Tuesday, June 30, 2009

After Madoff, Fix the SEC and FINRA

While Bernard Madoff is sentenced to 150 years in prison for his Ponzi scheme fraud, let us not forget that an outrageous lack of oversight by FINRA and the SEC allowed a crime of this magnitude to occur and continue for many years.

Let us hope that Madoff's punishment does not end the oversight agency soul searching and revamping that must occur to prevent the recurrence of a fraud of a Madoff magnitude from happening again.

Madoff's crime is a simple form of affinity fraud. A gullible group with some cohesion, similarities and member trust is targeted, such as church groups, religious groups, ethnic groups, immigrant groups, etc. The fraudster relies on members of the group to introduce other members to the fraud. The referral among members of the group makes the job of the fraudster easier than if he targeted strangers.

The SEC has lots of experience with affinity fraud. Over the years, the SEC regularly targeted affinity group fraudsters, but usually those with a much smaller total dollar amount. As one example, see an SEC 1998 affinity fraud action here.

The oversight lapses at both FINRA and the SEC are responsible for the many year longevity of the Madoff fraud. As a simple example and certainly not the only issue with the regulatory agencies weaknesses, was that the agencies did not follow any simple audit procedures and verify any of the information supplied by Madoff or his firms, such as confirming the existence of any of the asset holdings or purported customer transactions.

It is not a question of an insufficient budget, inadequate staffing or a lack of leads. It is a structural and philosophical failure at the oversight agencies that allowed Madoff to defraud his investors over an extended period.

Unfortunately, there is nothing in the SEC chairperson (and former FINRA CEO) Mary Schapiro's background to indicate she has the knowledge or experience to change the culture of a large dysfunctional institution. As an example, see my previous post, "Time To Replace The US SEC."

Monday, June 29, 2009

Mankiw On Krugman

Greg Mankiw's post today about Paul Krugman and a rebuttal to Keynesian economics.

Mankiw's blog post is here.

Unintended Competitive Effects Of Cap And Trade

The US House of Representatives passed a Climate Control bill with a Cap and Trade provision.

One of the uncertainties of Cap and Trade is the unintended competitive effects of higher prices caused by the need to pass through the costs of carbon permits.

As I stated in my previous Cap and Trade blog,
It is likely, but not certain, that the additional cost of purchasing a permit in Cap and Trade will increase prices to buyers of the produced goods. Price increases are not certain because competition does not always allow production cost increases to be passed on to buyers. If the industry cannot achieve pricing that allows for a fair return on its investment, the industry will disinvest and eventually go out of business. However, if the price is increased, competitors with alternative lower greenhouse gas emission, equivalent processes and products will see an opportunity to enter the business whereas before the additional costs of Cap and Trade, the lower pricing did not give these new competitors an economic incentive to enter the business. It is uncertain how government will respond to a price increase or to industry competition. Based on the likely political effects of a price increase, especially if it is significant, politicians will chastise the industry and call for it to lower prices or as likely, the politicians will enact price controls. Both could be detrimental to the survivability of the particular industry. Another potential political outcome could be that the industry with a high cost cap and trade permits may not be competitive against a new competitor that either does not need a permit or can produce at a lower level of greenhouse gas emission. Will we see a replay of the current auto industry crisis in a different industry and how will the politicians respond? Will the political reaction ensure the continuation of a high level of greenhouse gas output?
For more about the concerns of any cap and trade legislation, read my entire earlier blog here.

The full text of the House bill is available here and here.

Overview Of CBO’s Long-Term Fiscal Modeling

The Congressional Budget Office (CBO) released a non-technical overview of its long-term fiscal model, called CBOLT.

CBOLT is a mathematical tool for analyzing and quantifying potential reforms to federal entitlement programs and the US's long-term fiscal challenges.
CBOLT is a microsimulation model of the US population, economy, and federal budget. A microsimulation model starts with individual-level data from a representative sample of the population and projects demographic and economic outcomes for that sample through time. For each individual in the sample, CBOLT simulates birth, death, immigration and emigration, marital pairings and transitions, fertility, labor force participation, hours worked, earnings, payroll taxes, Social Security benefit claiming, and Social Security benefit levels. A complex actuarial framework wraps around the microsimulation model to provide totals for demographic and economic variables as well as additional information in areas where the microsimulation model has not yet been developed. The model projects individual demographic and economic behavior of the population, the finances of the Social Security system, and the finances of the rest of the federal government more than 75 years into the future. In recent work, CBO has added detail on Medicare, Medicaid, and other health care spending to the actuarial framework. CBOLT also includes a macroeconomic model that analyzes the federal sector’s role in the larger economy and a repeated-simulation (Monte Carlo) mode that quantifies uncertainty about a variety of outcomes.
All mathematical models of the economy and US demographics have strengths and weaknesses. They also have more applicability in certain situations over others. The models also tend to do better in certain states of the economy than others. Unfortunately, CBOLT is a universal model meant to apply to all reforms to federal entitlement programs in all economic situations.

CBO did not provide data or links to studies that showed the degree of accuracy of CBOLT's projections against historical data or projections. Therefore, at this point, one does not know the biases inherent in the model and how those biases will affect long term US entitlement policy.
CBO Long Term Model

Response to Fox's "Myth of the Rational Market"

My comment posted on The Economist.com Blog, Free exchange in response to Justin Fox's comment on irrational markets. Fox is the author of the book, "The Myth of the Rational Market."

Fox said in response to a question about efficient markets:
FE (Financial exchange): Burton Malkiel concluded a recent review of your book by saying, "With "The Myth of the Rational Market" Mr. Fox has produced a valuable and highly readable history of risk and reward. He has not, however, been able to bury the hypothesis that our securities markets are usually remarkably efficient." How do you build a regulatory system around this notion? (And do you accept Malkiel's assertion?)

Mr Fox: Depends what you mean by “efficient.” If you just mean securities markets are hard to outsmart, which is what Malkiel’s getting at, then he’s right. I haven't been able to bury that notion, and I wouldn't want to. If you mean that the prices prevailing in securities markets are always rational and reasonable, which really is what lots of finance professors used to believe, then that’s pretty well dead and buried by now. The upshot for regulation is that financial markets go crazy, but you can’t rely on regulators knowing when markets are wrong. Which seems to point toward doing roles that would both temper the market's moves and reduce the risk of collateral damage there's a crash. Restricting leverage seems to be the most straightforward way to do this—as we've learned over the past decade, a bubble based on equity (the dot.com insanity) causes a lot less trouble when it collapses than one based on debt (real estate).

My posted response:
Fox's last statement contradicts his entire thesis. If markets are irrational and unreasonable at times then an analysis of the markets should allow someone to outsmart the markets. However, while there are always a few who do better in the markets at these times, the number is never more than would occur by chance.

