Regulating the Financial Sector in New York: Have the Activities of the State Attorney General Been Good or Bad for the Industry?

May 2006. Full Report >>

Executive Summary

Following the bursting of the “dot-com” and stock market bubbles of the late 1990s, and several widely publicized corporate-finance scandals, new federal regulations were put into place, most notably the Sarbanes-Oxley Act. At the State level, local regulatory institutions also focused new attention on the financial-services sector. In particular, the Office of the Attorney General (OAG) of New York State has been extremely active in investigating various financial-services firms in New York. These investigations resulted in a number of large financial settlements and some industry-level restructuring.

There have been concerns that actions taken by the New York OAG in the past few years regarding the investment banking, mutual fund, and insurance industries, have cost jobs in New York. This paper takes an early look at whether or not the new regulatory scrutiny hurt these sectors by introducing unwarranted penalties and restructuring, or fixed it, by restoring informational symmetry and investor confidence.

The earliest OAG regulatory actions in New York’s financial-services sector were made public in April 2002 with the investigation of a prominent investment bank. Investigations into mutual fund industry practices were initiated in September 2003, and insurance industry legal action got underway in October 2004.

The historical volatility of the financial-services sector has long been a factor in New York’s economic picture. The pronounced run-up in financial markets in the late 1990s ended with the bursting of the “dot-com” bubble in March 2000. New York City securities subsector employment peaked at the end of 2000, reflecting the peak levels of activity in mergers and acquisitions and initial public offerings. Financial-services employment retreated sharply through the middle of 2003, in New York and nationally. The financial markets, and New York financial-services employment, were also buffeted during this period by the September 11th terrorist attacks, corporate financial scandals affecting Enron, WorldCom and other companies in mid- and late-2002, and by the build-up to the Iraq War from the fall of 2002 through the spring of 2003. Nationally, investor, consumer and business confidence did not begin to rebound until mid-2003.

Econometric analysis was used to separate out macroeconomic factors from OAG regulatory actions in their effects on financial sector activity. Employment in investment banking and the securities subsector declined sharply in the wake of the dot-com crash, but the statistical analysis shows that there was no drop in employment following the OAG actions other than that predicted by market fundamentals and the macroeconomy. Investment banking employment has increased in recent years as the financial markets have rebounded and New York has maintained its share of national employment.

OAG enforcement actions may have benefited the mutual fund industry by restoring investor confidence. In the period since OAG actions, the inflow of funds into the mutual fund industry has increased relative to overall market performance. Because OAG enforcement action in the insurance industry has been more recent and is ongoing, it is premature to conclude anything about the possible effects of regulatory activity. It can be noted, however, that through consolidations and other developments, insurance brokerage employment in New York has experienced long-term structural decline since at least 1990, but that there has been a very slight up-tick in employment since the fall of 2004.

Although it is too early to make definitive judgments, the data and analysis presented here suggest that the financial-services sector is no worse off, and quite possibly better off, than it would have been absent OAG actions, because of improved confidence on the part of investors stemming from the more effective regulation and the corrective actions that followed widely publicized scandals.

The Economic Development Benefits of Prevailing Wage

May 25, 2006.  A background briefing paper reviews the academic literature on the impact of prevailing wage laws.

$90 million in TANF Funds Trapped in Budget Limbo

May 24, 2006. Advocates call upon Governor to adopt legislature’s bi-partisan agreement on TANF Funds. Press release below. Also see attachments: The Allocation of the New York’s TANF Block Grant Funds for 2006-07 and Flexible Fund for Family Services allocations by county.

Assemblymember Deborah Glick and Advocates for Low-Income New Yorkers held a press conference today at the Legislative Office Building to urge Governor Pataki to stop playing politics with federal Temporary Assistance to Needy Families (TANF) block grant funds. The groups urged the Governor to adhere to the funding recommendations that the Senate and Assembly Human Services Conference Committee suggested in their bi-partisan proposal and to resubmit his budget to reflect that agreement.

Assemblymember Deborah J. Glick, Chair of the Assembly Social Services Committee stated that, “The Executive has never focused on the myriad of smaller programs that are crucial in assisting families in New York as they work their way out of poverty. The Legislature has played that role. It is devastating that the Governor has chosen to wipe away these critical programs especially at a time when the federal rules require us to do more to engage people.”

