between better mileage and safety. The following is not rocket science, just Physics 101: Lightweight cars are less able than heavyweight cars to absorb the impact associated with a crash. In the late ’90s the Geo Metro was able to get 44 MPG. According to the EPA, this was one of the most fuel-efficient cars in America . The Geo Metro was also ranked by the Insurance Institute for Highway Safety as one of the most dangerous cars in America . It had a death rate double that of the overall car average. 

Deadly Standards 

As Robert Crandall of the Brookings Institution and John Graham of the Harvard School of Public Health wrote in the Journal of Law and Economics in 1989: “CAFE will be responsible for several thousand additional fatalities over the life of each model-year’s cars. We conclude that the real social cost of government-mandated fuel economy is much greater than is commonly believed.” They went on to state: “We estimate that these 1989 model year cars will be responsible for 2,200-3,900 additional fatalities over the next ten years because of CAFE.” While Crandall and Graham looked only at the 1989 model cars, CAFE-induced fatalities apply to every model year car since 1978. 

Echoing a similar conclusion, in 2002 the National Academy of Science estimated that CAFE was responsible for between 1,300 and 2,600 fatalities and 13,000 to 26,000 incapacitating injuries in 1993. Based on data from the National Highway Traffic Safety Administration and the Insurance Institute for Highway Safety (IIHS), USA Today reported on July 2, 1999 (based on data through 1998) that 46,000 people had died needlessly since the CAFE legislation became law. The article also stated: “Small cars comprise 18 percent of the vehicles on the road. . . . Yet they accounted for 37 percent of the vehicle deaths in 1997.” Given that the congressionally mandated killing and maiming has been going on another seven years, it is probably time to revise the total carnage figure to around 60,000 fatalities. 

It has been 28 years since CAFE became law. A case could be made that this was (and continues to be) the worst piece of legislation ever passed by Congress. Contrary to grandiose predictions, it did not reduce oil consumption and it did not decrease our dependency on uncertain foreign sources of oil. It did, however, result in 60,000 deaths and hundreds of thousands of serious injuries. And it has all but destroyed America ’s Big Three auto companies. Given the damage done, CAFE should be scrapped. Any pending CAFE legislation should be permanently tabled as well. 

Micromanaging the automobile industry through government centralized planning has been a colossal failure. It is time to let the marketplace create jobs, save lives, and efficiently allocate resources. The automakers should no longer be punished for producing products that consumers want. Consumers are fully capable of making rational decisions about cost, safety, fuel efficiency (hybrid and non-hybrid), comfort, appearance, and size without government mandates. They need no help from politicians, bureaucrats, consumer advocates, environmentalists, or media pundits. If a family wants to buy a safe vehicle big enough to transport grandma and all the kids, why is this controversial? It is time to restore freedom of choice in the automobile market.

Related posts:

1. Uncle Sam’s False Fuel Economy
2. Auto-Safety Standards
3. Efficiency in Government

The amended Clean Air Act (CAA) of 1990 called for cleaner automobile-engine combustion and a reduction in tailpipe emissions. To meet these goals, the Environmental Protection Agency (EPA) directed the petroleum industry to modify the composition of gasoline to comply with the “Oxygenated” and “Reformulated” Gasoline (RFG) Programs. While only those parts of the country with the most severe pollution (high ozone or carbon monoxide levels) would be required to participate in the programs, many city, county, and state governments in less-polluted areas volunteered their citizens to participate as well. The transition to the new environmentally friendly gasoline began in 1992. These programs would eventually affect over 100 million people in 19 states and the District of Columbia. Today, over 30 percent of the gasoline sold in the United States is RFG.¹

The EPA requires the new reformulated gasoline to have an oxygen content of just over 2 percent to help the gasoline burn cleaner. The two primary oxygenate additives are ethanol (corn alcohol) and methyl tertiary butyl ether (MTBE). Because these additives are not pure oxygen, the amount needed to meet the required oxygen content is significant. For example, since MTBE is only 19 percent oxygen, RFG made with this oxygenate additive must contain at least 11 percent MTBE.²

