FORTUNE MAGAZINE: JEB HENSARLING TAKES SWING AT CORPORATE WELFARE
Jeb Hensarling, chairman of the powerful House Financial Services Committee, champion of free markets, and tight-fisted protector of the public purse. The very mention of his name can send blood pressures rising everywhere from organic food co-ops in Seattle to the 9th tee of Burning Tree Country Club. The left views him as a hard-hearted fiscal conservative who wants to cut benefits for the poor. But some C-Suite denizens take exception to the fact that he has come after their government subsidies, too.
I first became acquainted with Hensarling decades ago, when we both served as Senate aides—me for Bob Dole, him for Phil Gramm. Then, as now, we probably disagree as much as we agree, particularly on financial regulation. But I have always respected his principled commitment to the free market and believe it stems not from ideological rigidity– as his critics claim — but from his sincere belief that free markets provide the best chance for the little guy to succeed.
We recently sat down to discuss the plight of Main Street, Dodd-Frank, tax reform, and his passion for ending the Ex-Im Bank, whose loan guarantees overwhelmingly go to support America’s largest corporations.
Fortune: The middle class is hurting and both parties are trying to claim the issue. Why has the recovery been so bad for the middle class?
Hensarling: This may be picky but I discipline myself to talk about middle income, not middle class. I think that “class” is a vestige of our European heritage. I like to think in terms of upward mobility. I love Paul Ryan’s phrase the “right to rise.”
For middle-income families, their wages are stagnant and their bank accounts are smaller. That’s the evidence. And the polls show that these families have an “un-American view.” I say “un-American because it is not characteristic for Americans to be pessimistic. But for the first time, they are saying, “I’m not convinced that my children will have a better future than I have had.” This lackluster economic growth is holding them back. This economy is capable of so much more with the right public policies.
So if you were dictator, what would those policies be?
You mean as opposed to our current one?
There is no greater engine of economic growth than an innovative and free American mind coupled with a risk-taking heart. We are not seeing that today. Startups are at a generational low. There is an aging of our average business profile. That’s the data. A few years ago, I talked to a guy with a small cabinetry business in my district. His business was profitable. He employed a dozen or so folks, but he shut his business down. I asked him why, and he started going through this litany of regulations he had to contend with. And he said “Congressman, it just got to the point where I didn’t think my government wanted me to succeed.”
People feel constrained. The regulatory burden, as you know, can fall disproportionately on small businesses. Financial regulators have gone from under-reacting to over-reacting. I have an 11-year-old and sometimes when every teacher gives you homework on the same night, you just feel overwhelmed. And that’s what we’re seeing now, particularly with our community institutions. The sheer volume, complexity, and weight of regulatory costs just drags them down.
But sometimes you need regulation, as we learned in 2008.
The dichotomy to me is not really regulation vs. deregulation, it’s between smart regulation and dumb regulation, and smart regulation ought to be about making competitive, transparent, and innovative markets. That means you have to have an identifiable goal, you have to measurable outputs, and do this thing called cost-benefit analysis aka common sense.
So what’s your plan?
Number one, with the exception of health and safety, I would freeze all regulations just to give the economy time to catch up. I would require a formal cost-benefit analysis, which – if I recall – the FDIC is subject to but the Fed, in their role, is not. I like the REINS Act, which would ensure that Congress ultimately has to pass [judgment] on economically significant regulations. We are the ones—especially in the House facing election every two years—who are most accountable to the American people.
Step number two, I’m not sure anything says economic growth much like fundamental tax reform. We need a flatter, fairer, simpler tax code. That could really help ignite economic growth. I don’t think there is a single deduction, exemption or credit that I wouldn’t be willing to trade in for lower marginal rates. Now, we on the GOP side may want to use the code for health care and to support the safety net, but outside of those two areas, I would try to make the code as flat and fair as possible.
Do you like Milton Friedman’s negative income tax?
It would be far better than feeding the poverty industry and bureaucracy. Having said that, the recipients would be using somebody else’s money. There need to be levels of accountability to make sure the money was used for housing and food and medicine. We would be far better off with a housing voucher system combined with a refundable tax credit for health care. I’d buy into about 90% of a negative income tax.
So regulatory reform and tax reform. What else?
Frankly we have to change the tone coming out of Washington. We shouldn’t vilify success and assume that every successful person is a crook.
Let’s go back to that small-businessperson in your district. Was the problem regulation of him or regulation of institutions who could provide him with credit that he needed?
In his case, I don’t know. But I’ve heard from other small businesses in my district that credit lines they’ve had for decades have dried up. To some extent, relationship banking as practiced by community banks and credit unions is threatened by the current regulatory structure.
What’s the saying? Water, water everywhere, but not a drop to drink. With quantitative easing, money is everywhere, but you can’t get it.
Well some people are getting it. Maybe the wrong people. Complex regulation does tend to help the big guys. That’s a classic problem.
