TOPICS IN POLITICAL ECONOMY

THE HEALTHCARE DEBATE: THE PUBLIC OPTION

Bob Samuelson, the sharpest economic columnist in the country (at the Washington Post, no less), has written an incisive and devastating analysis of the "public option" proposal in pending healthcare legislation. 

He calls it "an exercise in political avoidance: it pretends to control costs and improve access to quality care when it doesn't." 

If you are at all interested in how this major policy debate is going to be settled, read Bob's column - and send it around to others.

WHERE ARE THE TRUE REFORMERS?

The real problem in Washington, Holman Jenkins reminds us in a grim column in today's Wall Street Journal, is: 

. . . the giant riverboat gamble that Washington can save the economy by doing what comes naturally—spending money carelessly, creating massive new entitlements without funding them, dishing out cheap credit to politically favored sectors, telling business people where and how to invest.

Current healthcare legislation working its way through the Congressional sausage factory is described by Jenkins as "the equivalent of climbing aboard a train about to plunge into a canyon and deciding what it really needs is a bomb on board," thanks to the expansion of coverage paid for largely with flimsy assumptions about "cost savings."

Jenkin's wishes that Larry Summers and Ben Bernanke would step up and try "to steer Team Obama off its suicide mission."  

I would note that Council of Economic Advisers Chair Christina Romer recently observed, there is a "budgetary catastrophe looming for our children and grandchildren."  Was the White House listening?

There are plenty of good, robust proposals for real reform ready for implementation, Jenkins reminds us:

The hopper is hardly barren of ideas, like raising the retirement age, enacting the Breaux Commission's Medicare proposals, instituting a flat tax and eliminating the tax distortions that every serious economist knows contributed to the housing bubble and the health-care bubble.

 

Anybody listening?

 

 

PRESIDENT OBAMA AND THE COLA: PANDERER IN CHIEF

On October 5th, I commented - critically - on the legislation moving through Congress to award Social Security recipients a special $250 payment.  Due to a small projected decline in inflation for 2009, there will be no cost-of-living  (COLA) increase in Social Security monthly stipends for 2010.

Now President Obama has come out in favor of this $13-$14 billion post-Christmas present (financing unspecified by the White House), thus joining the pandering politicians in Congress at throwing money at what might be called "the grasping geezers." 

The original legislation which provided for COLAs said that upward adjustments in COLA would always be made (my social security check went up 5.8% this year), but if prices declined (as in 2009, for the first time since the COLA was instituted) downward adjustments were ruled out. Talk about a sweetheart deal.  But not sweet enough, apparently, especially for frequent voters. 

The White House says that seniors are among those "hardest hit by this recession."  In a class with automobile workers??  The  Presidential statement points to the decline in home values, but ignores the reality that, so long as seniors stay in their current residence, the fluctuation in home values has no impact on them - only their heirs. Yes, maybe their retirement savings accounts have fallen in value - but so have those of "juniors."  And juniors didn't get a 5.8% increase in Social Security stipends this year.

Now that the President has endorsed it, the $250 pandering payment is probably unstoppable in Congress, despite a growing sense that Federal spending is on a suicidal track. Only a resolute, far-sighted leader in the White House could have mustered the political courage to derail a craven, populist proposal.

But we don't have a lion in the White House; we have a free-spending fox. 

SOCIAL SECURITY COLAS: THE PANDERING POLITICIANS AT WORK

Here's a letter I have just sent one of my Senators.  The leaders of this classic example of the mob at work are Senator Sanders from Vermont and Congressman Pete DeFazio of Oregon.  The official title of the legislation is The Emergency Senior Citizens Relief Act (H.R. 3597 in the House, S. 1685 in the Senate). If you agree with the thoughts, send something similar to your Senators and Congressman - or, better yet, your newspaper.

Dear Senator Casey:

I understand you are a co-sponsor of legislation to provide a one-time payment of $250 to all Social Security recipients, since there will be no cost-of-living (COLA)  increase for them this year.  Your proposal would increase federal outlays by $14 billion.

