« December 2009 |
| February 2010 »
I agree with Brad DeLong:
Stimulus Too Small, by Brad DeLong, WSJ: Fourteen months ago, just after
Barack Hussein Obama's election, most of us would have bet that the U.S.
unemployment rate today would be something like 7.5%, that it would be heading
down, and that the economy would be growing at about 4% per year. ... Well, we
have been unlucky. Unemployment is ... not 7.5% but 10%. More important,
perhaps, is that the expectation is for 3% real GDP growth in 2010.
That leaves us with two major questions: First, why has the outcome thus far
been so much worse than what pretty much everyone expected in the late fall of
2008? And second, why is the forecast ... for growth so much slower than our
previous experience with recovery from a deep recession in 1983-84?
I attribute the differences to four factors:
First, the financial collapse of late 2008 did much more damage than we
realized... The shock now looks to have been about twice as great as the
consensus in the fall of 2008 thought. ...
And that leads us to Factor No. 2. The Obama administration envisioned a $1
trillion short-term deficit-spending..., had the administration known how big
the problem would turn out to be, it would have sought a $2 trillion stimulus.
And what did we get once Congress got through with it? A $600 billion
stimulus—about one-third of what we needed.
Making matters worse: The stimulus was not terribly well targeted. In an attempt
to attract Republican votes, roughly two-fifths of it was tax cuts. Such
temporary cuts are ineffective... (It also failed to win any extra votes.)
Roughly two-fifths ... was infrastructure and other ... direct
federal spending. But it is hard to boost federal spending quickly without
wasting money, and those projects that are shovel-ready are not terribly labor
Meanwhile, the most-effective stimulus would have been aid to the states... But
senators don't want to hand out money to governors; the governors then tend to
run against the senators and take their jobs away.
This problem with both the quantity and quality of the stimulus is tied up with
the third factor: that the Obama administration declared victory on fiscal
policy with the American Recovery and Reinvestment Act ... and then went home.
There was no intensive lobbying for a bigger program,... no attempts to expand
the stimulus programs... The background chatter is that trying for more deficit
spending would have been fruitless, given the broken Senate...That background chatter is probably right. But ... there is still the Federal
Reserve. And that's where the fourth factor comes in.
It is true that as far as normal monetary policy is concerned, the Federal
Reserve was tapped out... But there is more in the way of extraordinary monetary
policy that could have been attempted in 2009—including inflation-targeting
announcements, the taking of additional risky assets out of the pool to be held
by the private sector, larger operations on the long end of the yield curve.
And I must confess that what the Federal Reserve thought and did in 2009 remains
largely a mystery to me.
Posted by Mark Thoma on Wednesday, January 20, 2010 at 11:42 AM in Economics, Fiscal Policy, Monetary Policy, Politics |
The administration's proposed bank tax can be considered an insurance payment
that is paid after disaster strikes rather than the more usual case of
collecting premiums ex-ante (as I talked about
here). But what's the best way to structure this after the fact insurance
premium? Diamond and Kashyup say that the answer is to base the tax on the difference between bank assets at the end of August 2008, and
their level of capital today:
Investment, by Douglas Diamond and Anil Kashyup, Commentary, NY Times: Wall
Street is considering legal action to prevent President Obama from imposing a
new tax on bailed-out financial institutions. Because the law that created the
Troubled Asset Relief Program compels the government to recoup the bailout
money, it’s unlikely that banks will succeed... So rather than debate the
constitutionality..., it is far more productive to design the
best possible repayment plan.
The consequences of getting this right are huge: with a new tax, the
administration aims to raise $90 billion over the next 10 years, which would do
much to offset TARP’s estimated $117 billion losses. We therefore suggest taxing
banks based on the difference between their assets at the end of August 2008 and
their current level of capital. After all, the support these firms received was
based on the size of assets before the financial panic began, not the size of
those assets today.
With the bailout money, the government wound up insuring the bondholders and
other creditors of the financial institutions. The tax we propose would allow
the government to effectively collect insurance premiums now that should have
been charged ahead of time. ...
Because our version of the tax would require each firm to pay a tax
proportionate to the size of its bailout, it would fall hardest on the former
investment banks whose very survival was in doubt before the government stepped
in. These firms are now making eye-popping profits and are on a path to pay
record bonuses, but more importantly they had the most borrowed money that wound
up being unexpectedly insured. This is why they ought to pay more.
Even TARP recipients that have repaid the bailout funds benefited from the
stability the government provided, so they too would have to pay some portion of
the tax. But our formula would lower the tax for organizations that have raised
capital after August 2008...
By focusing on each institution’s assets before the fall of Lehman Brothers
almost brought down the system, our plan would make it impossible for banks to
shrink their way out of the tax. ... Likewise, by focusing on the historical
size of a bank, our plan would allow little room to engage in sham accounting
transactions to sidestep the tax. ...
It is generally a bad idea to enact after-the-fact penalties. But giving away
free insurance, as the government did during the bailout, is also bad. Our tax
would merely ask financial institutions to finally pay for the insurance policy
that kept them afloat.
If we are going to provide such insurance -- and there is an implicit
guarantee that the insurance will be available whenever a shock to the banking
system has the potential to create systemic trouble -- then (as I argue here), one part of the regulatory response to the crisis must be to limit the amount of risk that these firms can take on.
Posted by Mark Thoma on Wednesday, January 20, 2010 at 02:17 AM in Economics, Financial System, Taxes |
I don't see this as good news:
White House, Democratic lawmakers cut deal on deficit commission,
by Lori Montgomery, Washington Post: Faced with growing alarm over the nation's soaring debt, the White House and
congressional Democrats tentatively agreed Tuesday to create an independent
budget commission and to put its recommendations for fiscal solvency to a vote
in Congress by the end of this year. ...
Under the agreement, the commission would have 18 members, including six
lawmakers appointed by congressional Democrats and six lawmakers appointed by
congressional Republicans. Obama would appoint six others, only four of whom
could be Democrats.
Fourteen commission members would have to agree on any deficit-reduction
plan, a prospect that skeptics called a recipe for gridlock because action would
depend on the support of at least two Republicans for a plan that is sure to
include tax increases. ...
Has this worked in the past?:
Bipartisan Panel: Did It Really Work?, by Jackie Calmes, NYT: The White
House has joined some senators in a claim that upends an old saw. If there is no
will among politicians to resolve budget problems, they argue, there is
nonetheless a way — through a bipartisan commission. ...
Washington’s shelves are full of unheeded commission reports gathering dust. Yet
after more than a quarter-century, the supposed success of the 1982-83 Greenspan
Commission to save Social Security continues to inspire calls for bipartisan
But just in time for the latest debate, the unpublished posthumous memoir of a
central figure on the Greenspan panel, Robert M. Ball, a former Social Security
commissioner, has emerged to challenge the conventional wisdom about its
In a sprightly account promoted by former staff members from both parties, Mr.
Ball calls the Greenspan Commission a failure. As he tells it, only a willingness to compromise by the two principal
antagonists of the time —
Ronald Reagan, the Republican president, and Representative Thomas P.
O’Neill, the Democratic House speaker — made it possible for Mr. Ball and a few
others to salvage from the deadlocked panel a deal that raised payroll taxes and
trimmed benefits enough to keep Social Security solvent.
“A commission is no
substitute for principled commitment,” wrote Mr. Ball...
The deficit hawks on the right have their sights set on Medicare and Social Security, and the administration seems far too willing to allow these programs to be used as bargaining chips in negotiations (and to give into the right's insistence that spending cuts - except for the military - take precedence over tax increases). Unless the administration takes a turn away from the tendencies it has shown in the past, this seems to be headed in that direction.
Posted by Mark Thoma on Tuesday, January 19, 2010 at 11:47 PM in Budget Deficit, Economics, Politics |
Posted by Mark Thoma on Tuesday, January 19, 2010 at 11:02 PM in Economics, Links |
Ben Bernanke tries to overcome some of the Fed's negative publicity:
Bernanke Invites GAO to Audit AIG Bailout, by Sudeep Reddy: In a bid to
soften congressional criticism, Federal Reserve Chairman Ben Bernanke on Monday
invited the Government Accountability Office to audit the central bank’s
involvement in the U.S. rescue of American International Group Inc. In a
letter to Acting Comptroller General Gene Dodaro, Bernanke said the
Fed would provide “all records and personnel necessary” for the auditing arm of
Congress to review the rescue. ...
The invitation from Bernanke does not change existing policies about
congressional reviews of the Fed. The GAO already has authority to review the
central bank’s involvement in the AIG bailout, along with other company-specific
rescues by the Fed and Treasury Department. ...
Most people won't realize Bernanke is asking for something the GAO could have
done on its own (though perhaps with less cooperation), e.g. the LA Times
does not even mention this, so the politics work in the Fed's favor.
And it does send the message that the Fed doesn't think it has anything to hide.
Posted by Mark Thoma on Tuesday, January 19, 2010 at 03:25 PM in Economics, Monetary Policy, Politics |
I don't put much of the blame for the financial crisis on the bad incentives
embedded in executive pay structures. But that doesn't meant that pay structures didn't
contribute to the problem. And it certainly doesn't mean that executive pay is
justified by productivity, or that there are no important market failures
associated with the way executive pay is structured:
The CEO Pay Slice, by Lucian Bebchuk, Martijn Cremers, and Urs Peyer,
Commentary, Project Syndicate: ...In our recent research, we studied the
distribution of pay among top executives in publicly traded companies... Our
analysis focused on the CEO “pay slice” – that is, the CEO’s share of the
aggregate compensation such firms award to their top five executives.
We found that the pay slice of CEOs has been increasing over time. Not only has
compensation of the top five executives been increasing, but CEOs have been
capturing an increasing proportion of it. The average CEO’s pay slice is about
35%,... typically ... more than twice the average pay received by the other top
four executives. Moreover, we found that the CEO’s pay slice is related to many
aspects of firms’ performance and behavior.
To begin, firms with a higher CEO pay slice generate lower value for their
investors..., such firms have lower market capitalization for a given book
value. ... Moreover, firms with a high CEO pay slice are associated with
lower profitability. ...
What makes firms with a higher CEO pay slice generate lower value for
investors? We found that the CEO pay slice is associated with several
dimensions of company behavior and performance that are commonly viewed as
reflecting governance problems.
First, firms with a high CEO pay slice tend to make worse acquisition
decisions. ... Second, such firms are more likely to reward their CEOs for
“luck.” They are more likely to increase CEO compensation when the industry’s
prospects improve for reasons unrelated to the CEO’s own performance...
Financial economists view such luck-based compensation as a sign of governance
Third, a higher CEO pay slice is associated with weaker accountability for
poor performance. In firms with a high CEO pay slice, the probability of a CEO
turnover after bad performance ... is lower. ... Finally, firms with a
higher CEO pay slice are more likely to provide their CEO with option grants
that turn out to be opportunistically timed. ...
What explains this emerging pattern? Some CEOs take an especially large slice
... because of their special abilities... But the ability of some CEOs to
capture an especially high slice might reflect undue power and influence over
the company’s decision-making. As long as the latter factor plays a significant
role, the CEO pay slice partly reflects governance problems. ...
[O]ur evidence indicates that, on average, a high CEO pay slice may signal
governance problems that might not otherwise be readily visible. Investors and
corporate boards would thus do well to pay close attention not only to the
compensation captured by the firms’ top executives, but also to how this
compensation is divided among them.
Which opens the door to ask the question, is it time for Obama to
pick a fight with the banks?:
Whatever happens today in Massachusetts, finding 60 votes in the Senate for
meaningful financial regulatory reform is likely impossible. That means it is
now high time to jettison the middle road, and go full bore against the banks.
Given Obama's cautious approach so far in his administration, it is difficult to
feel any confidence in such a prospect, but really, at this point one has to
ask, what's he got to lose?
We've got a lot to lose if we don't get meaningful financial reform, so just
as with health care, if what we can get through Congress actually improves
conditions in financial markets, we need to
take what we can
get and hope to build upon it later. The question is how to construct a
political strategy that will allow us to get as much done as possible. It may be
that aggressively going after big banks can create public support for reform,
support that would be difficult for politicians of either party to ignore. But
there's also a chance that such a strategy will harden the resolve of those now
opposed to reform making it harder to get anything done at all.
So a second question is whether the baseline level of reform we could get
without an all out, "jettison the middle road" strategy is acceptable, If it is,
I'd prefer to protect that and proceed cautiously. My loss function is
asymmetric. Getting something, even if it isn't as much as we'd like, is much
better than nothing at all.
But my sense is that right now the administration can't get enough support to
do anything except fairly cosmetic changes. If that's the case, and I'm not
completely sure that it is, but if so, then hammering the big banks relentlessly
may be the only chance we have to create the coalition needed to implement more
Posted by Mark Thoma on Tuesday, January 19, 2010 at 12:24 PM in Economics, Financial System, Market Failure, Politics, Regulation |
Lane Kenworthy is skeptical about new research that finds a link between
income inequality and health outcomes:
Inequality as a social cancer, by Lane Kenworthy: Income inequality makes a
lot of things we care about worse, according to a new book,
The Spirit Level: Why Greater Equality Makes Societies Stronger, by
Richard Wilkinson and Kate Pickett. Looking across 20 or so rich nations and
across the 50 American states, Wilkinson and Pickett find that countries and
states with greater income inequality tend to have lower life expectancy, higher
infant mortality, more mental illness, more obesity, higher rates of teen
births, more murder, less trust, and less upward mobility.
