Marijuana Businesses and Banks – The Federal Government’s Non-Reassurance Reassurance

Recent headlines would seem to indicate that the Treasury Department and the Justice Department had given the green light to financial institutions to provide financial services, such as checking accounts and credit card services, to marijuana businesses that are licensed and legal under state law. The articles themselves, though, tell a different story. The light isn’t exactly green. In fact, the Colorado Bankers Association issued a statement which said in part:

“The guidance issued today by the Department of Justice and the U.S. Treasury only reinforces and reiterates that banks can be prosecuted for providing accounts to marijuana related businesses.

“‘In fact, it is even stronger than original guidance issued by the Department of Justice and the Treasury,’ said Don Childears, president and CEO of the Colorado Bankers Association. ‘After a series of red lights, we expected this guidance to be a yellow one. This isn’t close to that. At best, this amounts to ‘serve these customers at your own risk’ and it emphasizes all of the risks. This light is red.’”

Now that twenty states and the District of Columbia have legalized marijuana for medical use, and two states, Colorado and Oregon, have gone further and legalized it for recreational use as well, there is a glaring conflict between federal and state laws. As it stands, states cannot preempt federal law, and marijuana remains illegal under federal law. In fact, the U.S. Supreme Court in a 2005 case (Raich v. Gonzales) decided that the federal Control Substances Act (“CSA”) applied to the legal use of marijuana under California law with marijuana that was grown and used in California and thus had not entered into interstate commerce. (This was a strange case since it involved an issue in which conservatives are more likely to favor a strong government stance against drugs such as marijuana but also raised federalism questions, in which conservatives are usually on the side arguing for limits to federal government power. The three dissenters were Chief Justice William Rehnquist and Justices Sandra Day O’Connor and Clarence Thomas. The opinion of the Court was written by Justice John Paul Stevens. Justice Antonin Scalia wrote a concurring opinion.)

This situation poses a dilemma for the Obama Administration. Obviously, a significant portion of the public does not agree with federal law’s treatment of marijuana, and the Administration has decided not to go after marijuana businesses which have been licensed by state government authorities if certain conditions are met. If these businesses, though, are not able to obtain banking services and can only receive and make payments in cash (including tax payments), this is likely to increase crime. Banks, though, are reluctant to provide services to entities that they know are breaking federal law for fear that they would be violating federal law.

On February 14, the Financial Crimes Enforcement Network (“FinCEN”), a bureau of the Treasury Department, issued guidance to financial institutions on what is expected of them when they do business with marijuana-related businesses. Banks have not been reassured by this guidance nor by a memorandum from Deputy Attorney James Cole to U.S. Attorneys (prosecutors) on “marijuana related financial crimes” the same day.

FinCEN administers the Bank Secrecy Act (“BSA”), a statute with a misleading name. The BSA does not protect customers by imposing secrecy requirements on banks but rather requires banks, among other things, to report suspicious activities of their customers to FinCEN. The secrecy is that the banks are prohibited from telling their customers that they have filed a report to FinCEN on their transactions. Some have, therefore, humorously called the BSA the “Bank Snitching Act.”

The Cole memorandum list eight areas of concern about state-licensed marijuana businesses. These are:

• Preventing the distribution of marijuana to minors;

• Preventing revenue from the sale of marijuana from going to criminal enterprises, gangs, and cartels;

• Preventing the diversion of marijuana from states where it is legal under state law in some form to other states;

• Preventing state-authorized marijuana activity from being used as a cover or pretext for the trafficking of other illegal drugs or other illegal activity;

• Preventing violence and the use of firearms in the cultivation and distribution of marijuana;

• Preventing drugged driving and the exacerbation of other adverse public health consequences associated with marijuana use;

• Preventing the growing of marijuana on public lands and the attendant public safety and environmental dangers posed by marijuana production on public lands; and

• Preventing marijuana possession or use on federal property.

The memorandum goes on to state that “if a financial institution or individual offers services to a marijuana-related business whose activities do not implicate any of the eight priority factors, prosecution for these offenses may not be appropriate.” It is hardly surprising that bankers do not find that statement totally reassuring.

As for FinCEN, financial institutions that have marijuana-related customers are required to file with FinCEN suspicious activity reports (“SARs”) periodically on these customers’ transactions. If a financial institution “reasonably believes, based on its customer due diligence,” that the transactions of a marijuana-related business customer do “not implicate one of the Cole Memo priorities or violate state law,” it “should file a ‘Marijuana Limited’ SAR. If the financial institution subsequently has reason to believe “in the course of conducting customer due diligence (including ongoing monitoring for red flags)” that its customer is engaged in activity “that potentially implicate one of the Cole Memo priorities or violate state law, the financial institution should file a ‘Marijuana Priority’ SAR.”

