Sunday, May 17, 2009
The New York Times has published an excellent review, by Jonathan Rauch, of A Failure of Capitalism. This is the best review of the book I've seen so far, and also the best short summary of the book's contents. (It's much better than, for example, Nobelist Robert Solow's cranky, condescending review in the New York Review of Books.)
Thursday, May 14, 2009
Wednesday, May 13, 2009
As I've pointed out elsewhere in this blog, Judge Posner argues in A Failure of Capitalism that depressions are poorly understood, and that where hard data is in short supply, preconceptions will fill the void.
That argument came to mind today when I read Judge Posner's latest post on his "Failure of Capitalism" blog. He is describing the causes of possible "aftershocks" of a depression:
The government has created a great deal of money, and borrowed a great deal of money, to finance the bailouts and the stimulus package and increase the amount of money in circulation (to help push down interest rates). If when demand rises the banks lend their $800-plus billion in excess reserves, the ratio of money in circulation to the output of goods and services is likely to rise--and this will mean inflation. The ratio will rise further if the government decides to finance some of the huge additional debt that it is incurring as a result of its anti-depression expenditures by increasing the money supply, that is, by inflation, which is a form of taxation--taxation of cash balances. A low rate of inflation is manageable and does little economic harm, but a high rate is very harmful, and can be broken usually only at the cost of a sharp recession (consequent upon a sharp rise in interest rates in order to reduce the amount of lending and hence the amount of money in circulation). And the recession might (as in 1937) disrupt a recovery from the depression. These costs have to [be] balanced against the benefits of the anti-depression programs; unfortunately only guesses are possible.
The last point -- "only guesses are possible" -- leads one to wonder how we should choose between the "guesses" of Keynesian economists and the "guesses" of "conservative" economists. Both sides make plausible arguments that rely partly on hard research but also partly (largely?) on naked reasoning. What would be worse -- a deflationary spiral (assuming the absence of bailouts and stimulus spending would have resulted in one), or post-depression inflation, or a double-dip depression? Not to mention permanent growth in the scope of government. Whose bogey is more likely to be real? Whose would be worse if real?
UPDATE: After posting this, I noticed that economist Arnold Kling has a post today touching on what appears to be the same uncertainty. He passes along the Three Iron Laws of Social Science: (1) "Sometimes it's this way and sometimes it's that way." (2) "The data are insufficient." And (3) "The methodology is flawed."
Tuesday, May 12, 2009
Judge Posner -- at his other blog -- has a fascinating post on the recent history of conservatism in the United States. He argues that, today, the intellectual underpinnings of conservatism are "weak." Conservatism now has no one filling roles comparable to those of William F. Buckley, Milton Friedman, et al. It has grown "strident and populist."
Judge Posner puts this in autobiographical terms:
By the end of the Clinton administration, I was content to celebrate the triumph of conservatism as I understood it, and had no desire for other than incremental changes in the economic and social structure of the United States. I saw no need for the estate tax to be abolished, marginal personal-income tax rates further reduced, the government shrunk, pragmatism in constitutional law jettisoned in favor of "originalism," the rights of gun owners enlarged, our military posture strengthened, the rise of homosexual rights resisted, or the role of religion in the public sphere expanded. All these became causes embraced by the new conservatism that crested with the reelection of Bush in 2004.
* * *
By the fall of 2008, the face of the Republican Party had become Sarah Palin and Joe the Plumber. Conservative intellectuals had no party.
The reactions to Judge Posner's A Failure of Capitalism demonstrate his point. So far, no one on the right, as far as I know, has engaged the book's arguments regarding market failure and re-regulation. Conservative magazines seem not even to have acknowledged that the book exists. It does not fit the conservative conventional wisdom and therefore must be either ignored or shouted down.
Thursday, May 7, 2009
Richard Posner continues to, in effect, revise and enlarge his latest book, A Failure of Capitalism, by posting timely short essays on his blog of the same name. His most recent entry, posted last night, evaluates the government's various responses to the depression so far. I'm pleased that, among other things, he takes the President to task for "leading the attack on the resistance of Chysler's secured creditors (whom he referred to unhelpfully as 'speculators,' when the government is desperate to encourage lending, including by lenders who will not lend without collateral that gives them a favored position should the borrower go broke)...."
This is the first time I've made intensive use of a book-blog combination. It works especially well here, because the book appeared in the midst of a crisis that is not yet ended and will have ramifications far into the future. Hearing Judge Posner's views on the changing situation is fascinating. They enhance the usefulness of having read the book, by causing me to employ what I picked up from the it. And the background knowledge provided by the book enables me to fit the blog updates into a larger argument.
Wednesday, May 6, 2009
Today's post (really, late last night's post) on Judge Posner's Failure of Capitalism blog discusses the auto bailouts, the second stimulus package (which was passed after he finished the book), and bank stress tests.
In the book, Judge Posner argued that the auto bailouts were necessary simply to keep the major auto companies from collapsing when uncertainty about the course of the depression was highest. Their utility lay in delaying bankruptcy, not in making the companies viable again.
Today, some five months later, Judge Posner observes that the bailouts "worked." They kept the companies from failing at the height of public fear, when there was the greatest risk of a deflationary spiral. But by the end of March, the generalized, public fear had largely subsided. Thus, the bankruptcy of Chrysler and likely bankruptcy of GM do not raise the same concerns they did in December.
Although Judge Posner does not say this, it would therefore appear that there is now no emergency that could justify the administration's efforts to strong-arm Chrylser's bondholders.
Hat tips to Volokh Conspirator David Bernstein and to Instapundit.
Tuesday, May 5, 2009
The second post on Richard Posner's new blog about A Failure of Capitalism is now up. It is the first of three promised posts on the federal government's responses to the current depression. Today's post looks at the Fed's "easy money" response, Treasury's effort to partner with private investors to buy mortgage-related assets from banks, and planned legal changes to give relief to underwater mortgagors.
Of particular interest to me is the paragraph explaining why nationalization of "bad banks" would be a wrong step. Nationalization would be much more complicated, time-consuming, and unpredictable than it at first sounds: Because the bad banks are not worthless, their current owners would need to be compensated in any takeover. And then the government would face the question of what to do with the banks it would now own.
Monday, May 4, 2009
As promised in his latest book, A Failure of Capitalism, Judge Posner has launched a new blog in which he will expand upon the book's argument as events unfold. The first post appeared today.
He observes that events since February, when he finished the book, have not "alter[ed] the basic analysis and conclusions in my book." He cites data showing that the economy is continuing to decline, "but there is evidence that the rate of the decline has slowed" (his emphasis).
He refuses to speculate on whether we have hit bottom. My own (very impressionistic) sense is that we have, and that we're seeing more and more signs of impending recovery. I hope I'm right about that.
The WSJ today has a positive opinion piece on Richard Posner's Failure of Capitalism (may be gated). The author appears to agree with the book's argument and concludes:
Even capitalism's staunchest supporters recognize that it cannot function unless government plays its proper part. If all the players, including regulators and bankers, can accept their rightful share of blame and responsibility, we can begin to prevent future failures.
New regulations will inevitably come out of the current economic crisis. And they will inevitably be bad regulations if "capitalism's staunchest supporters," especially those with finance-industry know-how, do not participate in the process with a good attitude.
Friday, May 1, 2009
This post concludes my ongoing review Failure, which I finished reading last night. The last chapter of the book, "The Future of Conservatism," is followed by a "Conclusion" that is (by design) nothing more than a summary of the entire argument.
Judge Posner's hope is that both conservative and liberal preconceptions can be sufficiently loosened that "pragmatic, apolitical, nonideological solutions to economic crises" can be considered. The Republican "coalition" of economic, security, and social conservatives has been shaken by recent events, each component pulling away from the others. The Democratic Party, meanwhile, came out on the winning side of the "competence gap" during the presidential campaign. But both conservatism and liberalism have "substantial" histories of failures.
Judge Posner realizes that politics cannot be banished from economic policymaking. ("There are conflicts within society that can be resolved only by political competition.") The current crisis, however, has given rise to a spirit of pragmatism among economists that with luck will result in better policy-making once the current crisis has passed.