The following plot of life expectancy by income inequality shows a pattern that
appears again and again in The Spirit Level.
...The book has received a good bit of attention. ... It’s easy to see why. Many
progressives worry about inequality. Here is a book, referencing hundreds of
social scientific studies and making extensive use of quantitative data, which
says, in effect, that many of our social problems can be significantly eased by
reducing income inequality. Is it correct? I was initially skeptical, and after
reading the book I remain so.
What’s the causal link?
It wouldn’t be surprising to find that inequality in the income distribution
contributes to inequality in health, education, and so on. And there’s
of evidence that it does. Wilkinson and Pickett make a different claim:
income inequality worsens the average level of health, education,
safety, trust, and other good things. How does it do that?
Wilkinson and Pickett say high inequality increases status competition, which in
turn increases stress and anxiety, which leads to social dysfunction. ...
Other mechanisms are discussed at various points in the book, including
oppositional culture, perceived expectations of inferiority, and humiliation.
But stress is the key. ...
Improving social outcomes is certainly a worthwhile aim. What’s the best way to
do it? According to Wilkinson and Pickett,
“Attempts to deal with health and social problems through the provision of
specialized services have proved expensive and, at best, only partially
effective…. The evidence presented in this book suggests that greater equality
can address a wide range of problems across whole societies.”
I wish it were that simple. I share Wilkinson and Pickett’s conviction that
it would be good for America and some other affluent nations to reduce
income inequality, but this book hasn’t convinced me that doing so would help us
to make much headway in improving health, safety, education, and, trust. To
achieve those gains, my sense is that our best course of action is greater
commitment to specialized programs and services, coupled with poverty reduction.
Then again, I’m not certain that Wilkinson and Pickett are wrong. I’ve focused
here mostly on the effect of inequality on life expectancy, because that is the
social outcome for which the hypothesized causal link (stress) seems most
plausible and because it has received the most attention in prior research. I’m
skeptical that income inequality has much of an impact on average life
expectancy. But perhaps life expectancy will turn out to be the exception to the
[There is quite a bit more detail and two additional supporting graphs in the full post.]
Posted by Mark Thoma on Tuesday, January 19, 2010 at 02:11 AM in Economics, Income Distribution |
Andrew Leigh summarizes recent research suggesting that the provision of
social services is a key factor in stopping terrorism:
The Economics of Terrorism, by Andrew
Leigh: My AFR op-ed today is on the economics of terrorism, discussing a new
book by Eli Berman...:
What Makes Martyrs Tick, Australian Financial Review: ...Why were hardly any lives lost to suicide bombing in
the 1970s, but over 10,000 in the 2000s? What makes suicide bombing so popular
in the modern age?
Most people find it impossible to answer this question without using the word
‘crazy’. But a fascinating strand of research has begun to use the tools of
economics to try and better understand what drives suicide attacks, and how we
might stop them in the future.
In his new book,... economist Eli Berman ... takes a ... look at one of the
hottest policy questions today. He begins by popping a few myths. Interviews
with families and friends of suicide bombers, as well as with failed bombers,
show that they are not particularly motivated by the afterlife, but by concerns
closer to home. ...
Careful studies ... suggest that they are not generally depressed or mentally
ill, and would not be the kinds of people who would otherwise kill themselves.
Rather than regard suicide bombers as mad zealots, Berman argues, we should
think of suicide bombers as misguided altruists, who truly believe that their
acts will bring great benefits to their community.
To understand why suicide bombing has become more common, Berman contends, we
need to stop focusing only on the motivations of bombers, and consider the
‘hardness’ of their target. As it becomes more difficult for terrorists to do
damage, they are more likely to switch to suicide bombing. ... Faced with no
other option, ‘rebels counter with suicide attacks’. Thus the rise in suicide
bombings over the past quarter-century has a lot to do with the improvements in
the military capability deployed against them. ...
What can we do to reduce the number of terrorist attacks in the future? One
approach is to limit the amount of money reaching insurgent groups. ... But
Berman’s main focus is the relationship between terrorism and social service
provision. It is no accident, he says, that the Taliban run law courts,
Hezbollah collects garbage, and Hamas operates health clinics. Social services
provide a way of harvesting new recruits, and testing their commitment to the
leadership. And because they can be withdrawn at will, social service provision
gives leverage over the local population...
To really shut down terrorist groups, Berman argues, we need to undermine their
social service provision. He gives the historical example of Egypt’s President
Nasser, who undermined the Muslim Brotherhood by nationalising their network of
schools and clinics in the 1950s. By directly providing electricity, healthcare
and welfare services, governments improve the outside options for young people.
In the past, researchers such as Princeton University’s Alan Krueger have
pointed out that the typical suicide bomber is better-educated than other
members of their group. If suicide bombers are well-schooled, the argument goes,
antipoverty programs won’t reduce terrorism.
Yet by looking at groups rather than just individuals, Berman’s book shows why
the two are intertwined. ...Berman argues that ‘social service provision creates
the institutional base for most of the dangerous radical religious rebels’.
Demolish that base, and you begin to unravel the organisation.
Unusually for a book about terrorism, Berman keeps it in perspective. Global
terrorism is not the greatest threat to the world. ... The more we can help poor
governments provide basic services to their citizens, the less space we allow
for radical rebels to fill the void.
I don't know how effective this would actually be, but even if it was the best policy ever, would there be much support among conservatives for using nationalized
health care, welfare, and the provision of other social services as
Posted by Mark Thoma on Tuesday, January 19, 2010 at 01:50 AM in Economics, Terrorism |
[Warning: Wonkish] I've said several times recently that I favor limiting leverage as one of the responses to the financial crisis,
but I haven't talked a lot about the theoretical underpinnings for this view.
Fortunately, Rajiv Sethi describes one of the papers in this area that helped to
convince me that limiting leverage cycles is important. I've also included a
summary of another paper by Ana Fostel and John Geanakoplis on the same topic from an
interview of Eric Maskin (The paper has several attractive features. It is a
general equilibrium model, it has heterogeneous agents, incomplete markets, and
asymmetric information, and it can generate endogenous leverage cycles that can
lead to a collapse of the banking sector. But it is just one in a series of papers on the
topic, with the most recent described next):
John Geanakoplos on the Leverage Cycle, by Rajiv Sethi: In a series of
papers starting with
Promises Promises in 1997, John Geanakoplos has been developing general
equilibrium models of asset pricing in which collateral, leverage and default
play a central role. This work has attracted a fair amount of
attention since the onset of the financial crisis. While the public
visibility will surely pass, I believe that the work itself is foundational, and
will give rise to an important literature with implications for both theory and
The latest paper in the sequence is
Leverage Cycle, to be published later this year in the NBER Macroeconomics
Annual. Among the many insights contained there is the following: the price of
an asset at any point in time is determined not simply by the stream of revenues
it is expected to yield, but also by the manner in which wealth is distributed
across individuals with varying beliefs, and the extent to which these
individuals have access to leverage. As a result, a relatively modest decline in
expectations about future revenues can result in a crash in asset prices because
of two amplifying mechanisms: changes in the degree of equilibrium leverage, and
the bankruptcy of those who hold the most optimistic beliefs.
This has some rather significant policy implications:
Continue reading "Leverage Cycles" »
Posted by Mark Thoma on Tuesday, January 19, 2010 at 12:46 AM in Academic Papers, Economics, Financial System, Regulation |
Posted by Mark Thoma on Monday, January 18, 2010 at 11:02 PM in Economics, Links |
Robert Shiller says financial engineering can fix the instability problems in
Engineering Financial Stability, by Robert J. Shiller, Commentary, Project
Syndicate: The severity of the global financial crisis ... has to do with a
fundamental source of instability in the banking system, one that we can and
must design out of existence. To do that, we must advance the state of our
In a serious financial crisis, banks find that the declining market value of
many of their assets leaves them short of capital. They cannot raise much more
capital during the crisis, so, in order to restore capital adequacy, they stop
making new loans and call in their outstanding loans, thereby throwing the
entire economy – if not the entire global economy – into a tailspin.
This problem is rather technical in nature, as are its solutions. It is a sort
of plumbing problem for the banking system... Many finance experts ... have been
making proposals along the lines of “contingent capital.” The proposal by the
Squam Lake Working Group ... seems particularly appealing. ... The group calls
their version of contingent capital “regulatory hybrid securities.” The idea is
simple: banks should be pressured to issue a new kind of debt that automatically
converts into equity if the regulators determine that there is a systemic
national financial crisis, and if the bank is simultaneously in violation of
capital-adequacy covenants in the hybrid-security contract.
The regulatory hybrid securities would have all the advantages of debt in normal
times. But in bad times, when it is important to keep banks lending, bank
capital would automatically be increased by the debt-to-equity conversion. The
regulatory hybrid securities are thus designed to deal with the very source of
systemic instability that the current crisis highlighted.
The proposal also specifies a distinct role for the government in encouraging
the issuance of regulatory hybrid securities, because banks would not issue them
otherwise. Regulatory hybrid securities would raise the cost of capital to banks
(because creditors would have to be compensated for the conversion feature),
whereas the banks would rather rely on their “too big to fail” status and future
government bailouts. Some kind of penalty or subsidy thus has to be applied to
encourage banks to issue them. ...
Contingent capital, a device that grew from financial engineering, is a major
new idea that might fix the problem of banking instability, thereby stabilizing
the economy – just as devices invented by mechanical engineers help stabilize
the paths of automobiles and airplanes. If a contingent-capital proposal is
adopted, this could be the last major worldwide banking crisis – at least until
some new source of instability emerges and sends financial technicians back to
work to invent our way of it.
The last sentence highlights why we shouldn't put all of our regulatory eggs
into one policy basket, a point I've made before in arguing for broad based solutions that limit the damage if a breakdown occurs. That is, while contingent capital might help, and maybe even fix
existing problems, we should also be sure to implement measures that limit the damage and protect us if
the financial sector implodes again despite the creative financial engineering and regulatory changes designed to prevent it.
Posted by Mark Thoma on Monday, January 18, 2010 at 02:30 PM in Economics, Financial System, Regulation, Technology |
Evidence that the dream has not yet been fully realized.
Posted by Mark Thoma on Monday, January 18, 2010 at 12:08 PM in Economics, Unemployment |
This is by ari at Edge of the American West:
MLK Day, by ari, [Creative Commons]: The Martin Luther King of American memory serves this nation as the safe
Civil Rights leader. When shrunk to fit within the confines of
soundbite history, the pages of a textbook, or the scenes of a primary
school pageant, King is cleansed of anger, of ego, of sexuality, and
even, perhaps, of some of his humanity.
Counterpoised against the ostensibly violent Malcolm X, who supposedly would have forced America to change its ways by using “any means necessary,”
King comes off as a cuddly moderate — a figure who loved everyone,
enemies included, even whites who subjugated black people. Although
there’s some truth lurking behind this myth, there was more (about both
X and King) to the story:
complexities and nuances that escape most popular recollections. Martin
Luther King, no matter how people remember him now, was not nearly so
safe as most of us believe.
On March 12, 1968, less than a month before he was shot and killed
in Memphis, Tennessee, King visited the wealthy Detroit suburb of Grosse Pointe.
Largely white, Grosse Pointe was — and to some extent still is — a
bastion of establishment power. By that point in his career, King had
embraced issues that moved well beyond the struggle against de jure segregation in the South. He had begun focusing most of his energy on inequality nationwide — de facto issues of poverty, job discrimination, fair housing, and, as Matthew Yglesias notes, the Vietnam war.
While in Grosse Pointe, King delivered a speech, “The Other America,”* which details the orator’s evolution over the course of his too-brief career:
Continue reading ""MLK Day"" »
Posted by Mark Thoma on Monday, January 18, 2010 at 10:19 AM in Economics |
Criticism that the administration is having political difficulties today because it put too much effort into health care reform, and too little into fixing the economy, is incorrect. Effort wasn't the problem, it was the "policy and political misjudgments" that were problematic:
What Didn’t Happen, by Paul Krugman, Commentary, NY Times: Lately many
people have been second-guessing the Obama administration’s political strategy.
The conventional wisdom seems to be that President Obama tried to do too much —
in particular, that he should have put health care on one side and focused on
I disagree. The Obama administration’s troubles are the result not of excessive
ambition, but of policy and political misjudgments. The stimulus was too small;
policy toward the banks wasn’t tough enough; and Mr. Obama didn’t ... shelter
himself from criticism with a narrative that placed the blame on previous
About the stimulus: it has surely helped. Without it, unemployment would be much
higher... But the administration’s program clearly wasn’t big enough to produce
job gains in 2009.
Why was the stimulus underpowered? ... According to The New Yorker’s Ryan Lizza,...
in December 2008 Mr. Obama’s top economic and political advisers concluded that
a bigger stimulus was neither economically necessary nor politically feasible.