For Fox's thesis to be true, the majority of people must be irrational at times, and then they must become rational for prices to return to normality.

What Fox assumes is that events that affect prices must directly reveal themselves to investors before they change. However, investors make rational assumptions about the future based on signals in current events. These signals can change before future events happen and investors will modify their expectations of the future and the value of things.

To see this in a more obvious and shortened time example, let use a pharmaceutical company. If the company does research on a few individuals that shows that a new drug has the potential to be a blockbuster, the company's stock will increase. If later, small studies by that company or other researchers question that conclusion, the company's stock will decline. Sometimes, just allocating funds to do the research is enough to increase a company's stock price because it shows that the company believes there is a potential reward in this kind of drug. Just allocating funds for the research is a signal to investors. Sometimes, the publication of a scientific paper is enough of a signal to change a stock price.

All this occurs prior to actual clinical trials or production and sale of the drug. It is rational. It is about making a best guess on available information and signals.

The same logic is true for the recent home value rise and decline. Materials and labor costs for homes varies little across the country, increases generally by inflation and accounts for a small part of home price changes. However, land costs are a major determinate of house prices, but in different parts of the country account for a different share of the total home price.

In the San Francisco area, land can account for 80 percent of the value of a home, while in parts of the Mid-West it can be 20 percent of a home's value. A 50 percent increase in land values across the country will have different effects on home prices in different regions. In San Francisco, homes will increase by 40 percent (.5 x .8), but in the Mid-West by 10 percent (.5 x .20). A similar reverse effect also occurs when land prices decline. Of course, there would also be some local price changes due to local economic and demographic conditions.

No one has, however, studied land price changes in the US during the so-called "housing bubble" to see if there were logical reasons for this price change. For example, there could have been changes in expectations of the tightening of laws restricting home building, changes in immigration laws, changes in birth rates, changes in US mobility patterns, increased costs of residential development due to environmental laws, etc.

Until researchers verify that there were or were not rational reasons for land value changes, I will continue to believe markets are rational. It is like the example of guessing about the number of jellybeans in a large jar. Nobody need get it right or understand how to do it, but the average of all the guesses will be the best guess. The price of an object is the average best guess at the time and the one that is most likely correct until information about the future changes. Irrational market belief is like a belief in UFOs. Until someone actually produces a UFO or an alien, I will continue to believe that they do not exist on this planet. Others, however, do not need proof. Mr. Fox obviously needs much less proof than I do that markets are not rational.

Friday, June 26, 2009

Long Term US Budget Forecast

The Congressional Budget Office issued its report on the long term forecast of the US budget. It includes a projection of US debt as a percent of GDP.
Under current laws and policies, rapidly rising health care costs and an aging population will sharply increase federal spending for Medicare, Medicaid, and Social Security. Unless increases in revenues kept pace with escalating spending, or spending growth was sharply reduced, soaring federal debt would weigh heavily on economic output and incomes.
CBO predicts US government debt could reach almost 200 percent of GDP by 2035. That ratio is substantially higher than the highest amount of debt during WWI, WWII or the Great Depression of the 1930s.

Thursday, June 25, 2009

Are US Physician Salaries Too High?


Harvard Professor Greg Mankiw posted a chart comparing the income of doctors in the US and in the OECD countries. US doctors have higher income in absolute dollars, as a percent of total medical spending and as a percent of GDP.

Mankiw, being the intelligent economist that he is, looks beyond the numbers for an explanation. However, he posts his analytical answers as hypothetical and rhetorical questions, which will leave the economically uneducated reader without the direct answer.

US doctor income is higher because US doctors pay for their own medical education, as opposed to other countries where the taxpayer is paying for the doctor's education. US doctors charge more in part to recoup their education costs and other countries do not include doctor education costs as part of health care costs.

In the US, income dispersion is higher than in other countries and there are more opportunities to make high incomes. Doctors' income must compete with these alternative opportunities, such as lawyer, investment banker, entrepreneur, etc., otherwise the medical profession will not be able to attract the better physician candidates.

Mankiw also seems to believe that part of the explanation for higher US physician income is due to the high premium paid in the US for skilled labor.

Mankiw's complete blog post on this topic is here.

Mark Perry of the Carpe Diem blog, however, believes it is mostly due to the American Medical Association's power in limiting the number of medical schools and the number of medical students. He notes that there has been almost no growth over the last 20 years.

Howvever, Mark Perry forgot to consider the availability and effect of the competition of foreign medical schools.

A study of US citizens who attend foreign medical schools shows a significant increase in foreign schooled doctors in the US. The study, "U.S. Citizens Who Obtain Their Medical Degrees Abroad: An Overview, 1992-2006" by John R. Boulet; Richard A. Cooper; Stephen S. Seeling; John J. Norcini; Danette W. McKinley found:
International medical graduates (IMGs) constitute approximately 25 percent of practicing physicians in the United States, a level of participation that has increased from 18 percent in 1970 and only 10 percent in 1963.

Wednesday, June 24, 2009

Economic Cost Of US Education Gap

The McKinsey Quarterly discusses the lost GDP due to the persistent educational under achievement of US students versus students in other countries.
A persistent gap in academic achievement between children in the United States and their counterparts in other countries deprived the US economy of as much as $2.3 trillion in economic output in 2008, McKinsey research finds.
The complete article is available here. (Free registration may be required).

The complete McKinsey achievement gap study plus supporting material is available here.

Tuesday, June 23, 2009

Irrational People - Rational Outcomes

You do not need rational people to reach rational market outcomes. See Don Boudreaux's post on Cafe Hayek.
[C]ompetitive, decentralized markets -- commerce -- generally manage to produce results that make us seem to be more rational and smarter than we really are.
Boudreaux quotes from an interesting paper,"The Market: Catalyst for Rationality and Filter of Irrationality" by John List and Daniel Millimet, winner of the 2008 Arrow Prize for Senior Economists. (Free working paper copy is available here.)
[E]ven when markets are populated solely by irrational buyers, aggregate market outcomes converge to the intersection of the supply and demand functions.
In other words, even when people act irrationally in the market place, market prices are determined by supply and demand. The prices are the same as if people acted rationally.

Kudlow -- No Need For Big Health Care Reform

Larry Kudlow, the economist commentator on CNBC, on his blog, Kudlow's Money Politic$, questions the need for a major health care reform:
But my [Kudlow] question is why do we need it at all? According to a recent ABC News/USA Today/Kaiser Family Foundation survey, 89 percent of Americans are satisfied with their health care. That could mean up to 250 million people are happy. So why is it that we need Obama’s big-bang health-care overhaul in the first place?

There’s more. According the U.S. Census Bureau, we don’t have 47 million folks who are truly uninsured. When you take college kids plus those earning $75,000 or more who chose not to sign up, that removes roughly 20 million people. Then take out about 10 million more who are not U.S. citizens, and 11 million who are eligible for SCHIP and Medicaid but have not signed up for some reason.