Chapter twelve of Failure (entitled "The Way Forward") discusses measures that could be taken to help prevent future depressions. In keeping with his view that systemic reforms should not be attempted or even devised until after the depression has ended, Judge Posner here offers an open-ended array of changes to consider, not a fully worked out program. Among other things, we need to see first what "the new, bound-to-be activist regulatory regime . . . can do within the existing regulatory framework."
Almost nothing is off the table. Possible (but not necessarily recommended) changes include consolidating the various federal and state financial regulatory bodies; forming an "international regulatory authority"; capping credit-card and mortgage debt; further restricting the extent to which debt can be discharged in bankruptcy; changing compensation arrangements for credit-rating agencies, to reduce conflicts of interest; "forbidding proprietary trading by banks (that is, trading of their equity capital, which puts that capital at risk)"; changing bank reserve requirements; regulating hedge funds more like banks and credit-default swaps more like stocks; "and even resurrecting usury laws." Controlling executive compensation through income taxation, and increasing income taxes generally to finance the anti-depression programs, are other suggestions that will surprise readers accustomed to thinking of Judge Posner as a libertarian.
Judge Posner devotes several pages to the difficulties that will be faced in trying to regulate well. We could, he notes, return to the regulatory framework of the 1960s, but we don't know how much value on net is added by having a deregulated financial industry. Consequently, we're unable to compare the costs and benefits that would be associated with various forms of re-regulation. (Judge Posner's description of everything that will need to be taken into account for regulations to be of benefit left me wondering where we can find the Solons capable of meeting the challenge.)
Thursday, April 30, 2009
In chapter nine of Failure (entitled "Apportioning Blame"), Judge Posner explains that his thesis -- viewing the current depression as a market failure -- "doesn't let the government off the hook." This chapter thus overlaps to a considerable extent with chapter seven, "What We Are Learning about Capitalism and Government."
The argument here focuses on the government's failure to keep a recession from devolving into a depression. Recessions are frequent, and it's "unrealistic" to expect the government to prevent them. But the government should be able to prevent depressions, especially given our experience with the Great Depression "and the tools forged then and later to prevent a repetition."
The "seeds" were sown and nurtured in the gradual deregulation of banking and credit, which began in the 1970s. This process included repeal of the Glass-Steagall Act and the decision not to regulate credit-default swaps and other innovative financial products. The experts in charge in the '90s -- Greenspan, Rubin, and Summers -- "allowed the head of steam to build up."
But a depression might still have been avoided were it not for "the Bush Administration's mismanagement of the economy." Judge Posner notes that Paulson's predecessors as Secretary of the Treasury weren't "financial experts." President Bush also erred in "firing" Lawrence Lindsey as chair of the National Economic Council in December 2002. None of Lindsey's successors as chair (until President Obama's appointment of Larry Summers) was an economist.
Other mistakes under President Bush were the budget deficits and increase in the national debt, and a philosophy of lax enforcement of financial regulations. Judge Posner also spends several pages helpfully explaining why, in his view, the decision to let Lehman Brothers fail in September 2008 is "the single biggest blunder to date in the response to the gathering storm." Aside from the financial fallout, the episode and its aftermath shattered confidence by making it "increasingly obvious that the government had no game plan." This was exacerbated by President Bush's apparent lack of engagement with the crisis and abdication of leadership to Bernanke and Paulson, "neither of whom has the communication skills that the emergency required."
Congress is likewise to blame, for its "squabbling and grandstanding and demagoguery" in an effort to use the crisis to advance political agendas, such as its "eagerness to promote unionization in a depression."
Greenspan and, to a lesser extent, Bernanke are also culpable for their actions as chairmen of the Fed. Greenspan did not use the opportunity afforded by his "tremendous prestige" to arrest the housing bubble's growth. Bernanke shared Greenspan's misapprehension that any recession caused by the eventual bursting of the housing bubble could be "neutralized by lowering interest rates."
Finally, Judge Posner explains why he is not being harder on private actors: Although private actors are "responsible" for the depression in the sense that their rational market behavior primarily caused it, they (unlike the government) are not morally culpable "any more than one can blame a lion for eating a zebra." Judge Posner therefore criticizes journalists and politicians "and some who should know better, like . . . Paul Krugman," for directing their ire at Wall Street. "They have the wrong target."
Wednesday, April 29, 2009
Chapter eight of Failure tries to answer the question why economists did not anticipate trouble. Aside from a few outliers (Judge Posner mentions Nouriel Roubini, Raghuram Rajan, Paul Krugman, Martin Feldstein, and Robert Shiller), economists "whether in academia, the government, or business" gave warnings too late or not at all.
In Judge Posner's opinion, this failure to see what was approaching arose not from "obtuseness" (he acknowledges that "the leading macroeconomists and finance theorists are brilliant people"), but from "disbelief" that we were facing anything more than another manageable recession. Likewise, the failure to warn did not result from over-reliance on "abstract mathematical models." Many of the economists under consideration had real-world experience with financial markets.
One cause that Judge Posner offers is something he has mentioned before: "an overinvestment . . . in a free-market ideology that opposes aggressive governmental interventions in the operation of the economy." Yet he is quick to add that free-market leanings are not confined to conservatives -- "economists can be liberal in the sense of being egalitarian and favoring redistributive policies without wanting to regulate corporate practices."
He also notes that depressions are not well understood; they're hard to model and occur rarely, in disparate settings that are not readily comparable. Consequently, a preference for one theory over another will be more than usually influenced by "preconceptions." The public and politicians have no basis for crediting one position or another -- they "wander in an untracked wilderness."
Nonetheless, current experiences add to our stock of data. Judge Posner offers Ben Bernanke as an example of a "conservative economist" who has "come to doubt that a depression can be averted or cured by monetary policy alone." Unspoken is that Judge Posner himself, while not by profession an economist, could be added to the list of those who have altered their views based on events.
Chapter seven addresses "What We Are Learning about Capitalism and Government" from the current depression. Here, Judge Posner revisits his claim that the depression was not caused by government action. Rather,
As far as one can judge on the basis of what is known today (obviously an important qualification), the depression is the result of normal business activity in a laissez-faire economic regime -- more precisely, it is an event consistent with the normal operation of economic markets.
He obliquely supports this claim by examining the government's conduct in the years leading up to the depression. The government's role in the rise of risky mortgage lending, he finds, "was one of permission rather than of encouragement." In other words, government allowed the rational self-interest of private actors to pursue, in the aggregate, a course that was harmful.
The government's permissivenes, or inaction, is exemplified in the SEC's failure to investigate the Madoff scheme, notwithstanding Harry Markopolos's repeated efforts over several years to alert the SEC to what was going on. Judge Posner rejects "conservatives'" interpretation of this episode as an example of government incompetence. Instead, he proposes, "the emphatically pro-business philosophy of the Bush Administration made the SEC too trusting of the securities industry."
He concludes that "there undoubtedly was a grave government failure as well as a market failure" in the run-up to the depression. He predicts that the government's response will be, as usual, "regulation and reorganization." Reorganization is the easier move and the less effective. Regulation or reregulation is more likely to do good, but it should not be attempted until the depression is at an end.
Chapter six of A Failure of Capitalism -- entitled "A Silver Lining?" -- somewhat quickly reviews possible beneficial effects of the current depression.
These include: The bursting of the housing bubble, which had to happen eventually, and having it happen when it did is preferable to having it happen, say, a year later, when it would be that much bigger. The exposure of fraudsters such as Bernard Madoff, who, again, would have done still more damage the longer the bubble lasted. Increasing the efficiency of business enterprises' use of labor and capital, since the drop in revenues requires that "slack" be taken up. Inducing federal, state, and local governments to increase their efficiency, since tax revenues drop. (But, on the other hand, the depression will also likely cause government to grow in size.)
More beneficial effects: "The depression may give the Administration and Congress pause concerning measures to strengthen unions, such as the proposed Employee Free Choice Act[,]" since unions can cause "an increase in wages, and a reduction in the efficiency with which labor is utilized." An increase in taxes (once the depression is over) will not "necessarily" be a bad thing. Increased unemployment will lead to an increase in the general level of education, since the opportunity costs associated with spending more time in school have been temporarily lowered. The depression has taught the banking industry "a great deal . . . about the risks of leverage and the downside of complex financial instruments intended to reduce the risk of default more cheaply than by traditional means." The public has learned "about the dangers of speculating on housing prices and investing the rest of one's savings in the stock market."