Their political judgment may or may not have been correct; their economic
judgment obviously wasn’t. Whatever led to this misjudgment, however, it wasn’t
failure to focus on the issue... The administration wasn’t distracted; it was
The same can be said about policy toward the banks. Some economists defend the
administration’s decision not to take a harder line on banks, arguing that the
banks are earning their way back to financial health. But the light-touch
approach to the financial industry further entrenched the power of the very
institutions that caused the crisis, even as it failed to revive lending... And
it has had disastrous political consequences: the administration has placed
itself on the wrong side of popular rage over bailouts and bonuses.
Finally, about that narrative: ... It’s often forgotten now, but unemployment
actually soared after Reagan’s 1981 tax cut. Reagan, however, had a ready answer
for critics: everything going wrong was the result of the failed policies of ...
Mr. Obama could have done the same — with, I’d argue, considerably more justice.
He could have pointed out, repeatedly, that the continuing troubles of America’s
economy are the result of a financial crisis that developed under the Bush
administration, and was at least in part the result of the Bush administration’s
refusal to regulate the banks. But he didn’t. ... Mr. Obama has allowed the
public to forget, with remarkable speed, that the economy’s troubles didn’t
start on his watch.
So... Could the administration have made a midcourse correction on economic
policy if it hadn’t been fighting battles on health care? Probably not. One key
argument of those pushing for a bigger stimulus plan was that there would be no
second chance: if unemployment remained high, they warned, people would conclude
that stimulus doesn’t work rather than that we needed a bigger dose. And so it
It’s important to remember, also, how important health care reform is to the
Democratic base. Some activists have been left disillusioned by the compromises
made to get legislation through the Senate — but they would have been even more
disillusioned if Democrats had simply punted on the issue. ...
So what comes next?
At this point Mr. Obama probably can’t do much about job creation. He can,
however, push hard on financial reform, and seek to put himself back on the
right side of public anger by portraying Republicans as the enemies of reform —
which they are.
And meanwhile, Democrats have to do whatever it takes to enact a health care
bill. Passing such a bill won’t be their political salvation — but not passing a
bill would surely be their political doom.
Posted by Mark Thoma on Monday, January 18, 2010 at 12:57 AM in Economics, Politics |
Posted by Mark Thoma on Sunday, January 17, 2010 at 11:02 PM in Economics, Links |
Is continental Europe repeating mistakes made in the 1930s?:
Ominous lessons of the 1930s for Europe, by Paul De Grauwe, Commentary,
Financial Times: The Great Depression taught us several lessons. ...
There is one area of policymaking where authorities may not have learned the
lessons of history... During
much of the 1930s ... the so-called gold bloc countries (France, Italy, Belgium,
the Netherlands and Switzerland) kept their currencies pegged to gold. When in
the early 1930s Great Britain and the US went off gold and devalued their
currencies, the gold bloc countries found their currencies to be massively
overvalued. This had the effect of depressing their exports and of prolonging
the economic depression in these countries.
It is remarkable to see ... the same mistakes ... today involving some of the
same countries... This time it is again the continental western European
countries tied together in the eurozone that have seen their currency, the euro,
become strongly overvalued. The two countries that in the 1930s responded to the
crisis by devaluing their currencies, the US and the UK, today have also allowed
their currencies to depreciate significantly ... against the euro...
Why do the euro area countries repeat the same policies as the gold bloc
countries in the 1930s? The answer is economic orthodoxy. In the 1930s it was
the orthodoxy inspired by the last vestiges of the gold standard. Today the
economic orthodoxy that inspires the European Central Bank is ... the view that
the foreign exchange market is better placed than the central bank to decide
about the appropriate level of the exchange rate. A central bank should be
concerned with keeping inflation low and not with meddling in the forex market.
As a result, the ECB has not been willing to gear its monetary policy towards
some exchange rate objective.
Just as in the 1930s, the euro area countries will pay a price for this
orthodoxy..., a slower and more protracted recovery from the
recession. ... One could object ... that the central bank is powerless to affect
the exchange rate. This is a misconception. A central bank can always drive down
the value of its currency by a sufficiently large increase in its supply. ...
True,... the ECB has injected plenty of liquidity in the euro money markets to
support the banking system. Yet it has been much more timid than the US Federal
Reserve and the Bank of England... Such an imbalance in the expansion of central
bank money inevitably spills over in the foreign exchange markets. ...
Ultimately a central bank has to make choices. The Fed and the Bank of England
have opted for massive programmes of liquidity creation, attaching a low weight
to the possible inflationary consequences... The ECB has been more
conservative... The future will tell us which of these choices was right.
Posted by Mark Thoma on Sunday, January 17, 2010 at 03:59 PM in Economics, International Finance |
Please, sir, may we have some justice?, by Maxine Udall: We have just witnessed
highly compensated investment bankers asserting that they are the
clueless victims of an unforeseeable, unpreventable hundred year financial crisis
(except when it happens every five to seven years).
Until last year, Maxine had always assumed that at least one reason for investment
bankers' high compensation was that the market had chosen to reward them for competence
and knowledge about high finance, things we lesser mortals couldn’t possibly grasp
with our mundane, tiny little minds. Now we find out that they apparently hadn’t
even grasped the basics... “The higher the returns, the higher the risk, and if
the returns are high and sustained, you’re in a Ponzi scheme or a bubble. ...” ...
It seems so basic and no amount of clever math and models can really change it...:
Higher returns means higher risk and if the returns are high and sustained, you’re
in a Ponzi scheme or a bubble.
We and our elected representatives have a choice to make. We can continue to compensate
clueless victims way beyond the value of their marginal product in any domain of
productivity you care to name and we can continue to allow them to cluelessly manage
financial institutions for their own short-term short-sighted gains until they plunge
the rest of us into serfdom or we can change how they are compensated and maybe
even who is compensated (as in throw the bums out) and we can change the rules by
which they are allowed to "play" with our money.
The latter shouldn’t be rocket science were it not for the wealth and power bankers
are able to exert in their own interest. If the political will is not there now
to do this, for heaven’s sake, when will it be????
Oh, right...after a full-blown depression, like last time.
But even then, reform and regulation will not be enough. We need a new language
about business and markets that is sensible and grounded in reality. In the last
thirty years, both have been elevated to near religion, with financiers and CEOs
as high priests.
Something has been lost in that transformation. When Adam Smith wrote about the
value and advantages of commercial society, he saw all of society (and, of course,
was comparing it to the vestigial remains of feudalism which set a very low, preliminary
standard). He wrote about how even those at the bottom were made better off. He
appeared to care about them. He worried that because of the drudgery of the work
at the lower end of society, people in those roles would require additional inputs,
like education, paid for by the larger society. He viewed the entire wealth of the
nation including the distribution not only of wealth but of opportunity (admittedly
within the confines of a rather rigid class structure). And he was quite critical
of the ne’er-do-well rich and of businessmen who colluded to extract welfare from
consumers in the form of higher prices.
Perhaps most importantly, Adam Smith appears to have understood the value of the
moral side effects of commercial transactions: trust, sympathy for our fellow tradesmen
and women, for our customers, for our neighbors, a sense of community and of the
common good, all traded in the marketplace along with the money, goods, and services
that change hands. He recognized the interdependencies that markets create and reinforce,
interdependencies that bind us to common objectives and that lower the transaction
costs of achieving them.
So you see it isn’t just about the money. ... It’s about the moral side effects
of market transactions and exchange.
Morally clueless investment bankers have trashed the fabric that binds us together
as a nation. They have sent a message loud and clear that short-sighted, immoral
cluelessness that serves only one’s own short-run self-interest is what is rewarded.
That unearned wealth, power and prestige have more political and economic currency
than the hard-earned trust, confidence, and lower profit margins of honest businessmen
embedded in, committed to, and serving their customers and their communities. ...
Moral, socially responsible, honest (usually small) businessmen and women ... provide
some of the moral glue that holds us together. Market forces in small, truly competitive,
transparent markets (which financial markets most definitely are not) often reinforce
the moral glue and sometimes even provide it by reining in the Mr. Potters and the
Gyges of the world.
Mr. Potter testified last week, pockets bulging with cash earned on the backs
of the people of Bedford Falls, that he is clueless and incompetent and that stuff
happens. He harmed Main Street, both the people who shop there and the people who
own businesses there. He harmed the backbone of our democratic society. We bailed
him out. Isn’t it time we held him to account?
We can reduce the
moral hazard we’ve created with a no-strings bailout, we can reduce the moral
side-effects of the moral hazard, and we can help Main Street. Let’s start by using
all the bonus money to extend the safety net for
unemployed workers, please. Then let’s tax the finance sector’s inordinate Ponzi
scheme profits and use the proceeds to build new infrastructure and to retool the
US workforce for the 21st century. And for God’s sake,
let's regulate Mr. Potter. Let’s take a longer-term view of economic and
societal well-being. Let’s make something good from this that will benefit our
Please, sir, may we have some justice?
Businesses will do whatever they can to give themselves an advantage over their
customers and increase profits. How can we level the playing field? Adam Smith believed
that competition was the best regulator of economic behavior. You can't trust government
to intervene and protect people because the rich and powerful will bend government
to satisfy their needs. We should rely upon competition instead, that's our best
chance of making these markets work for everyone, not just one side of the transaction.
It's easy to make the case that the financial system does not satisfy or even
closely approximate the conditions necessary for the textbook version of "pure competition,"
conditions that must be present if markets are going to maximize social welfare
in the textbook fashion. For example, pure competition calls for free entry and
free exit. Have we seen free exit among too big to fail firms? Pure competition
calls for a large number of firms, none of which is big enough to influence market
conditions on its own. Do those conditions exist? Pure competition requires that
all parties in transactions be equally informed, but that certainly wasn't the case
in these markets. The list of violations of the conditions for pure competition
is a long one, too long to list here extensively, but there is little doubt that
substantial departures from ideal conditions were present and pervasive in the financial
There was a time when I would have called for us to reestablish competitive conditions
in the financial industry as a means of fixing the problems that led to its breakdown.
I still think that is an important part of the solution -- I think the consequences
of departures from pure competition in these markets are larger than most people
recognize -- and it is part of what is behind my calls to reduce banks to their
minimum effective size. But is competition enough to fix the problems? If it is
enough, can we actually achieve an adequate approximation of pure competition in
I have lost my "faith" that competition alone is enough to regulate these
markets (I find that sentence surprisingly hard to write and do not wish to assert
it for all markets). Regulation, particularly regulation that reduces the impact
on the broader economy if the financial industry implodes again (and it will) is
essential. Perhaps the test that led to this conclusion was unfair since, as just
noted, the conditions in financial markets were nowhere near competitive. If we
could actually establish competitive conditions in these markets, maybe they'd be
fine. It's hard to say because I don't think those conditions were present in financial
markets, and I've come to doubt that they can ever be present.
Some people argue that these firms are natural monopolies (or that there's only
room for a few fully efficient firms). I don't think they are, but if so, they should
be heavily regulated just like any other natural monopoly. In any case, natural
monopolies or not, over time these markets appear to tend toward concentration rather
than competition, and inherent and important market failures do not appear to self-correct
(e.g., to name just one, participants in these markets do not consider the externalities
their failure would impose on the broader economy as they decide how much risk to
take on, or, to say it another way, how much capital to hold in reserve).
If we could overcome these market imperfections, would competition be enough
to maximize the safety of these markets? I don't know because an approximation of
the textbook conditions for pure competition have never existed in this industry,
and the structure of the industry works strongly against such conditions ever existing.
If that's the case, if we are unsure that competition would be enough to fully protect
us, and if we are unsure that we can get to those conditions and then maintain them
in any case, then the important role that these markets play in our economy makes
it essential that we insulate ourselves from the consequences of this happening
I don't think we can ever fully guarantee that we are safe from collapse in the
financial industry (though we should do our best to prevent it), but we can reduce
the consequences if and when the financial system does collapse again. That's why
I've been emphasizing broad measures such as limiting leverage/increasing capital
requirements/increasing margin requirements (which all amount to the same thing),
measuring and limiting interconnectedness, etc., rather than trying to identify
and fix specific problems. The individual problems are important and need to be
addressed, that will reduce the likelihood of collapse so I don't mean to ignore
them, but insulation from big shocks and widespread collapse comes mainly through
the more broad-based measures.
Posted by Mark Thoma on Sunday, January 17, 2010 at 12:45 PM in Economics, Financial System, Market Failure, Regulation |
Posted by Mark Thoma on Saturday, January 16, 2010 at 11:02 PM in Economics, Links |
"FCIC Interviewing the Wrong People", by Calculated Risk: Jillayne Schlicke
The Financial Crisis Inquiry Commission is Interviewing the Wrong People
If the Commission really does want to learn WHO knew what, when, then they’re
interviewing the wrong people.
They need to interview the line workers. Mortgage loan processors, managers,
escrow closers, underwriters from the banks, private mortgage insurance
companies as well as wholesale lending, loan servicing default and loss
mitigation workers and even consumers. Seasoned mortgage industry veterans who
have proof in the form of saved memos or emails, that they informed senior
management of the red flags, predatory lending, and the insane relaxation of
underwriting guidelines that started to pop up as early as 2001 and 2002 yet
were ignored or whose concerns were dismissed.
I think this is the key - instead of interviewing bank CEOs and top regulators,
start with the field examiners and the "line workers" in the mortgage
industry. And as Jillayne noted, talk to the consumers too.