So that really leaves only 10 million to 15 million people who are truly long-term uninsured.

Yes, they need help. And yes, I would like to give it to them. But not with mandatory coverage, or new government-backed insurance plans, or massive tax increases.
Read the whole blog post here.

Monday, June 22, 2009

What If Regulators Hadn't Bailed Out Bear Stearns?

Interesting article about alternative to the proposed regulatory changes to financial supervision and regulation, "Give Bankruptcy a Chance" by David Skeel, the S. Samuel Arsht professor at the University of Pennsylvania Law School.
But what if regulators hadn't bailed out Bear Stearns? If we conduct this simple thought experiment, it raises serious questions about both the conventional wisdom and the Obama administration's new proposals for regulating investment banks and bank and insurance holding companies. Bankruptcy starts to look much better, although it could use several market-correcting tweaks.
...
The bankruptcy alternative would not prevent regulators from regulating. Nothing would stop them from imposing high capital requirements on systemically important institutions, for instance, to make them less risky. But it would give creditors an incentive to pay close attention to the creditworthiness of systemically important institutions. And it would give the managers of these institutions a reason to file for bankruptcy before the house of cards crumbled, rather than running to regulators to beg for money.

Friedman on Health Care Cure

Excellent and highly relevant article by Milton Friedman, "How to Cure Health Care." (HT: Greg Makiw).
Two simple observations are key to explaining both the high level of spending on medical care and the dissatisfaction with that spending. The first is that most payments to physicians or hospitals or other caregivers for medical care are made not by the patient but by a third party—an insurance company or employer or governmental body. The second is that nobody spends somebody else’s money as wisely or as frugally as he spends his own.

CBO Cap And Trade Cost By Income Quintile

Congressional Budget Office cap and trade costs analysis, "The Estimated Costs to Households From the Cap-and-Trade Provisions of H.R. 2454" by income quintile. (See Table 2, page 16).

It appears to be less expensive than originally suggested in the media.

Friday, June 19, 2009

Health Care Costs: Chronic Vs Catastrophic Care

McKinsey and Company, one of the top business consulting firms in the world, has an interesting point of view on health care. Unfortunately, except for a teaser, the entire article requires an expensive premium subscription to the McKinsey Quarterly.

McKinsey believes the key to understanding health care costs is to understand health risk. The article's point of view is that health care risk has changed from infrequent catastrophic events to more chronic conditions requiring constant care.

The fundamental nature of medical risk in the United States has changed over the past 20 to 30 years—shifting away from random, infrequent, and catastrophic events driven by accidents, genetic predisposition, or contagious disease and toward behavior- and lifestyle-induced chronic conditions. Treating them, and the serious medical events they commonly induce, now costs more than treating the more random, catastrophic events that health insurance was originally designed to cover (Exhibit 1). What’s more, the number of people afflicted by chronic conditions continues to grow at an alarming rate.

Mckinsey states, "Treatment for unpredictable, catastrophic events accounts for only 31 percent of total US health care spending."

Thursday, June 18, 2009

Unlearned Lessons Of Housing Bubble

My Comment on Economist's View about the "Unlearned Lessons" of the housing bubble follows:
Shiller's work does not explain the increase in the home price to rent ratio. Land scarcity (real or imagined), economic boom times, bubbles, etc., should have increased rents also. The price to rent ratio index (Shiller's or OFHEO's) from 1982 to 1999 varied slightly (up and down about 10 percent) and was fairly constant. 1998 ratios were roughly equal to 1987 ratios. However, from 1998 to 2005, it rose 40 to 65 percent depending on the index, and the ratio is still above its 1987-98 levels. The property owners were giving up some of their investment returns by not charging a price equivalent rent to tenants during the period of the increase in the price to rent ratio.

Bubbles do not explain the apparent differences in behavior between owner occupied and owner rented residential properties.

Shiller is correct in that material and construction costs were not influencers of home price appreciation during the period.

Homes ownership rights contain two rights, the right to occupancy, including renting, of the structure and all remaining rights including the land and all structural modification rights.

If occupancy had increased in value, we would have seen higher rents and a lower price to rent ratio during the housing bubble.

Because construction costs are relatively constant (except for some labor variations, transportation and materials storage costs) across the nation for equivalent structures, the greatest disparity will be in land values, especially if desirability varies by geographic location and translates into different land prices. However, increases in land values are not directly observable in home price increases.

Using an example from "The Price of Residential Land in Large U.S. Cities" by Morris A. Davis and Michael G. Palumbo:
Going into the recent boom — that is, at the end of 1998 — we estimate that land represented about 81 percent of the average single-family home’s value in San Francisco, whereas in Milwaukee land accounted for a share of only 33 percent. This means that, abstracting from any changes in real construction costs, a cumulative 90 percent increase in the real price of residential land in both cities would have translated into a 73 percent increase in home prices in San Francisco (0.73 = 0.81 x 0.90), but only a 30 percent increase in home prices in Milwaukee (0.30 = 0.33 x 0.90).

Of course, the fact that the price of land appreciated at the same rate in both San Francisco and Milwaukee does not imply that both areas experienced the same sized demand or supply shock.

Rather, our point is that a simple comparison of gains in house prices might make San Francisco seem “glamorous” compared with Milwaukee, but the rapid pace of appreciation in the price of residential land in Milwaukee tells a different story about conditions in Milwaukee’s housing market.

And, it’s not just Milwaukee: As we show below, for many other cities across the country, data on home prices significantly obscure the increases in residential land prices that have been registered over the past two decades and particularly in the recent housing boom.
A reversal of land prices, even if in equivalent percentages across the US, would result in areas with higher land value to total value ratios showing greater percentage declines in home prices.

The failure of rent increases to match increases in land values could be due to a timing difference in the factors affecting the values of the two items. Rents reflect the period of occupancy and the length of the lease. It is of finite duration, usually in the present and affected by current occupancy values. Land values reflect the value of an infinite life asset. Increases in the value of the land after the termination of the lease will increase the current value of the land, but not the value of current occupancy and of current leases.

Any factors that affect the future value of land will show up as a land price increase but not as an occupancy increase. House prices would rise without an equivalent increase in rents. The timing difference will result in a higher price to rent ratio.

Positive changes in expectations of the next generation's household formation rate, such as due to relaxed immigration policies, higher fertility and birth rates, declines in mortality rates, increases in life expectancy, and higher divorce rates, etc., would affect future household formation rates and increase the value of land but not the value of current occupancy.

Home prices would increase and appear to be in a bubble, especially if expectations returned to a lower household formation rate and home prices declined.

If there were a Shiller index for residential land values as there is for houses, it would be possible to disaggregate the value of occupancy from the total home value. With that or equivalent data, comparison of current occupancy values versus future land values as determinates of the recent housing bubble and various hypotheses about land value increases would be testable.