For environmentalists ethanol presents a dilemma. On the plus side it is a renewable energy source. On the minus side it is highly “volatile.” (It evaporates far more rapidly than gasoline.) In the summer the evaporative emissions of ethanol before combustion are a major contributor to smog. This serves to negate the advertised benefit of reduced tailpipe emissions.³It is therefore not surprising that advocates of ethanol only want us to look at what happens during and after combustion. To offset this problem, ethanol needs to be blended with a more expensive, lower-volatility gasoline that is not readily available in the market.⁴To make the situation worse, the ethanol separates from the gasoline if it is transported by pipeline over any significant distance. Because of this distribution problem, ethanol needs to be mixed with non-oxygenated gasoline as close to the final market as possible.⁵

Given all these inherent problems (environmental, cost, and logistical), ethanol is extremely fortunate to have very strong support from the “Big Corn” lobby. This is a coalition of Midwest politicians, big agriculture, and such agri-business firms as Archer Daniels Midland. Ethanol is exempt from federal excise taxes.

MTBE is derived from natural gas. It has been used since the late 1970s in low concentrations as an octane booster. This coincided with the phase-out of lead in gasoline. Compared to ethanol, MTBE is far less expensive and it can be more easily added during the refining process. For these reasons, MTBE is used in over 87 percent of the reformulated gasolines. The oxygenated-gasoline mandate increased MTBE production from 83,000 barrels per day in 1990 to 269,000 barrels per day by 1997.⁶

While the RFG program is advertised as being “great for the environment,” the benefits for the consumer are hard to find. Since the oxygenate additives can cost up to twice as much as gasoline, reformulated gasoline can cost up to 10 cents more per gallon than the non-oxygenated gasoline.⁷Unfortunately, it gets worse. Both major oxygenated additives have a lower energy content than regular gasoline, MTBE roughly 20 percent less, ethanol 30 percent less.⁸This results in a 2–3 percent loss in fuel efficiency. Translation: Consumers pay more to get fewer miles per gallon than before.

Vanilla Gasoline

Before the reformulated-gas mandates started to kick in, the logistics of fuel distribution were relatively simple. The product was homogeneous; all gas was “vanilla.” When one area of the country was experiencing a higher demand, it was easy to redirect more gas from another area to meet it. With RFG, in addition to “vanilla” we now have “rocky road” gas, “butter pecan” gas, and “pistachio almond” gas. While some parts of the country will require RFG all year long, others will only need a special gas in the summer to combat high ozone levels. Still other areas will only need a special gas in the winter to address high carbon-monoxide levels. As a result of the requirement for multiple types of gasoline that vary both by location and season, the logistics of fuel distribution have become a nightmare for the petroleum industry.

Unfortunately for the consumer, multiple flavors of gas are not interchangeable. If one part of the country is running low on “rocky road” gas, you cannot divert surplus “butter pecan.” Thus it should not be surprising that since the implementation of the RGP there have been many shortages (with accompanying price spikes) in certain parts of the country.

As if on cue, the media responded with a barrage of headlines charging Big Oil with “price gouging” and “obscene profits.” Grandstanding politicians got airtime to “call for investigations.” However, nothing ever came of these investigations, and the news media dropped the subject because the villain was not Big Oil but Big Government and its “environmental gas” mandate. As Jerry Taylor of the Cato Institute put it during testimony before Congress, “This congressionally mandated balkanization of the gasoline market has seriously hampered the flexibility that refiners would otherwise have to react to spot shortages.”⁹

“Environmentally-friendly” MTBE has another problem. Since MTBE is extremely soluble in water, it moves farther and more rapidly through both groundwater and surface water than gasoline. A study by the Vermont Agency of Natural Resources (ANR) found that MTBE migrated nearly ten times the distance of the non-MTBE gasoline contaminants.¹⁰

In tests conducted by the U.S. Geological Survey, MTBE has been detected in approximately 20 percent of the ground water where RFG is sold. This compares to a 2 percent detection rate in non-RFG areas.¹¹It is increasingly being found in municipal drinking-water wells and reservoirs. Even in extremely small amounts MTBE makes drinking water unusable. MTBE causes the water to smell and taste like turpentine. For some reason, humans are hypersensitive to even small traces of MTBE. We are able detect MTBE-tainted water at ten times lower concentrations than water containing just gasoline.¹²;As a result of this low threshold, it only takes a spoonful of MTBE to completely contaminate enough water to fill an Olympic-sized swimming pool.¹³