Still more: "The depression has shown that privatizing social security -- that is, allowing recipients to invest in the stock market some or all of the money in their social security retirement accounts -- would have been calamitous." The depression has caused commodity prices to drop, especially with oil. The level of carbon emissions has fallen as business activity has slowed. Lower oil prices have reduced the wealth of many nations that are "either hostile to the United States . . . or politically unstable." The depression will free up to pursue other work a lot of "brilliant people" who were formely employed in the financial industry. "The depression is a wake-up call to the economics profession." And the depression may lead to "a durable increase in the personal savings rate."
Tuesday, April 28, 2009
This is the second of two posts on chapter five of Failure.
As I noted in the preceding post, Judge Posner asks, after reviewing the stimulus program, whether it is "an $800 billion mistake?" He answers this question in a roundabout way.
He acknowledges that much of the "stimulus" will not be aimed primarily at stimulating economic activity but will instead be an enactment of President Obama's legislative agenda. Judge Posner then proceeds through a lengthy discussion of the "monetarist" and "Keynesian" views of the Great Depression and of solutions to depressions generally. The monetarist solution (in which the Fed increases the money supply through the banking system in order to stimulate economic activity) is problematic because, as previously mentioned, the current situation is so bad that banks are mainly "hoarding" the additional money in order to build their reserves, not lending it. To get beyond this hoarding, the Fed would have to pump so much new money into the banks that, when the depression finally ends and the Fed starts to contract the money supply (as will be necessary to prevent wild inflation), "a severe recession will be unavoidable." Thus, Judge Posner concludes, the monetarist solution alone will not remedy the depression "at a tolerable cost."
The fear in the background, as he explains in this chapter, is that the economy will enter a deflationary spiral. Deflation is a situation in which the general level of prices persistently decreases. This frightens economists because deflation makes it economically rational not to spend money. Since prices are dropping generally, money gains in value simply by being stuffed in a mattress for a few months. People don't need to put their money to work in order to earn a return. Accordingly, the economy contracts and contracts.
After painting this bleak picture, Judge Posner observes that "[e]ventually deflation will bottom out. As income shrinks, consumers will cease to be able to hoard cash; they will have to start spending everything they have." This will start a "virtuous cycle" of increased spending, increased production, and increased employment. "But the progress of recovery will be protracted because it will begin from a very low level."
Judge Posner now comes back to his question whether the stimulus is a mistake. He has concluded that the monetarist solution is not likely to prevent a deflationary spiral "at a tolerable cost." As a result, Keynesian deficit spending (i.e., the stimulus program) is also needed to prompt economic activity. Although he doesn't use these words, he in effect says that we have no choice.
He further points out that, even if the stimulus "will do nothing to speed recovery from the depression, there would still be a compelling argument for it. . . . "
Suppose that President Obama were to tell the American public: "We're trying to avert or ameliorate a depression by pumping up the money supply, but it may not work, in which event we'll find ourselves in a deflationary spiral that may resemble what happened to the United States in the 1930s and Japan in the 1990s. And then we'll just have to tough it out because our toolbox will be empty." (This is what, in effect, some conservative economists would like him to say.) His statement would guarantee a severe depression, because people would react by curtailing their consumption further, accelerating a deflationary spiral that would carry the economy to a lower level and keep it there for years.
The government must instead, for psychological reasons, express optimism and be seen to be doing something.
I don't have the time to review other interesting passages in this chapter, other than to mention them. Judge Posner argues that the monetarist solution "is potentially more socialistic" than the Keynesian one, because under the former, the Fed has found itself needing to buy stakes in businesses. He also looks at Congress's attempt to reduce the number of residential foreclosures by amending the bankruptcy code. In his view, that is not a good plan. Instead, while his preference would be no mortgage relief at all, he suggests a moratorium on foreclosures or a Columbia-devised plan in which certain lien-holders would be compensated with government funds for consenting to modification of mortgage terms.
In chapter five -- by far the longest chapter in the book -- Judge Posner examines the efforts the federal government has made so far to combat the current depression.
I will blog this chapter in two parts, this being part one.
By this point, his arguments will already have alienated libertarian and conservative readers. This chapter will now alienate readers on the left. Judge Posner has no illusions about the political nature of what the Obama administration is undertaking. At one point he suggests that the stimulus program perhaps "should be called the 'half stimulus-half New Deal' program," and notes that "[t]here is a legitimate concern that Keynesian depression-fighting theory is being used as a fig leaf to disguise a program of massive government expenditures based on a liberal ideology that a majority of Americans may not subscribe to -- at least not yet." (That closing "at least not yet" is apparently a reference to an argument earlier in the chapter that wealth-transferring programs are very hard to remove once they have been put in place, because they create their own constituencies of supporters/dependents.)
He identifies five phases that the government's response has so far moved through or into, not necessarily in sequence. The first three phases together form the "bailout": (1) the attempt to use TARP funds to buy "sick" mortgage-related assets from banks, (2) direct government investment in large banks in exchange for preferred stock, and (3) loans to GM and Chrysler in December '08 "to head off the bankruptcy of these companies or at least defer it." The fourth phase Judge Posner calls "easy money" -- the Fed's purchase of $800 billion of private debt (as opposed to buying back debt issued by the federal government). The fifth phase is the stimulus program, which had not become law at the time Judge Posner completed the book, in February '09, though he correctly assumed that it would be enacted.
Judge Posner explains the economic rationale behind each of the above phases, the political complications associated with them, and their likelihood of being effective on balance. The first phase, as he discussed in a previous chapter, failed because it was based on the faulty premise that the illiquidity of the "sick" assets resulted from uncertainty as to their value. (It turns out that they're just not worth much.) The second phase did help stabilize banks, but it did not have much immediate effect on the depression because banks needed funds so badly that they added much of the invested money to their reserves rather than loaning it out and thereby boosting economic activity.
The third phase (the second shoe of which is dropping now) was, in Judge Posner's view, more successful than is generally allowed. There was never any chance that the government could remake those companies or the auto industry as a whole. But, he argues, the main benefit of the loans to GM and Chrysler was simply to help them survive until the depression is over. In "normal" times, their bankruptcies would not be a problem. But the failure of such large firms "just as the nation was sliding into a depression" would have dangerously accelerated the cycle of lowered spending / lowered production / increased unemployment / lowered spending / etc.
After discussing the above, Judge Posner turns his attention to the stimulus program. The stimulus was planned (at the time he was writing) to consist of three elements: tax cuts, transfer payments and "other social-welfare expenditures," and public works. Conservatives prefer the tax-cut solution because, of the three, it's the only one that promises to make government smaller instead of larger. Tax cuts alone, however, are unlikely to increase economic activity much, because most people view tax cuts as temporary and therefore tend to save, not spend, the additional money they get to withhold from Uncle Sam. (And people who are so poor that they must spend all the money they have are also so poor that they pay little, if any, income tax in the first place.)
As for transfer payments and social programs, that "component of the proposed stimulus is also questionable, though politically irresistible." On the plus side, this component puts money directly into the hands of the poor, who are the ones most likely to spend it soon -- what we want a stimulus program to accomplish. On the negative side, this component is most likely to create permanent new "drains" on the federal government.
In that regard, the public-works component of the stimulus is superior, because public-works projects are, by their nature, more likely to be temporary. They are also more likely to result in real benefits to society aside from the benefit of helping to end the depression. To an extent, they also accomplish the same thing as the second component, since some of the money spent on public works finds its way to individuals who also spend it. (Relatedly, Judge Posner mentions the Keynesian "multiplier" that is supposed to capture the extent to which government spending results in additional spending down the road. He acknowledges that some estimates put the multiplier at 1.4, but "this is one of the roughest of rough estimates and some economists think the multiplier is less than [1.0].")
The problem with public-works spending is that public-works projects need a long lead time. Judge Posner's solution is to focus the spending on infrastructure repairs, and on projects (whether state or federal) that have already been started but have stalled for lack of funds.
At this point, Judge Posner ask if the stimulus program is "an $800 billion mistake, as the economist Martin Feldstein has called it?"