Until a data series of residential land value becomes available, a possible explanation of the sharp increase in home prices, without an equivalent increase in rents, is that there was an expectation of an increase in the next generation's demand for housing. A subsequent negative change to that expectation caused home prices to decline.

Wednesday, June 17, 2009

Kling on Regulatory Reform

Arnold Kling's excellent take on Obama' regulatory reform proposal, "What's Wrong with the Financial Regulation White Paper."
Overall, the white paper offers a highly skewed narrative of the financial crisis. All of the misbehavior took place in the private sector. No mention is made of government policies that contributed. Instead, the story is one of government that needed a better regulatory structure and more powers.

Intellectually, this is a very disappointing piece of work. But given political considerations, I cannot say that I am surprised.

CBO On Health Care Reform

If you want to understand the debate on health care, then the CBO's analysis to Senator Kent Conrad, Chairman of the Senate Budget Committee, is easy to read.

It is a comprehensive statement of the issues and forces affecting health costs. It is also a good demonstration as to how CBO views costs in the health care debate.

Bank Leverage Is A Red Herring

Many offer higher capital and lower leverage requirements as a solution to the problem of the recent banking crisis. However, it is a risk preference problem and it is not a capital or leverage problem. As anyone familiar with financial theory knows, leverage can be placed anywhere in the investment chain to create a higher risk level. Higher leverage is just a way to increase risk and the potential return.

So, if capital is increased at the bank level (lower leverage and lower risk), banks will either invest in riskier products or make safer investment products riskier by incorporating leverage into the product directly or implicitly, such as through embedded options, etc.

Using residential mortgages as an example, their risk is increased by going from 80 percent loan to value to 100 percent loan to value. Additional risk is created by lending to lower credit worthy borrowers.

When the mortgages are packaged as investment products, borrowed funds can be used to increase the value of mortgages in the product so that the total mortgage value exceeds the equity investment in the product, which increases their riskiness. The investors in these leveraged products can borrow funds themselves to increase their equity investment in the leverage products, further increasing the risk to the investors.

The investor's risk preference ultimately determines the amount of risk in the invested products. There are too many ways to increase risk. Regulations and regulatory supervision will not stop excessive risk from occurring if that is what the bank or any other investor desires.

It is a rehash of the old Modigliani-Miller problem about the optimal capital structure. A bank with low leverage can invest in riskier products to achieve the same total institutional risk that higher leverage would achieve. Despite the regulators' attempt to prevent increased risk, an institution with a higher risk tolerance will find ways to invest in products that match its risk profile. The risk to the institution will not be lower with higher capital amounts.

As Arnold Kling stated, "the problem was not a gap in regulatory structure." What would cause financial institutions to take on so much risk that the continued existence of the entire institution was in jeopardy?

Moral hazard and incentive compensation themselves cannot explain the institutional behavior. Participants, many of whom had restricted company stock, risked too much of their own personal wealth, careers and reputations for the bonus compensation structure to be the answer. Furthermore, many of the investors, including the investment and commercial banks, are too sophisticated not to have understood the risk, despite the credit rating agencies' stamp of approval and their post mortem statements.

While there are many "expert" answers proffered, none offer an adequate explanation of why institutions took on so much risk. Many sophisticated investors and financial institutions either misread the risk in the market or intended to take on excessive risk. Both are troubling and not easily fixed.

Service Jobs And New Trade Theory

Excellent discussion by Mark Thoma on International Trade. Thoma discusses the New Trade Theory and uses data to show that jobs are insourced and outsourced as a result of trade. Additionally, the US is a net insourcer of service jobs.

Read the full discussion at http://economistsview.typepad.com/economistsview/2009/06/reinterpreting-the-blinder-numbers-in-the-light-of-new-trade-theory.html.

Bush Tax Cuts Stimulated Consumption

The Congressional Budget Office found that the Bush tax rebates stimulated the economy and added 2.3 percent (annualized) to consumption growth in the 2nd quarter of 2008.

See The New York Times Blog on this finding.

Tuesday, June 16, 2009

Regional Medical Costs Are About The Same

When one looks at total medical expenditures by state and at the average per patient cost of medical services in the two often cited states, Colorado and Florida, one reaches an entirely different conclusion than the Dartmouth Health study.

For example in 2006, according to the Meps (Medical Expenditure Panel Survey), the average medical expenditure (including Medicare, private health insurance, out of pocket, uninsured, etc.) by all patients in 2006 in Colorado was $3,585. It was $3,586 for Florida. The Dartmouth Health study, which only looks at Medicare, finds that Miami is $16,351 per patient and Grand Junction, Colorado is $5,873.

The Dartmouth study seems to be in part an artifact of Medicare reimbursement policies. There are other federal funding programs to medical providers, e.g., Rural Health Grants and others, etc., and these vary in per capita amount for each state according to federal law and formulas. Dartmouth only looks at Medicare expenditures and does not include other federal medical reimbursement and funding programs. It does not look at total state medical expenditures.

Complex and strict rules limit what can be included in Medicare reimbursement, but as a general rule, double billing is prohibited. The differences that Dartmouth sees could be that some states get less non-Medicare funding and bill a higher share of costs through to Medicare. Other states bill the federal government for part of the same costs under different federal programs. While Medicare expenditures look higher per procedure in some states than other states, the total costs of the two procedures could be identical. It could all be due to reimbursement laws and rules.

The link to the Meps data is:

http://www.meps.ahrq.gov/mepsweb/data_stats/summ_tables/hc/state_expend/2006/table1.htm

The link to the main Meps data page on state medical expenditures is:

http://www.meps.ahrq.gov/mepsweb/data_stats/quick_tables_results.jsp?component=1&searchText=&tableSeries=8&year=-1

Income Mobility And Taxing Upper Income

In all the comments, stories and political speeches about taxing the rich, one point that is almost never mentioned is that in the US there is a lot of income mobility. People in the top income brackets move down into lower income brackets and people in the bottom brackets move up into higher income brackets. Income is not like height or IQ, which are relatively static over time.

Taxing upper income brackets, taxes a lot more people than the numbers in the bracket in a single year, and will be felt by many more people over a decade than the simple percentage numbers of the bracket would indicate. The poor this year are not the poor in the next few years. The rich this year are not the rich in the next few years.

Mark Perry on his Carpe Diem Blog discusses this fact in his post, Movin' Up and Down The Income Quintiles

Monday, June 15, 2009

We Are So Much Poorer Now!

Excellent post by Rebecca Wilder of News N Economics Blog, "Wealth effect update: Q1 2009.
Household net worth, total assets minus liabilities, is falling at a 16.25% annual clip.
...

At any rate, it no wonder why households are reacting so vehemently to the liabilities side of the balance sheet right now: reducing consumption and increasing saving.
Rebecca noticed the negative effects of the of the rising minimum wage in March, "The rising unemployment rate can't be entirely cyclical," while others are just now writing about it.