To make matters worse, the cleanup of MTBE-contaminated water is more difficult and costly than water contaminated with just conventional gasoline. Much of the MTBE contamination remains “beyond the reach of even the most sophisticated cleanup technologies.&rdquo ¹⁴ Instead of degrading over time, MTBE has a tendency to accumulate. So as long as we have a mandate for reformulated gasoline with MTBE, water pollution will only get worse.

Most MTBE-contaminated ground water has been traced to leaking underground storage tanks. This comes as quite a surprise since the federal government ordered gas stations to replace their old underground tanks with double-walled tanks and pipes in an effort to prevent environmental damage. The conversion was to have been completed by 1998. But in California a “state study found that two-thirds of the upgraded tanks and pipes tested in Yolo and Sacramento counties [were] leaking MTBE.”¹⁵

These new upgraded storage tanks cost consumers $2 billion. Even more tragic is the fact that thousands of gasoline stations across the country, mostly the “mom and pop” operations, were forced out of business.¹⁶;They simply could not come up with the $100,000 for “the upgrade.”¹⁷

MTBE Makes People Sick

In November 1992 about 200 residents of Fairbanks, Alaska, reported having headaches, dizziness, eye irritation, a burning sensation in their noses and throats, disorientation, and nausea. These health problems were linked to the newly introduced reformulated gas containing MTBE. So many people complained that the governor banned its use after only three months.¹⁸

As the use of reformulated gas increased across the country, so did the incidence of illness. Thousands of people became ill after being exposed to MTBE/gasoline fumes (before combustion), MTBE/gasoline exhaust (after combustion), and MTBE-tainted water. North Carolina banned MTBE after it was classified as a probable human carcinogen.¹⁹;At its annual meeting in 1994 the American Medical Association passed a resolution calling for a moratorium on the use of oxygenated fuel based on the risks posed by MTBE.²⁰

In addition to Alaska and North Carolina, at least 12 other states (Arizona, California, Colorado, Connecticut, Iowa, Maine, Michigan, Minnesota, Nebraska, New York, South Dakota, and Washington) have taken steps independent of the federal government to limit, phase-out, or ban MTBE.

As the biggest champion of reformulated gas, the EPA continually dismissed the growing criticism of MTBE. The agency’s official position was that while MTBE posed some risk, it was no greater than the risk of other gasoline components. The EPA responded to the ground water contamination problem by simply “providing information, intensifying research, and focusing on the need to minimize leaks from underground fuel tanks.”²¹

For six years the EPA opposed all measures to limit the use of MTBE. It was not until 1998 that the agency made MTBE a “potential candidate” for regulation under the Safe Drinking Water Act. Later that year the EPA finally established an independent panel to investigate the problems associated with the reformulated gas program. According to observers, the panel’s 1999 final report recommended, among other things, “that Congress act to remove the current Clean Air Act requirement that 2 percent of RFG, by weight, consist of oxygen,” that the “use of MTBE should be reduced substantially (with some members supporting its complete phase-out), and that Congress should act to provide clear federal and state authority to regulate and/or eliminate the use of MTBE and other gasoline additives that threaten drinking water supplies.”²²

Given these damning findings, the EPA was forced to admit that its advocacy of the MTBE fuel additive had been a mistake.²³

As a result of the government’s overzealousness in “helping the environment,” people pay more per gallon of gas, get fewer miles per gallon, and get sick. The biggest irony, however, is that the environment is worse off thanks to this “environmental program.” So far, the misguided policy has cost consumers untold billions of dollars. Unfortunately, the environmental and economic nightmare caused by government gas is not over. Be prepared to cough up another $30 billion or more to deal with the clean-up and phase-out costs of MTBE.²⁴

What Next?