I’ve seen fairly recent quotes from both Jamie Dimon at JP Morgan Chase and Lloyd Blankfein out of Goldman Sachs. I’m sure they don’t like federal regulators embedded in their organizations, but they have pointed out that all of this regulation is a huge barrier to entry and solidifies their competitive position. It has helped them get a larger share of a shrinking pie.
I wouldn’t disagree. It has surprised me that regulation hasn’t been more targeted. We clearly had a problem with the large, complex, interconnected institutions, especially with leverage.
And as you know, a fair amount of that was off-balance sheet.
Absolutely which makes their high levels of leverage even scarier. But let me ask you about cost-benefit analysis, because in principle, I agree with it, but in practice, some of this you need to leave to expert judgment. It’s widely recognized that there was too much leverage prior to the crisis. But it could be tough to prove mathematically that the benefits of higher capital requirements exceed the costs. Isn’t there a chance cost-benefit analysis could be abused to stop regulations common sense tells us are needed?
I suppose anything can be abused. If something impacts economic growth and opportunity, there are trade-offs. We have a reserve banking system. You can clearly make the case that capital and leverage standards were not proper. I don’t think you can make the case that they were insufficiently complex. And now they’ve become more hideously complex.
And cost-benefit analysis would get to that because it’s not clear the complexity gives you any benefit.
We want stable financial markets, but what does that mean? What price do we want to pay? There is always a trade off on economic growth. At least have the data to go through the process of balancing the two. It may sound like a formal economic term, but I kind of know it as common sense.
Financial reform is getting politicized. There is some narrative that Democrats are for it while Republicans are in bed with Wall Street.
It would surprise my wife that I’m in bed with Wall Street. Look. I’ve never wanted to “occupy” Wall Street. I’m neither for nor against it. I just want to stop bailing it out. We will continue to debate what caused the crisis. The left’s narrative is of this alchemy of Wall Street greed and deregulation. Well, when hasn’t there been greed on Wall Street? All I can say is that after the passage of Dodd-Frank, big banks are bigger, small banks are fewer, and hardworking, middle income taxpayers are not better off, in many cases, they are worse off. I believe there is a causal connection.
What’s your view of monetary policy in all of this? Zero interest rates have been going on for quite awhile. How well do you think middle-income families have been served by that policy?
Well, I think poorly. You know, an 82-year-old lady told me, “When you’re young, you work for your money, and when your old, you expect your money to work for you. And my money is not working for me.” It is a fairly common refrain amongst seniors. I think we are pushing them out on the yield curve.
Yes. They shouldn’t be taking risk. They need a nice, safe investment that will pay them something higher than inflation – that will give them a real return on their money.
We have a monetary policy that picks winner and losers. It favors debtors over savers. It favors sovereign and mortgage debt. I try not to second-guess people in 2008. You were involved. You were making decisions in the fog of war. But the extraordinary measures of 2008 have become the ordinary measures of 2015. To borrow an old advertising campaign – this is not your father’s Fed.
We’ve seen a vast increase in the Fed’s power. We have to do a better job of bifurcating their role as director of monetary policy vs. their role as prudential regulators. They are less accountable than other financial regulators because they hide behind the cloak of monetary policy independence. We would be better served by more predictable monetary policy. People should know the variables, the inputs. Clearly there are contingencies every day that the Fed must deal with, but the improvisation of monetary policy is not a good thing. Ben Bernanke just mused that tapering might start one day and we saw one of the worst one-day drops in the Dow’s history. One person shouldn’t have that much power.
I was at the 7/11 near my home and the guy behind the counter said something about Janet Yellen – and I thought, okay, if the guy behind the counter knows Janet Yellen’s name, the footprint of the Fed is too big in our economy.
Let’s talk about the Ex-Im Bank. You want to get rid of it. You are taking a lot of hits in the business community, some traditional GOP supporters. But you are fighting the good fight. Why is it so important?
Relative to the size of your average agency in D.C., it’s pretty small, but it represents this Washington insider economy. It’s a small, boutique credit agency that primarily benefits Fortune 50 companies which can finance their own operations. GE or Boeing aren’t going to have a problem getting credit.
It confuses people about the true nature of free enterprise. That system rises based on how hard you work and how smart you work, not who you know in D.C.
I just think there is something fundamentally wrong when a Fortune 50 company does the calculation and decides it can get a better rate of return off of lobbying activities in DC than off research and development. I think it exposes, to some extent, the hypocrisy of the left when they say they are for the downtrodden, but they defend these Fortune 50 CEOs and their seven-figure compensation packages. All of these companies can find financing elsewhere.
So how does this debate impact the GOP?
This is an important fight for our party to have. We have been tagged as the party to some extent of big business. There is something very different between business interests and free enterprise. I don’t believe in political lending. I would say that the epicenter of the crisis was the political allocation of capital in cajoling financial institutions to lend money to people to buy homes they could not afford to keep.
Ex-Im is about political lending. Green-energy quota. Small-business quota. Sub Sahara quota. Enron was financed with Ex-Im. Solyndra was financed by Ex-Im. There are investigations today at Ex-Im for possible bribes and kickbacks. So we have corruption in the legal sense, but also corruption in our values. I think it’s important for the GOP to say, “Ex-Im is not fair. This is about political connections, not merit. This prevents people from using their God-given talents to rise up the ladder of success.” I think it’s an important statement to make, and I want to help make it and I hope we succeed. If we don’t, then I guess I’ll just go home and drink a beer.
You’ve done a lot already, just getting the public focused on it and the favoritism it creates for large companies. The tax code also provides plenty of examples of corporate welfare.
Yes. I think many CEOs would support corporate tax reform. I think many wouldn’t. I’m happy to meet with CEOs who want the opportunity to grow. If they’re coming in here for special privilege, earmarks, set-asides, barriers to entry, no thank you. I have better things to do.
Does it feed on itself? Because of all these loopholes, many major corporations already have extremely low effective tax rates. How do you convince them to rise above that and engage in a constructive debate about reform? They’re not paying that 35% top rate.
You’re right. Many aren’t. So frankly it’s an excellent question because enlightened self interest works wonders in a competitive, transparent market place, but it doesn’t work so well in the corridors of power in Washington D.C. Many are loath to let go of their special privileges. And was it Lenin—Vladimir, not John—who said that capitalists will give themselves enough rope to hang themselves? If we allow corporate welfare to become confused with free enterprise, we will kill off the free-enterprise system.
I would hope that at the end of the day, they have enough confidence in themselves, their people, their products and services to say, “You know what. We can compete on a fair and level playing and we will support reform if we can trade it in for lower marginal rates and a more sensible regulatory environment.” But if we can’t do Ex-Im, I don’t think there’s much chance for tax reform.
I had a conversation with Elizabeth Warren over corporate tax reform and she was saying things that were not dissimilar to what you were saying. Is this an area where you could build some bridges?
Now you’re worrying me.
Look, everyone is for the little guy. Of the things you mentioned, tax reform is the area where I think she is most likely to agree.
Potentially. I was the Republican co-chair of the less than super supercommittee [on deficit reduction], where we were unable to get agreement on much of anything. We did come closest on fundamental business tax reform. Raising tax rates is anathema to most Republicans. It will make a lackluster economy worse. Our view is that you do reform on a deficit-neutral basis. Listen, we want higher tax revenue. We are on an unsustainable fiscal trajectory, but we think more tax revenue will come from greater economic growth. We have the highest marginal corporate rates in the industrialized world. Even Japan wised up a few years ago and lowered theirs. So does it remain a potential? Yes, but it doesn’t seem that this White House wants to do much other than circling the wagons around Obamacare and Dodd-Frank. Hopefully, I’m wrong.
Well, you have to look at the perverse consequences of their efforts to crack down on inversions. Now our companies are no longer inverting. We just have foreign companies coming in and buying them.
For generations, companies have wanted to site in America, and since Barack Obama came into office, they are trying to leave.
Washington loves to typecast. What is a position that you’ve taken that would surprise people?
I’ve worked this debt issue for a long time, and if there is one thing I know it is that Democrats – and for whatever reason, God made a lot of them– they insist on additional revenue. So when we convened the supercommittee, my opening bid was: We want the Medicare premium support written by Paul Ryan – you tell us what tax increase you want in exchange for that. They refused. So I want to make clear: Tax increases are incredibly harmful, but you cannot solve the impending debt crisis unless you do fundamental entitlement reform. You could have double- digit economic growth for a decade. It helps, but it doesn’t solve the problem. We have to figure out how to get quality health care and retirement security at a cost that doesn’t bankrupt future generations. I don’t want to do it, but I’m willing to do a revenue increase if they do entitlement reform.
Would you take a revenue increase if marginal rates went down? So you increase revenues by closing loopholes?
If the additional revenue was used to do entitlement reform, I’d take a look at it. But typically, when you have these deals, Republicans will sign up for the revenue increase and we get that, but spending reforms never come. It’s like the Popeye cartoon. Lend me $3 for a hamburger and I’ll pay you back next Tuesday, and Tuesday never comes.
So who is your favorite economist?
That’s easy. Milton Friedman. Probably a lot of folks in my generation would say that Capitalism and Freedom is one of the most profound works they’ve ever read. I had the great fortune to meet him and I have a signed copy. He also taught me that you can be successful as a short person.
Who’s your favorite president?
That’s more difficult. You can see the 3 busts I have behind my desk, Lincoln, Jefferson, and Reagan.
Jefferson? That’s a little surprising.
There’s the obvious evil of slavery that Jefferson both lamented and practiced that you have to get past. But through his Presidency and writings, he did a lot to increase freedom. And Reagan—he inspired us all. It’s morning in America. The sky’s the limit.
I’m not quite ready to say who is the greatest president in history, but he is clearly the greatest president in my lifetime. He ended the Cold War and ignited one of the greatest periods of sustained economic growth in our history
Through tax reform.
Yes. And making us feel like Americans again. That anything is possible, and you can dream bold dreams.