Is Behavioural Economics Wrong?

There is a very interesting post, "Is behavioural economics wrong?" on the Stumbling and Mumbling Blog by Chris Dillow. (HT: Mark Thoma)

The blog discusses research that shows people act rationally and opposite to predictions of behavioral economics.
The issue here is a deep political one, not just an academic matter. Behavioural economics implies that a task for politicians is to protect people from themselves. However, if people behave rationally and prudently, this might not be necessary. Instead, the task of politics is to protect people not from their own stupidity, but from other people, bad luck and from their rulers, whether these are in government or boardrooms.

Saturday, June 13, 2009

Health Care Lacks Effective Competition

Good article in St Louis Today, "Health care reform: The real problem is lack of competition" by David C. Rose.
The reason for rising frustration with insurance companies is that patients can't do what patrons they do when they receive poor service at a restaurant, which is to go elsewhere. Most health insurance is tied to employment, so most patients are stuck with their insurance company. And it shows.

Minimum Wage Increases Unemployment

Three good articles on the negatives of the coming minimum wage increase:

The first is The Wall Street Journal article, "Delay the Minimum-Wage Hike" by David Neumark.
Based on 20 years of research, I doubt there is ever a goodtime to raise the minimum wage. However, with the aggregate unemployment rate at 9.4%, the teen unemployment rate exceeding 22%, and the unemployment rate for black teens nearing 40%, next month's increase seems like the worst timing possible.
The second is by Mark Perry of Carpe Diem Blog, which has a very interesting chart on how minimum wage kills teenage jobs.

The other article is,"The Coming Minimum Wage Increase" by David Henderson.
Early in the Great Depression, President Herbert Hoover made things worse by persuading big businessmen to keep wages high. At those high wages, employers wanted to employ fewer people than otherwise. We are about to suffer another small dose of Hoover economics.

Friday, June 12, 2009

The Great Debt Scare

My comment to Robert Reich's Blog about "The Great Debt Scare: Why Has It Returned?"
As I am sure you know, GDP is a flow measure and not a stock measure like debt. As far as I know, there are no good stock measures of intertemporal GDP.

However, a possible explanation of the increasing yield on longer-term treasuries, besides expected inflation and the inflation risk premium, is a decline in the expected value of future multi-period GDP. Investors themselves may internalize and verbalize the decline in the multi-period expected GDP as higher yields and concerns about debt levels.

Concerns about US debt levels may be concerns about future GDP growth and about the Government's ability to capture a sufficient percentage of future GDP through taxes and fees to stay current on existing and future debt levels.

Without a GDP stock measure, we must rely on models, which may be missing important signals that the market is incorporating into its expectations of future GDP.

The market may be rationally concerned about debt levels. A stock level accelerates future period concerns into the present. Concerns about long-term debt reflect concerns that the bonds may face during their entire term to maturity, such as the last 15 years of a 30-year bond, as much as concerns about the current and early years of debt service. The market may see things that the current modeling does not incorporate.

Even if one substitutes the total value of non-governmental equity and debt as a proxy for a GDP stock measure, the recent periods have shown a significant value decline in the total value of equity and debt, far in excess of the percentage decline in recent GDP. The decline in total investment value may reflect a market expectation of an equivalent amount of future declines in GDP, corporate cashflows, dividends and profits. In this scenario, taxes would also decline substantially and the government may not have the ability to service high debt levels.

Likely OTC Derivatives Plan

Excerpts from Reuters article about the Administration's plan for regulating Over The Counter (OTC) derivatives:
In another sign that a merger is unlikely between the Securities and Exchange Commission and the Commodity Futures Trading Commission, the sources said the agencies could split oversight of OTC derivatives under the legal language they are working on for eventual submission to Congress.

The SEC, the larger and older of the two agencies, may take charge of regulating credit default swaps, a type of OTC derivative, for publicly traded companies, one source said.
...

In the United States, four large banks control over 90 percent of the derivatives market: JPMorgan Chase & Co, Bank of America Corp, Citigroup Inc, and Goldman Sachs Group Inc.
...

A key feature of the administration's plan will be to move more OTC derivatives trades through central clearinghouses or, in the case of standardized instruments, onto exchanges.

Customized instruments unsuited to such treatment would be subjected to more record-keeping, under the proposed changes.
The complete Reuters article is at http://www.reuters.com/article/businessNews/idUSTRE55A0LK20090611.

Thursday, June 11, 2009

Average Wages Rose Again

Link to Bureau of Labor Statistics average employee compensation per hour for March 2009. It also breaks out the average cost of different benefits per hour. Additionally, there are regional, industry, union vs. non-union, and government vs private breakdowns.

"Employer costs for employee compensation averaged $29.39 per hour worked in March 2009, the U.S. Department of Labor’s Bureau of Labor Statistics reported today. Wages and salaries, which averaged $20.49, accounted for 69.7 percent of these costs, while benefits, which averaged $8.90, accounted for the remaining 30.3 percent."

Wages and salaries average a 2.91 percent annualized increase from December 2008 to March 2009.

"Employer costs for employee compensation for civilian workers averaged $29.18 per hour worked in December 2008, the U.S. Department of Labor’s Bureau of Labor Statistics reported today. Wages and salaries, which averaged $20.37, accounted for 69.8 percent of these costs, while benefits, which averaged $8.81, accounted for the remaining 30.2 percent."

Despite the decline in employment and the increase in unemployment, average wages continue to increase. If wages were declining, we would see greater hiring than we do and a decline in unemployment.

There is also a total employer compensation report and it shows an increase from December 2008 to March 2009. The next release of this report is on July 31, 2009.

Wednesday, June 10, 2009

Too Bad Financial Regulatory Agencies Do Not Know Coase's Work

New financial industry regulations are very likely in response to the current recession and financial industry crisis. The restructuring of the various government agencies that oversee the financial industry is still uncertain. For example, see The Washington Post story, "Goals Shift For Reform Of Financial Regulation."

Turf wars among the various agencies and the several Congressional agency oversight committees are the major political obstacles to a rational reformulation of the oversight and regulation of the US financial services industry. Effective changes to financial industry regulations also require an understanding of the causes of the perceived current financial industry crisis, both from a product supply side, i.e. the over production of risky, housing related investment products, and the demand side, i.e., the over investment and lack of diversification in housing related investments.

None of the current explanations is very satisfying as they all rely on a suicidal tendency of firms to self-destruct or irrationality to the point of absurd stupidity. Nor does employee compensation structure offer any explanatory help since only one side of the transaction was volume compensated, usually the seller and not the buyer (investor) of the product.