From the current devastation wrought by the EPA, stand by for still more government command and control of the nation’s fuel supply. With MTBE rapidly falling into disfavor, that just leaves ethanol. The prospect of having ethanol as the only game in town has Big Corn salivating. In June the Senate approved an amendment to the energy bill that would mandate the use of ethanol in every state except Alaska and Hawaii by 2012. This new rule would also ban the use of MTBE. While the House version also supported ethanol, it left the resolution of the MTBE problem with the states.²⁵

An alternative solution, based on common sense, calls for a policy that objectively weighs both environmental and economic trade-offs. With this criterion, a strong case can be made that the EPA should just get out of fuel micromanagement altogether. As Michael Centrone observes: “the need for oxygenated fuels may be unfounded inasmuch as 75–85% of [the] smog in major cities is from non-automobile sources and tailpipe emissions of new cars are 95% lower that they were in the 1960’s.”²⁶Eric Stork, a former EPA employee, stated that “reformulated gasoline was a good idea 30 years ago, but in cars built in 1983 or later, the fuel is obsolete and pointless.”²⁷

It is time for us to rein in the EPA so that it can no longer do damage to the environment, to our health, to the consumer, or to the business community.

Notes

1. James E. McCarthy and Mary Tiemann, “MTBE in Gasoline: Clean Air and Drinking Water Issues,” National Council for Science and the Environment (98-290), www.ncseonline. org/NLE/CRSreports/Air/air-26.cfm?&CFID=6942884&CFTOKEN=41159272.
2.    2. Ibid.
3. A. Blakeman Early of the American Lung Association, Testimony on Issues Concerning the Use of MTBE in Reformulated Gasoline: An Update, November 1, 2001, House Committee on Energy and Commerce, Subcommittee on Oversight and Investigations, http://energycommerce.house.gov/107/hearings/11012001hearing407/Early694.htm.
4. “Commonly Available Ethanol and MTBE Gasoline Blends Do Little to Reduce Smog,” News, National Academies, May 11, 1999, www4.nas.edu/news.nsf/isbn/0309064457? OpenDocument.
5. McCarthy and Tiemann.
6. “MTBE, Oxygenates, and Motor Gasoline,” Energy Information Administration, www.eia.doe.gov/emeu/steo/pub/special/mtbe.html.
7. Ben Lieberman, “The Ethanol Mistake: One Bad Mandate Replaced by Another,” Competitive Enterprise Institute March 12, 2002, www.cei.org/utils/printer.cfm?AID=2895.
8. Larry Weitzman, “The Formula,” Mountain Democrat Online, December 15, 1999, www.mtdemocrat.com/display/inn_1999_columnists/Larry%20Weitzman/N1215_W.txt.
9. See Jerry Taylor, “The Effect of Federal Regulations on Gasoline Prices in the Milwaukee/Chicago Area,” Testimony before House Committee on Government Reform Subcommittee on National Economic Growth, Natural Resources, and Regulatory Affairs, July 7, 2000, www.cato.org/testimony/ct-jt070600.html.
10. Vermont Agency of Natural Resources (ANR) Study, www.anr.state.vt.us/env02/graphics/Waste%20Toxics.doc, p. 2.
11. “MTBE/Oxygenates in Gasoline Fact Sheet,” Environmental Health and Safety Online, www.ehso.com/news+MTBE.htm.
12. “The Efficacy of MTBE Use in Connecticut,” Connecticut Academy of Science and Engineering, September 30, 1999, www.ctcase.org/reports/MTBEsum.html.
13. “MTBE Still Leaking at Gas Stations Despite New Tanks,” North County Times (AP), March 10, 2002, www.nctimes.net/news/2002/20020310/54956.html.