“The Governor has unilaterally decided to spend $1.041 billion in federal TANF funds on a risky experiment called the Flexible Fund for Family Services (FFFS). He is moving forward on TANF spending without regard for the bi-partisan agreement reached by the Legislature and without funding many programs that have been effectively operating for years,” complained Ron Deutsch, Executive Director of New Yorkers for Fiscal Fairness. “This budget is far from done. If we do not get some movement on remaining TANF funds, families and the organizations that serve them will start to feel the pain of this inaction.”

The advocates also were upset that almost $400 million in Child Care subsidies have been lumped into the Flexible Fund and that funding for SUNY/CUNY childcare and facilitated enrollment services have been completely omitted by the Governor. The elimination of the SUNY/CUNY childcare funding could inevitably mean the end of these services at our state/city institutions of higher learning.

The Governors actions also eliminate $8.3 million of TANF funding for childcare facilitated enrollment projects. “Childcare facilitated enrollment is helping thousands of average working parents pay for quality child care by allowing families earning up to 275% of poverty to apply at their worksites, community based organizations, and union halls during lunch time and on weekends. These funds would help working families across the state access the licensed, quality childcare they so desperately need,” stated Sonte Ducote of the NYS Union Childcare Coalition.

Many other organizations that rely on TANF funds to provide support services to families transitioning from welfare to work have also seen their funding eliminated by the decisions the Governor is making unilaterally. “While millions of immigrants across the State are eager to learn English and improve their community and economic standing, Governor Pataki is defying the State Legislature and cutting vital funding intended to help immigrants and all low-income New Yorkers,” said Jose Davila, State Government Affairs Representative for the New York Immigration Coalition. “The Governor should release the remainder of the TANF funds and ensure that vital educational services like adult English classes are kept open throughout New York State,” said Davila.

“We are just becoming quite worried about how we and the other groups will make ends meet this year. The $1 million in TANF funding for emergency homeless services can’t be replaced, and it is needed to pay for eviction prevention, emergency food and shelter, and crisis intervention services for homeless families. We need for the Governor to resubmit the legislation so that the bi-partisan conference committee agreement can become law, and we can continue to deliver these services,” said Shelly Nortz, Deputy Executive Director for Policy with Coalition for the Homeless.

The Women’s Employment and Resource Center in Albany has also expressed concerns that funding for the highly successful Displaced Homemaker program has been eliminated. “Without this essential funding Displaced Homemaker Centers across the state will face an almost 50% cut in funding and many of us may be forced to consider closing our doors to the women who rely on us to help them re-enter the workforce to become economically self-sufficient,” said Beth Miller, Executive Director of the Capital District Women’s Employment and Resource Center.

“The Disability Advocacy Program (DAP) helps low income disabled New Yorkers get disability benefits while at the same time saving the state money by shifting folks from welfare to 100% federally funded assistance. Without restoration of the $1 million in TANF funding the Legislature sought to direct to DAP, our programs will lose a substantial portion of their funding and will be forced to turn away people in need,” stated Kristin Brown, Director of Legislative Advocacy for the Empire Justice Center

New federal mandates, as a result of the reauthorization of welfare programs by Congress, will substantially increase the work participation rates in New York State.

“It has been estimated that New York could lose as much as $358 million in federal funds for failure to comply with the new federal work participation rules for public assistance recipients which take effect October 1, 2006. Funds for childcare, education, training, supportive services and transportation are critical to New York’s efforts to increase work participation rates. Governor Pataki cannot be allowed to play politics with these critical federal resources — particularly when it will be the next Administration that may have to live with the funds lost as a consequence of these games,” stated Trudi Renwick, Senior Economist at the Fiscal Policy Institute.

Statewide advocacy groups such as the Empire State Economic Security Campaign, the Fiscal Policy Institute, New Yorkers for Fiscal Fairness, Empire Justice Center and others strongly urged the Governor to resubmit this portion of his budget to fund the myriad of programs he has eliminated.

New York State’s Dual Crises: Low Graduation Rates and Rising School Taxes

May 18, 2006. A new report issued by the Public Policy and Education Fund of New York with the assistance of the Fiscal Policy Institute.