However, if the political architects of the proposed new regulatory structure and regulations familiarized themselves with the works of Ronald Coase, they would realize that the extent of industry changes that will occur at the end of their hard work and analysis is limited. The changes to the regulatory structure and regulations are important only to the extent that they change the transaction, including search, costs of the firms they supervise and regulate.

Based on Coase's Theorem and Coase's work on the Nature of the Firm, the regulated firms, independent of the starting point, will voluntarily transfer rights, obligations and functions among themselves based on costs and efficiencies.

Just as mortgage originations that fed securitized products shifted to loosely, state regulated mortgage bankers from banks, functions will shift among the various financial firms based on costs and efficiencies. The shifts will be independent of the number of agencies supervising the industry and new regulations.

Most likely, individual firm regulatory and transaction costs will remain relatively stable pre and post Congressional changes to the regulation and supervision of financial industry firms.

No matter how the new rules modify the starting point of the rights and responsibilities of financial firms, the firms will reallocate among themselves based on costs and efficiencies.

All the major financial firms that ran into trouble are already highly regulated, supervised and transparent to the regulators. There is little likelihood of any of the proposed changes resulting in any fundamental shift in the total industry's product offering or product demand.

Congressional and Executive staff will work very hard for little change when one looks at the entire industry's functions, product offerings, demand and investments before and after their many sleepless nights.

Also see my previous post on regulation, Regulations Relocate Risk Taking.

Tuesday, June 9, 2009

Average Wages Report Probably Will Show Increase Again Tomorrow

Link to Bureau of Labor Statistics average employee compensation per hour for December 2008. It also breaks out the average cost of different benefits per hour. Additionally, there are regional, industry, union vs. non-union, and government vs private breakdowns.

"Employer costs for employee compensation for civilian workers averaged $29.18 per hour worked in December 2008, the U.S. Department of Labor’s Bureau of Labor Statistics reported today. Wages and salaries, which averaged $20.37, accounted for 69.8 percent of these costs, while benefits, which averaged $8.81, accounted for the remaining 30.2 percent."

Wages and salaries average a 4.85 percent annualized increase from Sept. 2008 to Dec. 2008.

"Employer costs for employee compensation for civilian workers averaged $28.87 per hour worked in September 2008, the U.S. Department of Labor’s Bureau of Labor Statistics reported today. Wages and salaries, which averaged $20.13, accounted for 69.7 percent of these costs, while benefits, which averaged $8.74, accounted for the remaining 30.3 percent."

The March 2009, average wage report will be released by BLS on June 10, 2009. A comparison with the upcoming release and with the December 2008 release will answer the question if compensation increased from December 2008 to March 2009.

Despite the decline in employment and the increase in unemployment, average wages probably continued to increase. If wages were declining, we would see greater hiring than we do and a decline in unemployment.

There is also a total employer compensation report and it shows an increase from December 2008 to March 2009. The next release of this report is on July 31, 2009.

Why Active Investing Is a Negative Sum Gain

From Fama/French Forum Blog:

Why Active Investing Is a Negative Sum Game

by Eugene F. Fama and Kenneth R. French

William F. Sharpe has a great article in the January/February 1991 issue of The Financial Analysts Journal (Vol. 47, No.1, pages 7-9). The title is "The Arithmetic of Active Management." It should be required reading for academics and investment professionals alike.

The whole article is at: https://web.stanford.edu/~wfsharpe/art/active/active.htm

Monday, June 8, 2009

A Guess At A Supreme Court Win-Win At Chrysler

For update about Chrysler and the Indiana secured creditors request for a stay of the Chrysler Fiat sale, read The BLT, The Blog of LegalTimes. Also ScotusBlog updates on Chrysler bankruptcy stay.

Indiana secured bondholders are requesting the US Supreme Court to issue a stay to delay the sale of Chrysler to Fiat. As of 1:00 AM, Monday, June 08, 2009, New York time, there is no word from the Supreme Court or any of the parties about the status of the stay request. [Monday afternoon, Justice Ginsburg issued a stay for a full court review.]

The press has made the stay an all or nothing issue. Either the court can grant the stay to the bondholders or it can deny the stay and the secured creditors lose and the government wins.

There is another possibility besides letting the deal close as is or delaying the close of and allowing the bondholders to get more than 29 cents on the dollar.

The bondholders need to show irreparable harm to get the deal delayed, but when money is involved there rarely is irreparable harm if there is somebody to sue for money damages later.

Justice Ginsburg, or the whole Supreme Court, can find that there is not irreparable harm, deny the stay and allow the Fiat deal to close as is. Simultaneously, the Supreme Court can say with the denial that the bondholders have the right to sue the US Government and the UAW for the loss of value due to not following bankruptcy priority. The Supreme Court would have to find some way to limit the lawsuit as much as possible to the peculiar situation, such as when the government ends up with a controlling interest in the post bankrupt company.

It would be a win-win for all parties. The deal closes. Fiat gets Chrysler. The government and the UAW get what they want and the secured bondholders get their day in court to prove they are entitled to more money. If the secured bondholders win, the payout would come from the funds for US lawsuits and not from Chrysler or Fiat.

Saturday, June 6, 2009

D-Day June 6, 1944

(HT: Brad DeLong)

Soldiers, Sailors and Airmen of the Allied Expeditionary Force!

You are about to embark upon the Great Crusade, toward which we have striven these many months. The eyes of the world are upon you. The hopes and prayers of liberty-loving people everywhere march with you. In company with our brave Allies and brothers-in-arms on other Fronts, you will bring about the destruction of the German war machine, the elimination of Nazi tyranny over the oppressed peoples of Europe, and security for ourselves in a free world.

Your task will not be an easy one. Your enemy is well trained, well equipped and battle hardened. He will fight savagely.

But this is the year 1944! Much has happened since the Nazi triumphs of 1940-41. The United Nations have inflicted upon the Germans great defeats, in open battle, man-to-man. Our air offensive has seriously reduced their strength in the air and their capacity to wage war on the ground. Our Home Fronts have given us an overwhelming superiority in weapons and munitions of war, and placed at our disposal great reserves of trained fighting men. The tide has turned! The free men of the world are marching together to Victory!

I have full confidence in your courage and devotion to duty and skill in battle. We will accept nothing less than full Victory!

Good luck! And let us beseech the blessing of Almighty God upon this great and noble undertaking.

SIGNED: Dwight D. Eisenhower

Friday, June 5, 2009

Does Council Of Economic Advisers Read Appendices

It is difficult to understand why the President's Council of Economic advisers (CEA) and the press continue to report 45.7 million as uninsured when the US Census Bureau, which was responsible for the original survey number 45.7 million, says that the number is not valid and grossly over reports the number of uninsured.

The CEA report states on page 7, the same page as the chart of uninsured by age:
In 2007, 45.7 million Americans did not have health insurance. About one out of every six U.S. residents under the age of 65 is currently without health insurance.