     

14. Vermont ANR Study.
15. “MTBE Still Leaking.”
16. “Testimony of John C. Felmy of the American Petroleum Institute before the Federal Trade Commission,” August 2, 2001, www.ftc.gov/bc/gasconf/comments/felmyjohn.htm.
17. “Thousands of gas stations to miss deadline for fixing leaks,” CNN, December 22, 1998, www.cnn.com/US/9812/22/gas.tanks.02/.
18. Suzanne Zolfo Patton, “What Price, MtBE?” www. emagazine.com/july-august_1998/0798curr_mtbe.html.
19. Ibid.
20. “MTBE: Ozone Solution or A New Kind of Pollution?” Everyone’s Backyard, Spring1995, www.chej.org/SF/MTBE.html.
21. McCarthy and Tiemann.
22. Ibid.
23. “Clinton and EPA Chief Browner Act to Eliminate MTBE from Gasoline, and Boost Ethanol Instead,” November 17, 2002, www.ehso.com/news+MTBE.htm.
24. “MTBE Still Leaking.”
25. “Senate Adds Rule to Energy Bill to Double Ethanol in Gasoline,” New York Times (AP), June 6, 2003.
26. Michael Centrone, “How the Environmental Protection Agency Became a Public Health Risk,” National Center for Public Policy Research, National Policy Analysis # 304, August 2000, www.nationalcenter.org/NPA304.html.
27. Taylor.

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According to Deborah Miller of the Air Conditioning and Refrigeration Institute (ARI), “the DOE, in its own words, ‘rushed’ to publish a proposed new rule. It cut short the comment period; new analyses were injected into the record with only nine days left in this abbreviated period; it ignored its statutory mandate to balance economic interests in the rulemaking; failed to consult the Department of Justice on the impact 13 SEER would have on competition; and published a new rule of 13 SEER ‘literally in the final minutes of the last administration.’”¹

On January 22, 2001, the last day on which Clinton administration regulations could be published, the final rule mandating a 30-percent increase in the heating and cooling standards appeared in the Federal Register.² From a political standpoint, this administrative legerdemain was pure genius. By throwing these restrictive regulations over the fence, the outgoing administration’s legacy of being “for the environment” was preserved without any of the negative green baggage that so often evokes the wrath of consumers. Nevertheless, under the new, more-stringent environmental standards, the cost of air conditioners and heat pumps will go up $274 to $687.³

The incoming Bush administration had three options (all unsatisfactory) in dealing with the left-behind hot potato.

Option 1:

Just say no and repeal the regulation. Benefit: Momentarily keeps one onerous regulation at bay. Downside: High risk (99.99 percent) of being branded “anti-environment” by the media, environmentalists, and the Earth-first politicians. (Remember what happened with the arsenic-in-water standard?)

Option 2:

Hold your nose and simply accept it as written. Benefit: An absence of negative media coverage. Downside: Consumers are saddled with still more restrictive environmental regulations of dubious value. Ironically, the label “pro-environment” does not come with this option. The best that can happen is that the phrase “anti-environment” will not be used as frequently.

Option 3:

Propose a watered-down or “lite” alternative. Benefit: Although still bad, this is not so bad as the regulation proposed. Downside: High risk (99.98 percent) of still being branded “anti-environment” by the media and environmentalists. It is interesting that the vitriolic response accompanying this option is exactly the same as if the regulation had been withdrawn. Since there is never any distinction made between the out-and-out repeal and the watering down of a bad environmental regulation, why ever settle for half measures?

As it turns out, Option 3 was the path that the Bush administration chose. On April 13, 2001, the Department of Energy (DOE) announced its intention to raise the existing standards by 20 percent instead of the proposed 30 percent. The SEER value would be raised from 10 to 12 (instead of 13). The higher standards would take effect January 2006.

How was this 20 percent increase in the SEER value received? The Natural Resources Defense Council was typical: “This latest rollback . . . hurts the consumer and the environment.”⁴ Only in Washington is a 20 percent increase called a rollback.

What seems to be lost in the debate over heating and cooling standards is the consumer. There are two possible questions that could be asked. The appropriate question is: What does the consumer want? The inappropriate and elitist question is: What is best for the consumer?

The answer to the first question is always the same, no matter what the product. Consumers want choices. They want a number of options so that each buyer can pick the most suitable product. When it comes to purchasing an air conditioner or a heat pump, these options relate to the upfront cost, annual operating cost, aesthetics and special features, size of the unit, reliability, and performance. Other factors that influence a consumer’s choice include his or her age, family size, financial status, and location.