Posted by Mark Thoma on Saturday, January 16, 2010 at 01:30 PM in Economics, Financial System |
David Brooks saves the world in 1000 words, by Chris Blattman:
Haiti, like most of the world’s poorest nations, suffers from a complex web of
progress-resistant cultural influences. There is the influence of the voodoo
religion, which spreads the message that life is capricious and planning futile.
There are high levels of social mistrust…
We’re all supposed to politely respect each other’s cultures. But some cultures
are more progress-resistant than others, and a horrible tragedy was just
exacerbated by one of them.
…it’s time to promote locally led paternalism. In this country, we first tried
to tackle poverty by throwing money at it, just as we did abroad. Then we tried
microcommunity efforts, just as we did abroad. But the programs that really work
involve intrusive paternalism.
These programs, like the Harlem Children’s Zone and the No Excuses schools, are
led by people who figure they don’t understand all the factors that have
contributed to poverty, but they don’t care. They are going to replace parts of
the local culture with a highly demanding, highly intensive culture of
achievement — involving everything from new child-rearing practices to stricter
schools to better job performance.
That is David
Brooks selectively quoting the development literature.
His confidence makes me uncomfortable. To paraphrase, unkindly: These Haitians
need to be more like hardworking, thrifty Americans. We’ve spent five decades
learning that everything we thought would work in aid did not. Clearly it’s time
to get tough. I read about some people who made this work in Harlem, so it’s
obviously the answer for Haitians, whom through newspaper reading, I have
deduced are also resistant to progress.
Don’t misunderstand me: Brooks could be right. In fact, I’m starting one
randomized control trial to test the idea. I’m a little further from
propounding it as God’s honest truth on the pages of the Times.
Sometimes the problem with big development solutions is they spring from hubris
and certitude rather than caution and humility. ...
I’m slightly terrified now that Bill Clinton, special envoy to Haiti, has said
David Brooks is his leading intellectual light.
Intrusive Paternalism worked so well in Iraq and other places, especially when combined with
forced free market solutions introduced with no supporting institutional
structure, and without consideration of local culture, history, or social relationships, that I guess conservatives like Brooks just can't wait to try it again.
Posted by Mark Thoma on Saturday, January 16, 2010 at 11:40 AM in Development, Economics |
Posted by Mark Thoma on Friday, January 15, 2010 at 11:02 PM in Economics, Links |
This is from an email that said, "I thought these non-economists' views on the
crisis might be of interest to you and your readers."
I *think* I understand this one:
Mae Kuykendall on David A. Westbrook's Out of Crisis: Rethinking Our
Financial Markets. I did have to stop and think for a moment when I hit
sections such as this:
Westbrook directs us to a critical insight for this crisis: we are collectively
enmeshed in a tragedy of language, using it to govern financial exchange in ways
that are naïvely representational or, in the alternative, unrealistic about the
power of a linguistic construct to constrain the world. Disclosure as a
strategy, given to us by our savants of the last finance reset, assumes what the
English professors tells us is really a childish idea: that language serves as a
window to a real picture and, as such, is just a conveyance to us of what is
there to be seen and understood. In Westbrook’s phrase, this idea about managing
the problems investment presents makes language invisible.
In our other principal strategy-- risk management-- language is asked to set up
containers for large swaths of poorly described arrays of claims on something
real. The tragedy is the contradiction. We believe, like children, in being told what our basket of claims
contains, and we rely, like language engineers, on the idea that a big
enough basket of abstractions—claims on too many things to try to
understand with the faith of children looking through a picture
window—is conceptually safe.
This too, e.g.:
Out of Crisis explores a more complex and interwoven approach to both
diagnosis and reform. It conceives the relation between regulation and markets
differently than prevailing talk. Markets do not arise or arrive bearing
inevitable or immutable traits, rules or roles. They are instead products of
particular features of social and political organization whose participants help
to shape their attributes and functions.
If so, the theme modestly emerges, debate must not dwell upon simple trade offs
between regulation versus markets. People must appreciate that markets are
social and political products and that participants in effect choose what design
features particular markets should offer.
Update: Nick Krafft comments on the contribution from Mae Kuykendall.
Posted by Mark Thoma on Friday, January 15, 2010 at 07:22 PM in Economics, Financial System |
Bruce Judson wants to see change he can believe in:
Are A Better Nation Than This, by Bruce Judson: In a few days, President
Obama will deliver his State of the Union Address. Right now, Martin Luther King
Day is upon us. Both events suggest that it is a particularly appropriate moment
for every American to stop and think about our society.
As a nation, have we made progress in realizing the vision articulated by Dr.
King? Are we closer or further from living the virtues he described? In 1980,
Ronald Reagan famously asked "Are
you better off now than you were four years ago?" What percentage of
Americans would answer that question affirmatively right now?
America today is characterized by excess, anger, mistrust, polarization,
increasing pessimism, self-interest, and a lack of accountability. Of even
greater concern, we are becoming a nation that is accepting the unacceptable.
In October 2008 when unemployment hovered
between 6% and 7%, Barack Obama
declared that we were in the middle of "an economic emergency:"
We face an immediate economic emergency that requires urgent action. We can’t
wait to help workers and families and communities who are struggling right now –
who don’t know if their job or their retirement will be there tomorrow; who
don’t know if next week’s paycheck will cover this month’s bills.
With an unemployment rate now in double digits and at least 50% higher than the
level in October 2008, President Obama says "there is only so much
government can do." Meanwhile, millions of people are suffering in a crisis
of our own making. A crisis that is the result of what Paul Krugman recently
called "the dysfunctional nature
of our own financial system." Yes, the President has proposed additional
spending to create jobs, but few authorities expect that it will have a
significant impact on our actual level of employment. But, few believe this
program will have a meaningful impact. Robert Reich writes, "the chances of unemployment
being 10 percent next November are overwhelmingly high."
At the same time, the Administration’s housing program is a complete failure,
and the nation faces massive foreclosures. As joblessness continues, one in
eight mortgages is in default or
foreclosure, and half of all
mortgages may be underwater within a year. There do not appear to be any
serious proposals to keep people in their homes as owners, so an even greater
housing crisis may occur later this year or in 2011. It’s the elephant in the
room that no one wants to discuss.
In the era of the New Deal, American ingenuity led to a series of job creation
programs, social security, the FDIC (which eliminated the scourge of bank-runs),
ultimately the GI Bill (perhaps the greatest investment in human capital the
nation has ever made). The Roosevelt Administration was also committed to
keeping people in their homes as owners, and the precursor to the modern-day 30
year mortgage was one of the central innovations of the era.
How does our response to the Great Recession compare to the age of FDR? To date,
the most innovative response to the financial crisis, and the ensuing national
misery, has been….TARP?
I refuse to believe that our current situation is the best that America can
accomplish. I refuse to believe that we have truly harnessed the
legendary ingenuity and resourcefulness of the American nation. I also
believe there is a way to move forward and dramatically revitalize our suffering
The president must recognize that more of the same is not good enough. He must
stop accepting the idea that our nation is limited in what it can accomplish. He
must also realize that difficult moments require strong leadership, not
moderation or a search for consensus. Great leaders articulate an unwavering
vision that causes people to believe they can accomplish more than they thought
possible, and creates a sense that each of us has a responsibility that
transcends our own well-being.
What if President Obama were to step up to the podium at his State of the Union
message and challenge the nation to achieve 3% unemployment within 2 years? What
if he committed the future of his Presidency to realizing this goal? What if he
said that America is only America when we have jobs for people that want to work
and opportunities for the generation of young Americans that is now threatened
with a paucity of prospects? He could create a new sense of possibilities, and
awaken a hunger inside almost everyone to ensure we remain a great nation.
Today, it’s easy to oppose any job creation efforts. There is no clear goal, and
no stated vision. We are increasingly accepting a two-tier society: those with
jobs and those who are forgotten. There is also no clear sense that creating
private sector jobs is an act of patriotism. The president has the opportunity
to shift these dynamics. By articulating a vision of a better nation, he can
stimulate action and bring out the best in our society.
FDR brought hope to a miserable country when he promised, and delivered, "action and action now."
Roosevelt had no clear plan of how he would accomplish his agenda; but he was
determined to relentlessly experiment until he succeeded.
Winston Churchill rejuvenated the British nation when he declared, "We
shall never surrender," despite what seemed like impossible odds. It’s worth
noting the absolute resolve and determination in Chruchill’s words, which
propelled the British people forward:
…we shall not flag or fail. We shall go on to the end, we shall fight in
France, we shall fight on the seas and oceans, we shall fight with growing
confidence and growing strength in the air, we shall defend our Island, whatever
the cost may be, we shall fight on the beaches, we shall fight on the landing
grounds, we shall fight in the fields and in the streets, we shall fight in the
hills; we shall never surrender…
In a later era, John Kennedy did not know how America would land a man on the
moon and return him safely “Before this decade is out” when he challenged the
nation to accomplish this seemingly impossible task. But,
in his speech before Congress,
Kennedy did say:
I believe we possess all the resources and talents necessary. But the facts of
the matter are that we have never made the national decisions or marshaled the
national resources required for such leadership. We have never specified
long-range goals on an urgent time schedule, or managed our resources and our
time so as to insure their fulfillment.
We often forget that at the time of Kennedy’s speech, America was a nation
shaken badly by Soviet advances in space. JFK responded with strength and
determination to restore confidence. By stating a clear goal, President Kennedy
created action and momentum.
Moreover, I believe that Kennedy’s description of our innate resources and
talent applies, as well, to the nation today. We need Barack Obama to offer this
same commitment to America, and to support his words with swift actions and
A few weeks ago I was a guest on
WNYC’s Leonard Lopate show. At the end of the interview, I was asked why no
political movement had grown up around reinventing our nation – if I believed it
was so critical. I paused, leaned back in my chair, and said it had: America
voted for change we can all believe in.
In October 2008, candidate Obama
This country and the dream it represents are being tested in a way that we
haven’t seen in nearly a century. And future generations will judge ours by how
we respond to this test. Will they say that this was a time when America lost
its way and its purpose? …
Or will they say that this was another one of those moments when America
overcame? When we battled back from adversity by recognizing that common stake
that we have in each other’s success?
I have not forgotten what these powerful words or what our nation sought on
election day in 2008. After one year in office, I hope that President Obama
remembers as well.
Posted by Mark Thoma on Friday, January 15, 2010 at 01:23 PM in Economics |
Will the Administration's Proposed Bank Tax Create a Moral Hazard Problem?, by Mark Thoma: I reconsider yesterday's contention that the bank tax won't affect bank behavior. Will it create moral hazard?
Update: See also:
TARP oversight report: 'Implicit guarantee' of future bailouts hampering reform,
The Hill: Unwinding the Treasury Department's $700-billion rescue program
will be difficult, so long as there is an "implicit guarantee" that the federal
government will continue to save failing banks, according to a new report.
The 2008 Troubled Asset Relief Program (TARP) has ultimately prompted banks to
adjust "to the notion... [they] will be safe, no matter what," explained
Elizabeth Warren, chairwoman of the Congressional Oversight Panel that has been
tracking those dollars.
"The whole market has adjusted to the notion that the big banks will be safe no
matter what, and they can start planning their business approaches accordingly,"
Warren told CNBC on Thursday. "And thats dangerous." ...
Posted by Mark Thoma on Friday, January 15, 2010 at 11:07 AM in Economics, Financial System, Regulation |
The testimony of "clueless" bank executives before the Financial Crisis Inquiry
Commission undermined the credibility of
their arguments against financial reform:
Without a Clue, by Paul Krugman, Commentary, NY Times: The official
Financial Crisis Inquiry Commission — the group that aims to hold a modern
version of the Pecora hearings of the 1930s, whose investigations set the stage
for New Deal bank regulation — began taking testimony on Wednesday. In its first
panel, the commission grilled four major financial-industry honchos. What did we
Well,... the bankers’ testimony showed a stunning failure, even now, to grasp
the nature and extent of the current crisis. And that’s important: It tells us
that as Congress and the administration try to reform the financial system, they
should ignore advice coming from the supposed wise men of Wall Street, who have
no wisdom to offer. ...
The U.S. economy is still grappling with the consequences of the worst financial
crisis since the Great Depression; trillions of dollars of potential income have
been lost; the lives of millions have been damaged, in some cases irreparably,
by mass unemployment; millions more have seen their savings wiped out; hundreds
of thousands, perhaps millions, will lose essential health care because of ...
job losses and draconian cutbacks by cash-strapped state governments.
And this disaster was entirely self-inflicted. This isn’t like the stagflation
of the 1970s, which had a lot to do with soaring oil prices, which were, in
turn, the result of political instability in the Middle East. This time we’re in
trouble entirely thanks to the dysfunctional nature of our own financial system.
Everyone understands this — everyone, it seems, except the financiers
There were two moments in Wednesday’s hearing that stood out. One was when Jamie
Dimon of JPMorgan Chase declared that a financial crisis is something that
“happens every five to seven years. We shouldn’t be surprised.” In short, stuff
happens, and that’s just part of life.