The data is from a US Census Bureau survey, "Income, Poverty, and Health Insurance Coverage in the United States: 2007, Current Population Reports, Consumer Income" released August 2008.

Surveys, however, are notoriously unreliable. The Census Bureau itself, in Appendix C of the survey report responsible for the 45.7 million of uninsured, questions the validity of that number.

The Census Bureau states in Appendix C on page 59 of the report:

Quality of Health Insurance Coverage Estimates

National surveys and health insurance coverage.

Health insurance coverage is likely to be under reported on the Current Population Survey (CPS). While under reporting affects most, if not all, surveys, underreporting of health insurance coverage … appears to be a larger problem than in other national surveys that ask about insurance.

Because the CPS is largely a labor force survey, interviewers receive less training on health insurance concepts than labor concepts. Additionally, many people may not be aware that a health insurance program covers them or their children if they have not used covered services recently.

The Census Bureau cites in the same appendix a research project it undertook with the University of Minnesota to look at the Medicaid numbers in the survey versus actual Medicaid enrollees. The research found, "A key finding indicating survey response error … was that 16.9 percent of people with … Medicaid coverage reported … that they were uninsured."

Medicaid under reporting alone reduces the 45.7 million by 7 million. The Census Bureau looked at Medicaid because it had computerized records of Medicaid enrollees readily available.

The Census Bureau survey also does not ask the person if they currently have insurance. It asks them about the previous year. Researchers who have looked at the other categories of the uninsured also have found that the Census numbers grossly over report the uninsured.

Additionally, one of the biggest problems with the survey, which is also mentioned in the report appendix, is that it is a snapshot at a specific point in time. People who have a short waiting period before coverage begins, such as a 30 day waiting time at a new job, etc., indicate that they are uninsured. Researchers who have followed up on people reporting no health insurance have found that most of them have insurance within a few months.

The number of truly long-term uninsured in the US is much smaller than 45.7 million..

There is nothing wrong with the President and the CEA promoting universal health care, but it is politically shortsighted to use an invalidated number.

It really calls into question the credibility of all the numbers that this Administration is providing on health care.

Thursday, June 4, 2009

Are GM's Actions Government Actions?

Does the US government's controlling equity ownership of GM grant constitutional rights to dealers and others affected by GM's decisions? Is due process, i.e. notice, hearing, right to judicial review, fairness and lack of arbitrariness, required as part of the automaker's decision-making process?

The Washington Post published a story, "Senators Blast Automakers Over Dealer Closings."

The Thursday, June 4, 2009 article states:
Empowered by the government's emerging ownership role, members of a Senate committee yesterday excoriated General Motors and Chrysler for their decisions last month to close more than 2,000 dealers.

The senators have been besieged by auto dealers who say the franchise closures were capricious or unfair.
Are the dealers entitled, under the Fifth Amendment, to due process constitutional rights before their GM dealerships are terminated?

I am sure some enterprising attorneys will litigate the dealership closings and raise constitutional issues. Will every GM decision become a government decision and raise constitutional notice and review rights?

Seeking Alpha Blog Comment On Barney Frank And Regulation

My comment to a Seeking Alpha Blog, "Will Congress Try to Dictate Better Market Outcomes with Regulation?" by Jeffrey Korzenik.

For some reason, Barney Frank is overly protective of Fannie Mae and Freddie Mac. He was instrumental as chair of the House Financial Services Committee, in preventing direct oversight by Treasury of these two GSE's in 2003. Greenspan and many others at the time testified that the GSE's needed stronger oversight. In 2003 and prior, many in and outside of government recognized that the GSE's had become too big and were reaching beyond their housing mandate by directly investing in mortgages to increase their size, income, and executive bonuses instead of facilitating home ownership by guaranteeing the mortgages.

Frank was also very protective and supportive of Frank Raines, the Fannie Mae CEO who resigned due to accounting irregularities to increase Fannie Mae's income and his bonuses. See the March 31, 2005, The Washington Post article, "Study of Fannie Mae Cites 'Perverse' Executive-Pay Policy."

Any product, including securitized mortgages, relies on a sufficient supply and a sufficient demand for it to be successful in the marketplace. The GSE's in 2000 through 2007 were major purchasers of securitized mortgages of all types and the GSE's purchases of securitized mortgages in the years leading up to the financial crisis are a contributing factor to the housing bubble and banking crisis.

The GSE's had the ability to borrow in the market at rates significantly below those of other mortgage buyers due to the implicit government backing of the GSE's. Without GSE purchases, the originators of the securitized mortgages products would have found it much more difficult to find a sufficient number of buyers for all the mortgage securities that they could produce.. Without sufficient buyers, prices of the mortgage products would have had to decrease, which increases the yield, to attract more buyers into the marketplace. Mortgage originator profits would have declined because of the lower prices, which would have forced some originators out of the business. Additionally, the remaining producers would have had to increase the cost to borrowers through higher interest rates or points to remain profitable, which also would have had the effect of decreasing the number of borrowers and the number of mortgages originated.

While not the sole cause of our current financial malaise, Barney Frank certainly is an important contributor to the banking crisis.

Wednesday, June 3, 2009

Switch To Gallons Per 100 Miles Instead Of MPG

What you see by using gallons per 100 miles (and what scientists that study energy efficiency know) is that it is no longer worth the expense or effort to increase miles per gallon to reduce gasoline usage by automobiles. For example at 25 mpg, it takes 4 gallons to drive 100 miles. At 33 mpg, it takes 3 gallons. At 50 mpg, it takes 2 gallons. At 100 mpg, it takes one gallon. To get from 25 to 33 mpg and save one gallon of gasoline per 100 miles, it is an 8 mpg increase. To save an additional 1 gallon of gasoline and get from 33 to 50 mpg, it is a 17 mpg increase. To save another 1 gallon of gasoline and get from 50 to 100 mpg, it is a 50 mpg increase.

A car getting 25 mpg needs above a 33 percent increase in gasoline efficiency to get to 33 mpg (4 to 3 gallons per 100 miles). This reduction will have to be in weight, along with a reduction in engine power, at this point in the development of automobiles. There is very limited potential to increase an automobile's gasoline engine efficiency without making it smaller and weaker and most of the efficiency will have to come from cars getting a third lighter. To get from 33 mpg to 50 mpg, cars again will have to become a third lighter (3 gallons to 2 gallons per 100 miles). They will have to weigh half as much as a car getting 25 mpg.

The most cost effective way to make cars lighter that use weaker engines is to make cars smaller. As cars get lighter and engines get weaker, the weight of the occupants becomes a greater percentage of the weight of the car and a limiting factor. However, there is an overriding concern to reducing the weight, engine power, and size of a car. The car must be able to protect the driver and passengers in case of an accident.