Sunday, April 26, 2009
Chapter four of Failure focuses on why government did not pay attention to warning signs that the housing market was hugely inflated and that the inevitable bursting of the housing bubble would trigger widespread bank failures. Judge Posner reviews the warnings that were given by Nouriel Roubini, The Economist, and others during the 2000s, along with the collapse of several mortgage hedge funds in 2007. He also discusses possible reasons why the warnings were ignored or underappreciated, and why governing officials in general lack incentives to take precautions against low-probability catastrophic events. "Until the biggest financial ninepins started falling in September 2008, the magnitude of the crisis was largely invisible to government, the business community, and most economists, even specialists in financial economics and macroeconomics."
Among the reasons Judge Posner offers for this lack of comprehension are a reliance on faulty pro-non-interference preconceptions when facing uncertainty, the political costs associated with using Fed policy to preemptively pop the bubble, the uncertainty of whether the social costs of preemptive action will be less than the costs of letting things run their course, and the sheer size of the mass of data from which one would have had to sift out reliable warnings.
Notwithstanding his recognition of those countervailing forces, Judge Posner feels that the Fed and Treasury should have known to take action after the Bear Stearns collapse:
It is the passivity of the Federal Reserve between Bear Stearns' collapse in March 2008 and the calamitous collapses in September, and the failure (for which the Fed was jointly responsible with the Treasury Department) to avert Lehman Brothers' bankruptcy, that merit strong criticism.
Judge Posner devotes chapter three to a fuller explanation of a point he made briefly in chapter one: that systemic forces led bankers and others to take risks -- notwithstanding some perceived threat of catastrophic failure -- that were excessive. This is a key component of his argument that the current depression resulted from market failure. I.e., if people were for the most part acting rationally in the run-up to the depression, then we cannot expect market forces alone to prevent depressions.
As Judge Posner explains, executives, private investors, and home buyers were acting in their rational self-interests in making the decisions they did over the past nine years. The depression was not the result of irrational exuberance or bad motives "such as 'greed' (whatever that means)." He lays out the various circumstances (including some conflicts of interest in the financial world) that caused the rational course of action to be largely what people did.
The problem -- and the reason why this was a market failure -- was that decisions that were rational on an individual basis were irrational, and harmful, for the economy as a whole. Government action is therefore needed to prevent actions that are harmful in the aggregate:
Rational indifference to the indirect consequences of one's business and consumption behavior is the reason the government has a duty, in regulating financial behavior, to do more than prevent fraud, theft, and other infringements of property and contract rights, which is the only duty that libertarians believe government has. Without stronger financial regulation than that, the rational behavior of law-abiding financiers and consumers can precipitate an economic disaster.
Judge Posner acknowledges that not all market failures should be prevented. If the regulations needed to do so would cost more than the "social cost" of the failure, then trying to prevent it would be a net waste of resources. But depressions, he argues, are not of this type. The Great Depression "inflicted horrendous costs," including "the excesses of the New Deal," and possibly Nazi Germany and World War II. The current depression could likewise result in far-reaching costs, such as over-regulation, dependence of business on government handouts, etc.
In the second chapter of Failure, Judge Posner enlarges upon his discussion in chapter one about how the current depression particularly involved the financial industry. Throughout the book, he uses "banks" to refer to all financial-intermediary firms, because by the 2000s, the regulatory restrictions on what non-bank intermediaries could do had been so eroded that they were all involved in "banking."
He recounts the rise of securitization of mortgage obligations -- how interests in baskets of mortgages were sold far and wide -- although he believes that securitization may not have been integral to this depression. He also explains (i) credit default swaps, which banks entered into in a (not irrational) effort to insure against losses on their mortgage and mortgage-securities holdings, and (ii) that insurers and credit-rating agencies lacked the history of dealing with these products in order to realistically calculate their riskiness.
When the housing bubble burst and credit froze, the Fed initially believed that banks were afraid to lend because their mortgage-related assets were illiquid. They were illiquid (not readily salable) because, it was thought, no one was confident of their precise value. The Fed's initial plan was therefore to buy the illiquid assets. However, it soon became evident that the problem was not merely uncertainty about the assets' value, but an absolute lack of value in such assets. In other words, the value of the mortgage-related assets was in fact very low.
The Fed then changed its plan. Instead of buying the mortgage-related assets, it would invest directly in the banks in exchange for preferred stock. The hope was that the cash invested by the Fed would then be loaned out, unfreezing credit. However, banks were so overleveraged, that a lot of the invested cash had to be retained simply to get the banks solvent (in banking terms), before any thought could be given to loaning some of it out. The Fed tried to persuade banks to lend rather than "hoard" the invested cash, but banks' problems were simply too great at that point.
Along the way, Judge Posner explains the policy behind some of the older banking regulations. Put very simply, banks stay in business by loaning out a large portion of the funds deposited with them. Thus, if all of a bank's depositors simultaneously decided to withdraw their deposits, the bank would fail -- it could not meet all such demands at once. Federal deposit insurance (under the FDIC) was created by the federal government in order to assure depositors that their deposits, up to a certain amount, would be safe even if the bank failed. This removed the incentive of despositors to "run" on the bank in order to get first dibs on the limited funds whenever a bank was rumored to be in trouble.
Next, in order to keep the now-insured banks from taking excessive risks with depositors' money on the Fed's dime (a "moral hazard" problem), regulations were imposed on the banks. Such regulations required that banks not make as risky loans -- and so offer as high interest rates -- as non-bank intermediaries could. Therefore, non-bank intermediaries had to be kept from taking advantage of the limits on banks and thereby drawing deposits into uninsured accounts. Accordingly, additional regulations put in place to prevent non-bank intermediaries from encroaching on the functions of banks.
Saturday, April 25, 2009
The first chapter of Failure lays out the standard theory of what causes depressions and how governments should normally respond, and then discusses what about our financial industry makes the current depression unusual.
Judge Posner's explanation of depressions seems (to me) to be basically Keynesian: A "shock" to the economy causes the value of individual savings to drop, which causes people to reduce their spending in an effort to rebuild their savings, which causes demand to drop, which causes producers to produce less, which results in layoffs, which makes individuals still more nervous and more inclined to spend less, which causes the pattern of contraction to continue. If banks were overextended when the shock occurred, "cascading" failures will make it harder for the pattern to be broken.
The government's tools for dealing with this situation are increasing the money supply through the banking system and, if that fails, to increase spending by spending more itself or by cutting taxes.
The shock to economy in this instance, as in the 1930s and in the late 1990s, was the bursting of an investment bubble. The bubble started in the housing industry and spread to the financial industry as a result of "low interest rates, aggressive and imaginative marketing of home mortgages, auto loans, and credit cards, diminishing regulation of the banking industry, and perhaps the rise of a speculative culture[.]"
Judge Posner then discusses how banking has changed in a way that helped bring about the depression. "[T]he regulatory barriers separating the different types of financial intermediary have eroded to the point where [for present purposes] all financial intermediaries can be regarded as 'banks.'" Restrictions on risky lending were eroded, and subprime lending increased.
Banks do not have enough incentive to avoid the risk because the rewards outweigh their exposure to a disaster that (they think) is of low probability. "A depression is too remote an event to influence business behavior." Hence government regulation is needed to prevent excessively risky lending.
Moreover, Americans' saving rate was so low in the 2000s that many now have little set aside to enable them to keep spending at the pre-downturn levels. The Fed's easy money policy in the 2000s (as it attempted to correct for the bursting of the dot-com bubble) enabled lending to continue even as people saved less.
Yesterday I received my copy of Richard Posner's new book, A Failure of Capitalism: The Crisis of '08 and the Descent into Depression. My plan is to blog the book here as I read it.
Last night I just had time to read the preface (completed in Feb. '09) and the first half of Chapter 1. Judge Posner begins by arguing that we are in a depression, not just a recession. It's not a "Great" depression like that of the 1930s -- the current indicators are nowhere near what was seen then -- but this is more than a recession, "especially if, as may well happen in the present instance, a 'successful' effort to avoid a repetition of the Great Depression will impose enormous long-term costs on the economy."