Roth IRA “Conversion” Gimmick May be Used to Mask the True Cost of New Tax Cut Package Nearing Adoption by Congress

May 5, 2006. Press release below; also, links to additional resources.

Roth IRA “Conversion” Gimmick May be Used to Mask the True Cost of New Tax Cut Package Nearing Adoption by Congress

As news reports of the last several days have indicated, the chairs of the Senate Finance Committee and the House Ways and Means Committee have reached an “agreement in principle” on a tax reconciliation bill that would include approximately $70 billion of tax-cut extensions including a two-year extension of the dividends and capital gains tax rate cuts, which don’t expire until 2008, and a one-year adjustment in the Alternative Minimum Tax to prevent more middle-class Americans from being hit by the tax.

Not as widely reported, however, is the likely use in this tax cut package of a gimmick that would increase federal tax revenues temporarily to help “offset” the cost of the capital gains and dividends tax cuts in 2011 through 2015. If not offset, these costs would violate a Senate budget rule, subjecting the reconciliation bill to a 60-vote point of order. After raising revenues for a few years, however, the gimmick would substantially reduce federal revenues after 2015 and increase deficits in the long term.

The gimmick involves the removal (for a temporary period of time) of the income limits on who can convert traditional Individual Retirement Accounts (IRAs) to Roth IRAs. Congressional and independent budget analysts agree that this change would spur a large number of high-income households to convert their traditional IRAs to Roth IRAs in order to take advantage of the long-term Roth IRA tax breaks. This, in turn, would lead to an increase in revenues over the 2011-2015 period, because people converting a traditional IRA to a Roth IRA would pay taxes in that period on the amount being converted. But it also would reduce
revenues in years beyond 2015 when withdrawals from the new Roth IRAs would be made and would be tax free. This is essentially a timing shift that accelerates into the 2011-2015 period revenues that otherwise would be collected in subsequent years.

Moreover, over the long run, the proposal would result in a net reduction in tax revenues. People would elect to convert their traditional IRAs to Roth IRAs only if doing so would be to their advantage because it would lower their tax bills. In other words, they would elect to pay some additional taxes now only if they expected that it would reduce their tax bills by larger amounts in the future. Anyone who expects that such a transaction would increase his or her tax bill simply would not covert a traditional IRA to a Roth IRA.

This gimmick, in effect, allows the Congress to use one tax cut (i.e., increasing the income limit on Roth IRA “conversions”) that only benefits higher income Americans to pay for other tax cuts (i.e., the extension of lower capital gains and dividend rates) that overwhelmingly benefit the wealthy.

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Links to additional materials on this issue

A.  Distributional analyses from the Urban-Brookings Tax Policy Center:

Possible Major Individual Income Tax Provisions in 2006 Tax Reconciliation Bill Fully-Phased In Impact at 2006 Income Levels, Distribution of Federal Tax Change by Cash Income Percentile

Possible Major Individual Income Tax Provisions in 2006 Tax Reconciliation Bill Fully-Phased In Impact at 2006 Income Levels, Distribution of Federal Tax Change by Cash Income Class

IRA Conversion Provision Fully-Phased In Impact at 2006 Income Levels, Distribution of Federal Tax Change by Cash Income Percentile

IRA Conversion Provision Fully-Phased In Impact at 2006 Income Levels, Distribution of Federal Tax Change by Cash Income Class

B.  Analyses from the Center on Budget and Policy Priorities:

Reconciliation Tax Cuts Would Average $42,000 for Households With Income Over $1 Million, But Only $20 for Middle-Income Households

Joint Tax Committee Estimate Shows That Tax Gimmick Being Designed to Evade Senate Budget Rules Would Increase Long-Term Deficits: Approach Would Add New Tax Cuts to “Pay For” Other Tax Cuts

House GOP Tax Cuts Ignore Crucial Funding

May 4, 2006. A letter to the editor by FPI Senior Economist Trudi Renwick, commenting on a Times Union editorial (April 19, 2006) on tax cuts being considered by Congress.