Consumer Forgotten

Unfortunately the federal government never asks, nor does it want to hear, what the consumer really wants. Since it is predisposed to solutions based on central planning, should it come as any surprise that officials turn only to like-minded advocates of central planning for advice, guidance, and direction? The government’s summary dismissal of the true interests of consumers is legitimized by a self-appointed coalition that thinks it knows best: the “consumer advocates” and environmentalists.

According to Andrew deLaski of the Appliance Standards Awareness Project, more than a hundred organizations support the SEER 13 standard.⁵ It would be interesting to know how many of these consumer-advocate groups even bothered to survey people on what they really want. Maybe the public is not interested in what these “consumer advocates” are advocating: fewer choices and higher prices. As Thomas Sowell put it, “Indeed, there are no requirements for any knowledge whatsoever to become an environmentalist or a consumer advocate. There are more qualifications required to become a taxi driver or a meter maid than to engage in any of a number of busybody occupations that are taken seriously in the media, as if they represented expertise on something.”⁶

When viewed in total, the evolution of government-mandated products, whether the toilet, the washing machine, or the air conditioner and heat pump, displays several disturbing principles⁷:

First, the right to choose is anathema to proponents of central planning. The elimination of the consumer choice is based on the attitude that people are not bright enough or informed enough to make the “correct” decision when left to their own devices.

There is nothing high-tech or mysterious about either the 20 percent increase or the 30 percent increase in efficiency standards. According to the Appliance Standards Awareness Project (one of the standard’s advocates), “manufacturers have successfully marketed SEER 13 air conditioners, now considered “mid-efficiency” units, for more than a decade. The most efficient units available reach SEER 16 or higher.”⁸ (Apparently the free market works just fine without government mandates.) The real problem is that consumers have chosen to ignore the government and environmentalist endorsement of the more-expensive systems for the reasons mentioned. The consumers’ rejection helps explain why government products are mandated while preferred, free-market products are outlawed.

Second, central planning, by definition and in practice, undermines competition and innovation. The Department of Justice concluded that the SEER 13 mandate would have “a disproportionate impact on smaller manufacturers. Currently less than 20 percent of the total product lines meet the proposed government standards.

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2. Planned Chaos And The New Idolatry
3. Dim Bulbs

This mandate appears to be at odds with the wishes of the American people. In spite of the outstanding theater-quality picture and sound on the high-definition televisions (HDTV), they account for less than 1 percent of all the TVs in American homes. It is hard to win the digital revolution when there are over 265 million of the primitive nondigital TVs still in use. That’s 2.4 sets per household. Since these TVs have a lifespan of between seven and ten years, most will still be alive and kicking when the federal government flips the “off” switch. So unless the government blinks, Congress can expect to hear from a lot of angry constituents. Thus far the federal government has been hanging tough. In 2006, America will have five choices: Buy a digital-ready TV, subscribe to cable TV, subscribe to satellite TV, buy a set-top box converter so that your old-fashioned TV can decode the digital signal, or start reading books.

Joel Brinkley of the New York Times has noticed the anomaly of government’s ordering a new consumer technology. “No other national technological transition has ever been backed by this sort of government decree. Nobody was forced to trade a horse for an automobile, a Victrola for a radio or a typewriter for a computer.”¹

Why aren’t the people buying these phenomenal government-endorsed TVs? There are two primary reasons. The first is cost. Although the price has started to come down in the last couple of years, HDTVs are still a luxury that few can afford. The price ranges from $1,300 to $10,000. It gets worse. You will still have to cough up another $650 for a set-top box converter to receive the digital signal.² In contrast, the average complete total price for a nondigital TV ranges between $200 and $400.

The other reason for not buying an HDTV is right now there is little to watch. For the few who decided to buy an HDTV, their biggest complaint was the lack of high-definition programming.³

Ironically, a surprising number of people use their HDTV just to watch DVD movies. The next time you are at an appliance store and see one of those “gold-plated” HDTVs with the “fabulous” cinema-quality picture and sound, ask the salesman: “Is that a broadcast high-definition picture or is that picture coming from a DVD player?” After a great deal of obfuscation, he will probably say: “Um . . . DVD player.”