He then states his thesis, which was unexpected from someone with Judge Posner's reputation as a libertarian:
Some conservatives believe that the depression is the result of unwise government policies. I believe it is a market failure. The government's myopia, passivity, and blunders played a critical role in allowing the recession to balloon into a depression, and so have several fortuitous factors. But without any government regulation of the financial industry, the economy would still, in all likelihood, be in a depression. We are learning from it that we need a more active and intelligent government to keep our model of a capitalist economy from running off the rails. The movement to deregulate the financial industry went too far by exaggerating the resilience -- the self-healing powers -- of laissez-faire capitalism.
This is strong stuff, almost shocking, in view of who's written it. Many libertarians believe that there is, or very nearly is, no such thing as market failure. In other words, they believe that market forces, if left to themselves, will (almost) always bring about the optimal situation.
Even those who agree that market failures can sometimes occur nonetheless deny that regulation, especially federal regulation, is needed for the financial industry. Judge Posner clearly has rejected that view (if he ever held it). "Our model of a capitalist economy" needs regulation.
Judge Posner also explains that this book is divided into two main parts: the first five chapters deal with how the depression came about and what the government is doing to try to remedy it, and the remaining six chapters deal with the lessons we can learn.
He acknowledges that it may seem "premature" to write about this depression, since it may not even have bottomed out. (I think it has.) He thinks his effort is useful now because "hindsight will rewrite history" once the depression ends. In addition, he promises to launch a blog one week after the book's publication to provide weekly updates to the book. I have not yet checked to see whether this blog -- to be called "The Posner Economic Crisis Blog" -- is up.
Friday, April 24, 2009
When progressives talk about business, I often get the feeling that they think successful enterprises just pop up naturally, like weeds in a vacant lot. They forget (or were never aware of) the talent, energy, and risk exposure that are entailed in creating and maintaining a thriving business, whether it's a mom-and-pop store or a publicly traded corporation.
Vice Chancellor Leo Strine, of the Delaware Court of Chancery, understands the challenges that entrepreneurs must overcome in trying to build the businesses that we all rely on for providing goods and services we need, as well as our livelihoods. In an opinion that Vice Chancellor Strine issued yesterday, he held that a company will not be judicially dissolved "merely because [it] has not experienced a smooth glide to profitability or because events have not turned out exactly as [its] owners originally envisioned[.]" We have to assume that many businesses will face financial trouble:
[S]uch events are, of course, common in the risk-laden process of birthing new entities in the hope that they will become mature, profitable ventures.
I love the metaphor he uses here -- comparing the creation of a business to childbirth and child rearing. The process is risk laden. Dedicated, intelligent nurturing is needed for the new entity to become a mature venture that creates value.
(The case is In re Arrow Investment Advisors, LLC, C.A. No. 4091-VCS, slip op. at 6 (Del. Ch. April 23, 2009).)
Thursday, April 23, 2009
Over the past year, I've seen a number of things that have amazed me -- the Treasury Department buying stakes in private corporations, the president pressuring the CEO of a car company to resign, Congress authorizing $700+ billion in spending to bail out companies nearing insolvency, etc.
Today I saw something that is amazing in a good way.
According to the Washington Post (may require registration), two toy companies -- Mattel and Uncle Milton -- are preparing to release in the fall games that use brain waves to move objects. Yes, just like a science-fiction story:
You slip the wireless headset on. It looks like something a telemarketer would wear, except the earpieces are actually sensors, and what looks like a microphone is a brain wave detector. You place its tip against your forehead, above your left eyebrow.
A few feet away is a ping-pong ball in a clear tube called the Force Trainer. The idea is to use your thoughts alone, as recognized by the wand on your forehead, to lift the ball. Your brain's electrical activity is translated into a signal understood by a little computer that controls a fan that blows the ball up the tube. Levitates it. As if by magic. It's mind over matter.
All you have to do is concentrate.
The Post website also has a video in which different Post personnel successfully use the device. I have to admit, I found it thrilling. I'm planning to buy one.
I can imagine games being devised in which multiple players try to gain control of a ball or something similar, with the "strongest" brain winning. I could also imagine the technology being developed into silent communication devices. And into devices to test intelligence or to test certain types of mental aptitudes (attention to detail, flexibility, etc.). Very, very exciting.
Hat tip to Hit & Run.
In our society, politicians are remembered and eulogized and idolized out of all proportion to their accomplishments. Businesspeople, especially, get the short end of the stick when it comes to recognizing contributions. At worst, they are viewed as parasites; at best, as necessary evils.
I was therefore pleased to come across U.S. Supreme Court Justice Joseph Story's dedication of his 1845 treatise on the law of promissory notes. The treatise is dedicated to the wealthy merchant Thomas H. Perkins and includes the following:
You justly stand at the head of our commercial community; and you have achieved this enviable distinction by a life of successful enterprise, in which one knows not which most to praise, the skill, and intelligence, and integrity which have deserved that success, or the liberal spirit and unostentatious hospitality which have constantly been its accompaniments.
Interestingly, while Justice Story notes Perkins's generosity (his "liberal spirit"), the dedication contains no pieties about "giving back to the community" or being a "public servant" in his spare time. Instead, Perkins's success in business is itself a sufficient reason for honoring him.
Tuesday, April 21, 2009
US News & World Report issued its 2009 law-school rankings yesterday, according to the Volokh Conspiracy here and here.
For better or for worse, the US News rankings are one indicator of how hard it will be for law students at a given school to find a job. (The other main indicators being law-school GPA and whether one was on law review and/or a moot-court team.)
I interview a lot of candidates for positions with my firm as summer associates or first-year associates. The rank of one's law school matters to us partly out of self-defense -- we receive thousands of resumes and talk to dozens of candidates, and most of the people we interview are pleasant and articulate with decent grades. Since we can't hire all of them, we need some other way of sorting to help us find the individuals who are most likely to succeed in our practice areas.
But law-school rank matters for two other reasons. First, the business of law is largely brand driven. Law firms work hard to establish strong brands and work hard to maintain their brands once they've been established. A lot of practitioners could do what the big-name firms do, very nearly as well and for a much lower rate. Clients pay a premium for big-name-firm service because they want the assurance of good work that comes with the big name. And one way in which firms build and maintain their brands is by hiring attorneys from law schools with strong brands.
Second, graduates of higher-ranked schools are, on the whole, more likely to be successful lawyers. Now, I hasten to add that there are many counter-examples. I know a few graduates of top schools who really struggled in practice, and I know a few graduates of fourth-tier schools who are brilliant practitioners. But when big numbers are taken into account, it appears that you have a better chance of finding great talent at the higher-ranked schools.
Still, small differences in rank do not matter much. I think most practitioners probably view law schools as falling into the following rough divisions: Yale, Harvard, Stanford; the rest of the top 10-20; the "second tier" (i.e., from ~20 to ~100); the "third tier"; and the "fourth tier." Also, most practitioners know the rankings of only a small fraction of schools. They know which schools are "top," they know where their own schools fall, and they know the ranking of a random assortment of other schools. For the rest, they frequently consult US News.
UPDATE: Law professor Brian Leiter's take on the rankings here.
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Rasmussen has reported that, according to a poll it conducted on April 16-17, 32% of the sample had a very favorable impression of the tea parties, 19% had a somewhat favorable impression, 15% had a somewhat unfavorable impression, 18% had a very unfavorable impression, and 15% were not sure. Thus, more people had a favorable impression than an unfavorable one. I think that's good news, insofar as it may represent a widespread dissatisfaction with big government.
In addition, 25% of the sample said they personally knew someone who had attended a tea party.
Hat tip to Power Line.
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Monday, April 20, 2009
Today's Wall Street Journal has a long article (may be gated) about the Amazon Kindle and how e-books in general will change our world. Of course, the Kindle is now well over a year old, but the recent release of version 2.o has prompted a new wave of media interest.
The article's author, Steven Johnson, describes the "aha" moment most Kindlers have when they first buy a book on-line:
A few weeks after I bought the device, I was sitting alone in a restaurant in Austin, Texas, dutifully working my way through an e-book about business and technology, when I was hit with a sudden desire to read a novel. After a few taps on the Kindle, I was browsing the Amazon store, and within a minute or two I'd bought and downloaded Zadie Smith's novel "On Beauty." By the time the check arrived, I'd finished the first chapter.