But the truth is that the United States managed to avoid major financial crises
for half a century after the Pecora hearings were held and Congress enacted
major banking reforms. It was only after we forgot those lessons, and dismantled
effective regulation, that our financial system went back to being dangerously
Still, Mr. Dimon’s cluelessness paled beside that of Goldman Sachs’s Lloyd
Blankfein, who compared the financial crisis to a hurricane nobody could have
predicted. ... [T]his giant financial crisis was just a rare accident, a freak
of nature, and we shouldn’t overreact.
But there was nothing accidental about the crisis. From the late 1970s on, the
American financial system, freed by deregulation and a political climate in
which greed was presumed to be good, spun ever further out of control. There
were ... bonuses beyond the dreams of avarice ... for bankers who could generate
big short-term profits. And the way to raise those profits was to pile up ever
more debt, both by pushing loans on the public and by taking on ever-higher
Sooner or later, this runaway system was bound to crash. And if we don’t make
fundamental changes, it will happen ... again.
Do the bankers really not understand what happened, or are they just talking
their self-interest? No matter. As I said, the important thing looking forward
is to stop listening to financiers about financial reform.
Wall Street executives will tell you that the financial-reform bill the House
passed ... would cripple the economy with overregulation (it’s actually quite
mild). They’ll insist that the tax on bank debt just proposed by the Obama
administration is a crude concession to foolish populism. They’ll warn that
action to ... rein in financial-industry compensation is destructive and
But what do they know? The answer, as far as I can tell, is: not much.
Posted by Mark Thoma on Friday, January 15, 2010 at 12:54 AM in Economics, Financial System, Regulation |
Tim Duy looks at the Fed's likely interest rate and balance sheet actions in the months ahead:
It's Not About Interest Rates Yet, by Tim Duy: Incoming data continue to support expectations that the Federal Reserve will hold rates at rock bottom levels for the foreseeable future - likely into 2011. But interest rates should not be the focus of policy analysts. The Fed will manipulate policy via the balance sheet long before they fall back to the interest rate tool. The question is whether or not the slow growth environment is sufficient to persuade the Fed to hold the balance sheet steady or even expand the balance sheet beyond current expectations. And there always remains the third option, favored by a minority of policymakers - withdraw the stimulus now that growth has reemerged. At this point, I suspect the Fed will stick with the hold steady option.
One of the key elements of the slow growth story was the inability and unwillingness of households to revert to past spending habits. The critical parts of the story are that savings rates would rise as household struggled to rebuild tattered balance sheets and that credits would become dearer. These stories are playing out in the data:
Yet the trend of consumer spending has undoubtedly been upward since June, as has been the trend of overall economic activity. Cyclically, the economy is on an upswing, surprising many who believed the apocalypse was at hand. But fears of a consumer apocalypse were always overblown; the change need only be moderate to have a large impact on the overall economic environment. It is not necessary that consumers crawl into their basements, curled into a fetal position hugging a bar of gold in one arm and a loaded shotgun in the other, to dramatically alter the role of households in the economy. Consider, for instance the path of retail sales excluding gasoline:
The November-December average monthly growth trend is 0.032% (note: log difference approximation), while the July-December trend is 0.03% and averages out the distortion caused by the "Cash for Clunkers" program. In either case, the spending trend is below the prerecession trend in sales growth. What are the takeaways from such an analysis?
Continue reading "Fed Watch: It's Not About Interest Rates Yet" »
Posted by Mark Thoma on Friday, January 15, 2010 at 12:33 AM in Economics, Fed Watch, Monetary Policy |
Posted by Mark Thoma on Thursday, January 14, 2010 at 11:02 PM in Economics, Links |
Andy Harless says that, in the future, the Fed should target a higher level
of inflation to give it more room to maneuver in a crisis:
Inflation Targets and Financial Crises, by Andy Harless: There are basically four ways to deal with the possibility of severe
financial crises. First, you can just cross your fingers, hope such crises
don’t happen very often, and live with the consequences when they do.
Second, you can publicly insure and regulate your economy heavily in an
attempt to minimize the risk and severity of such crises. Third, you can
have your central bank monitor the fragility of general financial conditions
and “take away the punch bowl” when it thinks conditions are in danger of
becoming too fragile. Fourth, you can have your central bank target an
inflation rate that is high enough to give it a lot of room to respond to a
crisis (or an incipient crisis) by cutting interest rates far below the
Continue reading ""Inflation Targets and Financial Crises"" »
Posted by Mark Thoma on Thursday, January 14, 2010 at 05:49 PM in Economics, Inflation, Monetary Policy |
I know you are tired of hearing me make this point, and that many of you disagree, but maybe you'll be
convinced by Paul Volcker? Should the fire code designers, inspectors, and enforcers be part of the fire
department, or housed in a separate, independent agency? Does, for example, the knowledge inspectors gain about the risks of
fire in various buildings along with knowledge about the nature of
those risks (e.g. of spreading to particular adjacent buildings) help
firefighters plan a more effective response if a fire does break out? Conversely, does the knowledge that firefighters have help the inspectors to
know what to regulate and what to look for during inspections? Are
there economies of scale from consolidation, e.g. if we want experts on
how fires spread from building to building present among both
inspectors and firefighters, is it most efficient and effective
to concentrate this expertise in a single agency?:
Stands Up for Fed Role in Financial Oversight, Reuters: The Federal Reserve
must have a “strong voice and authority” on regulatory matters, Paul Volcker ...
said on Thursday. Mr. Volcker, a former Federal Reserve chairman, told a lunch
meeting at the Economic Club of New York that he had been “particularly
disturbed” by proposals to strip the Fed of its supervisory and regulatory
responsibilities. “What seems to me beyond dispute, given recent events, is that
monetary policy and the structure and condition of the banking and financial
system are irretrievably intertwined,” said Mr. Volcker...
What are the actual arguments for this?:
The Public Policy Case for a Role for the Federal Reserve in Bank Supervision
and Regulation, by Ben Bernanke: Like many other central banks around the
world, the Federal Reserve participates with other agencies in supervising and
regulating the banking system. The Federal Reserve’s involvement in supervision
and regulation confers two broad sets of benefits to the country.
Continue reading "Should the Fed Have a Large Role in Bank Regulation?" »
Posted by Mark Thoma on Thursday, January 14, 2010 at 04:32 PM in Economics, Monetary Policy |
Calculated Risk summarizes today's proposal from the Obama administration for a
"Financial Crisis Responsibility Fee" to recover the cost of the
bailout of the financial system:
Proposed "Financial Crisis Responsibility Fee," by Calculated Risk: From
Financial Crisis Responsibility Fee: Today, the President announced his intention to propose a Financial Crisis
Responsibility Fee that would require the largest and most highly levered Wall
Street firms to pay back taxpayers for the extraordinary assistance provided so
that the TARP program does not add to the deficit. The fee the President is
There is much more detail at the link. The proposed fee would be 15 bps of
covered liabilities per year.
- Require the Financial Sector to Pay Back For the Extraordinary Benefits
- Responsibility Fee Would Remain in Place for 10 Years or Longer if
Necessary to Fully Pay Back TARP:
- Raise Up to $117 Billion to Repay Projected Cost of TARP:
- President Obama is Fulfilling His Commitment to Provide a Plan for
Taxpayer Repayment Three Years Earlier Than Required: ...
- Apply to the Largest and Most Highly Levered Firms: The fee the
President is proposing would be levied on the debts of financial firms with
more than $50 billion in consolidated assets ... Over sixty percent of
revenues will most likely be paid by the 10 largest financial institutions.
gives the motivation for the tax over and abovethe desire to
recoup the money spent bailing the banks out:
The administration is clear in its desire that this function as an incentive for
banks to get smaller and less leveraged:
The fee the President is proposing would be levied on the debts of financial
firms with more than $50 billion in consolidated assets, providing a deterrent
against excessive leverage for the largest financial firms. By levying a fee on
the liabilities of the largest firms – excluding FDIC-assessed deposits and
insurance policy reserves, as appropriate – the Financial Crisis Responsibility
Fee will place its heaviest burden on the largest firms that have taken on the
most debt. Over sixty percent of revenues will most likely be paid by the 10
largest financial institutions.
What's mystifying, then, is that the fee will only apply until TARP has been
But how much impact will the tax actually have, i.e. is it substantial enough
to serve as a deterrent? Will the levy be large enough to change the behavior of investment banks?
FT Alphaville does some calculations:
A quick, very rough back-of-the-envelope calculation, has Goldman Sachs, for
instance, paying a very conservative (i.e. assuming all of its deposits
are FDIC insured, which is unlikely)
2008 figure of:
($884.55bn – $62.64bn – $27.64bn) * 0.0015 = $1.19bn.
Or, less than a tenth of the $10.93bn the bank spent on compensation and
benefits that year.
Ouch! That's hitting 'em where they hurt.
And if the Lucas critique type effects are stronger than anticipated (i.e.
firms taking actions to avoid the tax), the tax burden will be even smaller.
What else might have been done?
has a list:
In the discussion of taxing banks and bankers, a couple of possibilities have
been floated, some of which can reap short-term political points, others of
which have the potential to promote progressive policies:
Bonus tax – One of the easiest – and politically most
satisfying – would be a tax on excess bonuses. The British exercised
this option on London bankers this past year. Bonuses in the City above a
certain amount were taxed at a 50 percent rate. Banks responded by threatening
to move offshore and – when that threat rang hollow – doubled the bonus pool
they paid out to bankers. The end result was that the bankers whose decisions
led in part to the crisis were financially unharmed, the British government
raised a relative pittance in taxes, shareholders in City banks took a hit (as
the bonus pools were increased at their expense), and the underlying fault lines
in the British banking system remain unaddressed.
Transaction tax – The worst of the options would be a tax on
transactions. As discussed
before, this would merely pour sand in our financial system, breaking it and
slowing economic recovery.
Excess profits tax – A more appealing option would be a tax on
excess profits. A defining aspect of the financial bubble of the last decade was
the fact that financial profits were 40 percent of overall corporate profits –
more than double the slice financials made up of profits in the 1980s. A tax on
these excess profits would rein that in. But while this could be useful, as
Simon Johnson points
out, it would be fairly easy to game, and end up being ineffective.
Tax on assets – A tax on bank assets above a certain amount
addresses not just political sentiment that banks have made it through the
crisis unscathed, but also the fact that banks are too big to fail. Encouraging
banks to “right-size” themselves would make our economy safer from the systemic
risk imposed by banks like Citigroup or Bank of America – which are debilitated
but whose failure would be economically catastrophic.
Excess leverage tax – Taxing the leverage that financial
institutions use to increase returns would allow us to avoid situations like
that faced a year and a half ago when Lehman Brothers – leveraged over 30:1 –
collapsed over the course of a weekend. It would make banks “safer” but would
leave them still too big. In the event a bank were to fail, it would still be a
systemic threat to our economy. This would be a more targeted version than an
assets tax, but it would be harder to implement — definitions of leverage differ
– and if not properly defined would leave hedge funds, insurance companies and
other “non-bank financial institutions” untouched, leading to a crisis like that
perpetuated by Long-Term Capital Management in 1998 or AIG last fall.
I'm not sure I agree with the conclusions on the transactions tax,
particularly when applied to actions such as those described by
Take an extreme example. I have read that a firm such as Goldman Sachs has made
very large profits from having devised ways to spot and carry out favorable
transactions minutes or even seconds before the next most clever competitor can
make a move. Deep pockets in a large market can make a lot of money out of tiny
advantages. (Of course, if you have any such advantage the temptation is
irresistible to borrow a lot of money to enlarge your bets and your profits.
Leverage is good for you, until it isn’t. It is not so good for the system.) A
lot of high-class intellectual effort naturally goes into trying to invent ways
to find those tiny advantages a few seconds before anyone else.
Now ask yourself: can it make any serious difference to the real economy whether
one of those profitable anomalies is discovered now or a half-minute from now?
It can be enormously profitable to the financial services industry, but that may
represent just a transfer of wealth from one person or group to another. It
remains hard to believe that it all adds anything much to the efficiency with
which the real economy generates and improves our standard of living.
But that aside, I would have preferred to recoup the bailout money and increase the safety of the system at the same time through a tax on assets (to get at the too big
to fail problem) and a tax on leverage (to reduce the damage the big banks can cause if they
[More on the proposal:
Wall Street Journal,
Ezra Klein, ,
Jon Chait, Dean Baker, Brookings.]
Posted by Mark Thoma on Thursday, January 14, 2010 at 11:34 AM in Economics, Financial System, Fiscal Policy, Regulation, Taxes |
This is part of Robert Solow's review of How Markets Fail: The Logic
of Economic Calamities written by John Cassidy:
America, by Robert M. Solow: ...[I]n the course of producing and
distributing goods and services, market outcomes generate incomes, wealth,
status, and power. Any modification of market outcomes modifies the allocation
of incomes, wealth, status, and power. So it is no wonder that the discussion
has become thickly encrusted with ideology. And one convenient way to turn
subtle argument into ideology is to create dichotomies where there are
originally fine gradations of more and less. For example: are you for or against
“the free market”?
Today, of course, no one is against markets. The only legitimate questions are:
What are their limitations? Can they go wrong? If so, how can we distinguish the
ones that do from the ones that don’t? What can be done to fix the ones that do
go wrong? When is some regulation needed, how much, and what kind? ...