We should not be even focusing on mpg and automobile engine efficiency. The concept has nothing to do with clean air or greenhouse gases. It developed as a weak political response to OPEC during the 1970s. The Clean Air Act, which has had a great effect on cleaning our air of harmful pollutants, focused on the reduction of actual emissions from automobiles. The catalytic converter, along with other emission technologies, is what improved our air. Increasing mpg did not significantly improve our air.

MPG exists because politicians pander to our paranoia about importing oil from the Middle East. In actuality, only 1-3 percent of our gasoline is from Middle East countries other than Saudi Arabia.

Most of our imported foreign oil, about a third, comes from North America, i.e. Canada and Mexico. Include South America and we are at about half of our oil imports. Add the UK, Norway, Africa, and Russia (about 4 percent) and we are at 80-85 percent. 15 to 20 percent of our imported oil comes from the Middle East and about two thirds of that from Saudi Arabia.

Additionally, a third of our oil comes from the US, which obviously does not count as an import. When the US is included, the Middle East represents about 10- 15 percent of our total oil use. Only, 3 to 5 percent of our total oil use is from the Middle East and is not from Saudi Arabia.

Furthermore, only 45-50 percent of oil is used for gasoline. The rest is used for jet fuel, petroleum products, asphalt, plastics, synthetic fabrics, etc.

Therefore, only 1-3 percent of our gasoline is from Middle East countries other than Saudi Arabia. We are paranoid about something that is inconsequential to our energy independence. Forget mpg and our worries about importing oil.

Today, our greatest concerns are about greenhouse gases such as carbon dioxide and methane. Scientists (as opposed to environmentalist who have never stopped hating the automobile) who have no bias pro or against automobiles or coal fired plants know that our best efforts at reducing carbon emissions will not be enough alone to prevent global warming as currently predicted by models. These models and their dire predictions are still subject to new knowledge and to changes in their predictions.

The most important work to prevent global warming, and probably the solution, is coming from scientists who understand that we must increase the heat outflow from the earth into outer space. If one views the earth as a bathtub that is over flowing with heat, the problem is that too little heat is escaping from the earth, i.e. going down the bathtub drain. Eliminating a small percentage of the carbon dioxide emissions from cars or reducing the carbon dioxide output from utilities and other companies is insufficient at this point to stop excessive heat capture.

There are many ideas in development. One that recently got some press was the idea to make all building roofs reflective or white. The idea is that the white roofs will reflect the sun's energy back into outer space instead of captured by the earth and converted into heat and global warming.

MPG is a political response, not a scientific response, to a geo-political paranoia and not to an environmental concern.

Also, see my previous blog:
Benefits of Higher Auto MPG Will Not Occur.

Tuesday, June 2, 2009

Should The US Consolidate GM Onto Its Financial Books?

Would the US government have a controlling interest in GM, if it were required to follow the same accounting rules as business?

If Berkshire Hathaway owned 50 percent or more of GM, Berkshire would be required to issue a consolidated income and balance sheet statement that included GM. GM's assets, debts and earnings would be added to the comparable Berkshire accounts, subject to the removal of any transfers between the two entities.

The US investment in GM will result in the US owning 60 percent of the equity of GM. That is higher than the level of ownership required for issuing consolidated accounting statements under generally accepted accounting standards.

A consolidation into US's financial reports would replace the equity investment in GM with the auto company's assets and debts, and the increase in US debt needed to invest in GM. The consolidated US budget would include GM losses or profits. Additionally, the government's purchase of GM cars would become an intra-entity transfer and not a sale.

The trend these days is to issue consolidated statements in business. For example, rules are changing so that bank accounting statements include the off balance sheet entities that hold their securitized mortgages.

Statement of Federal Financial Accounting Standards No. 24 requires government agencies to follow generally accepted accounting standards unless specifically excluded. SFFAS No. 24 requires the government to publish a Consolidated Financial Report of the United States Government. I have not reviewed the relevant law for the US's investment in GM and the ownership of its 60 percent equity stake, but I am assuming it exempted the US from treating the investment in GM like a business would.

If the US had to consolidate a GM entity into its financial statements, there probably would have been more transparency about the benefit and nature of the investment and there would have been more criticism of the GM investment.

Knowledge Jobs Are The Future Of US Manufacturing

A great blog piece by Robert Reich about the future of manufacturing jobs in the US.

Reich says:

First and most broadly, it doesn't make sense for America to try to maintain or enlarge manufacturing as a portion of the economy. Even if the U.S. were to seal its borders and bar any manufactured goods from coming in from abroad--something I don't recommend--we'd still be losing manufacturing jobs. That's mainly because of technology.


Too bad, neither President Obama nor Lou Dobbs understand what modern manufacturing in the US is all about.

Read the whole article at http://robertreich.blogspot.com/2009/05/future-of-manufacturing-gm-and-american.html

Monday, June 1, 2009

Excellent Post On Regulatory Arbitrage

James Kwak posted an excellent blog on The Baseline Scenario about Regulatory Capital Arbitrage.

Kwak states:

Regulatory capital arbitrage happens because, all other things being equal, banks would like to hold less rather than more capital….

How does regulatory capital arbitrage work? There are many strategies, but the most straightforward to describe and to implement is securitization….

The magic is that by getting sufficiently high credit ratings for the senior tranches, the bank can lower the risk weights on those assets, thereby lowering the amount of capital it has to hold for those tranches….


Read the entire posting at http://baselinescenario.com/2009/05/30/regulatory-capital-arbitrage-for-beginners/

Incentive Compensation Did Not Induce Excessive Risk Taking

The individuals who are opposed to incentive compensation at financial firms are probably risk adverse individuals who have not experienced the thrill of working on large trades or deals in a financial firm. For example, see comments by James Kwak and Alan Blinder.

Some people are greater risk takers than others. Just as some people drive faster or ski down the expert slopes, people with a greater risk taking profile, take jobs where they can engage in greater risk taking. Trading ranks as one of the most stressful jobs with a high degree of risk.

Lowering the compensation will not change that part of the job profile. Risk seeking individuals will still take these jobs.

Lowering the compensation and incentive pay structure will change the types of people who take these jobs along other measures but it will not stop their risk taking.

People self select for jobs using many attributes of the job as their criteria. Compensation is just one of a job's characteristics. People who enjoy jobs where there is stress and thrills will always seek to be traders and deal makers. They will always push the envelope.

Just as incentive pay is not the defining difference between test pilots and regular pilots, lowering the compensation and incentives will remove those applicants who self-select based on total compensation, but it will not remove thrill seekers as applicants.

Yes, a lower compensation without bonus incentives will change the types of individuals in financial firms, but not along the qualities that you want to eliminate. It will not prevent a recurrence of excessive risk taking, just as it was not the cause of the excessive risk.

Blaming incentive compensation is equivalent to blaming a high performance sports car for a driver's speeding instead of blaming the driver. Drivers who speed choose fast cars and not vice versa.