I am one of those potential recipients. And I strongly oppose your proposal. The reason there is no COLA this year is because consumer prices have declined. When consumer prices increase, my Social Security check increases; but it doesn’t decrease if prices decline. That was the deal when Congress wrote COLA into the Social Security System in 1975.  A lot of working people would say that’s pretty good deal – if they’re still working.

You argue that medical costs keep going up.  But most Social Security recipients are on Medicare, which insulates them from the bulk of such cost increases.

My bus fare hasn’t gone up in years: I pay nothing, thanks to my senior pass.

You say you will make up the $14 billion in handouts by increasing Social Security taxes on the working rich.  Sounds very familiar: robbing Peter at work to pay Paul at home.

Seniors have been insulated from economic hardship more than any other age group during this economic recession.

Senator, stop pandering to us.

  Sincerely,

    James B. Burnham

THE PERILS OF MODELING: FINANCE AND CLIMATE

The 10-year plateau in global temperatures is beginning to draw considerable attention.

A recent New York Times article, "Momentum on Climate Pact is Elusive," documents the fears of global warming pessimists that the prospects for "action" are weakening in the face of hard data. Some pessimists are also warning that the relative stability in temperatures could prevail for another decade due to "cyclical shifts in the oceans" - but rest assured, their models promise us that the long-run outlook is decidedly grim. 

Modelers' Hubris. The faith that such forecasters have in their models would be touching if it were not so dangerous.  While the most reputable forecasters admit to the vast complexities and unknowns in modeling global climate patterns, that doesn't stop many of them - and their publicists, like Al Gore - from calling for massive economic dislocations designed to forestall modest possible increases in temperature.

You would think that such individuals would take a few lessons from the recent travails of chastened hedge fund managers and the  financial market modelers and quantitative analysts who fed them great ideas.  They, too, used massive computers and reams of data, along with sometimes plausible theories, to forecast future trends in stocks, bonds, options, and the like.  They even had the history of  multi-billion dollar collapse of hedge fund LTCM in 1998 to warn them of "long tails" in statistical distributions.

When it comes to climate modeling, while many of the data time series are longer than those of financial modelers, they are subject to much more "measurement error." The daily record of Interest rates and stock prices is a lot more certain and precise than global average temperatures in the 19th or 20th centuries.

Of even greater importance, consider the problems in measuring the amount of solar radiation that reaches the earth. While climate pessimists credit the sun spot cycle with a very modest impact on the earth's temperature, some reputable scientists argue that it has a major effect (see Scafetta and West, "Is Climate Sensitive to Solar Variability?" Physics Today, March 2008).

 According to NASA, we only have modestly accurate data on solar radiation since 1979, when the first satellite designed to take such measurements was launched.  Even now, while we can measure solar radiation to within a few watts (per square meter of earth surface area), the measurement error is greater than the natural fluctuation which takes place over an 11-year sun spot cycle.

Wait Til Next Year! A mini-test of sorts is now underway, since the current minimum in solar sun spot activity is the deepest in a century, according to NASA.  By itself, that would suggest less radiation is reaching the earth, and cooler times are ahead.

So, rather than rush to judgment with coercive "cap and trade" regimes and similar steps to reduce carbon emissions, let's simply asked the climate modelers to give us hard forecasts for the next five years, backed up with their own money via bets in Las Vegas (financed by home equity loans and hedge funds?). 

FINANCIAL MARKETS, THE G-20 AND UNINTENDED CONSEQUENCES

One year ago, following the collapse of Lehman Brothers, the $3.4 trillion money market fund industry essentially froze up when The Reserve Fund "broke the buck."  That was the real start of the financial crisis, as this blog has suggested in the past.

The best detailed description how this event caught the Fed and the Treasury Department off-guard is now the recent extensively researched article by Bloomberg reporters.

There is a lesson to learn (or relearn, if you have forgotten three hundred years of financial market history) from the article: in a complex financial world with many players, an unexpected, catalytic event can lead to a rush for liquidity which threatens to overwhelm not just all the players, but the customers and spectators as well.