To begin..., if a market economy is to be advertised as doing an acceptable job, we
need a definition of a good economic outcome.
The standard version says that one allocation of goods and services to
individuals (call it A) is better than another (B) if everyone is at
least as well off (in his or her own estimation) in A as in B, and at least one
person is better off. So there is to be no trading off of one person’s
well-being against another’s. That sounds fair; but notice that judgments about
inequality are ruled out: if everyone is equal but poor in A, and B differs only
by making one person fabulously rich, B is better than A. That sounds a little
less appetizing, but this extreme case underscores the individualistic nature of
the whole exercise: nothing is supposed to matter to anyone but his or her own
access to goods and services. Notice also that, by this definition, most As and
Bs simply cannot be compared: some people are better off and some worse off in A
than in B, so neither is “better” than the other.
The next step is to say that such an allocation is “efficient” if no feasible
allocation can leave everybody at least as well off as they were and make
somebody better off. In other words, there is no “better” allocation. You would
like your economy to lead to an efficient outcome. There are many efficient
allocations, some egalitarian and some just the opposite, and none of them is
better or worse than any of the others. They cannot be said to be equal either;
they are simply not comparable in this language.
It is important to understand what this definition does not mean: it does not
say that any efficient allocation is better, more desirable, than any
inefficient one. Why not? Suppose you happen to gain from the inefficiency and I
happen to lose. Then eliminating the inefficiency does not meet the test for a
“better” state: you lose and I gain. ...
I have insisted on these gory--or dreary--details for a reason. Careful analysis
shows that, if there are no distortions (and under further assumptions, to be
discussed in a moment), a competitive market economy in equilibrium will achieve
an efficient allocation of resources. ... Now comes the layer of ideology: advocates,
some of whom may know better, use the “efficiency of free markets” to argue
against taxes and regulation in general--they are distortions--and in favor of
laissez-faire. Any interference with the free market, they declaim, is ipso
facto a bad thing.
There are at least two things wrong with this ploy. The first has already been
discussed. If a tax or regulation creates an inefficiency, “better” outcomes are
available, but the pre-tax or pre-regulation situation is very unlikely to be
among them. Some group will have gained from the regulation or from the tax and
the use of its revenues. ... Perhaps I
should be explicit also on the other side: many taxes and regulations create
large inefficiencies for very little gain. The point is that no blanket
statement is possible.
The second reason is that the Invisible Hand Theorem is valid only under certain
assumptions, some of which only need to be stated to be seen as very dodgy.
Clarifying those assumptions is the role of Cassidy’s “reality-based economics.”
One of them is the absence of distorting taxes and regulations. Another is the
absence of elements of monopoly, or monopolistic imperfections that fall well
short of monopoly, like catchy brand names or advertising gimmicks that give a
seller some freedom in setting prices, or other barriers to competition. Of
course such imperfections are ubiquitous in every modern economy. The existence
of economies of large-scale production in some industries is already a deal
breaker for the Invisible Hand, and they make some element of monopoly
And that is far from the end of the matter. The informational requirements for
the validity of the Invisible Hand Theorem are considerable..., and they
must be willing and able to behave rationally in the light of it. ...
Yet another requirement is the absence of significant external effects or
“externalities.” ... Again, externalities are ubiquitous in a densely populated
modern economy. ...
Faced with this list of obstacles, one might be tempted to give up on the market
economy altogether. That would be as much of a mistake as the one made by
doctrinaire free marketeers. The real point is that the choice is not either/or,
but when and how much. Many distortions, imperfections, and externalities are
small. To try to correct them all would be intolerably bureaucratic. The large
ones cannot be wished away or ignored for reasons of piety; they cause large
inefficiencies, and they can redistribute income in ways that most people would
reject. And so there is no good alternative to case-by-case decision-making. ...
The market evangelists, who tend to claim more for unregulated markets than
solid theory can justify, are ideologically motivated. They dislike and distrust
governments so much that they overlook the exceptions and the implausible
assumptions, and simply propose the blanket principle that the market knows
best. What is improper in this manner of argument is the frequent casual hint
that it is authorized by economic theory. Nothing so general is ever authorized
by economic theory. ...
It makes interesting reading, but I wish he had asked himself an additional
question. Why, in the marketplace of ideas, have the evangelists
for the unrestricted market attracted so much attention and the “realists” so
little? He argues, fairly convincingly, that the truth does not lie
predominantly on that side of the issue. So is it that believers always make
more effective advocates than skeptics do? Are we for some reason more receptive
to simple answers than to complex ones? Is it that, in the nature of the case,
there is more money backing one side than the other? Perhaps the long postwar
prosperity provided good growing conditions for conservative political and
economic ideology. If so, it will be interesting to see if the current recession
and financial meltdown leave traces in the course of serious economics. ...
It could also be that those with the most wealth and power attribute their
success to their own individual abilities. If so, then theories that attribute
rewards, even at executive compensation levels, to the contributions the
individual makes to society are naturally attractive, far more so than
theories that say the success is due in any way to market imperfections or some
other external factor.
[My take on the topic of market evangelism:
Markets are not Magic.]
Posted by Mark Thoma on Thursday, January 14, 2010 at 12:42 AM in Economics, Market Failure |
Posted by Mark Thoma on Wednesday, January 13, 2010 at 11:02 PM in Economics, Links |
Robert Reich warns Democrats of the political consequences of failing to
enact tough financial reform:
Why Obama must take on Wall Street, by Robert Reich, Commentary, Financial Times:
It has been more than a year since all hell broke loose on Wall Street and,
remarkably, almost nothing has been done to prevent all hell from breaking loose
again. ... Bankers are still making wild bets, still devising new derivatives,
still piling on debt. The big banks have access to money ... cheaply...,
courtesy of the Fed, so bank profits are up and bonuses as generous as at the
height of the boom. ... And, of course, American taxpayers are out some $120bn,
while millions have lost their homes, jobs and savings.
All could be forgiven if the House and Senate ... were about to come down hard
on the Street and if the Obama administration were pushing them to. But nothing
of the sort is happening. ... The bill that has already emerged from the House
is hardly encouraging. ...
What happened to all the tough talk from Congress and the White House early last
year? Why is the financial reform agenda so small, and so late? Part of the
answer is that the American public has moved on. A major tenet of US politics is
that if politicians wait long enough, public attention wanders. With the
financial crisis appearing to be over, the public is more concerned about jobs.
Yet if the president and Congress wanted to, they could help Americans
understand the link between widespread job losses and the irresponsibility on
Wall Street that plunged America into the Great Recession. They could make tough
financial reform part of the answer to sustainable jobs growth over the long
True, financial regulation does not make a powerful bumper sticker. Few
Americans know what the denizens of Wall Street do all day. Even fewer know or
care about collateralized debt obligations or credit default swaps. To the
extent Americans have been paying attention to the details of any public policy,
it has been the healthcare reform bill. But that only begs the question of why
financial reform has not been higher on the agenda of the president and
A larger explanation, I am afraid, is the grip Wall Street has over the American
political process. The Street is where the money is and money buys campaign
commercials on television. Wall Street firms and executives have been uniquely
generous to both parties, emerging as one of the largest benefactors of the
Democrats. Between November 2008 and November 2009, Wall Street doled out $42m
to lawmakers, mostly to members of the House and Senate banking committees and
House and Senate leaders. In the first three quarters of 2009, the industry
spent $344m on lobbying – making the Street one of the major powerhouses in the
Money is powerful. Talk is cheap. ... But the widening gulf between Wall Street
and Main Street – a big bail-out for the former, unemployment checks for the
latter; high profits and giant bonuses for the former, job and wage losses for
the latter; buoyant expectations of the former, deep anxiety and cynicism by the
latter; ever fancier estates for denizens of the former; mortgage foreclosures
for the rest – is dangerous. Americans went ballistic early last summer when AIG
executives got big bonuses after taxpayers had bailed them out. They will not be
happy when Wall Street hands out billions in bonuses very soon. Angry populism
lurks just beneath the surface of two-party politics in America. Just listen to
Sarah Palin or her counterparts on American talk radio and yell television. Over
the long term, the political stakes in reforming Wall Street are as high as the
I think people understand the connection between what happened on Wall Street
and job losses better than he implies (which bolsters his political argument).
Posted by Mark Thoma on Wednesday, January 13, 2010 at 11:43 AM in Economics, Financial System, Politics, Regulation |
In response to the question of whether the Fed's low interest rate policy is responsible for
the bubble, most respondents point instead to regulatory failures of one type or another. Ben Bernake has also made this argument. However, I don't think it was one or the other, I think it was both. That is, first you need something to fuel the fire, and low interest rates provided fuel by injecting liquidity into the system. And second, you need a failure of those
responsible for preventing fires from starting along with a failure to have systems in
place to limit the damage if they do start.
regulators didn't have the systems in place to prevent bubbles, they didn't see the bubble developing until it was too late to prevent major damage, and the systems needed to limit the damage were inadequate,
e.g. there were insufficient limits on leverage and other protections in the
system. By analogy, the Fire Department's inspections were inadequate and there was much more fire risk than anyone thought, they didn't notice the fire until it was already out of control (even though Dean Baker and others had tried to alert them), when they did notice and respond they were initially confused and didn't have the tools they needed to fight the fire or prevent it from spreading, and they hadn't thought to require protections such as automatic sprinkler systems that might have limited the damage.
What fueled the housing bubble? There were three main sources of the liquidity that inflated the bubble.
First, the Fed's (and other central banks') low interest policy added cash to the financial system, second, the high
savings in Asia, particularly China, along with cash accumulations within oil
producing nations, and third, some of the cash was generated endogenously within the
system (e.g. by increasing leverage or by diverting other investments into housing and mortgage markets).
Once the fuel was present, something had to allow the bubble to inflate and then do widespread damage, and that's where the
regulatory failure comes in. But I don't think the regulatory failure matters
much without a large amount of liquidity within the system, and I don't think the large
amount of cash in the system is problematic without the regulatory failures.
I've been making this argument for some time, so is there any support for the idea that bubbles are fueled by excessive liquidity? In the video embedded below of Nobel prize winning economist Vernon Smith that posted today at Big Think, he notes that in the experiments he has conducted that reproduce bubbles in the lab, the existence and size of bubbles depends critically upon the amount of "cash slopping around in the system."
In the video, he also notes that if you ask a different question, why was this
bubble so devastating as compared to the dot.com bubble even though the initial
losses were smaller -- $10 trillion in 2001 compared to $3 trillion in the housing bubble collapse -- you
get a different answer: a failure of regulation. Here, he points to a
failure to impose sufficient margin requirements as the key difference between
the two episodes (I agree that leverage should be limited through margin requirements, and this would have helped to contain the damage, but I would have focused on the markets for complex financial assets rather than down payments on homes).
So I think the bubble itself was driven by "cash slopping around in the
system" that originated from several sources, the Fed being one, and the regulatory failures (such as failing to provide sufficient transparency so that the smoke from the fire could be spotted in time, and failing to limit leverage) allowed the fire to spread rapidly and do major damage.
[More from Vernon Smith: Taking a
Hint from the Twenties, What Would
Hayek Say?, A Little Inflation
Would Do Us Good, Bernanke Didn’t
See It Coming, The Next Wave of Derivatives.]
Posted by Mark Thoma on Wednesday, January 13, 2010 at 12:42 AM in Economics, Financial System, Monetary Policy, Regulation |
Posted by Mark Thoma on Tuesday, January 12, 2010 at 11:03 PM in Economics, Links |
China Rule the World?, by Dani Rodrik, Commentary, Project Syndicate: Thirty
years ago, China had a tiny footprint on the global economy and little influence
outside its borders... Today, the country is a remarkable economic power: the
world’s manufacturing workshop, its foremost financier, a leading investor
across the globe from Africa to Latin America, and, increasingly, a major source
of research and development. ...
All of which raises the question of whether China will eventually replace the US
as the world’s hegemon, the global economy’s rule setter and enforcer. In a
fascinating new book, revealingly titled When China Rules the World,...
Martin Jacques is unequivocal: if you think China will be integrated smoothly
into a liberal, capitalist, and democratic world system,... you are in for a big
surprise. Not only is China the next economic superpower, but the world order
that it will construct will look very different from what we have had under
Americans and Europeans blithely assume that China will become more like them as
its economy develops and its population gets richer. This is a mirage, Jacques
says. The Chinese and their government are wedded to a different conception of
society and polity: community-based rather than individualist, state-centric
rather than liberal, authoritarian rather than democratic. China has 2,000 years
of history as a distinct civilization from which to draw strength. It will not
simply fold under Western values and institutions.
A world order centered on China will reflect Chinese values rather than Western
ones, Jacques argues. ... Before any of this comes to pass, however, China will
have to continue its rapid economic growth and maintain its social cohesion and
political unity. None of this is guaranteed. ... China’s stability hinges
critically on its government’s ability to deliver steady economic gains to the
vast majority of the population. China is the only country ... where anything
less than 8% growth ... is believed to be dangerous because it would unleash
social unrest. ...
The authoritarian nature of the political regime is at the core of this
fragility. ... The trouble is that ... China’s growth currently relies on an
undervalued currency and a huge trade surplus. This is unsustainable, and sooner
or later it will precipitate a major confrontation with the US (and Europe).