Over $1 Billion in TANF Block Grant Funds Trapped in Budget Limbo

May 3, 2006. Groups call upon the Governor to adopt the legislature’s bi-partisan agreement on use of Temporary Assistance for Needy Families funds. Joint release from New Yorkers for Fiscal Fairness, the Fiscal Policy Institute, the Hunger Action Network of New York State and the Empire Justice Center:

Advocates for Low-Income New Yorkers held a press conference today at the Legislative Office Building to urge Governor Pataki to stop playing politics with over $1 billion in federal Temporary Assistance to Needy Families (TANF) block grant funds. The groups urged the Governor to agree to the funding allocations that the Senate and Assembly Human Services Conference Committee suggested in their bi-partisan proposal.

“We currently have no idea what will happen to over $1 billion in federal TANF monies if the Governor continues to dig in his heals and say that the budget is done,” complained Ron Deutsch, Executive Director of New Yorkers for Fiscal Fairness. “This budget is far from done. If we do not get some movement on TANF funds families and the organizations that serve them will start to feel the pain of this inaction.”

The TANF funds trapped in budget limbo are needed desperately to make sure that the Summer Youth Employment Program (providing summer employment opportunities to needy children across the state) can begin operation. The advocates also stated that over $400 million in Child Care subsidies and facilitated enrollment monies are also tied up in
this boondoggle.

“Child care is critical for working families, allowing them to do their jobs knowing that their children are safe and well-cared for. But without child care subsidy assistance, many low-income working parents will face the dilemma of either leaving their jobs and returning to welfare or using unlicensed, unregulated care that is potentially neither safe nor developmentally appropriate for their children,” stated Carol Saginaw, Executive Director of the NYS Child Care Coordinating Council.

The Legislature’s proposal also allocates $8.3 million of the TANF funding for childcare facilitated enrollment projects. “Childcare facilitated enrollment is helping thousands of average working parents pay for quality child care by allowing families earning up to 275% of poverty to apply at their worksites, community based organizations, and union halls during lunch time and on weekends. This will help working families across the state access the licensed, quality childcare they so desperately need,” stated Jim Cullen of the NYS Union Childcare Coalition.

Many programs, like the Disability Advocacy Program, Wheels for Work, Domestic Violence, and Food Pantry assistance programs are also in need of operational funding. “The Disability Advocacy Program (DAP) helps low income disabled New Yorkers get disability benefits while at the same time saving the state money by shifting folks from welfare to 100%
federally funded assistance. Without restoration of the $1 million in TANF funding the Legislature sought to direct to DAP, our programs will lose a substantial portion of their funding and will be forced to turn away people in need,” stated Kristin Brown, Director of Legislative Advocacy for the Empire Justice Center.

Karla Digirolamo, Chief Operating Officer, Unity House of Troy, Inc., discussed how the lack of TANF funds would impact her program, “Without the TANF dollars dedicated to domestic violence services, scores of women and children might be unable to find the safety and support they need to establish independent, safe lives. We know that thousands of women in our community live with this danger every day and that even with existing resources, we struggle to meet the needs they have. Any loss could undermine our ability to provide these essential services and could literally come at the cost of a lost life.”

“The $12 million in TANF funds is more than half of the state funding for over three thousand emergency food programs, which feed close to a million low-income New Yorkers each week. While state funding is a fraction of the overall cost of feeding our consumers, it has been invaluable in improving the nutritional value of the food packages. Many programs are already reporting a decline in government donations. The loss of TANF dollars would be a devastating blow to the effort to alleviate hunger in our state. We need the Governor to resolve this impasse rather than holding poor New Yorkers hostage to this power play,” stated Mark Dunlea, Associate Director of the Hunger Action Network.

New federal mandates, as a result of the reauthorization of welfare programs by Congress, will substantially increase the work participation rates in New York State.

“It has been estimated that New York could lose as much as $358 million in federal funds for failure to comply with the new federal work participation rules for public assistance recipients which take effect October 1, 2006. Funds for childcare, education, training, supportive services and transportation are critical to New York’s efforts to increase work participation rates. Governor Pataki cannot be allowed to play politics with these critical federal resources — particularly when it will be the next Administration that may have live with the funds lost as a consequence of these games,” stated Trudi Renwick, Senior Economist at the Fiscal Policy Institute.