For Johnson, this "aha" moment was when he realized how sweeping are the changes we can expect from the rise of e-books. He goes on to describe them. One in particular struck me:
... an infinite bookstore at your fingertips is great news for book sales, and may be great news for the dissemination of knowledge, but not necessarily so great for that most finite of 21st-century resources: attention.
Because they have been largely walled off from the world of hypertext, print books have remained a kind of game preserve for the endangered species of linear, deep-focus reading. Online, you can click happily from blog post to email thread to online New Yorker article -- sampling, commenting and forwarding as you go. But when you sit down with an old-fashioned book in your hand, the medium works naturally against such distractions; it compels you to follow the thread, to stay engaged with a single narrative or argument.
As Johnson points out, the future of e-books is connectivity, as we've already seen with on-line content. That means more and more temptation to jump around.
I already have this problem with the web. If I'm reading a book within reach of my computer, it's all too easy, and too tempting, to jump on-line to follow up on some question the book has planted in my head. That may be good from an information-gathering perspective, but it's not good from a deep-reasoning perspective. The ability to stick to one line of thought and work it out is not something that will survive without practice.
Cafe Hayek passed the five-year mark yesterday. The two economists who write Cafe Hayek -- Don Boudreaux and Russ Roberts -- are clear, direct, consistent, principled, authoritative, and passionate. I have been following them from the beginning, back when comments weren't enabled and before Don adopted his excellent practice of posting on the blog his letters to the editors of various newspapers.
As their blog's title suggests, they are proponents of the economic theories of Friedrich Hayek. They favor individual choice over government management, and take a public-choice view of politics.
Here's one of Don's posts (from June 23, 2005) that hit me like a splash of cold water in the face when I first read it. Its title has stuck with me like few other phrases.
The contribution by Russ that has stuck most in my mind was an Econtalk podcast in which he spoke with economist Mike Munger. If I recall correctly, this was the podcast in which Russ asked us to consider, What kind of person would want the job of being a politician?
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Saturday, April 18, 2009
Yesterday, I had an interesting discussion with econ blogger Mike Moffatt in the comments section of EconLog. We were both commenting on economist David Henderson's post about the tea party he attended.
My question, posed to no one in particular, was why many people assert that the tea parties were meaningless because the people attending them (supposedly) did nothing to protest the growth in spending under the Bush II administration. In my view, if the federal government is currently spending too much, it's good that people protest against that conduct, regardless of whether they did or didn't protest sooner.
Mike's explanation (at least as far as he is concerned) was that (1) Republican administrations have been more fiscally irresponsible than Democratic ones; (2) all but a tiny fraction of the tea partiers were Republican partisans; (3) participation in, or promotion of, the tea parties thus amounts to lending support to the Republican party; and therefore (4) participation in, or promotion of, the tea parties is likely to make the federal government more fiscally irresponsible.
That explanation is rational, if one accepts the premises. I can see how someone who believes that a Republican administration is bound to be worse than a Democratic one would not want to do anything likely to increase the chances of having a Republican administration, even if he thinks that the current Democratic administration is doing some things that should be criticized.
To my way of thinking, however, protest against a bad policy is never out of order. I suppose one could imagine a scenario in which one would not want to join a particularly despicable group (neo-Nazis, for example) in protesting something one is also opposed to. But aside from such extreme examples, I can't see the good in withholding criticism only because one doesn't approve of the beliefs of others who are making the same criticism. Being too particular about my co-protesters would result in my silent acceptance of things that are harmful.
Economist Tyler Cowen notes that the "not-at-all-right-wing [economist] Lane Kenworthy" demonstrates how higher taxes on the rich alone will not be enough to pay for all of President Obama's programs. Kenworthy's prediction is heavier taxing of the middle class, such as a consumption tax.
Thursday, April 16, 2009
- John Hinderaker at Power Line has posted a video (which I have not yet viewed) and some nice photos he took at the tea party in St. Paul.
- I happened to be in the car this morning later than usual and caught the first 30 minutes of Glenn Beck. He played audio of his speech at a tea party in San Antonio, where his statement that the Republican party "sucks" got just as big a cheer as his statement that the Democratic party "sucks." He also played audio of an unbelievably tendentious "interview" of a tea-party participant by a CNN personality.
- Today's Wall Street Journal has an opinion piece today by Karl Rove (may be gated) on the political significance of the tea parties. I could not detect any other coverage of the tea parties in today's issue, however.
UPDATE: Here's a youtube video clip of the same CNN "interview" that Glenn Back played, although Beck's audio included some additional back-and-forth before the reporter walked away, in which she pointed out that Illinois, "the land of Lincoln," would receive a large amount of stimulus money.
UPDATE: Here's a longer youtube video clip with all the CNN material that I heard this morning on Beck's radio show. (Plus another protester with Obama = Hitler material that is over the top, needless to say.)
UPDATE: Here's the New York Times' story, which seems to be pretty fair. It describes the turn-out as "moderate," whatever that means.
The LA Times' story, by contrast, is noticeably slanted, portraying the parties as a "Republican" event. The opening paragraph:
Republicans sought to ignite a popular revolt against President Obama on Wednesday by staging "tea party" protests across the nation to demand lower taxes and less government spending -- but the tactic carried risk for the party. [Emphasis added.]
UPDATE: Wikipedia entry including information on yesterday's protests and lots of links.
UPDATE: Reason magazine's Hit & Run blog discusses claims about who/what was behind the tea parties.
UPDATE: A balanced article from today's Christian Science Monitor. One participant is quoted as follows: “On the one hand, I feel optimistic to see so many people coming out, . . . But I’m also pessimistic because I think it’s too late. I think both parties in this country are bent on repressing the individual rights the Founders worked so hard to craft into the Constitution.”
UPDATE: Economist David Henderson has posted his thoughts on the Monterey tea party he attended.
Wednesday, April 15, 2009
I tried to attend my local tea party this afternoon. I finally got away from the office at 5:35, making my way to the party a little after 6:00. Unfortunately, it was breaking up just as I arrived. Since the weather here was cold, windy, and rainy, I'm not surprised that people were heading briskly to their cars. As for how many attended, I have no idea -- all I can say is that there was quite a traffic jam getting away from the location.
The Freakonomics blog at the New York Times has an interview with Richard Posner about his forthcoming book, A Failure of Capitalism. This paragraph caught my eye, about what the future holds:
There will be more regulation of financial institutions, and that is probably a good thing, though most of the goals of tighter regulation could probably be achieved just by more assiduous enforcement of existing regulations; regulatory laxity was a particularly marked characteristic of the Bush administration’s economic philosophy. The United States was capitalistic when banks were tightly regulated, and it will still be capitalistic if they are again tightly regulated. My fear is that the rush to re-regulate will produce more than the usual quota of dumb regulations. Since there is not going to be another housing and credit bubble in the next year, I would urge that the proposal of new regulations be deferred for a year, to provide time for a calm and thorough appraisal of the regulatory options.
I didn't vote for McCain in the 2008 election because, among other reasons, I couldn't imagine how a Democratic administration could be any more irresponsible than the outgoing Republicans in running up deficits. (I voted for the Libertarian candidate, Barr.) Well, apparently the Democrats can be a lot more irresponsible.
This graph from The Heritage Foundation (not new, and widely reprinted) sums up the situation so nicely that I'm linking to it here for ease of reference.
Two commenters at EconLog ("John Thacker" and "Matt") posted comments yesterday that I think are well worth repeating:
As someone who works in the medical industry, I can attest to the fact that health care consumers want to have their cake and eat it too. There is simply no way to reduce health care costs without some form of rationing.
The fact is we do ration health care in favor of the elderly in this country. An earlier poster, Neil, brought this up and anyone who works in health care can tell you this. Medicare, which at current levels of payout, will overtake the majority of the US budget as the baby boomers start taking benefits. When you turn 65 in this country, you enjoy a bottomless pit of medical expenses. It is not uncommon for an obese smoker on Medicare to consume well over a million dollars of health care in a year. If you are an unemployed pregnant 20 year old you get the bare minimum - that is if you get enrolled into Medicaid. You can forget about experimental cancer treatments. Not to sound conspiratorial but the AARP has a lot to do with this sorry state of affairs.