As with all products, consumers weigh tradeoffs. There is no doubt that many shows will look fantastic in high-definition color. However, many people (in fact, the overwhelming majority) have decided that it is really not all that important (nor worth the money) to be able to see every pore on Larry King’s face or to hear Katie Couric’s voice in theater-quality Dolby sound.

Since HDTV is designed to work best with screen sizes of 45 inches or larger, what about all those small TVs in the kitchen? Consumers have apparently decided that a giant HDTV home-entertainment center on the kitchen counter is not very practical. Watching TV on a 13-inch color set first thing in the morning while eating corn flakes may not be the greatest viewing experience possible, but the American people have decided that it is good enough. Unfortunately, this lackadaisical attitude is at odds with what Congress and the FCC think consumers want.

How does the federal government justify its efforts to pawn off digital TV on a public that is clearly not interested? It appears that the ghost of industrial policy past has come back to haunt America. In the case of HDTV, we have an elitist government making policy based on what it thinks will be good for industry and what it thinks an uninformed public really wants. To the FCC, the digital TV revolution is far too important to be left to the inefficient and time-consuming whims of the marketplace. Since there is no individual industry or company that has the wherewithal or long-term vision to win the “digital revolution” by itself, the FCC will use its omnipotent knowledge and its mandate power to insure the correct outcome.

But how smart is the FCC really? Does its track record in choosing winners warrant an “Oracle of Washington” status? Should we entrust the adoption of digital television to the wisdom of the FCC with its heavy-handed mandates? Or, should we simply let the marketplace decide? A review of the last TV revolution provides some interesting insights.

The FCC and the Color TV Standard

In the early days of television there were three competing color standards vying for the FCC’s blessing. The CBS Field Sequential System had the inside track. However, it had a major flaw. It was incompatible with the nine million black-and-white sets already in homes across America. Viewers with those TVs would not have been able to watch a show broadcast by that system (even in black and white) without a costly converter. If this incompatible standard were to be adopted and the public refused to buy the converter, color broadcasters would be beaming their signals to a nonexistent audience. The other two competing color systems were compatible with black-and-white sets. Would you like to guess which system the FCC picked?

On September 1, 1950, it approved the CBS system by a 4-to-1 vote. But a year later something strange happened. CBS discontinued its color broadcasts. Maybe the lack of an audience contributed to the decision.⁴

To no surprise, on December 17, 1953, the FCC publicly changed horses and adopted the National Television System Committee (NTSC) compatible color system as the U.S. standard. It was based on one of the black-and-white-compatible designs that the FCC had dismissed as technically inferior. Color broadcasts using the new FCC standard were authorized to begin in January 1954.

Even though the compatibility problem was resolved, the transition from black and white to color was still exceedingly slow. It took 12 years (1954–1966) before each of the three networks would have a full prime-time color lineup. It took 23 years (from 1954–1977) until 75 percent of the homes in America had at least one color television. Although slow, there was little “technology frustration” and there were no government-mandated transition deadlines to elicit the wrath of either viewers or broadcasters. A viewer with a black-and-white TV did not need a set-top box converter to see a color-broadcast program. It simply appeared in black and white.

People could quickly grasp the concept of going from black and white to color. However, the average consumer today doesn’t have a clue as to what going from analog to high-definition means. “Walt Disney’s Wonderful World of High-Definition” does not have the same ring to it. Most would-be consumers have no idea what “better pixelation” is or really care to know.

In the color-TV revolution 50 years ago, we had a government that eventually acquiesced to the realities of the marketplace. Today, we have a government hell-bent on riding roughshod over everyone in order to make its digital vision of the future a reality.

Opposing Sides in the Digital War

There are clearly two opposing sides in the “Digital TV War.” As usual, the consumers are all alone on one side. Aligned against them are the federal government (Congress and the FCC) and its two allies: the National Association of Broadcasters (NAB) and the Consumer Electronics Association (CEA). The TV manufacturers, represented by CEA, clearly had the most to gain from the digital war. If crawling in bed with the federal government would force every family in America to buy a $1,500 TV, why not go for it? In contrast, it was a mystery why the broadcast industry was also crawling in the federal bed.

As if part of a horror movie, this bedroom scene turned into a nightmare. The first bedfellow to start screaming when the lights went out was the broadcast industry. The TV manufacturers would be next.