Preliminary Oral Comments of New York State Attorney General Eliot Spitzer on the Allocation of Carbon Dioxide Allowances Pursuant to the Regional Greenhouse Gas Initiative Cap-and-Trade Program

May 2, 2006. The comments below were delivered in Hartford, CT, by New York State Assistant Attorney General J. Jared Snyder.

In general, the Attorney General’s office supports the carbon dioxide emission reduction program embodied in the Regional Greenhouse Gas Initiative (RGGI) model rule. Global warming is undoubtedly the most significant environmental problem facing America today and the RGGI cap-and-trade program is a good first step to reducing emissions from power plants, one of the two main sources of CO2 emissions in the northeastern states.

Let us be perfectly clear on one point however: while it is a good first step, it is by no means sufficient. Unless it is superceded by an effective federal program, significant additional reductions in the regional cap will be needed. The science is clear that eventual reductions in worldwide carbon dioxide emissions of about 80% are needed to stabilize the climate. Because the United States is, and long has been, the world’s largest source of carbon dioxide emissions, and power plants are the largest source of emissions within the United States, reductions of at least that magnitude in US power plant emissions will ultimately be necessary. RGGI is a good first step in that direction.

Now that the RGGI states have agreed to implement a carbon dioxide cap-and- trade program, the states must decide how to initially distribute the carbon dioxide allowances. Generators will need to have enough allowances to match the amount of their CO2 emissions, in a ratio of one allowance per ton of CO2 emitted. Among the options are: distributing the allowances to generators free-of-charge based on historic emissions, distributing the allowances free-of-charge based on electricity generation output, and auctioning the allowances to generators and using the auction revenue for some public purpose. The remainder of these comments at this time focus on the selection of an allocation methodology. In further written comments, our office will address a number of other issues relating to the RGGI design.

The importance of the allocation methodology transcends this limited emission reduction program. As the federal acid rain experience demonstrates, the allocation methodologies chosen now may well develop their own propulsion and provide the default choice for future reduction programs as well. In addition, considering the need for additional reductions in the future, it is essential that the allocation methodology minimize the burdens of the program to the public at large in order to build public support for the further reductions that will be needed in the future, both at the state and federal levels.

The state memorandum of agreement requires that at least 25% of the allowances must be sold to generators through an auction or similar mechanism for the public benefit. It is our view that the public benefit allocation should be expanded from the 25% minimum to 100% of the allowances.

We believe that three principles should guide the selection of an allocation methodology. The first goal is to minimize the impact on consumers’ electricity bills. Second, the allocation methodology should provide an incentive for development and implementation of clean sources of energy and energy efficiency. Third, the states should select an approach to allocation of allowances that ensures that CO2 emitters bear at least some of the cost of the harm caused by their emissions but borne by society at large, otherwise known as the externalities of their pollution.

Principles of economics and the modeling undertaken by the working group demonstrate that all of these goals are served by developing a mechanism whereby the allowances are auctioned to generators with all proceeds used for energy efficiency improvements and direct ratepayer or resident rebates.

Free Allocation vs. Auction of Allowances

Free allocation of allowances to CO2 generators will not lead to lower electricity prices to consumers. The price of electricity will rise to the same extent under RGGI whether the allowances are given to the generators for free or auctioned for the benefit of the public. The reason is a matter of fundamental economics.

In New York and other RGGI states, electric power is bought and sold on wholesale spot markets (the NYISO, ISO-NE, and PJM). Load serving entities, such as utilities and competitive energy service providers, purchase power from generators at a price set by the market. Generators offer power into the market at a price which represents their marginal cost (which includes all variable and fixed costs). The independent system operator matches generator offers with demand bid into the market, from least to most expensive power offered. When the demand is satisfied, the price at which it is satisfied, the “market clearing price,” is paid to all generators who have offered power at or below that price.

A generator will include in its variable costs, and thus in its offering price, the current market value of the CO2 allowances it uses to cover its emissions, regardless of how it originally obtained those allowances. This is because, in offering power into the market, a generator has to decide whether it is more profitable to produce electric power and expend the necessary CO2 allowances to do so, or not to produce electricity and instead sell its allowances to others. If it decides to offer power, it is foregoing the opportunity to sell the allowances in favor of consuming the allowances. This “opportunity cost,” which is the market price of the allowances, is a variable cost that will be included in generators’ marginal cost (i.e., the marginal bid price for the electricity they generate). The opportunity cost represents the cost to the generator of deciding to produce the power and use up allowances. The same opportunity costs will be included in the generator’s bid regardless of how the allowances were originally dispensed.