The real danger now is that governments will over-react with poorly thought-out legislation and regulation that will create even greater problems down the road.

While some of the suggestions for reform are sensible (such as requiring larger banks to hold more capital), the list of "further steps" that the G-20 heads of state and ministers are supposed to consider in Pittsburgh later this month contains the potential for substantial amounts of mischief and unintended consequences, e.g. "global standards on pay structure" and "oversight for systemically important firms."  (The latter item has taken on concrete form in the proposed legislation to have the Federal Reserve designate "Tier I" firms, as discussed in my previous blog.)

At Least Lehman Brothers Was Allowed to Fail. Despite much talk of the "mistake" in letting Lehman Brothers fail, there are some astute observers (see Niall Ferguson in yesterday's Financial Times) who point to that event as a much-needed reminder that very large institutions can fail - and all managers, shareholders and creditors of other financial institutions should keep this always in mind.

Never permitting another Lehman-type bankruptcy is the worst possible policy goal of financial reform.  As Ferguson points out, "the real tragedy is that the failure of Lehman has left Wall Street's survivors both bigger in relative terms and more secure politically . . . if only we had learnt from Lehman that no bank should be 'too big to fail', we might still have a real capitalist system, instead of the state-guaranteed monstrosity that is the real legacy of last year's crisis."

Ferguson is a bit too gloomy, and no doubt the attempt to ensure "a level playing field" around the globe will slow down truly ill-advised initiatives. But never underestimate the ego of determined politicians to "do something."

REAL REGULATORY REFORM: FOR MONEY MARKET FUNDS

 

The Securities and Exchange Commission is supposed to look out for the small investor.  So, how did it end up precipitating the collapse, last September, of the entire money market fund (MMF) sector and the need for the U.S. Treasury to step in and guarantee $3.4 trillion in shares?

 

Take a look at Joe Nocera's outstanding piece, "The Risk in Money Funds," in today's New York Times business section, (normally not a solid source for economic and financial analysis). The massive run on all MMF shares was precipitated by The Reserve Fund's "breaking the buck" (marking down the value of its shares from $1.00) because of its holdings of $785 million in bankrupt Lehman Brothers' commercial paper. The run was aborted by the U.S. Treasury Department's guarantee of the $3.4 trillion in outstanding shares last September. 

 

The SEC Sponsors a Shadow Banking System. Originally, MMFs were not allowed to design and market their shares around a stable $1 @ share net asset value.  However, in the late 1970s the investment companies persuaded the SEC to let them follow accounting rules and marketing pitches that permitted them to do so under almost any conditions - and sell them, in effect, as alternatives to bank checking accounts, complete with check writing features - "turbocharged" bank accounts, as Nocera describes them. 

 

In the high interest rate environment of the 1980s, the MMFs prospered mightily. By the 1990s, they had become a parallel banking system, providing billions of dollars of short-term credit in competition with commercial banks. To further confidence in MMFs, the SEC started, with industry support, to mandate investments only with top credit ratings from the likes of Moody's and Standard & Poor's. Then, during the subprime mortgage boom, they plunged, indirectly, into that lending business, too, which the credit rating agencies facilitated with plenty of AAA marks on mortgage-backed securities.

 

In short, the MMFs had everything but FDIC insurance - and now, as a result of last September, they have demonstrated that Washington will guarantee $1 @ share if another run threatens.

 

Now What?  We can't rewrite history - but we can rewrite regulation so that the true riskiness of MMFs is transparent to investors, and reduce the likelihood of another government bailout.  As Nocera points out, the single best way to do that is to undo the SEC regulations that let them price and market their shares under almost any conditions at $1.00. Insist that MMF shares trade the way all other mutual fund shares trade.

 

Another action to make investors more conscious of risk would be to remove the mandate that MMFs invest only in SEC-defined "eligible" securities, and force fund managers to pay more attention to the creditworthiness of their investments. (S&P gave Lehman Brothers' short-term paper their highest credit rating until the day before that firm declared bankruptcy.)

 

Real reform of the money market sector means it will not enjoy all of the SEC-bequeathed competitive advantages they have had in the past.  But if the agency is more concerned about investor protection than the MMF's market share of  deposits v.v. commercial banks and savings institutions, it will take the steps advocated above. Otherwise, we might just as well force the conversion of MMFs into FDIC-insured banks (as Paul Volcker, for example, has advocated).

WHOLE FOODS AND HEALTHCARE: REALITY V. IDEOLOGY

There is a wonderful tempest in an (organic) teapot currently swirling around Whole Foods, the leading purveyor of organic products and assorted liberal bloggers.  It demonstrates clearly the yawning gap between knee-jerk, ideological thinking and the way the world is actually made a better place.

The CEO of Whole Foods, John Mackey wrote an op-ed for the Wall Street Journal describing his company's high-deductible health insurance plan.  He also suggested various ways in which less government and more individual choice could result in a fairer, less costly system for everyone. The Wall Street Journal's headline writer entitled the piece, "The Whole Foods Alternative to ObamaCare."

Mackey pointed to his own Company's plan, developed painfully over the past six years, as a example of what could be done under existing federal and state  law to maximize choice and employee satisfaction. (See his 2004 talk to the State Policy Network for illuminating details, including about how employees votes help to define the benefit package.)

For the cardinal sin of doubting that the federal government is the solution to health care's problems, the liberal blogosphere has descended upon Mackey with an outpouring of nastiness and a call to boycott the leading purveyor of granola to the literati of the left. At last count, his company's website forum on the issue had over 14,000 posts. 

By all accounts, Whole Foods treats its generally younger workers very well, as its low employee turnover rate would suggest. Its high deductible plan is something that many organizations have been moving towards in recent years, with generally positive results for both employees and employers. It would be nice to think that such facts should help shape the debate about how to reform health care.  

Read Mackey's op-ed  - and go buy a few granola bars from the nearest Whole Foods.

 

TIER 1 AND "TOO BIG TO FAIL" - BEWARE THE LAW OF UNINTENDED CONSEQUENCES

 

The problem of how to deal with very large and failing financial firms is as old as the privately-owned Bank of England’s problems in 1797, when it prevailed upon the British government to permit it to suspend payments in specie (coin) to its note holders.  It was carefully analyzed by the British economist Henry Thornton in 1802.  He saw a role for central bank "bailouts" so long as the rescued institution was solvent (e.g. facing a depositor panic that was based on erroneous fears).   

The bailout problem has bedeviled banking regulators in the United States for decades, most prominently (before the current financial cycle) in the case of Continental Illinois in 1984.   Only 10% ($4 billion) of its funding base was in insured deposits. But everyone, including bondholders, got all their money back.

Despite the Continental precedent, up until recently the Federal Reserve, the FDIC and other U.S. banking regulators have been careful to ensure that a reasonably high degree of “constructive ambiguity” existed to try keep bankers and creditors focused on sound banking practices.  Lehman Brothers was allowed to fail.  In the past 12 months, however, all the old rules have been thrown out and replaced with massive bailouts and federal guarantees on nearly every kind of short-term borrowing that exists.

Now comes the Obama Administration's proposal for another way to deal with the problem - and it's a very flawed approach: establish a "Tier 1" category of very large regulated financial firms.

 Such firms would be chosen by the Federal Reserve Board on the basis of their potential to “pose a threat to global or U.S. financial stability or the global or U.S. economy during times of economic stress.”  They would be subjected to more stringent standards than other financial firms.

The Tier 1 concept would apply to any “financial company” with more than $10 billion in assets, $100 billion in assets under management or $2 billion or more in gross annual revenue. In other words,  very large insurance  and investment companies, finance companies, and hedge funds, among others,  are to be herded into the Tier 1 corral. 

In effect, Tier 1 firms would be designated “too big to fail” and become a protected class. All their liabilities (except the shareholders’ investment) would be guaranteed by the Federal government.  Depositors, bondholders, and transaction counter-parties need not concern themselves with the financial stability of the Tier 1 firms they are doing business with.  “Let the regulators worry about that” is the message.

 The proposed legislation tries to inject a shred of uncertainty by requiring a bankruptcy hearing if a firm becomes “critically under-capitalized.”  But the whole purpose of the Tier 1 concept is to make sure this never happens and, even if it does, the only parties at risk are going to be shareholders.

Why “Tier 1” is Bad Policy.  Maintaining a sufficient degree of uncertainty about government support for specific financial institutions (“constructive ambiguity”) is a critically important  incentive for financial firms to act prudently –  historically, even more important than regulatory restrictions on capital and bank operations.

When the uncertainty level is low, e.g. government bailout probabilities are high, we end up with imprudent lending  (the “moral hazard” problem) and massive government bailouts – Fannie Mae and Freddie Mac being today’s prime examples.

By making it 99.9% certain that creditors of the largest financial firms will not be allowed to lose their investment, smaller firms will suffer an even greater  competitive disadvantage. (Small banks are already seriously disadvantaged by the largest banks' free ride in the deposit insurance system - as in the case of Continental.) 

Tier 1 makes analytical sense only if the promised “more stringent” standards on capital and liquidity ratios cost Tier 1 firms more than they gain in lower funding costs. Trying to make the cost of such standards equal to the value of the funding subsidy – across a myriad number and variety of financial institutions via regulatory fiat  - will only result in a massive and counterproductive web of paperwork and bureaucratic intrusions.  And it will lead to the establishment of a lobbying powerhouse (“The Tier 1 Toughs”?) that would make sure their clients came out ahead.

A Better Way Forward.  While there are many debatable aspects to the Administration’s package of financial reform regulation, the Tier 1 concept has the highest probability of major, adverse and unintended consequences.

Already the working assumption in financial markets today is that every “very large” financial institution will be supported.  While the Administration’s recent refusal to assist CIT Financial (a $75 billion finance company) helps to distinguish “large” from “very large,” the Tier 1 concept needs to be totally abandoned. 

Instead of Tier 1, all banking firms (including finance companies and government-sponsored agencies, such as Fannie Mae) should face a relatively seamless series of increasingly higher capital requirements as they grow in size.  Regulators should continue using “constructive ambiguity” (e.g. the possibility of large firms' bankruptcy and losses to their creditors) as a way to encourage prudent management - and to offset any tendency by managers to invest in increasingly risky assets as their capital requirements grow.

Nonbanking institutions, such as insurance and investment companies as well as hedge funds, should be excluded from the new regime.  No substantive evidence has been advanced that demonstrates these institutions, as a group, need to be included;  AIG was an outlier, already subject to federal regulatory oversight.

Final Note.  Unfortunately, rather than focusing on the implications of Tier 1, Congressional and media attention has been directed at relatively minor turf fights among federal regulatory agencies  -  and Treasury Secretary Geithner’s irritation about what is going on in the back of the bus. 

It's time for all the players to pay attention to the dangerous economic and political consequences of establishing a "protected class" of mega financial firms.

MAN-MADE CLIMATE CHANGE: THE CASE FOR SKEPTICISM

If you think there is a "consensus" among scientists regarding human responsibility for climate change, read the letters to the editor in the July 27 issue of Chemical and Engineering News, published by the American Chemical Society.

Members of the Society were incensed by a June 22 editorial, written by the editor-in-chief, asserting that

The science of anthropogenic climate change is becoming increasingly well established. The scientific consensus on the reality of climate change has become increasingly difficult to challenge, despite the efforts of die-hard climate-change deniers.

Nearly all of the correspondents attack the editor-in-chief (of a scientific society's publication) for condemning skepticism - a critical driver of scientific discovery.

A substantial majority of the letter writers are quite open to the possibility of global warming, but highly doubtful of the assertion that it is primarily driven by man-made activity. The summaries of the scientific basis for skepticism are highly readable and strongly recommended.

Yet another reason to oppose the massive energy bill winding its way through Congress (see "The Big, Bad Energy Bill, June 12).