From the earliest days of the digital revolution, the NAB has been fighting (against the consumer and even against its own constituents) to make the government’s vision of HDTV possible. The TV manufacturers’ business model is obvious: “Sell millions of HDTVs to make billions.” In contrast, the broadcaster’s business model for HDTV makes absolutely no sense. It appears to be: “Spend billions to make millions.” Advertisers pay to have viewers watch their commercials. If just a few viewers will see their commercials with a great high-definition picture, how appealing can this be to advertisers?

In April 1997 the FCC mandated that all TV broadcasts would be digital by 2006. As a result, each station would be forced to meet an aggressive digital-transition schedule. By May 1, 2002, all commercial TV stations were to be online with at least “some” of their programming in digital format.

And how successful were the commercial stations in meeting their deadline? Of the 1,240 commercial stations in the country, 68 percent failed to meet it. The FCC was clearly not amused. Although 772 stations were granted a six-month extension, another 71 stations had their requests denied. Those recalcitrant stations that choose to flout the authority of the FCC run the risk of having their broadcast licenses revoked.

The major reason for the failure to meet the deadline was cost. It is easy for the federal government to make mandates—they don’t have to pay for them. For the small broadcast stations in “fly-over America,” this digital mandate presents a severe financial hardship. The conversion price tag, for all stations, both large and small, starts at around $3 million.⁵ High-definition broadcasting thus causes capital and operational expenses to skyrocket without any increase in revenue. It would appear that the concept of “making a profit to survive” is totally alien to the FCC bureaucrats since they operate in a taxpayer-funded bankrupt-proof environment.

The Next Victim: Television Manufacturers

While the nightmare for the broadcasters is ongoing, the nightmare for the TV manufacturers is about to begin. On August 8, 2002, the FCC voted 3 to 1 to require electronics manufacturers to include digital tuners in all new television sets by 2007. The actual phase-in date will depend on the size of the set. TVs with screens 36 inches or wider would be required to include the digital tuner by July 1, 2004.

The TV manufacturers feel that this mandate is absurd. The FCC’s own data shows that only 14 percent of viewers watch TV using an over-the-air broadcast. The other 86 percent get their TV from either cable or satellite.⁶ Since the overwhelming majority of viewers will never use the $250 tuner, why is the federal government forcing all TV consumers to buy a product they clearly do not want? Answer: the federal government feels that by manipulating the market, it can artificially create a demand for HDTVs where one does not currently exist. In theory, this will lead to a groundswell of real consumer demand for HDTVs. The CEA estimates that the federal government’s mandate to stimulate that demand will cost $7 billion. The Detroit News calls this a “TV tax on consumers.”⁷

The federal government’s latest attempt at industrial policy has been, and continues to be, a fiasco. It is very clear that it has lost the digital TV war. Based on the incredibly slow pace of the transition to digital TV, it is incomprehensible that the American people will accept 2006 as the end of TV as we know it. The federal government did not mandate an end to black-and-white TV, and it should not impose a mandate this time either.

But don’t expect the bureaucrats to learn the right lesson: on October 10, 2002, the FCC unanimously approved a new standard for broadcast digital radio.⁸

Notes

1. Joel Brinkley, “The Dawn of HDTV, Ready or Not,” New York Times, October 26, 1998.
2. “TV Sets,” Consumer Reports, October 2002, search “HDTV” at www.consumerreports.org.
3. “DTV Owners Survey,” HDTV Magazine, November 2000.
4. Karla Robinson, “H is for Headache,” Ace Weekly, September 14, 2000.
5. David Lieberman, “Order to Go Digital Staggers Small TV Stations,” USA Today, July 17, 2002.
6. “Many Broadcasters Will Not Meet 2002 DTV Deadline,” General Accounting Office Report, GAO-02-466, April 23, 2002.
7. “Stop FCC’s Stealth TV Tax,” Detroit News, August 13, 2002.
8. Barnaby Feder, “FCC Approves a Digital Radio Technology,” New York Times, October 11, 2002.

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3. High-Definition TV: Government or Market Choice?