The price of electric power is ultimately passed on to the consumer, whether in the form of a direct pass-through on the bill (such as most New York electric customers get) or indirectly through recalculations down the road when fixed rate services are revisited by ratemaking agencies or when bilateral contracts are renegotiated or otherwise adjusted. Since the opportunity cost will be included in the generator’s bid price regardless of how the allowances were originally dispensed, giving the allowances for free to the generators will not lower the ultimate price paid by the consumer. It will simply provide a windfall to generators, who will be able to keep or sell the allowances received as needed. An auction would not provide such a windfall, but instead would generate revenue for public purposes, including reduction of electricity bills.

Cost studies for RGGI and other CO2 cap-and-trade programs confirm that the electricity price impact of the CO2 policy is the same whether under a historic allocation or under an auctioned allocation. However, the allocation methodology will have a significant impact on who benefits from the value of the allowances. For example, Resources for the Future (RFF) found that “due to electricity deregulation in the northeast, allowance value is reflected in electricity price to an equal degree for auction and historic approaches to distribution,” and generators would actually make more money under a CO2 policy with free allocation of CO2 allowances than they would in the absence of a CO2 policy altogether. In contrast, the value of allowances in an auction approach (i.e., the auction revenues) would benefit the public if used for rebates and energy efficiency improvements.

In the UK, where CO2 allowances were originally distributed at no charge based on historic emissions, it is anticipated that power generators will make increased revenue of approximately $500 million per year. Importantly, the Environmental Audit Committee of the UK House of Commons has concluded that auctions should be considered in future due to the massive windfalls generators have received.

Auction Revenues

As mentioned above, distributing allowances by auction eliminates the windfall to the emitters and allows the proceeds to be used to defray the increased prices. Through mechanisms such as rebates, credits and offsets, some portion of the proceeds can be returned directly to ratepayers who would otherwise bear the increased cost of electricity. In addition, auction proceeds can be used to fund energy efficiency programs directed at reducing consumers’ electricity usage. In this way, the effect of increased electricity prices on consumers’ bills will be tempered, if not eliminated completely. Furthermore, by reducing demand for power generation, improvements in energy efficiency will suppress both wholesale energy prices and the cost of allowances.

New York’s existing energy efficiency program has been a tremendous success, but there is still potential for further efficiency gains. Through 2004, NYSERDA’s energy efficiency and clean energy programs have reduced annual electricity use by 1,400 gigawatt-hours, reduced energy bills by $195 million annually, created 4,200 jobs per year, and reduced annual carbon dioxide emissions by 1,000,000 tons. By 2022, NYSERDA estimates that the potential energy savings from additional cost-effective energy efficiency improvements could be as high as 27,244 gigawatt-hours per year. Auction revenues could be used to help realize the full potential of energy efficiency in New York.

Allocating allowances by auction also promotes the development of cleaner sources of energy, because they will not have to bear the cost of acquiring allowances. This will give renewable energy and efficient generators modest advantage over higher emitting generators but that is unlikely to balance the significant existing indirect advantage the higher emitting generators have in the form of currently allowed pollution (of both CO2 and other pollutants) – basically free waste disposal.

Internalizing Externalities

The RGGI modeling demonstrates that the financial interests of most generators will be served by providing them with allowances free-of-charge, rather than requiring them to pay for their allowances. But no system of environmental regulation is without costs to the regulated industry and it makes economic sense to require the generators to internalize the true societal and environmental costs of their emissions.

Since higher emitting plants cause greater societal and environmental harm, it is appropriate for them to have to pay for the greater number of allowances they need to cover their higher CO2 emissions. If, as a result, some of higher-emitting plants are ultimately replaced by cleaner, more efficient sources of energy, then the program will be working as it should.

Summary

We strongly urge the RGGI states to provide for all allowances to be auctioned or, in other words, allocated to the public. We will submit additional comments on the allocation of funds received by the sale of the allowances, the sale mechanism, and other RGGI design issues.

Thank you again for considering the views of the Attorney General’s office on this important issue.

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