There are no easy ways out of this dilemma. China will likely have to settle for
If China surmounts these hurdles and does eventually become the world’s
predominant economic power, globalization will, indeed, take on Chinese
characteristics. Democracy and human rights will then likely lose their luster
as global norms. That is the bad news.
The good news is that a Chinese global order will display greater respect for
national sovereignty and more tolerance for national diversity. There will be
greater room for experimentation with different economic models.
Update: More on China -- Google is considering shutting down
Google.cn, its search engine services in China, due to "attacks and the surveillance" on Google's email accounts (in particular, those held by human rights activists in China) and "attempts
over the past year to further limit free speech on the web."
Posted by Mark Thoma on Tuesday, January 12, 2010 at 06:03 PM in China, Economics |
Bruce Bartlett says it's time for Republicans to give up the idea that tax
cuts are the solution to all our woes:
How Much Did Capital Gains Contribute to 1990s Budget Surpluses?, by Bruce
Bartlett: I like the way Derek Thompson of The Atlantic
op-ed in the Wall Street Journal this morning as a “column/slash/GOP
strategy memo.” Unfortunately, much of what appears on the Journal’s
editorial page these days falls into this category—how else to explain why GOP
political hack Karl Rove has a column there?
What Thompson specifically objects to in the column is its statement that the
budget surpluses of the late 1990s can somehow be attributed largely to a cut in
the capital gains tax rate that was passed by a Republican Congress in 1997 and
signed into law by Democrat Bill Clinton. This is not really a debatable topic
because we have precise data upon which to base our analysis. ...[T]he increase
in capital gains revenues accounted for a little over 20 percent of the total
increase in federal revenues and just over 10 percent of the total change in the
deficit between 1996 and 2000.
In any case, it’s silly to attribute all of the increase in capital gains
revenues to the economic effects of reducing the tax rate. Undoubtedly, some
portion of the increase was due to an unlocking effect as people sold assets
acquired over many years when the rate fell, but obviously there were a lot of
other things going on as well, such as the growth and spread of the Internet.
I think it’s a good idea to keep the capital gains tax rate as low as possible,
but I am tired of hearing Republican partisans attribute virtually magical
powers to changes in the capital gains tax.
Some other bright idea from the op-ed linked above are to campaign on
canceling health care reform, ending help for people hurt by the recession, and to go after Social Security and Medicare. I hope they follow through since that's the key to electoral success - for Democrats. But what I really
liked was this, the top idea on the list:
1) Take a lesson from Ronald Reagan... Reclaim the party's franchise for
economic growth, entrepreneurship, personal liberty, and spending restraint.
This is the route to a big victory in November—and a true service to the nation.
Is he kidding? Economic growth? It's been dismal under Republicans,
especially if you look at the growth in underlying factors such as wages and
jobs (and net out growth from the housing bubble). Personal liberty? Tapping phones, body searches at airports, etc., etc. under Republicans have
decreased, not increased freedom and liberty. And that doesn't even touch upon social issues where their authoritarian instincts also reduce freedom and liberty for some segments of the population. Spending restraint? Has the author
actually looked at the Bush years. (And earmarks should be the focal point of the attack on the budget? That's a minuscule part of the problem.) Oh, and I left out entrepreneurship. I
suppose if undying support for big business translates into support of
entrepreneurship, they have a point, but beyond that what is so special about
their views here? That they oppose the minimum wage, that sort of thing?
The key to electoral success for Republicans appears to be to fool people
into believing things that aren't true (Tax cuts pay for themselves! We're the
party of liberty! We'll reduce the debt!). It's worked before, so I guess it's
hard to blame Republicans for trying it again.
Posted by Mark Thoma on Tuesday, January 12, 2010 at 11:07 AM in Economics, Politics |
Here is an Unofficial List of Pundits/Experts Who Were Wrong on the Housing Bubble:
The housing bubble has precipitated a severe, and possibly catastrophic,
economic crisis, so I thought it would be useful to put together a list of
pundits and experts who were dead-wrong on the housing bubble. They were the
enablers, and deserve to be held accountable. People also need to know (or be
reminded of) which pundits/experts should never be listened to again.
The list includes only pundits and (supposed) experts. That means the list
doesn't include policymakers such as Alan Greenspan and Ben Bernanke, because
however wrong they may have been, policymakers—and especially Fed chairmen—are
undeniably constrained in what they can say publicly. I strongly suspect
that both Greenspan and Bernanke honestly believed that there was no housing
bubble, but alas, we'll never know for sure. The list also doesn't include
pundits/experts who were wrong only about the
fallout of the collapse of the housing bubble—that is, the extent to
which the collapse of the housing bubble would harm the economy.
Many of the names on the list won't shock anyone, I'm sure. And FWIW, a few of
the pundits seemed to deny the existence of the housing bubble simply because
argued that there was a housing bubble, and they absolutely hate
Krugman. Unfortunately (for our economy), Krugman was right—again. ... [list of dead-wrong pundits/experts]
Posted by Mark Thoma on Tuesday, January 12, 2010 at 01:17 AM in Economics, Housing |
Alan Blinder is not very optimistic about the prospects for meaningful
When Greed Is Not Good, by Alan S. Blinder, Commentary, WSJ: ...[W]hen the
Treasury and Federal Reserve rushed in to contain the damage [from the financial
crisis], taxpayers were forced to pay dearly for the mistakes and avarice of
others. If you want to know why the public is enraged, that, in a nutshell, is
American democracy is alleged to respond to public opinion, and incumbents are
quaking in their boots. Yet we stand here in January 2010 with virtually the
same legal and regulatory system we had when the crisis struck in the summer of
2007, with only minor changes in Wall Street business practices... That's both
amazing and scary. Without major financial reform, "it" can happen again.
...[H]istory shows that financial markets have a remarkable ability to forget
the past and revert to their bad old ways. And we've made essentially no
progress on lasting financial reform.
Perhaps reformers just need more patience. The Treasury made a fine set of
proposals that the president's ... agenda left him little time to pursue—so far.
The House of Representatives passed a pretty good financial reform bill late
last year. And while there's been no action in the Senate as yet, at least they
are talking about it. ...
But I'm worried. The financial services industry, once so frightened that it
scurried under the government's protective skirts, is now rediscovering the
virtues of laissez faire and the joys of mammoth pay checks. Wall Street has
mounted ferocious lobbying campaigns against virtually every meaningful aspect
of reform, and their efforts seem to be paying off. ...
My fear is that a once-in-a-lifetime opportunity to build a sturdier and safer
financial system is slipping away. Let's remember what happened to health-care
reform ... as it meandered toward 60 votes in the Senate. The world's greatest
deliberative body turned into a bizarre bazaar in which senators took turns
holding the bill hostage to their pet cause (or favorite state). With zero
Republican support, every one of the 60 members of the Democratic caucus held an
effective veto—and several used it.
If financial reform receives the same treatment, we are in deep trouble, both
politically and substantively.
To begin with the politics, recent patterns make it all too easy to imagine a
Senate bill being bent toward the will of Republicans—who want weaker
regulation—but then garnering no Republican votes in the end. We've seen that
movie before. If the sequel plays in Washington, passing a bill will again
require the votes of every single Democrat plus the two independents. With veto
power thus handed to each of 60 senators, the bidding war will not be pretty.
On substance,... health care at least benefited from broad agreement within the
Democratic caucus on the core elements... The fiercest political fights were
over peripheral issues like the public option ... and whether Nebraskans should
pay like other Americans...
But financial regulatory reform is not like that. Every major element is
contentious... What's worse, several components would benefit from international
cooperation... This last point raises the degree of difficulty substantially. No
one worried about international agreement while Congress was writing a
All and all, enacting sensible, comprehensive financial reform would be a tall
order even if our politics were more civil and bipartisan than they are. To do
so, at least a few senators—Republicans or Democrats—will have to temper their
partisanship, moderate their parochial instincts, slam the door on the
lobbyists, and do what is right for America. Figure the odds. Gordon Gekko
I've been arguing that the longer that congress waits to move on financial
reform, the less likely it is that reform will be meaningful and effective. For
example, here's my
response to "Don't Let the Cure Kill Capitalism," by Gary Becker and Kevin
Murphy. They were worried that if we move too fast on regulatory reform, we will
go overboard and undermine all the wonderful things that the financial sector
has done for our economy:
When the golden goose is too wild for its own good, you can clip its wings
without killing it.
While it's possible that regulation will go overboard in response to the crisis,
there are powerful interests that will resist regulatory changes that limit
their opportunities to make money (and Nobel prize winning economists willing to
back them up), so my worry is that regulation will not go far enough,
particularly with people like Kashyap and Mishkin
arguing that we should wait for recovery before making any big regulatory
changes to the financial sector. They may be right that now is not the time to
change regulations because it could create additional destabilizing uncertainty
in financial markets, and that waiting will give us time to see how the crisis
plays out and to consider the regulatory moves carefully. But as we wait,
passions will fade, defenses will mount, the media will respond to the those
opposed to regulation by making it a he said, she said issue that fogs things up
and confuses the public as well as politicians, and by the time it is all over
there's every chance that legislation will pass that is nothing but a facade
with no real teeth that can change the behaviors that got us into this mess.
That was last March. Worries that moving on reform will undermine the
stability of the financial sector have faded considerably, so even if you
thought the stability argument was strong enough to overcome the arguments for
moving forward back then (I didn't), that objection is now hard to defend.
Will the reform we get will be meaningful and effective? It's hard to have a
lot of faith in Congress, I certainly agree with Blinder on that. But we have to do something, and the longer it takes to complete the reform process -- the more we give in to the interests of those seeking to delay reform and undermine the process -- the more likely it is that little
Posted by Mark Thoma on Monday, January 11, 2010 at 11:07 PM in Economics, Financial System, Politics, Regulation |
Posted by Mark Thoma on Monday, January 11, 2010 at 11:03 PM in Economics, Links |
I have an op-ed in the Oregonian (on state ballot measures to fill a hole in the state's budget).
Posted by Mark Thoma on Monday, January 11, 2010 at 11:43 AM in Economics, Oregon |
Europe shows that social democracy does not undermine economic dynamism and
Learning From Europe, by Paul Krugman, Commentary, NY Times: As health care
reform nears the finish line, there is much wailing and rending of garments
among conservatives. And I’m not just talking about the tea partiers. Even
calmer conservatives have been issuing dire warnings that Obamacare will turn
America into a European-style social democracy. And everyone knows that Europe
has lost all its economic dynamism.
Strange to say, however, what everyone knows isn’t true. ... The real lesson
from Europe is actually the opposite of what conservatives claim...
It’s true that the U.S. economy has grown faster than that of Europe for the
past generation. Since 1980 — when our politics took a sharp turn to the right,
while Europe’s didn’t — America’s real G.D.P. has grown, on average, 3 percent
per year. Meanwhile, the E.U. 15 ... has grown only 2.2 percent a year. America
Or maybe not. All this really says is that we’ve had faster population growth.
Since 1980, per capita real G.D.P. — which is what matters for living standards
— has risen at about the same rate in America and in the E.U. 15: 1.95 percent a
year here; 1.83 percent there.
What about technology? In the late 1990s you could argue that the revolution in
information technology was passing Europe by. But Europe has since caught up in
many ways. ...
And what about jobs? Here America arguably does better: European unemployment
rates are usually substantially higher..., and the employed fraction of the
population lower. But if your vision is of millions of prime-working-age adults
sitting idle, living on the dole, think again. In 2008, 80 percent of adults
aged 25 to 54 in the E.U. 15 were employed... That’s about the same as in the
United States. Europeans are less likely than we are to work when young or old,
but is that entirely a bad thing?
And Europeans are quite productive, too: they work fewer hours, but output per
hour in France and Germany is close to U.S. levels.
The point isn’t that Europe is utopia. Like the United States, it’s having
trouble grappling with the current financial crisis. Like the United States,
Europe’s big nations face serious long-run fiscal issues... But taking the
longer view, the European economy works; it grows; it’s as dynamic, all in all,
as our own.
So why do we get such a different picture from many pundits? Because according
to the prevailing economic dogma in this country — and I’m talking here about
many Democrats as well as essentially all Republicans — European-style social
democracy should be an utter disaster. And people tend to see what they want to
After all, while reports of Europe’s economic demise are greatly exaggerated,
reports of its high taxes and generous benefits aren’t. Taxes in major European
nations range from 36 to 44 percent of G.D.P., compared with 28 in the United
States. Universal health care is, well, universal. Social expenditure is vastly
higher than it is here.
So if there were anything to the economic assumptions that dominate U.S. public
discussion — above all, the belief that even modestly higher taxes on the rich
and benefits for the less well off would drastically undermine incentives to
work, invest and innovate — Europe would be the stagnant, decaying economy of
legend. But it isn’t.
Europe is often held up as a cautionary tale, a demonstration that if you try to
make the economy less brutal, to take better care of your fellow citizens when
they’re down on their luck, you end up killing economic progress. But what
European experience actually demonstrates is the opposite: social justice and
progress can go hand in hand.