A lot of great ideas are being thrown around like Computerized Medical Records and More Research. I can tell these people don't work in health care. These reforms will save money, but its just nibbling around the edges of the problem. The "meat" of the problem is the inherent high cost of medical care that will never go away no matter how much efficiency you introduce to the system. Medicine is not like other businesses. Costs continue to rise as we are able to treat more and more diseases.
Doctors are expensive. Nurses are expensive. MRI machines are expensive. Don't get me started on malpractice insurance (grrr!!!) Do you think these costs will go away if the Government takes over medical insurance?
From John Thacker (slightly edited down):
Medicare spends considerably more on over 65s than universal health systems in other countries spend on over 65s. Other apples-to-apples comparisons, such as comparing health care costs among people file for Medicare early, or among people who have private insurance (such as UAW retirees) instead of Medicare after 65, or simply comparing costs among people 63-64 who are just barely not under Medicare with people 65-66 who have just signed up, show no significant difference. Medicare does not save money; nor does it spend less on health care treatments. Medicare and Medicaid "look like" the US's private insurance health care system, from treatments to cost, much more than they look like the universal health care systems in other countries.
[Commenter Dan Weber wrote]: "I would very willingly put my health decisions into the hands of a group that said 'we won't try any radical treatments, and we won't try super-hard to save your life once you are over 60.'"
[John Thacker replies:] You say that now, and perhaps you mean it. However, I feel that many people would say that and change their mind in the actual case. Still, your argument remains the most plausible one-- that government will somehow have the ability to force through even stricter rationing, of the kinds imposed by HMOs in the early 1990s that people politically rebelled against, and manage to grant itself sovereign immunity to the inevitable lawsuits that would occur against private insurers.
And once again, there seems to be a lot of people who regard the idea that insurance companies engage in rationing as some kind of trump card. Certainly they do, but the argument from universal health care proponents is that they don't engage in enough rationing, and that we need to go back to early '90s HMO you can't choose your doctor style rationing and other savings. And that just seems to me to be politically impossible.
I see nothing that changes my opinion that universal health insurance in the US will be like Medicare and Medicaid, not like other countries'. The experiences of TennCare and Massachusetts do nothing to change that. Spending and premiums in Massachusetts are rising much faster than the national average, as political pressure groups ensure that everything must be covered.
There are some savings from forcing the young and healthy to get insurance and subsidize the sick, but it's not clear that that actually leaves the young better off. (And President Obama, when a candidate, specifically denied that he would mandate coverage.) If OTOH the deal is sweetened sufficiently that all young and healthy choose to sign up, then there are no savings.
Tuesday, April 14, 2009
Discussing the extraordinary meeting of the Assembly of Notables called by Louis XVI in 1787, Thomas Jefferson wrote:
The government is said to want eighty millions of livres revenue more than they have. They propose to give to the people provincial administrations, and to make other improvements. It is a pity they had not more of the virtue called economy, of which we have something to spare.
(from a letter to Richard Peters dated Feb. 26, 1787, written from Paris)
Arnold Kling has another great post today on the economics of healthcare. He explores some of the reasons why it will be hard to bring down Americans' healthcare spending, with a story about how he would react if his daughter had cancer:
Imagine it were my daughter. What would be my attitude? I imagine that I would be walking into the oncologist saying, "Look. There has to be something you can try. I don't know whether it's bone marrow transplants or stem cells or some clinical trial somewhere. But we can't just sit here and watch her die. Either you give us something that has a chance of working, or we'll find another oncologist who will."
Next, imagine that the best hope is a treatment that costs $100,000 and offers a chance of success of 1 in 200. Would I want her to get that treatment? Absolutely.
But look at the issue from a rational, bureaucratic perspective. You have to treat 200 patients at a cost of $100,000 each in order to save one life, for a cost per life saved of $20 million. Is that what a rational bureaucracy would do?
Arnold's point here is just to show how hard it will be to get most Americans to accept any arrangement in which they are not more or less guaranteed the utmost that can be done, while paying out of pocket only a fraction of the cost.
Since I'm a lawyer in private practice, discussions like this always put me in mind of how Americans handle legal emergencies. The legal analogue of contracting a life-threatening disease is, I suppose, being charged with a crime. We don't have legal "insurance" comparable to healthcare "insurance" for such situations. No one assumes that an insurance company paid by one's employer will provide whatever legal help one needs, with at most a relatively modest "co-pay."
Instead, families shoulder the costs themselves. They use their life's savings, mortgage their homes, borrow from relatives, and so on. They do whatever they must in order to get the best defense lawyer they can afford. Those who don't have any resources fall back on the safety net of a court-appointed public defender.
We find it unconscionable that anyone could be denied medical care regardless of cost, but we have little problem accepting the absence of comparable coverage for legal needs. I think this is merely a result of conditioning. We've become used to medical coverage as part of our employment compensation or government-provided retirement benefits. We're just not accustomed to such coverage in the realm of law.
It could be argued that law is different because being charged with a crime usually involves some fault on the defendant's part, whereas one can become ill through no fault of one's own. But the difference is not as great as it might seem. Faultless people are sometimes charged with crimes, and sick people have often knowingly done things that greatly increased the chances of becoming seriously ill.
"Free" healthcare is something we're used to. Any other arrangement strikes us as inhumane. Yet we're comfortable with privately paid legal representation. How real, then, is the perceived "inhumanity" of expecting most people to arrange to pay their medical expenses on their own?
Mary K. Ham, at the blog run by the Weekly Standard, recounts the steps taken by the Democrats in Congress to kill the school-voucher program in Washington, D.C. The program has been popular with parents and appears to have worked well. So what's the problem?
The problem is that voucher programs threaten the unions' stultifying grip on teacher evaluations, promotions, and pay. And since teachers' unions are among the most reliable sources of votes for Democratic candidates, the incumbents need to pay the unions back by ending the voucher program in the one jurisdiction where Congress can have a direct impact.
Hat tip to Hit & Run, which also offers some choice remarks on this despicable behavior.
Monday, April 13, 2009
Arnold Kling, author of the wondeful Crisis of Abundance, has an excellent post today briefly exploring the difference between what most Americans call "health insurance" and what health insurance would consist of if it really were "insurance." Some highlights:
Let me offer two choices:
(a) Health insurance is the collective provision of all health care.
(b) Health insurance is the sharing of extreme risk in health care spending.
In my view, (a) represents what most people think of as good health insurance. For example, I have a friend who says her health insurance is great because she can get new eyeglasses every year for everyone in her family for a co-payment of only $10.
We have never observed (b). (b) would mean something where you only make a claim when your expenses are going to run into the tens of thousands of dollars. Claims would be rare and large, as in fire insurance. Premiums would be low, as in fire insurance.
* * *
. . . if you believe that government can save significant money on health care, then by the same token you have to believe either:
(i) our current mix of medical services is optimal, and we could deliver it much more cheaply;
(ii) our current mix of medical services is far from optimal, with too many cost-ineffective services provided.
Most people who can do arithmetic realize that (i) is not the answer. The standard bogeymen of drug industry profits and insurance company overhead are not big enough to make a major difference. Moreover, the evidence for (ii) is broad and overwhelming.
The bottom line is that what we think of as health insurance is not going to survive if we are going to get control of health care costs. Either health insurance is going to become very intrusive about our choices of medical services (the top-down, government option, under the guise of "health care quality"), or we are going to see much higher deductibles and co-payments (the bottom-up option).
This topic came up (indirectly) at Cafe Hayek today. I posted the following two comments. (I copy them here because this is something I get asked so often.)
That Delaware corporate law is not "pro-management":
As a practitioner of Delaware corporate law, I've noticed this for years. The reason, based on my own observations, is that Delaware doesn't have a lot of powerful native industries (du Pont notwithstanding). Instead, a huge part of the state's economy, and of the state government's revenues, is based on the state's ability to attract entities. Delaware is selling a legal regime. Now, many have reasoned this far and then concluded that Delaware therefore caters to management. But the legal regime governing an entity must be attractive to more than just management -- it must be attractive also to the investors that management plans to draw. Thus, Delaware corporate law has for decades pursued a balance between directors'/managers' authority to run the business and investors' authority to protect their stake. Delaware corporate law is a product shaped by the wants of the people buying it -- both managers and investors.