It is perhaps not as well-known and appreciated as it should be that two Treasury Department entities, FinCEN and the Office of Foreign Assets Control (“OFAC”), which administers and enforces international economic sanctions programs, impose substantial burdens on financial institutions to perform what are essentially law enforcement functions. There can be substantial ambiguity concerning the degree of effort financial institutions are required in order to comply with FinCEN and OFAC regulations. Consequently, it has happened that when banks become worried because of high-profile enforcement actions against particular institutions, they have flooded FinCEN with SARs.

At the time I worked for about a year and a half at OFAC in the middle of the last decade, the policy was to be reasonable and somewhat forgiving with financial institutions that had made mistakes and were apparently earnestly trying to take corrective measures to reduce the risk of future mistakes. Financial institutions have reason to take OFAC and FinCEN regulations seriously.

In the current situation, therefore, it is rather strange that FinCEN and the Justice Department are hinting that it may be all right for financial institutions to facilitate violations of a particular federal law, but then again it might not be. That is probably more ambiguity than is comfortable for most bankers.

Furthermore, as the Colorado Bankers Association points out, there is uncertainty how the various bank regulators, which have a good deal of independence from the Administration, will view institutions they regulate having marijuana-related business customers. Also, of course, a future Administration could reverse the current Administration’s marijuana policy.

This is why the banks would like legislation to be enacted to clarify the situation. Representative Ed Perlmutter (D, CO) has introduced legislation that would clarify that financial institutions can provide services to “legitimate” marijuana-related businesses without fear of prosecution or other federal action. The bill (H.R. 2652) has 27 co-sponsors, only two of whom are Republicans (Mike Coffman of Colorado and Dana Rohrabacher of California). As such, there would seem to be very little chance that it gets passed by this Congress.

As far as the Administration is concerned, it probably could do more than it has. For one thing, it apparently has the authority to reclassify marijuana from a Schedule I drug under the CSA, which is reserved for the most dangerous drugs such as heroin, to a lower schedule, or it may be able to remove it from the controlled substances list altogether. President Obama has stated that only Congress can reschedule marijuana, but this is disputed. Rescheduling would seem to make the medical use of marijuana not illegal under federal law.

Opponents of legalization of marijuana use for recreational use will likely point to the Single Convention on Narcotics, a 1961 international treaty to which the U.S. is a signatory. The International Narcotics Control Board criticized Uruguay’s decision to legalize marijuana as a violation of its treaty obligations, but it has no real enforcement power. The treaty, not surprisingly, is ambiguous, and it is a subject of disagreement whether it requires criminal penalties for possession of marijuana for non-medical, personal use. It also appears that UNESCO’s Commission on Narcotic Drugs could remove marijuana from coverage by the treaty.

Finally, the conflict between federal law on marijuana and those of twenty states and the District of Columbia (which is interesting, since the DC government’s authority to enact laws derives from federal law), is untenable and, one way or another, will have to be changed. Financial institutions are right to be uncomfortable. It will be interesting to see how many, if any, financial institutions take the legal risk of accepting marijuana businesses as customers.

Some Comments on the CBO Appendix – “Labor Market Effects of the Affordable Care Act: Updated Estimates”

On February 4, the Congressional Budget Office released a report, The Budget and Economic Outlook: 2014 to 2024. It immediately created a furor, not because of the main report or its general projections but because of an eleven page appendix (Appendix C, “Labor Market Effects of the Affordable Care Act: Updated Estimates”). The CBO was probably a bit taken aback by the reaction in political and policy analysis circles and in the news and opinion media. Evidently feeling it necessary to clarify what the CBO had said, the CBO’s Director, Doug Elmendorf, posted on the CBO’s website on February 10 a piece entitled “Frequently Asked Questions About CBO’s Estimates of the Labor Market Effects of the Affordable Care Act”, in order to clarify that they did not mean that 2.5 million people would “lose their jobs in 2024 because of the ACA” (Affordable Care Act).

The sentence critics of the ACA jumped on stated: “The reduction in CBO’s projections of hours worked [due to the ACA] represents a decline in the number of full time equivalent workers of about 2.0 million in 2017, rising to about 2.5 million in 2024.” Republican politicians immediately denounced the ACA as a job killer, and initially the media played along. When the media finally realized that the Republican characterization of the report was misleading at best, or just plain wrong, they subsequently wrote better articles. Nevertheless, some, most notably Chris Cillizza, a political reporter for the Washington Post, wrote a much ridiculed post for his Washington Post blog, “The Fix” (a reference to political junkies). Cillizza argued that it did not really matter what the facts were for a political analyst like himself; what is important is voters’ perceptions. He wrote: “My job is to assess not the rightness of each argument but to deal in the real world of campaign politics in which perception often (if not always) trumps reality. I deal in the world as voters believe it is, not as I (or anyone else) thinks it should be.”

David Weigel of Slate, responded to Cillizza by writing: “Now, if we're talking or reporting on what Republicans are saying at this moment, true: They're talking about the CBO report. What will we be reporting on a few months from now? What'll the attack be? We don't know.” Ezra Klein, Cillizza’s former colleague at the Post, wrote on his public Facebook page:

“I don't quite understand the model of politics underlying the backlash-to-the-backlash over the CBO report. The theory is that though the GOP's initial spin on the report was wrong it's meta-right because the lies will be used to power effective attack ads in the fall -- and in politics, what's true, and what voters can be tricked into believing is true, are two equally valid categories for inquiry…

“Obamacare is an unpopular law that suffered from a disastrous launch. Does anyone think the GOP would've been unable to find a way to write devastating attack copy about it if that CBO report hadn't come out? Of course not.

“The parties often don't have enough money to air the attacks ads they want to air. They often lack candidates with the credibility to make the attack ads stick. They're often lack the economic conditions that predispose the electorate to listen to them. They're typically chasing voters who lack any interest in watching another nasty political commercial.

“There are plenty of real scarcities in American politics that could really change elections if one party or the other solved them. But "things to say in an attack ad" just isn't one of those scarcities.”

In his blog post, Doug Elmendorf wrote:

“Q: Will 2.5 Million People Lose Their Jobs in 2024 Because of the ACA?

“A: No, we would not describe our estimates in that way...

“Because the longer-term reduction in work is expected to come almost entirely from a decline in the amount of labor that workers choose to supply in response to the changes in their incentives, we do not think it is accurate to say that the reduction stems from people ‘losing’ their jobs.

“Here’s a useful way to think about the choice of wording: When firms do not have enough business and decide to lay people off, the people who are laid off are generally worse off and are therefore unhappy about what is happening. As a result, other people express their sympathy to those people for having “lost their jobs” due to forces beyond their control. In contrast, when the labor market is strong and people decide on their own to retire, to leave work to take care of their families, or to cut back on their hours to pursue other interests, those people presumably think they are better off (or they would not be making the voluntary choices they are making). As a result, other people are generally happy for them and do not describe them as having ‘lost their jobs.’

“Thus, there is a critical difference between, on the one hand, people who leave a job for reasons beyond their control and, on the other hand, people who choose not to work or to work less. The wording that people use to describe those differing circumstances reflects the different reactions of the people involved. In our report, we indicated that ‘the estimated reduction [in employment] stems almost entirely from a net decline in the amount of labor that workers choose to supply,’ so we think the language of ‘losing a job’ does not fit…

“There is a broader question as to whether the society and the economy will be better off as a result of those choices being made available. Even though the individuals making decisions to work less presumably feel that they will be happier as a result of those decisions, total employment, investment, output, and tax revenue will be smaller. (Those effects are included in CBO’s budget and economic projections under current law.) To be sure, the health insurance system in place prior to the ACA generated its own distortions to people’s work decisions, but many of the decisions to work less under the ACA will be made possible by government-funded subsidies, the burden of which will be borne largely by other people. Moreover, people’s decisions about work are also affected by taxes and benefit programs apart from those related to health insurance. Hence, whether voluntary reductions in hours worked owing to the ACA are good or bad for the country as a whole is a matter of judgment.

“A tradeoff of this sort—although not necessarily of the same magnitude—is intrinsic in any effort to significantly increase health insurance coverage or to provide other types of benefits that are aimed at low-income people. As we wrote in the report: ‘Subsidies that help lower-income people purchase an expensive product like health insurance must be relatively large to encourage a significant proportion of eligible people to enroll. If those subsidies are phased out with rising income …, the phaseout effectively … discourage[es] work.’ Again, the best way to address that tradeoff is a matter of judgment.”

As it turns out, the hue and cry over what the CBO said about the ACA and jobs has died down. The media appears to have some remorse in the way they initially reported the story and Republican politicians who have mischaracterized the CBO report have been pilloried by liberal political websites. The story for the most part has disappeared, at least for now.

Still, there has been some more intelligent commentary from some critics of the ACA. The argument they make is that the ACA’s phase out of health care subsidies as lower income people earn more income acts like an implicit marginal tax and discourages work. (For example, see these blog posts from Charles Blahous and Keith Hennessey.) This is in fact the main reason the CBO cites for its estimate of the reduction in labor supply.

If one looks at the structure of the subsidies for health insurance bought on the exchanges, the phaseouts are poorly constructed. In some cases, an extra dollar of income would mean a loss of a subsidy of more than a dollar if one’s income is just below the cutoff level for the subsidy. However, in general, the amount of subsidy that an individual gives up with extra income appears to be in the neighborhood of 10 to 16 percent of the additional income. (One can play around with examples with this handy subsidy calculator at the Kaiser Family Foundation website.) The subsidies end at 400 percent of the Federal Poverty Level (“FPL”). Income is defined to be modified adjusted gross income. (For 2013, the FPL was $11,490 for a single adult and $23,550 for a family of four.)

It is not clear how the CBO estimated how much this would reduce the amount of labor supplied either by workers reducing the number of hours worked or dropping out of the labor market entirely. While significant, these implicit marginal tax rates by themselves are neither huge nor confiscatory. Also, it is worth remembering that one cannot live on health insurance subsidies alone. People who drop out of the labor force because of the reduction in subsidies as their income increases need to have other sources of income or wealth. 

If workers take a full time job that provides health insurance, they lose the subsidy. Whether or not that loss acts as an implicit marginal tax from the point of view of the individual worker depends on the particular facts. One would have to look at the change in the net cost of health insurance premiums and expected out of pocket costs to do a full analysis. To do this in the aggregate would seem to be a daunting task for economic forecasters.

Also, it should be noted that for states that have chosen to expand Medicaid, subsidies for health insurance begins at 138% of the FPL. Below that amount, people get coverage through Medicaid. While losing Medicaid can be viewed as a cost, it is hard to assign an implicit marginal tax rate for earning income that crosses the 138% line, because the private health insurance plans offered on the exchanges are likely to be much better than Medicaid. The number of doctors who accept Medicaid is quite limited and there can be severe frustrations, which differ among the states, in dealing with the Medicaid bureaucracy. (There can be frustrations in dealing with private insurance companies, but my impression is that these are probably not quite as bad as dealing with some state bureaucracies and their legal processes.)

In states that have chosen not to expand Medicaid, there will be people who will neither be eligible for exchange subsidies nor Medicaid. For these people, the law will provide an incentive to work at least enough, if they can, to get to the 138% of FPL in order to benefit from the subsidy. 

Finally, people who are covered by Medicare are not eligible for the subsidies provided for health insurance on the exchanges.

As many have pointed out in the discussion of the CB0 report, means testing a government benefit leads to an increase in implicit marginal taxes until the benefit is totally phased out. This is not new to the ACA. For example, welfare benefits, the earned income tax credit, and food stamps are all subject to means testing. What would be useful for policy analysis would be a comprehensive analysis of means-tested government programs, along with federal, state, and local income taxes, and what this might mean to particular classes of workers. Conservatives are of course right when they say that high marginal tax rates discourage additional work. Devising solutions to this issue is not simple.

However, focusing on the ACA in isolation and criticizing it for this does not do much to advance solutions. Some critics of the ACA would like to go back to the status quo ante, but that is not going to happen. Other critics would like to reduce health care coverage substantially for poor people by giving everybody the same fixed amount (a “refundable” tax credit) to buy private health insurance. That also is not going to happen.

As far as what the ACA does to economic growth, this is unclear. In the first instance, as the CBO admits, there is “substantial uncertainty” concerning its estimates of the effects of the ACA on labor market participation. Even taking the estimates as given, former Federal Reserve Vice Chairman Alan Blinder writes in the Wall Street Journal:

“…The CBO now estimates that the ACA will reduce labor supply by about 1.5% to 2% over a decade. That's small and, arguably, a good thing. Let's count it as antigrowth, though certainly not as a ‘job killer.’ But what about the potential savings in health-care costs from the ACA—which are clearly pro-growth?

“Remember, one of the principal objectives of health-care reform is to slow down cost increases, thereby reducing the burdens on both businesses and the federal budget. And health-care costs have indeed slowed dramatically. The following little tidbit is buried deep in the CBO report, and has gotten little attention: CBO ‘lowered their estimate of average premiums for insurance coverage through exchanges in 2014 by about 15 percent.’ Let me repeat that: 15% lower, just since last May. That's huge.”

As a final point, as long as we have substantial unemployment, that the ACA reduces labor market participation should not be a source of concern. Finally, I would note that many of those arguing that the ACA is fatally flawed because of its effects on labor market participation and economic growth also have been in favor of our current contractionary fiscal policy, which has served to slow the recovery and which monetary policy cannot totally counteract.

Treasury Auctions Floating Rate Notes

On January 29, Treasury auctioned its first issue of floating rate notes. According to press reports, market participants and analysts felt the auction went well. After all, total bids (competitive and noncompetitive) amounted to almost $85 billion for an issue size of $15 billion, which is very good coverage.

The spread the Treasury will pay over the 13-week Treasury bill on these two-year notes is 0.045%. This spread is added to the latest 13-week Treasury bill rate determined at auction, meaning that the interest rate on the floating rate notes changes weekly and is paid out quarterly. (For more details, see the final rule for these securities.) With this spread, the floating rate notes are currently yielding about double the current rates on 13-week bills. It is less than the rate on 2-year notes, which are yielding in the neighborhood of 0.3%, and about equal to the one-month Treasury yield curve rate published by the Treasury.

Given that floating rate notes are effectively one-week instruments, I would agree that this auction produced a fair result. Also, in the current low interest rate environment, the floating rate notes are not likely to be a significant factor in either decreasing or increasing Treasury’s interest costs.

As readers of this blog know, I have not viewed the introduction of floating rate notes favorably. (For example, see this post.) One argument for them is that they are a way to extend the maturity of the public debt. The reasons for extending the maturity of the public debt are to lessen rollover risk and to reduce the variability of interest payments. As I noted in the linked post, the Treasury has never had a problem in rolling over bills in modern times, and floating rate notes do nothing to reduce fluctuation of interest payments due to changing market conditions.

I was surprised to see that usually astute Gillian Tett of the Financial Times seems confused on the latter point in an article of hers recently. She wrote:

“…this benefit [of borrowing short-term] comes with a sting that mortgage borrowers know well: if rates increase, interest payments could balloon. And if investors panic about inflation, higher rates or fiscal sustainability, that squeeze could be more intense.

“The good news is that the Treasury is aware of this danger, and trying to prepare. In recent months it has had success in raising the average maturity profile by selling more long-term bonds. This stands at 66.7 months, and officials say that by 2020 it could reach 80.

“Treasury officials are also trying to help the market absorb future rate rises by offering a more flexible range of instruments. This week’s experiment with floaters is one move…”

Another reason to issue floating rate notes is to broaden the appeal of Treasury securities to new investors. I think this argument had some merit in making the case for Treasury issuing inflation-indexed securities, since inflation-indexation made for a different asset class, though I am not certain how significant this has been. With floating rate notes, I am doubtful. These seem to be mainly designed to appeal to existing investors, such as money market mutual funds, for which there is a clear benefit. While Treasury does not have any problems rolling over securities, it is bit of a hassle for investors to have to rollover their maturing securities. Also, in the current climate, possible disruptions to Treasury’s auction schedule when Congress has not passed the debt limit in a timely matter may be of some concern to investors in short-term Treasury securities. Perhaps, money market mutual funds should bid aggressively for floating rate notes, giving Treasury a break in the yield, since there are clear advantages to them from these securities.

Finally, I would like to make one general point. In recent years, there has been instability in Treasury’s debt management strategy. During the Clinton and George W. Bush administrations, there were efforts to shorten the average maturity of the public debt, in addition to the decision by the Clinton Administration to issue inflation-indexed securities, an idea which had been rejected by previous Democratic and Republican administrations. The decision to shorten the average maturity of the public debt was pursued aggressively by the George W. Bush Administration with its decision to eliminate the issuance of 30-year bonds, a decision that was subsequently reversed after the major Treasury proponent of this, Under Secretary Peter Fisher, left Treasury.

The argument for shortening the average maturity of the public debt was that Treasury long-term yields are usually higher than short-term yields and that the Treasury would save money over time and interest rate cycle by issuing more short-term securities. That rationale was rejected by the Obama Administration, which decided to extend the maturity of the public debt during a time of historically low interest rates. The decision to issue floating rate notes does not fit neatly into the lengthening strategy, but it has been portrayed that way.

Of course, it is not the President who is making these decisions but the Treasury Secretary and political appointees at Treasury. While it is hard to ascribe motives, it appears that at least some political appointees wanted to leave their mark on debt management, which is usually, absent a debt limit problem or other crisis, a fairly low profile, though critical, task. In the broad scheme of things, the instability of debt management brought about by different political appointees is probably not that important, but it is not an optimum way to operate.