Posted by Mark Thoma on Monday, January 11, 2010 at 12:42 AM in Economics, Productivity, Social Insurance |
Richard Green notes another case of conservatives trying to support their
ideological preconceptions using evidence that doesn't withstand closer
examination. The larger goal here is to pin the blame for the housing crisis on
the government, to avoid further regulation of the financial industry, and to reinforce their faith in free markets. The intent is also to
pin the blame on Democrats and deflect blame away from deregulation supported by
Republicans which, in the view of free market ideologues, could not have been
responsible for the crisis:
The biggest stretch I have yet seen for blaming Fannie for the world's problem,
by Richard Green: Micky Kaus, who seems to have trouble sleeping at night
for fear that some below median income person somewhere might actually benefit
attacks Jim Johnson, former CEO of Fannie Mae, for contributing to our
The problem is that Johnson ran the company from 1991-1998; I am guessing that
few mortgages from his tenure are even around anymore, and if any are, their
balance is so much lower than the value of the house supporting them (house
prices are still much higher than in 1998, and the loan would have amortized a
lot), that the incentive to default is non-existent.
Of course, in the piece he approvingly quotes Peter Wallison, an AEI "scholar"
who never met a bank he didn't like.
Over the years, Fannie has done plenty of things not to like. But jeez!
Posted by Mark Thoma on Monday, January 11, 2010 at 12:33 AM in Economics, Housing, Regulation |
Posted by Mark Thoma on Sunday, January 10, 2010 at 11:02 PM in Economics, Links |
An argument that we don't need a "a major new stimulus program" devoted to
A job-rich US recovery is still plausible, by Robert Barbera and Charles Weise,
Commentary, Financial Times: Only one short year ago,
the world was staring depression in the face. Now the economy is recovering, but
many commentators are warning of a “jobless recovery” of the kind that followed
the last two recessions, in 1990-91 and 2001. ...
We believe that these meager expectations will turn out to be wrong, in large
part because they mischaracterize how employment has swooned over the past two
years. ... Our
more optimistic outlook is based on a ... theory of why payrolls were cut
so aggressively. Because of the turmoil in financial markets in autumn 2008,
companies faced a severe cash crunch. As a result, they attempted to hoard cash
in any way they could: they slashed order books, ran down inventories at an
unprecedented pace and cut short-term borrowing. And they slashed payrolls. The
drastic reduction in inventories and payrolls was not, in other words, a result
of restructuring: it was symptomatic of panic, the same panic that caused the
massive sell-off in equities, corporate bonds and mortgage-backed securities.
Nearly all projections for the US economy envision a sharp reversal for
inventories in the coming quarters. We argue that the recovery in jobs should
mirror the restocking of inventories because the collapse in employment and
inventories during the recession had the same source in panic-driven cash
The same logic can be applied to productivity. Using consensus expectations for
current-quarter real GDP we estimate that the last three quarters of 2009
registered an average rate of advance in labor productivity of almost 7 per
cent. We estimate that productivity is now above its normal level, so reversion
to the mean over the next year implies a productivity growth rate substantially
The following scenario then appears quite plausible. Real GDP grows at a rate of
3.8 per cent in 2010, with productivity growth of 0.7 per cent and a modest
increase in average weekly hours. In such a world, employment growth would
average 2.2 per cent. This translates to an average of about 240,000 jobs per
This scenario, while wildly optimistic compared with current consensus
forecasts, amounts to a weak recovery by historical standards. In the first full
year of recovery after the 1981-82 recession, GDP growth was more than 7 per
cent. Following the recession of 1974-75, growth was 6 per cent. It is not hard
to imagine growth over the next year well in excess of our 3.8 per cent
forecast, with jobs growth in the 300,000 per month range. We are not endorsing
that as our forecast but we believe it is as likely as the jobless recovery
predictions that define the conventional wisdom.
Barack Obama therefore needs to be patient. A modest fiscal stimulus focused on
aid to the states would be a helpful insurance policy against a further
weakening in the economy. But the trends are in the administration’s favour, and
a major new stimulus program should be resisted. ...
They're not even willing to "endorse" their own forecast? They do implicitly define a forecast since they say the optimistic and pessimistic outcomes are equally likely. So why does a 50-50
chance that there will, in fact, be a intolerably slow recovery in the job
market mean we should stand by and do nothing while we hope the coin comes up heads rather than
tails? The average of the two forecasts - the most likely outcome by their
reckoning - is not very rosy for labor and calls for something to be done.
There are lags between policy changes and changes in employment, and that
means it's much easier to back off of action initiated now if things turn out to
be better than expected than it is to do something later if the optimistic
scenario fails to materialize. That is, the risks of failing to do anything and
then realizing the pessimistic high unemployment outcome are much larger than doing something now
and then having things turn out better than expected. Even on their own terms, I
don't think their conclusion that we shouldn't devote any resources to job creation (other than protecting jobs through "modest" help for state and local governments) follows.
In any case, Dean Baker countered the part of the argument related to productivity before it was even made. Here's his
response to similar claims about robust job growth:
Silliness on Productivity, by Dean Baker: In discussing the December jobs
report the Post repeated some of the silliness about productivity that is
currently circulating among people who imagine themselves to be knowledgeable
about the economy. It told readers that:
Employers slashed positions more dramatically in the past two years, squeezing
more productivity out of remaining workers. That has led many analysts to expect
a substantial increase in the number of jobs in the early months of 2010, as
companies must hire again just to keep up with demand for their products.
Actually, productivity growth averaged 2.6 percent annually over the last two
years. This is somewhat more rapid than the growth rate over the prior two years
but it is below the 2.9 percent average annual growth rate in the decade from
1995 to 2005. In other words, there is nothing extraordinary about the recent
rates of productivity growth so there is no special reason for believing that a
burst of hiring is imminent.
In case you somehow missed it, I'd be happy to be wrong, but I am not
anticipating a sudden burst of job growth anytime soon, and this
worry is not new by any means.
Posted by Mark Thoma on Sunday, January 10, 2010 at 01:26 PM in Economics, Fiscal Policy, Productivity, Unemployment |
Uwe Reinhardt wants to know if you think community rating in health insurance is fair:
Is ‘Community Rating’ in Health Insurance Fair?, by Uwe E. Reinhardt, Economix:
One controversial feature of the health reform bill winding its way through
Congress is “community rating.” ...
[C]ommunity rating has long been widely accepted in the United States ... and in
virtually every other industrialized country. “Community rating” refers to the
practice of charging a common premium to all members of a heterogeneous risk
pool who may have widely varied health spending for the year. It inevitably
makes chronically healthy individuals subsidize with their insurance premiums
(rather than through overt taxes and transfers) the health care used by
chronically sicker individuals. ...
We can use the stylized numerical example in the table below to illustrate... To
make the example textbook-simple, we assume that individuals either will not
have medical bills at all in the coming year or, if they do, these bills can
have only one of three distinct sizes. In real life, of course, individuals
would be spread over medical bills of many more different sizes. We assume
further that there are two distinct cohorts, A and B. Once again to keep it
simple, let’s assume they are of equal size — e.g., 100,000 members each —
although this is not a crucial assumption. ...
If cohorts A and B were perfectly segregated by expected risk, as we assume
here, then within each cohort it would be impossible to predict which member
would end up in which row of the table. In the real world, an unregulated,
price-competitive market for individually sold health insurance will in fact
tend to segregate populations into such pure risk classes.
To continue with our illustration, suppose that the members of each risk cohort
decide to form a cooperative into which each member will pay a common premium P
at the beginning of the year, after which the pool will pay 100 percent of any
medical bill incurred. ...
Let’s focus strictly on the pure premium, that is, the money needed to pay
claims. Call that pure premium X. ... For risk pool A, for example, actuaries
would calculate X as
X = (.85)$0 + (.11)$5,000 + (.03)$30,000 + (.01)$100,000 = $2,450.
If every member of cohort A paid $2,450 into the risk pool and the actuary had
been accurate in predicting ... medical bills of different sizes, then the sum
of paid-in premiums would be just large enough to pay the medical bills of any
member requiring care during the year... For risk pool B, the similarly
calculated pure premium would be $6,600.
Now imagine a country half of whose citizens fall neatly into risk cohort A and
the other half into risk cohort B. The country’s leaders would sincerely like to
assure citizens of a “fair” health insurance system. But what would be “fair”?
Would it be “fair” that the healthy individuals of cohort A pay a pure insurance
premium of only $2,450 a year, while the sicker citizens in cohort B must pay
$6,600? This is, after all, how health insurance now is priced in most states
Or does “fairness” require that the two groups be merged into one large national
risk pool A & B, whose risk profile is shown in the right-most column of the
table. If each member of this merged pool is to pay the same pure premium, then
the latter will have to be $4,525 to break even. Such a premium would be said to
be “community rated” over these two distinct risk pools.
With a community-rated premium for the two risk pools, it would be predictable
ex ante that, on average, members of cohort A would be subsidizing members in
cohort B. We can infer the degree of subsidy from the premiums..., the
community-rated premium of $4,525 will cost members of low-risk cohort A $2,075
more and the sicker members of cohort B $2,075 less than they would have paid in
a risk-segregated market. Is that “fair”? ...
I think it's fair to include the medical risks an individual cannot control
in the common pool, e.g. genetic conditions. The harder question is about risks
that individuals have some but generally not perfect control over through their
choices. Higher premiums would encourage healthier behavior, but it's not clear
to me that the financial incentive that higher premiums provide would be enough
to change behavior, and it would be hard in any case to sort the genetic
predisposition from the individual's choices for something like heart disease.
So even in this case, I'd prefer to combine people into a common pool, and then
use other means besides high premiums to encourage healthy choices (though a higher fee for, say, smokers would be hard to oppose).
I have a question. If not having to pay higher health insurance premiums
encourages unhealthy lifestyles, then it must be true that Europe, Canada, etc.
have much bigger problems with diseases where individual choice matters. I don't
think that's true in general, though smoking might be a counterexample (however, precedence for some procedures within national health care systems can depend on factors such as whether an individual smokes
or drinks, so there is a penalty in these systems for some behaviors). But I don't know for sure what the data say on this
topic. Can anyone help with this? [In comments, dWj notes
that premiums for health care in the US obtained through employers, the usual case, do not vary with individual behavior, and the penalty faced by the self insured/uninsured is not large, so there's no reason to expect much of difference.]
Posted by Mark Thoma on Sunday, January 10, 2010 at 11:52 AM in Economics, Health Care |
Posted by Mark Thoma on Saturday, January 9, 2010 at 11:01 PM in Economics, Links |
Robert frank argues that libertarians ought to endorse government
intervention to reduce the damage from greenhouse has emissions:
Of Individual Liberty and Cap and Trade, by Robert Frank, Commentary, NY Times:
Some people oppose measures to limit greenhouse gases because they believe that
global warming is a myth..., but their influence has been steadily waning.
The biggest remaining obstacle is disagreement over the legitimacy of proposed
solutions. At the heart of attempts to curb carbon dioxide emissions are two
related proposals: taxation of those emissions and a system of tradable emission
permits... Both have been attacked as unacceptable
restrictions on individual liberty. The attacks have ... been pressed with
particular insistence by conservatives and libertarians.
It’s a puzzling objection, because both proposals are squarely consistent with
the framework advocated by conservatives’ patron saint regarding ... private
actions that harm others. That would be Ronald H. Coase, professor emeritus at
the University of Chicago and the 1991 Nobel laureate in economics, who will
turn 100 this year.
Mr. Coase ... summarized his framework in a 1960 paper titled “The Problem of
Social Cost”... He stressed that actions with harmful side effects — negative
externalities, in economists’ parlance — are ... best solved ... not by chanting
slogans about rights and freedoms, but by steering mitigation efforts to those
who can perform them most efficiently. ... Mr. Coase argued that whenever it was
practical for affected parties to forge private agreements among themselves,
they would have strong incentive to use the least costly solution...
His paper provoked a firestorm of criticism, based on the impression that he was
claiming that government didn’t need to regulate activities that cause harm to
others. As a closer reading makes clear, however, this could not have been his
view, especially with respect to activities like global pollution. ... Because
of the wide variety of activities involved and the large number of people
affected, there is no practical way to negotiate private solutions. In such
cases, Mr. Coase suggested, government regulators should try to mimic solutions
that people would have adopted on their own if negotiations had been practical.
I chatted with Mr. Coase briefly last week, and he is still following these
issues. He agreed that both taxes and tradable permits satisfy his criterion of
concentrating damage abatement with those who can accomplish it at least cost.
... Although both proposals pass muster within the Coase framework, conservatives
remain almost unanimously opposed to the cap-and-trade proposal approved last
year in the House... Much of this opposition is rooted in a passionate distaste
for “social engineering”...
But social engineering is just another term for collective action to change
individual incentives. And unconditional rejection of such action is flatly
inconsistent with the Coase framework that conservatives have justifiably
In the case of global warming, markets fail because we don’t take into account
the costs that our carbon dioxide emissions impose on others. The least
intrusive way to have us weigh those costs is by taxing emissions, or by
requiring tradable emissions permits. Either step would move us closer to the
conservative/libertarian gold standard — namely, the outcome we’d see if there
were perfect information and no obstacles to free exchange. ...
Posted by Mark Thoma on Saturday, January 9, 2010 at 03:33 PM in Economics, Environment, Regulation |