Reasons for the pre-eminence of Delaware corporate law:
Some other states have in fact copied Delaware's corporate law (Nevada is the most aggressive example). However, they have not been able to make much of a dent in Delaware's market share for three reasons:
First, Delaware has about a century's worth of court decisions expanding upon its corporate law and how it applies in different factual situations. This makes it much easier to predict how Delaware law will be interpreted and applied when one is trying to decide on a course of action. Other states can (and sometimes do) SAY they will follow Delaware law, including its court decisions, but people will have a lot more certainty that Delaware law will be applied as expected by a Delaware court than by a court in another state. (In other words, you might as well go to the source, as long as the source is not charging too much in taxes and fees.)
Second, Delaware has an excellent judiciary. All Delaware judges are appointed, not elected, and the bar and governor realize how important it is that smart, knowledgeable practitioners be on the bench. Moreover, unlike most states, Delaware has a court of chancery that (1) does not use juries, (2) is willing to move quickly on important matters (such a whether to prevent an impending merger), and (3) focuses on business litigation (i.e., very little family-law cases, no criminal cases, no products liability / personal injury cases). The Chancellor and Vice Chancellors in Delaware are almost all distinguished former corporate-law practitioners.
Third, the state government derives so much of its revenue from corporations formed in Delaware that it is motivated to make its systems as user-friendly as possible. You can file papers by fax, you can get same-day service, the rules are easy to understand and follow, etc. Most other states are Kafka-esque by comparison.
Saturday, April 11, 2009
Thomas Piketty is a French economist who believes, among other things, that all income above 1 million euros should be taxed at 80%. As discussed in this post at Reason, he appears to acknowledge that such a high marginal rate will not increase government revenues much. His goal, rather, is simply to hold down the incomes of top earners.
Why do his views matter in the U.S.? Because his analysis of income distribution forms a basis of the Obama administration's economic policies, as pointed out in a March 12 opinion piece in the Wall Street Journal:
"A New Era of Responsibility: Renewing America's Promise. The President's Budget and Fiscal Preview" (Government Printing Office, 141 pages, $26; free on the Web) . . . is the U.S. budget for laymen, and it's a must read.
Turn immediately to page 11. There sits a chart called Figure 9. This is the Rosetta Stone to the presidential mind of Barack Obama. Memorize Figure 9, and you will never be confused. Not happy, perhaps, but not confused.
The [chart] on page 11 is attributed to "Piketty and Saez." . . .
Thomas Piketty and Emmanuel Saez, French economists, are rock stars of the intellectual left. Their specialty is "earnings inequality" and "wealth concentration."
As described in Mr. Obama's budget, these two economists have shown that by the end of 2004, the top 1% of taxpayers "took home" more than 22% of total national income. This trend, Fig. 9 notes, began during the Reagan presidency, skyrocketed through the Clinton years, dipped after George Bush beat Al Gore, then marched upward. Widening its own definition of money-grubbers, the budget says the top 10% of households "held" 70% of total wealth.
Turn to page five of Mr. Obama's federal budget, and one may read these commentaries on the top 1% datum:
"While middle-class families have been playing by the rules, living up to their responsibilities as neighbors and citizens, those at the commanding heights of our economy have not."
"Prudent investments in education, clean energy, health care and infrastructure were sacrificed for huge tax cuts for the wealthy and well-connected."
"There's nothing wrong with making money, but there is something wrong when we allow the playing field to be tilted so far in the favor of so few. . . . It's a legacy of irresponsibility, and it is our duty to change it."
Mr. Obama made clear in the campaign his intention to raise taxes on this income class by letting the Bush tax cuts expire. What is becoming clearer as his presidency unfolds is that something deeper is underway here than merely using higher taxes to fund his policy goals in health, education and energy.
The "top 1%" isn't just going to pay for these policies. Many of them would assent to that. The rancorous language used to describe these taxpayers makes it clear that as a matter of public policy they will be made to "pay for" the fact of their wealth -- no matter how many of them worked honestly and honorably to produce it. No Democratic president in 60 years has been this explicit.
Friday, April 10, 2009
Reason writer Michael Moynihan provides a handy round-up of political trends in Europe. While left-liberals in this country continually point to European social democracy as the ideal ("they do it there, why can't we do it here?"), citizens in European countries have responded to the global financial crisis by, if anything, moving rightward.
Today's Wall Street Journal has an article (may be gated) on a Pennsylvania state code-enforcement officer's shutting down the sale of homemade pies at a church in Rochester, PA:
On the first Friday of Lent, an elderly female parishioner of St. Cecilia Catholic Church began unwrapping pies at the church. That's when the trouble started.
A state inspector, there for an annual checkup on the church's kitchen, spied the desserts. After it was determined that the pies were home-baked, the inspector decreed they couldn't be sold. . . .
The problem is the pies are illegal in Pennsylvania. Under the state's food-safety code, facilities that provide food at four or more events in a year require at least a temporary eating and drinking license, and food has to be prepared in a state-inspected kitchen. Many churches have six fish fries a year, on Fridays during Lent. St. Cecilia's has always complied with having its kitchen licensed, so food made there is fine to serve. But homemade goods don't make the cut.
The article also includes a nice little lesson on how "safety" regulations become a weapon that private actors can wield indirectly against their competitors:
Mr. Chirdon [the PA Dept. of Agriculture's food-safety director] says the pie episode has shed light on an often-overlooked aspect of food safety. "I've gotten a lot of letters from churches that are tattletaling on churches down the street that aren't licensed and don't meet standards for food service."
The good folks at Reason, the Heritage Foundation, and Americans for Prosperity have put together a frightening little video on the insane amounts of money the federal government is spending, and how they compare to (inflation adjusted) amounts spent in previous crises.
Too bad they can't afford to buy airtime on a major TV network. Every American should see this.
Thursday, April 9, 2009
In an episode of Monty Python's Flying Circus several decades ago, the troupe poked fun at scientific researchers, with a sketch about the comparative intelligence of humans and penguins. A lab-coated researcher addressed the camera about his findings:
Here at the Institute Professor Charles Pasarell, Dr Peaches Bartkowicz and myself have been working on the theory originally postulated by the late Dr Kramer that the penguin is intrinsically more intelligent than the human being. . . .
If we increase the size of the penguin until it is the same height as the man and then compare the relative brain sizes, we now find that the penguin's brain is still smaller. But, and this is the point, it is larger than it was!
This sketch came to mind as I was reading an essay by Lawrence Reed (president of the Foundation for Economic Education) that takes apart a fatuous New York Times article. In the Times piece, the writer argued that Washington's stimulus package is likely to succeed, because the federal funds poured into New Orleans after hurricane Katrina resulted in an increase in construction there:
The Times story notes that the feds have dumped more than $50 billion in money on Louisiana since Hurricane Katrina. “Indicators suggest,” notes ace reporter Nossiter, that “dumping a large amount of reconstruction money into a confined space . . . has had a positive outcome.” It’s an “experiment” that he says bodes well for the flood of stimulus spending Washington is doling out to alleviate the nation’s financial woes.
Lo and behold, guess what has happened to construction in Louisiana? It’s up! (Apparently, not even government can spend $50 billion on construction without yielding some construction.) Nossiter quotes a professor who says this proves that “stimulus can have an effect.”
Apparently, an effect -- any effect -- is enough to make a stimulus worthwhile. What's important is that the penguin's brain is larger than it was!
Hat tip to Cafe Hayek.
In a post yesterday at EconLog, economist David Henderson raised a point that I've often thought myself. Many of us have the idea that some jobs are a "public service," while others are "merely" about making money. A paid job with a government or a non-profit organization is "public service." A paid job with a for-profit organization is supposedly not.
In my view, everyone who makes something that other people want or need, or provides a service that other people want or need, is doing public service. All these people may not be motivated by a desire to benefit "the community," but neither are many people who work in government or non-profits (as I used to do). Most people just want a decent job, and whether it's with the government, a non-profit, or a for-profit is not especially important.
The public service that for-profit workers do is making or providing something that other people want more than the money they part with to get it. That's the essence of adding value, creating wealth in the non-zero-sum activity of free exchange. As Adam Smith said, in a statement that is well known but too poorly internalized, "It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest."