Wednesday, September 30, 2009

Coast Guard Video: Actual Helicopter Evacuation of Sick Submarine Crewmember At Sea


Link to video here.

ASTORIA, Ore. – The Coast Guard medically evacuated a crewmember from a U.S. Navy submarine off the coast of Wash., Tuesday.

The Navy contacted the Coast Guard at 5:50 p.m. to request assistance in transferring a crewmember to a hospital from a submarine.

Coast Guard Air Station Astoria, Ore., launched an MH-60 Jayhawk helicopter crew to assist. The rescue helicopter arrived on scene at 7:12 p.m. and hoisted the crewmember by basket from the sail of the submarine. The crewmember was transferred to Oregon Health and Science University in Portland, Ore.

U.S. Coast Guard video by Air Station Astoria.

SEC, CFTC To Release Rules Harmonization Report On October 15

The SEC and the CFTC announced today that they expect to issue a report on October 15 on the harmonization of futures and securities regulation.

The report will include the following topics:
  • Product listing and approval
  • Exchange/clearinghouse rule approval under rules- versus principles-based approaches
  • Risk-based portfolio margining and bankruptcy/insolvency regimes
  • Linked national market and common clearing versus separate markets and exchange-directed clearing
  • Market manipulation and insider trading rules
  • Customer protection standards applicable to broker-dealers, investment advisors and commodity trading advisors
  • Cross-border regulatory matters
In addition, the report will recommend to Congress and the President that they (1) strengthen enforcement powers; (2) enhance and harmonize customer protection standards; and (3) establish an ongoing coordination and advisory process.

"We must continue to build upon the progress we are making to reduce regulatory arbitrage, avoid unnecessary duplication and close regulatory gaps," said SEC Chairman Mary Schapiro.

Read the complete joint statement here

Bush Vs Obama 2008-2018 Projected Deficits Chart

















 From The Journal of the American Enterprise Institute September 30, 2009 article, "Making Bush Look Like a Piker" by Veronique de Rugy.

More To Schooling Than Higher Earnings

Schooling improves a students' decision making ability, and makes students more goal-oriented and less likely to engage in risky behavior, among other positive outcomes, according to a recent NBER Working paper by Philip Oreopoulos and Kjell Salvanes.

It would be interesting to compare students who score higher on standardized tests, such as those required by No Child Left Behind legislation, and students who do not do well on the standardized test along other measurable attributes. If the test scores do not correlate with life skills, maybe we should also measure a student's school achievement by how the student performs on important life skills, such as goal-oriented, patience, decision making, etc and not just math and reading skills. Maybe even instead of subject matter skill levels.

NBER Working Paper No. 15339, "How large are returns to schooling? Hint: Money isn't everything" by Philip Oreopoulos, Kjell G. Salvanes, Issued in September 2009. Unfortunately, paper is gated and requires paid subscription.

From the abstract:
This paper explores the many avenues by which schooling affects lifetime well-being. Experiences and skills acquired in school reverberate throughout life, not just through higher earnings. Schooling also affects the degree one enjoys work and the likelihood of being unemployed. It leads individuals to make better decisions about health, marriage, and parenting. It also improves patience, making individuals more goal-oriented and less likely to engage in risky behavior. Schooling improves trust and social interaction, and may offer substantial consumption value to some students. We discuss various mechanisms to explain how these relationships may occur independent of wealth effects, and present evidence that non-pecuniary returns to schooling are at least as large as pecuniary ones. Ironically, one explanation why some early school leavers miss out on these high returns is that they lack the very same decision making skills that more schooling would help improve.

Tuesday, September 29, 2009

Laugh With Comedian Economist Yoram Bauman (HT: Greg Mankiw)

Many funny moments and laughs in the video below about the financial crisis by stand-up economist Yoram Bauman. One of his punchlines, "Thanks But No Thank You I Rather Listen To N Greg Mankiw" at about the 1:40 mark. He is also publishing a comic book guide to economics. See picture and ad below video. Bauman is an Instructor at the University of Washington.





(HT: Greg Mankiw)

2008-09 Financial Crisis Not Predictable

The 2008-2009 financial crisis is not predictable, according to Federal Reserve Bank of San Francisco research, "Predicting Crises, Part II: Did Anything Matter (to Everybody)?" by Andrew K. Rose and Mark M. Spiegel.

The authors looked at the factors mentioned as possible causes, including plausible variables, such as the magnitude of real estate price appreciation or the quality of the regulatory environment, and they all failed to perform well in predicting the crisis.
However, we have less success in linking crisis severity to its causes. We examine over 60 factors that have been advanced in the literature as potential causes of the 2008 credit crisis, but few emerge as robust predictors of its severity. Indeed, we find only one variable--the size of the equity market run-up prior to the crisis--that is a robust predictor of crisis severity. Other equally plausible variables fail to perform well, such as the magnitude of real estate price appreciation or the quality of the regulatory environment. Since early warning models must predict both the cross-country incidence of crises as well as their timing, our analysis bodes poorly for the success of such models
.

Foreclosure Crisis Driven By Severe Decline In Housing Prices, Not Relaxation Of Underwriting Standards

the foreclosure crisis was primarily driven by the severe decline in housing prices that began in the latter part of 2005, not by a relaxation of underwriting standards
according to a research paper by the Federal Reserve Bank of Atlanta, "Decomposing the Foreclosure Crisis: House Price Depreciation versus Bad Underwriting" by Kristopher Gerardi, Adam Hale Shapiro, and Paul S. Willen, Federal Reserve Bank of Atlanta Working Paper 2009-25, September 2009.

From the abstract:
conclude that the foreclosure crisis was primarily driven by the severe decline in housing prices that began in the latter part of 2005, not by a relaxation of underwriting standards on which much of the prevailing literature has focused. We argue that relaxed underwriting standards did severely aggravate the crisis by creating a class of homeowners who were particularly vulnerable to the decline in prices. But, as we show in our counterfactual analysis, that emergence alone, in the absence of a price collapse, would not have resulted in the substantial foreclosure boom that was experienced.
The abstract is available here. The paper is available here.

The paper's authors are:
Kristopher Gerardi, Research Department, Federal Reserve Bank of Atlanta;
Adam Hale Shapiro, U.S. Department of Commerce, Office of the Chief Economist, Bureau of Economic Analysis;
Paul S. Willen, National Bureau of Economic Research and Research Department, Federal Reserve Bank of Boston.

Monday, September 28, 2009

The Riskiness Of Risk

There is tremendous risk in attempting to evaluate and use risk as a metric for evaluating firms, investments and individual financial decisions. Using risk as a dominant feature for decision-making is in and of itself highly risky. The recent financial crisis shows that risk measurement cannot be the premier guide for business and individual actions.

Investors, homeowners, regulators, analysts and financial institution executives learned in the financial crisis that the actual risk of an investment is different from the expected risk. In the financial crisis, the risk and investment losses were much greater than were expected in the worst-case scenarios. Firms and homeowners faced insolvency and the entire landscape of financial firms and homeownership changed.

Institutional investors and financial firms are sophisticated. They are not self-destructive and employees would not knowingly risk their entire careers, their equity in their firms and their firms. Many know how to analyze collateralized mortgage obligations, derivatives and other mortgage related investments. If they do not know how to analyze the risk of these investments, they know they can get an analysis, showing the value of the investment under different economic situations and mortgage default scenarios, from the firms originating and selling the investments. Investors can always buy a US treasury bond as an alternative and are not powerless. Likewise, homeowners would not knowingly risk losing their homes.

Holders take great effort to limit their investments to the acceptable levels within their firms' risk guidelines or risk losing their jobs and careers. Certainly, there are aberrant traders, salespeople and investors, but they are isolated and not system or firm wide. The financial crisis is not the result of a few rogue individuals. The risk affected many firms and most developed countries. There is no easy explanation of past events.

Additionally, for over twenty years, derivative modelers and analysts knew how to value fat tails, otherwise known as black swans or low probability events. They can also model investments where prices break from past behavior, i.e. jump diffusion models. Even without that knowledge, firms have analysts who could run sensitivity analysis for different economic events, even very low probability ones, to accurately gauge how an investment will behave in unlikely scenarios. Brokers would show that truthful information to risk-adverse investors, if needed or requested.

The crisis taught everyone that past investment behavior, modeling, sensitivity analysis, risk expectations and any other decision-making criteria for dealing with risk is in itself very risky.

There is a second order effect. Risk and risk evaluation is risky and using risk criteria for decision making and investment decision entails risk to an institution not captured by the measurement of the investment and product risk.

The riskiness of risk is separate and different from the systemic risk of the interconnectedness of financial institutions.

It is the recognition of the riskiness of risk that has made all of us much more risk adverse. It is showing up in many indicators. Households are paying down debt. They are not making major purchases, such as homes or autos. There are fewer business startups. Employers are hiring many fewer people than in the past, which is the primary cause of the high unemployment numbers and not the layoffs.

The country is placing too much attention on why and how we got into this mess. When we are wiling to accept the recent past, our changed financial and housing landscape, our investment losses, and our and our children's changed career prospects, we will then be ready to move on and economically grow this country again, to start new businesses, develop new ideas and to take the necessary risks to improve the country's future prospects.

If we focus too much on the riskiness of the past, everyone will become risk avoiders and it will only delay strong future economic growth.

It will take awhile and some time separation from the present events for unbiased research to give us a clearer picture of the causes and results of the financial crisis. (See my older post, "Too Bad Financial Regulatory Agencies Do Not Know Coase's Work.")
At that time, we can institute reforms to prevent a reoccurrence. Until then, we should stop looking back and start looking forward at how we can rebuild the great economic growth that this country can achieve.

Sunday, September 27, 2009

A Marketing Cynic

On Thursday night, Megan Fox, the beautiful young movie actor who starred in Transformers, appeared on Late Night with Jimmy Fallon. She was promoting her upcoming Saturday night guest host appearance on the first show of the new season of Saturday Night Live and both SNL and Fallon are on the same network. So, her appearance on the show was as the expected typical self-promotional guest.

At about 3 minutes into an 8 and 1/2 minute interview, Fallon says to Fox that he hears she has a new game she plays and really likes. She responds excitingly and mentions and describes a game called "Sally's Spa" that she plays on her IPod. Almost all of the audience appears to be unfamiliar with the game.

The next day on my cell phone, which has internet access, prominently displayed on the cell carrier's home page for games, is "Sally's Spa." It was not on the page prior to her appearance.

Now, I am fully familiar with prominent product placements in TV shows and movies, e.g. example where the star visibly drinks a certain soft drink or eats a certain candy bar. Movies and TV shows also place open containers of name brand foods in the kitchen or on the table, etc with the labels visible, but it was not until the game showed up on my cell phone apps for purchase the next day that I realized the exchange between Fallon and Fox was most likely preplanned marketing.

So, Megan was being efficient and productive. She promoted more than one thing in the same Late Show appearance slot. She promoted SNL, herself as host, a new game seeking a broader audience and IPod. She also got in a mention for Kindle. She was like one of those internet video viewing sites that frequently interrupt the video for a commercial break for a few seconds before it continues. I did find that she was much less obvious than one of those video commercials.

She is well on her way to monetizing her actor image and recognition to its fullest marketing potential. If she were a company, I would invest in her for her tremendous future profitability and earnings potential.

One of my previous posts, about the tennis player Melanie Oudin's "believe" sneakers by Adidas, continues to rank in the top 15 of entry points to this blog with people out clicking to the manufacturer's website. Too bad I do not have any agreement with Adidas for payment for clicks to their ordering site.

Celebrity and sports marketing are a big part of an advertisers game plan these days for major companies and products.

Saturday, September 26, 2009

Basic Economics: Supply And Demand By Russ Roberts

Russ Roberts, economics professor at George Mason University, put up a link to an excellent supply and demand course supplement paper he wrote a few years ago, "How Markets Use Knowledge" on the Cafe Hayek blog where Roberts is a co-contributor with Don Boudreaux.

In fairly simple descriptive terms (except for the normal and expected supply and demand graph, which requires a little thought and patience to follow the concepts on the graph), Roberts utilizes a hypothetical example of graphite use in two industries.

Starting with the example of graphite tennis racquets and then introducing a new demand for graphite in the auto industry, Roberts shows how the higher demand changes the price and increases the production of graphite.

The most important take away from the article, for those readers that are unfamiliar with the mechanics of supply and demand, is that only part of the auto industry demand is met by increasing supply. The price increase makes suppliers go out, find, and produce more graphite but not enough to meet all the extra demand.

Part of the demand is also met by a decrease in graphite use in the tennis racquet industry. Tennis racquet manufacturers faced with higher graphite prices reduce their use of graphite through material substitution, through more efficient processes that use less graphite and maintain the same quality, or consumers buy fewer graphite racquets due to a higher price and switch to wood or switch to lower cost racquets that use less graphite.

Also, the auto industry gets most of the graphite it needs but not all and therefore is forced to find alternative materials or to improve its efficiency in the use of graphite.

Cafe Hayek is an excellent economics blog that should be read regularly.

Also see my other post, a video, in this series, "Basic Economics: Production And The Firm Video By Art Carden."

Friday, September 25, 2009

The Economy Is As Bad as The 1980's, Not the 1930s: Did We Scare Ourselves Into High Unemployment?

Mark Perry writing on the EnterpriseBlog, The Worst Economy Since…. the 1980s?, compares the current recession to the 1980s recession.

Perry writes:

[click image to enlarge]


By comparing today’s economic conditions to the 1930s and the Great Depression, the news media have apparently skipped the terrible economic conditions of the early 1980s and gone all the way back 75 years to the 1930s, without a comparison to a more recent period like the early 1980s. Compare for example some of the key economic variables today to the peaks for those variables in the early 1980s (see graph above).

We are not even yet anywhere close to the economic conditions of that period.

****
And consider that as bad as the economic conditions were back in the early 1980s, the U.S. economy started on an economic expansion in November of 1982 that didn’t end until July 1990, 92 months later, and marked the third longest expansion in U.S. history. Given the current environment with historically low interest rates and inflation, today’s economic and financial conditions are much more favorable for economic growth than the conditions of the early 1980s.
Perry's complete post is available here.

I am not a strong believer of behavioral economics or irrational markets, but still, I am surprised that no one discusses the possibility of an anti-bubble. Could the strong language of Bernanke, Paulson, Obama and Obama's economic team about the severity of the current economic downturn and the frequent association of current economic conditions with the 1930s Great Depression have contributed to more unemployment than would have otherwise occurred. Certainly, the Depression is viewed as a time of high, sustained unemployment.

Did the linguistics make companies lay off and delay hiring more people than they would have without the strong references to the 1930s Great Depression? The unemployment rate is exceeding economists' forecasts developed at the earlier stages of the crisis.

Personally, the economic language during the 2009 Winter frightened me. Did it cause me to purchase less and save more than I would have otherwise in this recession? I do not know.

What If Colleges Auctioned Classes?

What would happen at colleges and universities if registration for classes incorporated auction prices as part of the process and past pricing was available?

Probably, there would be better course descriptions of classes, better teaching, and better matching of students' interest with the classes. In addition, there could be a host of unthought-of and unintended consequences and some might improve the learning process. Professors might be motivated to be better educators.

Suppose colleges used an auction process for class enrollment instead of the normal, arbitrary, first come first serve procedure, also known as the lucky if you get in procedure. Of course, all perquisite prerequisite requirements and graduation requirements will still remain and be the same.

(Caveat: I am not an auction expert. The specific auction suggestions below are just a broad outline for discussion purposes only.)

Colleges could use the Dutch auction method similar to the one used for new issues of US Treasury bonds. Pricing would determine student demand. It would also create an observable metric, a market-clearing price for each course.

Under a Dutch auction system, all students wanting to take a course with a known time and professor would bid for the course. The lowest price that filled the class, the price at which that class cleared in the market, would set the price for all registrants to that class. Students could have a prepaid non-refundable credit for the semester's tuition as their budget to use for bids for their classes.

A student's class selections would be filled until the student used the entire prepaid credit or until they have enough courses. Since there are enough class openings available for all students, and students want to select the courses they take, most students will have sufficient funds to fill their semester course schedule. Some courses at the end might have a zero price. Students with zero funds who bid would be a match for a zero price course selected.

If there are a by chance a few students at the end who might need more courses, additional rounds of auctions could occur until all students are fully registered or some default method of assigning classes could be used.

Why do we not see free market economists, auction economists, other economists or professors in other disciplines propose using a pricing mechanism to assign students to their classes?

I think it is an idea worth pursuing. We are a capitalistic, business oriented country that relies on pricing. The stock market, the commodities market, the US debt market, and most items in our daily lives rely on frequent accurate, meaningful pricing. Shouldn't we have pricing in the college course market?

Do economics professors only talk the talk about pricing, free markets, auctions, etc. and no not really believe in them?

Are professors afraid to have their course evaluated through a pricing mechanism, as publicly traded businesses are daily?

Are professors concerned that some other professor will fill a course at a higher market-clearing price?

Will a decline in prices over time show that they have lost interest in teaching or that their material has become irrelevant to modern students?

Are professors fearful that not enough students value their teaching or subject matter?

Are they worried that they may have openings at the very end and the Dutch auction price will be zero?

I think an auction registration process will give colleges a better understanding of actual demand for specific classes and a better evaluation of professors from a student/course perspective. It will also give the students a tremendous real-life economics learning experience.

Thursday, September 24, 2009

CBO Presentation To National Economics Club:
The Budget and Economic Outlook

Director of the Congressional Budget Office Douglas Elmendorf's presentation, "The Budget and Economic Outlook" to the National Economists Club, on September 24, 2009.

The presentation is available here.

Scribd embedded version below.
CBO Presentation to the National Economics Club

Housing Is A Smokescreen To Keep US Funding Costs Low

A comment I posted on Cafe Hayek blog where Russ Roberts ask if the US government has any budget restraint:
US borrowing is near its debt ceiling limit and needs Congressional authorization to increase the limit. One of the reasons FDIC is looking to borrow (or prepayment) from banks instead of Treasury. See Bloomberg, http://www.bloomberg.com/apps/news?pid=20601087&sid=aonZB7NPmp1A

Given the anti US debt voter sentiment, it will be interesting to see how politicians and media respond to the need to increase the ceiling. My guess is it will be a non-event and the ceiling will rise, but surprises do happen.

The post office is underfunding its pension, a future liability, but the US is on a cash basis system so that the pension costs is not part of the US borrowing costs until retirees actually need to be paid.

Not only is the US taking on an enormous amount of debt, but it is at great financial risk because most of the debt is short term and cannot be inflated away. About 32 percent of US debt has a maturity under a year and 50 percent matures in one to ten years. Another 8 percent will reset because it is inflation protected (TIPS). This 90 percent of US debt will have its interest rate reset upon refunding (or resetting) to a higher interest rate if inflation occurs. A total of 90 percent of the US debt has an interest rate resetting risk.

Plus short term debt (bills) under year and less do not pay interest. Instead, they are sold at a discount and redeemed at a higher price. The (interest) expense is deferred until maturity, and those that mature next year become part of next year's budget due to US accounting. When short term debt levels increase, next year's expense increases.

Housing is a smokescreen used by Geithner and Bernanke to keep funding costs low. There is about $7.5 trillion of US debt in public hands. (About another $5 trillion in held by US agencies). Every one percent interest rate increase in rates of the debt in public hands subject to near term rate resetting is about $67.5 billion, and about a 25 to 30 percent increase in US interest expense. Additionally, the one percent increase is about 2-3 percent of the US government budget, which further increases the deficit, by a significant amount, and the debt.

The public is right to be apprehensive about the amount of US debt because the current cost of interest payments is artificially and unsustainably low. Bernanke and Geithner are using teaser rates to keep the current budget expense low and to avoid tax increase or program budget cuts until the President's second term or later.

If there were any truth in government borrowing, the government would use a realistic average expected interest rate to show what the true cost of the current debt is to the American public.

Evidence Against Banker Pay Link To Financial Crisis

The Wall St. Journal has a good article,"Bank Pay and the Financial Crisis" by Jeffrey Friedman, debunking the myth that compensation incentives caused the financial crisis. Friedman, editor of the journal Critical Review and a University of Texas, Austin visiting scholar, discusses the evidence and research that compensation incentives did not caused the financial and banking crises.

From Friedman's article:
In the only scholarly study of the relationship between banker pay and the financial crisis, Mr. Stulz and his colleague RĂ¼diger Fahlenbrach show that banks whose CEOs held a lot of bank stock did worse than banks whose CEOs held less stock. (The study was published in July on SSRN.com.) Another study by compensation consultant Watson Wyatt Worldwide in July shows a negative correlation between firm Z scores—a measure of their risk of bankruptcy—and their use of such widely criticized practices as executive bonuses, variable pay and stock options. These studies suggest that bank executives were simply ignorant of the risks their institutions were taking—not that they were deliberately courting disaster because of their pay packages.
Read the complete Wall St. Journal article here.

See my earlier post on Friedman, "Debunking Bonuses, Irrationality And Capitalism As Causes Of The Economic Crisis."

The findings mentioned in the article are consistent with Friedman's belief that bankers made cognitive errors and did not perceive the riskiness of their actions. See my prior posts, "Did Cognitive Errors Cause The Financial Crisis?" and "Incentive Compensation Restrictions Will Not Accomplish Their Goals: Incentive Bonuses Only Identify Risk Taking Employees."

Non-fatal Injury Jury Awards Are Rational

An article in the Review of Law Economics Journal, "Valuation of Quality of Life Losses Associated with Nonfatal Injury: Insights from Jury Verdict Data," finds that jury awards for non-fatal injuries are rational.

The authors, Deborah Vaughn Aiken and William W. Zamula, found that the awards include payment for reduction in quality adjusted life years (QALYs) due to the injury suffered. The QALY award is in addition to the award for direct costs, such as medical costs, and indirect costs, such as reduced productivity.

The researchers find that these non-fatal injury awards are rational and systematic, and that the most significant determinant appears to be injury severity, measured as the QALY loss.

The article is gated but the abstract is available here.

Wednesday, September 23, 2009

Schapiro Asks For Stronger OTC Derivative Regulations, Admits Regulators Failed To Enforce Existing Standards: Do Regulators Ever Ask For Less Regulation?

US Securities and Exchange Commission Chairman Mary Schapiro testified before the House Committee on Agriculture, yesterday, September 22, 2009, concerning the regulation of over-the-counter ("OTC") derivatives and the Over-the-Counter Derivatives Markets Act of 2009, which is a Treasury Department proposal.

Schapiro took the populist approach and partially blamed the financial crisis on derivatives and deregulation. She requested stronger powers to regulate derivatives. She admitted that the regulators failed to enforce existing standards and failed to adapt the existing regulatory framework to the new risks. She was oblivious in her prepared testimony to the obvious contradiction of asking for more regulatory power while failing to enforce the existing rules.

She said in her prepared testimony before the House of Representatives:
The recent financial crisis has revealed serious weaknesses in U.S. financial regulation. Among them were gaps in the existing regulatory structure; failures to enforce existing standards; and failures to adapt the existing regulatory framework and provide effective regulation over traditionally siloed markets that had grown interconnected through globalization, deregulation and technological advances. Fixing these weaknesses is vital, particularly in the current market environment, and it is a goal to which the SEC is absolutely committed.

One very significant gap in the regulatory structure was the lack of regulation of OTC derivatives....
About the Treasury proposal, Schapiro said:
While Treasury's proposal would go a long way towards bringing OTC derivatives under a comprehensive regulatory framework, I believe it should be strengthened in several ways to further avoid regulatory gaps and eliminate regulatory arbitrage opportunities....
The Chairman offered suggestions of several areas that needed more oversight and regulation than proposed by Treasury.

She discussed the areas in need of stronger regulation:
  1. Minimize Regulatory Arbitrage and Gaming Opportunities by Regulating Swaps Like Their Underlying "References"
    Gaming — regulatory arbitrage — possibilities abound when economically equivalent alternatives are subject to different regulatory regimes. An individual market participant can have incentives to migrate to products that are subject to lighter regulatory oversight.
  2. Strengthen Existing Anti-Fraud and Anti-Manipulation Authority
    Treasury's proposal also attempts to retain the SEC's existing anti-fraud authority over all securities-related OTC derivatives, even those securities-related OTC derivatives over which the SEC would not have regulatory authority. This authority is essential to policing fraud in the securities markets; to be effective, though, enforcement also requires: (1) examination authority over entities dealing in securities-related swaps; (2) direct access to real-time data on these swaps; and (3) comprehensive anti-fraud and anti-manipulation rulemaking authority for these swaps.
  3. Credit Default Swaps and Regulatory Arbitrage
    Under current law, the Commission has stated that exchange-traded CDS on securities, whether on one security or a basket of securities, are securities. To avoid gaming by financial engineers under the new regulatory regime, Congress should consider clarifying that the definition of "security-based swap" includes not only single-name and narrow-based index CDS, but also broad-based index CDS, and other similar products, when payment is triggered by a single security or issuer or narrow-based index of securities or issuers. This also would be consistent with the approach advocated above to extend the federal securities laws to all securities-related OTC derivatives.
  4. Business Conduct Standards and Eligible Contract Participants
    One of the lessons learned from the most recent financial crisis is that certain smaller and less sophisticated institutions need protections from abusive practices by their swaps intermediaries. There is a need for more stringent business conduct standards....

    Congress should consider revising the qualification standards for participation in the OTC derivatives markets. The standards for being an "eligible contract participant" ("ECP") are important under Treasury's proposal because only ECPs may trade derivatives over-the-counter. All other market participants must trade on exchanges, which provide better protections for less sophisticated participants. More specifically, Congress should consider raising the qualification standards for a governmental entity or political subdivision — such as a municipal government — to qualify as an ECP. Higher standards may also be appropriate for individuals, corporations and other entities.
  5. Protecting Customer and Counterparty Assets
    One key issue is how best to protect customer and counterparty assets in the event of insolvency....legislation should provide for an insolvency framework that protects, first and foremost, customers....a resolution regime should provide legal restrictions on how counterparty assets held by OTC derivatives dealers and other major market participants would be treated in the event of an insolvency, as well indicate the extent to which counterparties would have a prior claim on the other assets of the estate. Without legal certainty, the insolvency of an OTC derivatives dealer or other major OTC derivatives participant could result in further market disruptions and systemic risk.
  6. Ensuring that the "Identified Banking Products" Exception is Not Abused
    Treasury's proposal contains an exclusion from the regulatory scheme for OTC derivatives for products that are "identified banking products." Although this exclusion may make sense for banks that are regulated in the U.S., we believe that this exclusion could allow foreign banks (and their subsidiaries) that are not subject to oversight by any federal banking regulator, to offer OTC derivatives to U.S. persons in the guise of "bank products." I believe this exclusion should be revised to make clear that it is not available to foreign banks or their subsidiaries that are not subject to federal banking oversight.

Read her entire House testimony here.

Tuesday, September 22, 2009

Incentive Compensation Restrictions Will Not Accomplish Their Goals: Incentive Bonuses Only Identify Risk Taking Employees

Limiting incentive compensation will hinder employers from finding risk takers to hire or weed out.

One of the common myths of the causes of the past financial crisis in mortgage derivatives is that incentive bonus compensation contributed to undue risk by an excessive amount of improper mortgage lending to borrowers who could not afford their mortgage payments. Additionally, many argue that the incentive pay led to easy credit and an unsustainable housing bubble.

There is not any decisive research to show that incentive compensation caused excessive risk taking at financial institutions. Most research has been unable to substantiate this common narrative. (See Jeffrey Friedman article mentioned in my ealier post, "Debunking Bonuses, Irrationality And Capitalism As Causes Of The Economic Crisis.")

Fist of all, the issue is not the risk taking of the employees but the change in their risk behavior due to the compensation structure. Research to substantiate incentive compensation as a cause of excessive risk taking would need a measure of the employee's risk profile before and after exposure to incentive bonus compensation to measure a change due to incentive bonus compensation.

There is the obvious signaling/selection problem. Companies make their compensation structure known during the pre-hiring and hiring process. Anyone applying to the job is attracted to the idea of uncertain compensation based on performance and is already an above average risk taker. The bonus does not entice them to take on excessive risk. It identifies them. The payment structure is a signal to applicants that above average risk takers have a higher probability of hire.

If it is true, that incentive compensation is a signal to identify above average risk takers, then eliminating incentive bonus compensation removes the identification and filtering process. Excessive risk takers will remain in the applicant pool for all related finance and banking jobs. They will apply and find jobs where risk takers are unwanted. We have asymmetric information. Some applicants know they take excessive risk, but employers will not be able to identify them and will hire some of them. Employers who seek risk-taking employees might adopt some other signal or means to attract and find above average risk taking employees. If desired, they will still staff certain positions with personnel prone to excessive risk. Behavior in these risky areas of a financial institution will behave as if there were incentive compensation in place and take a lot of institutional risk.

Additionally, some of the personnel employed in non-risky positions will have an excessive risk profile because they will have applied to jobs believing the openings were for high risk taking individuals. Compensation structure without incentive bonuses will not distinguish employers seeking risk-taking employees from those seeking non-risk taking employees. Employees will lack job risk characteristics and information. Once employed, these employees will promote excessive risk taking in average and below average risk taking organizations. These companies might not be prepared for these excessive risk takers. Eliminating incentive compensation may only cause problems for a slew of companies and jobs that are unprepared for and unused to risk taking employees.

Banks Bailing Out FDIC In Lieu Of Treasury

The New York Times is reporting, "F.D.I.C. May Borrow Funds From Banks" By Stephen Labaton, September 21, 2009. From the article:
Tired of the government bailing out banks? Get ready for this: officials may soon ask banks to bail out the government.

Senior regulators say they are seriously considering a plan to have the nation’s healthy banks lend billions of dollars to rescue the insurance fund that protects bank depositors.
Read the complete article here.

The FDIC is short of funds from a wave of bank failures. It has a $100 billion unused credit line with the Treasury Department, but Shelia Bair, FDIC Chairperson, is looking for alternatives. She can assess banks but is reluctant to raise their premiums as much as needed in these tough economic times.

As a note, the FDIC insurance fund is not backed by the full faith and credit of the US. See my earlier post, "FDIC Insurance Fund Is Not Backed By US Full Faith And Credit."

Monday, September 21, 2009

Healthcare Reform Is Risky And Scary: Every Healthcare Proposal Needs Measurable Milestones And A Sunset Provision

Healthcare reform is risky and any legislation needs measurable milestones at a fixed time interval, e.g. five years after passage, with an automatic sunset provision if the independently measured milestones are not met. There are known health related and cost reasons for passing health reform legislation so let us write these reasons into the legislation as measurable numerical target milestones. Milestones can be many different targets, such as reduction in the number of uninsured to a predetermined level, a reduction in costs by a preset amount or percentage, etc. If the goals of the legislation turn out to be overly optimistic and not achievable, then let us have Congress reconsider the need for the legislation by having them actively vote for the continuation of the program at some later date. An automatic sunset provision in the legislation will require Congress to stand up and voice their reasons for voting on the continuation of the law that is not achieving its original intended goals.

Anyone who has ever read or prepared a business, strategic or operating plan for a new product, business or division knows, despite the best attempts and intentions, there is a lot of risk and uncertainty about the success of a new endeavor. There is also uncertainty about the accuracy of the projections of future sales, revenues, customers, market share, costs, profits, etc. Additionally, most new business ventures fails despite planning.

Despite the best intentions of the President, Congress and all their advisors, making significant changes to the current healthcare system and insurance entails a lot of uncertainty and risk. We have some idea of the strengths and weaknesses of the current healthcare arrangement in the US, but we only have conjectures about the effects of the changes that will occur by healthcare reform legislation. There is a chance that health reform legislation will pass but fail to achieve any of its goals and possibly make health care and insurance costs worse in the US.

Business mitigates its risks in new endeavors by pacing its roll out and evaluating successfulness. It might open a few stores to see how they do before it rolls out all the stores, or it might put a new product in a few areas to see if it sells well before it does a nationwide rollout. If things are not working as planned, a business might abandon the whole concept. Unfortunately, that is not how new legislation generally works. It is usually all at once, a regional rollout without reevaluation, or nothing. Legislative passage does not usually allow for abandonment after a law is passed because it is not working as planned. In business, investors and creditors stop putting new money into losing ventures and businesses cease to exist.

Healthcare is about 17 percent of US GDP. The healthcare industry is also hiring and growing during this period of high unemployment and recession. There is a lot at risk to the US economy,workforce and the public's healthiness if Congress unintentionally mucks things up.

I do not get any sense from the President's speeches or from Congress that there is general awareness of the risk involved to the US economy, healthcare industry, and the US workforce if passed health reform legislation does not work as planned.

A business is constantly evaluating the success of its endeavors through the measurement of profit. If the activities fail to be profitable, business will either close the activity down or make significant changes, such as cut costs, change product offerings, modify pricing, etc. to attempt to make it successful. Government programs are not measured by profit and are rarely shut down or responsively modified quickly to changes in strategy or the environment.

Putting a sunset provision in the law with realistic measurable metrics will, at least show that Congress and the President understand that despite good intentions there is a lot of risk and uncertainty about how new healthcare reform legislation will play out if it is passed. A sunset provision will also minimize the damage that a mistake could cause to the US economy, workforce and the health insurance and healthcare of US residents.

Sunday, September 20, 2009

Sweden Lowers Income Tax To Boost Jobs

Another way to boost your economy and create jobs without stimulus spending.

Sweden slashes income tax further to boost jobs.
Sweden's centre-right government on Saturday announced income tax cuts of 10 billion kronor to stimulate the job market, its primary objective.
Read the complete article here.

Saturday, September 19, 2009

David K Levine Rebuttal To Paul Krugman

Read Washington University Economics Professor David K. Levine's excellent rebuttal to Paul Krugman "An Open Letter to Paul Krugman."
I was reading your article How Did Economists Get It So Wrong. Who are these economists who got it so wrong? Speak for yourself kemo sabe. And since you got it wrong - why should we believe your discredited theories?
***
A progressive who would like to see higher taxes and more government programs? Wait until there is an economic crisis and call it a "fiscal stimulus bill." Here we are, the recession is over and we've spent 10% of the money...Not the 200% you thought we needed to end the recession.
***
If there was some sort of irrationality involved in a panic, prices ought to bounce right back the next day when everyone wakes up and sheepishly realizes that they were wrong. In fact asset prices seem to be tracking news of fundamentals pretty well - gradually recovering as we get better news about fundamentals.
Read Levine's complete response here.

Also see my post on Cochrane's response to Krugman here.

David K Levine is the John H Biggs Distinguished Professor of Economics, Washington University in St. Louis.

Friday, September 18, 2009

Lingering Effects Of GM Rushed Bankruptcy

Glenn MacDonald has a nice post on Organizations and Markets blog, "Bankrupt Bankruptcy" about the loss of value to GM due to the rushed government forced bankruptcy process.
Specifically, much value was wasted. For example, among car aficionados, there are few brands more revered than the Pontiac GTO; this persists despite the weak offering brought out in 2004. Where is the GTO? On the scrap heap with the rest of Pontiac. A more deliberate bankruptcy would have preserved this value, e.g., by folding parts of Pontiac into Chevrolet.
Read the MacDonald's entire post here.

Glenn MacDonald is the John M. Olin Distinguished Professor of Economics and Strategy at the Olin Business School at Washington University in St. Louis.

Is A Health Insurance Mandate Unconstitutional?

Two Washington DC attorneys, David Rifkin and Lee Casey, argue in a Wall St. Journal opinion article, "Mandatory Insurance Is Unconstitutional" that a Federal requirement to purchase health insurance, including a tax or penalty on those who do not have health insurance, is unconstitutional.
Federal legislation requiring that every American have health insurance is part of all the major health-care reform plans now being considered in Washington. Such a mandate, however, would expand the federal government’s authority over individual Americans to an unprecedented degree. It is also profoundly unconstitutional.
Read the complete article here.

Also, see my previous post on Thursday, August 27, 2009, "Is Government Mandated Health Insurance Constitutional?" about a Washington Post article by the same authors.

SEC Takes Steps to Undo NRSRO Monopoly And Capital Arbitrage

The Securities and Exchange Commission voted unanimously to take rule making action to bolster oversight of credit ratings agencies.

Currently, 10 credit rating agencies are registered with the Commission as NRSROs (Nationally Recognized Statistical Rating Organizations). The SEC adopted amendments to the Commission's rules and forms to remove some of the references to credit ratings by nationally recognized statistical rating organizations.

Additionally, the SEC reopened the public comment period to allow further comment on Commission proposals to eliminate references to NRSRO credit ratings from other rules and forms.

If the banking regulators follow suit to remove references to NRSROs in capital requirements, the whole process of securitizing loans to raise the credit rating of the loans in order to lower the capital requirements will come to a halt.

Securitization will still occur because it frees up the capital deployed in the initial lending. Eliminating references to NRSROs ratings as a determinate for the amount of bank capital will prevent the capital arbitrage that occurred during the past financial crisis.

Removing the ability to capital arbitrage residential mortgage loans is the single most important step in reforming the credit rating agencies.

Under current capital rules, home mortgages require capital for 50 percent of the loans. By securitizing and raising the credit rating, the amount of capital was reduced to 20 percent of the loans. The process enabled banks to hold 2 and 1/2 times as much securitized residential mortgage loans as unsecuritized residential mortgage loans.

Read the complete SEC press release here.

Thursday, September 17, 2009

Will More Bank Capital Prevent The Next Crisis? Not Really

There is a consensus call for more capital for banks and other financial institutions, but unfortunately, more capital (lower leverage) would not have prevented the financial crisis, nor will it prevent the next crisis.

The President, the bank regulators and just about everyone else who has offered an opinion on the past banking crisis say that a low capital requirement was one of the causes of the crisis. Additionally, they say one of the ways to prevent further crises is to have banks hold a higher level of capital than they did during and prior to the financial crisis of 2008-09. Calling for more capital is another way of saying allowable leverage was too high.

Financial institutions holding too large a percentage of assets in real estate investment related securities, loans and companies, in conjunction with a severe drop in real estate prices, caused the banking crisis. When the value of real estate declined by much more than anticipated by the majority of borrowers, lenders and investors, the financial institutions' over investment in real estate caused firms to suffer huge real estate related (paper and realized) losses. Major financial firms faced increased insolvency, liquidity and collateral risks, which froze the credit markets.

While there is a mathematical amount of capital that is sufficient to allow the banks to write off all their bad and devalued real estate related holdings, nobody is suggesting that banks hold that large of an amount of capital. The extent of the real estate investment along with the extent of the decline in real estate prices caused losses at the major financial firms that far exceed any reasonable amount of held capital.

Regulatory Insolvency Triggering Events


Regulators use capital amounts as triggering events to determine when they should declare an institution insolvent and take it over. From their point of view, it makes sense to have more capital because it decreases the number of likely triggering events. The past, recent crisis would still be a regulatory insolvency triggering event because the losses were so great that many institutions even with higher capital amounts would still be found insolvent. Additionally, increased capital requirements lower the leverage ratio of firms, and therefore likely the total dollar amount of real estate investments held, but increased capital does not prevent an over concentration in real estate related investments and loans. Severe losses in these investments and loans would still make the banks insolvent, even with higher capital.

Furthermore, capital is not the same as money in the bank. It is an arbitrary regulatory accounting concept. It reflects the sum of all past equity and equity-equivalent investments in the banks plus all profits less any dividend payouts, income losses and other capital reducing events.

Capital does not represent the value of the institution, nor the net proceeds from sale of its assets after paying the debt. The capital amount gives no indication about the future business and investment prospects of the financial institution. As I said above, capital is useful for regulators because it allows them clearly and mathematically to define a triggering event for government takeover of the financial firm. It also allows the regulators to show that they have taken action to prevent another crisis, but low capital levels were not the cause and high capital levels will not prevent another crisis.

Part of the past crisis was the over investment in real estate and the significant real estate price declines. Increasing capital ratios at financial institutions does not prevent over concentration in an asset class nor does it prevent major price declines.

Wednesday, September 16, 2009

Basic Economics: Production And The Firm Video By Art Carden

Excellent video about basic economic principle of the firm and production presented by Art Carden at the 2009 Mises University. Recorded 28 July 2009 at the Ludwig von Mises Institute; Auburn, Alabama.

Carden is an Assistant Professor of Business and Economics at Rhodes College in Memphis Tennessee.

SEC Announces New Division of Risk, Strategy, and Financial Innovation

SEC appoints University of Texas School of Law Professor Henry T. C. Hu as the first director of the newly created division of Risk, Strategy, and Financial Innovation.

From the press release:
Washington, D.C., Sept. 16, 2009 — Securities and Exchange Commission Chairman Mary L. Schapiro today announced that University of Texas School of Law Professor Henry T. C. Hu has been named Director of the newly-established Division of Risk, Strategy, and Financial Innovation.

The new division combines the Office of Economic Analysis, the Office of Risk Assessment, and other functions to provide the Commission with sophisticated analysis that integrates economic, financial, and legal disciplines. The division's responsibilities cover three broad areas: risk and economic analysis; strategic research; and financial innovation.
Read the complete press release here.

McKinsey Global Economic Conditions Survey Finds 'New Normal'

The crisis—one year on: McKinsey Global Economic Conditions Survey results, September 2009:
Overall, the responses indicate that a “new normal” is settling in—for many companies, an environment less comfortable than the one they knew in the pre-crisis world. Most are still cutting costs, and a third of all respondents say that their companies are in crisis. What’s more, executives remain skeptical about the economic health of their countries; a majority say that governments should continue supporting economies in the near term.

***
The world in five years

Respondents from almost three-quarters of the companies expect them to be in a stronger competitive position five years from now than they were before September 2008. Respondents who expect their companies to be stronger in the long term are likelier than others to say that they are focusing on flexibility, new products, and long-term planning and that their industries will consolidate. One source of competitive advantage may therefore be the elimination of weaker competitors.
Read the entire article in the McKinsey Quarterly here.
(Silly free registration required to read whole article. I thought companies by now, especially a top tier consulting firm, understood that registrations are unnecessary transaction costs, deter readership, decrease goodwill and invade privacy.)

WalMart Deserves Nobel Peace Prize

University of Michigan Economics Professor Mark Perry of the Carpe Diem Blog says:
Wal-Mart deserves the 2009 Nobel Peace Prize for all its ongoing anti-poverty measures, including Everyday Low Prices and $10 prescription drugs.
Read the entire blog post on this matter, "Walmart’s Ongoing Commitment To Drive Unnecessary Costs Out of the Health Care System."

Tuesday, September 15, 2009

RIP Norman Borlaug: Saved Millions From Starvation

Death of a Humanist by Guy Sorman, City Journal, 14 September 2009. From the article:
Norman Borlaug, who has just died at age 95 in Dallas, was an exception among living Nobel Peace Prize beneficiaries: he actually deserved the award, which he received in 1970. This media-shy and extremely modest scientist, who served on the faculty at Texas A&M University, saved from hunger hundreds of millions of starving peasants around the world.

***
Borlaug was no innocent scientist: he knew that science could feed the world only when political conditions were right. In the case of India and Mexico, the semi-dwarf wheat and rice worked marvels because the farmers owned their own land. As private owners, they had a vested interest in using more expensive seeds that would produce a higher yield. Local authorities provided the water for irrigation: both the Mexican and Indian governments did it right, later followed by Indonesia, Thailand, and the Philippines. But without private entrepreneurs, the Green Revolution would not have taken place. While touring the world, Borlaug always stressed that seeds by themselves could not eradicate hunger. Private property, entrepreneurship, and reliable governments were essential prerequisites.
Read Sorman's complete City Journal article here.

Monday, September 14, 2009

Debunking Bonuses, Irrationality And Capitalism As Causes Of The Economic Crisis

Jeffrey Friedman on the Causes Of The Crisis blog takes on "Three Myths about the Crisis: Bonuses, Irrationality, and Capitalism" on Monday, September 14, 2009.
With a year having passed since the start of the greatest economic crisis in our lifetimes, you’d think we would know a lot more now than we did then about what caused it. Yet by the spring of 2008, a three-part conventional wisdom about the crisis had taken hold that still governs mainstream thinking about what happened and why—even though there was never any evidence in favor of the conventional wisdom, and there is now much evidence against it.
Read the complete blog post here.

I would add that economists recognize that the oil price shocks of 2007-08 are a cause or at least a significant contributor to the recession and banking crisis. Yet, it is not part of the mainstream media discussion. See my April 26, 2009 post, "Did The 2007-08 Oil Price Shocks Cause The Current Recession?"

China Reacts Quickly and Badly to Tire Tariffs

A Naked Capitalism post, "China Reacts Quickly and Badly to Tire Tariffs."
It would be better if we were not proven correct on this one, but when the US imposed stiff tariffs on imported tires from China late on Friday, we noted, “This could get interesting in a bad way.” The Chinese responded quickly over the weekend to announce they were investigating US auto parts and chicken, which together account for roughly as much as the disputed tires ($1.2 billion versus $1.3 billion for tires).
The complete Naked Capitalism blog post is available here.

My previous post on the US tire tariff, "A Bad Day For American Consumers."

Saturday, September 12, 2009

Public Service: How to Use A Boat's Digital Selective Calling (DSC) Radio To Alert Coast Guard Of A Boating Emergency

When activated, the DSC system continuously alerts the Coast Guard and other boats in the area of an emergency situation on your boat, the boats GPS coordinates and the boats characteristics.

The short Coast Guard Auxiliary video explains Digital Selective Calling, or DSC, Marine Radios, as well as the safety benefits of combining the new technology with the Coast Guard Rescue 21 system.

Video produced by Florida State College at Jacksonville.

How to Use Digital Selective Calling (DSC) Radios from US Coast Guard Auxiliary on Vimeo.

A Bad Day For American Consumers

Obama to impose tariffs on Chinese tires by Jennifer Loven, AP White House Correspondent, Friday, September 11, 2009.

A Victory for the Protectionists by Greg Mankiw.

Punitive Tariffs Are On Americans, NOT the Chinese by Mark Perry.

As Mark Perry says in his Carpe Diem blog:
President Barack Obama has slapped punitive 35% TAXES on AMERICAN CONSUMERS (including the poor and middle-class) for all car and light truck tires VOLUNTARILY PURCHASED from Chinese producers...
How nice that 12 percent of the workforce, union workers, gets to penalize the other 88 percent. President for the few that belong to a union.

Friday, September 11, 2009

Cochrane: How Did Paul Krugman Get It So Wrong?

The Supply and Demand blog by University of Chicago Economics Professor Casey Mulligan links to a paper by University of Chicago Booth School of Business Professor John H. Cochrane,"How did Paul Krugman get it so Wrong?"

Here is one passage from an excellent paper:
In fact, I propose that Krugman himself doesn’t really believe the Keynesian logic for that stimulus. I doubt he would follow that logic to its inevitable conclusions. Stimulus must have some other attraction to him.

If you believe the Keynesian argument for stimulus, you should think Bernie Madoff is a hero. He took money from people who were saving it, and gave it to people who most assuredly were going to spend it. Each dollar so transferred, in Krugman’s world, generates an additional dollar and a half of national income. The analogy is even closer. Madoff didn’t just take money from his savers, he essentially borrowed it from them, giving them phony accounts with promises of great profits to come. This looks a lot like government debt.

If you believe the Keynesian argument for stimulus, you don’t care how the money is spent. All this puffery about “infrastructure,” monitoring, wise investment, jobs “created” and so on is pointless. Keynes thought the government should pay people to dig ditches and fill them up.

If you believe in Keynesian stimulus, you don’t even care if the government spending money is stolen. Actually, that would be better. Thieves have notoriously high propensities to consume.
The latest version of the full paper is available here.

For those of you that lack administrator privileges or are behind firewalls and cannot download the paper, here is the Scribd embedded version as of 9/11/09, 1:30 pm est.

Update: Also, see Levine's response to Krugman here.

How did Paul Krugman get it so Wrong?

Some Competition Increases Prices

An interesting NY Federal Reserve staff research report, "Price-Increasing Competition: The Curious Case of Overdraft versus Deferred Deposit Credit," September 2009, Number 391, by Brian T. Melzer and Donald P. Morgan, finds that banks charge more for overdrafts when there is a competitive product.

The abstract states:
We find that banks charge more for overdraft credit when depositors have access to a potential substitute: deferred deposit (“payday”) credit. We attribute this rise in prices partly to adverse selection created by banks’ practice of charging a flat fee regardless of the overdraft amount—pricing that favors depositors prone to large overdrafts. When deferred deposit credit priced per dollar borrowed is available, depositors prone to small overdrafts switch to that option. That selection works against banks; large overdrafts cost more to supply and, if depositors default, banks lose more, so prices rise. Consistent with this adverse-selection hypothesis, we document that the average dollar amount per returned check at banks and other depository institutions increases when depositors have access to deferred deposit credit. Beyond documenting another case of price-increasing competition, our findings bear on theories of adverse selection in credit markets and contribute to the debate over the pros and cons of payday credit.
The report concludes:
VI. Conclusion

Faced with competition from deferred deposit, or "payday lenders," mainstream depository institutions charge higher overdraft fees and cut back on "free" checking offers, particularly those without direct deposit.

The auxiliary findings we present suggest that these changes result, at least in part, from adverse selection when payday lenders enter the market. Small dollar overdrafters disadvantaged by the buffet (flat fee) pricing of overdraft credit switch to deferred deposit lenders (when available), saddling banks and other depositories with proportionately more higher cost, possibly riskier large-dollar overdrafts. Depository institutions raise prices and manage the extra risk by reducing the supply of free accounts without direct deposit.

Without a model, the welfare implications of our findings are not entirely clear. It might appear that the depositors who switch to deferred deposit lenders gain, but those who stick with bank overdraft at the new higher price lose. However, Gabaix and Laibson (2006) use overdraft protection as the leading example of a "shrouded attribute," an expensive, overpriced feature of a good or service that is hidden from consumers. "Debiasing," that is, educating consumers by unshrouding hidden attributes is welfare increasing.
The full research report is available here.

Thursday, September 10, 2009

Good Video On Why Health Care Costs Keep Rising

A John Stossel, 20 20, ABC, 7 minute video with an accurate explanation of why our health care costs keep rising.

Increasing Productivity In Health Care And Lowering Costs

An interesting article in The Journal of the American Enterprise Institute, "Baumol’s Solution to the Baumol Effect" by Tim Worstall, Thursday, September 10, 2009.

The solution to our healthcare cost problem is to use more technology and high tech solutions and not less as proposed by some, such as Dr. Ezekiel Emanuel. An excerpt from the article:
What we really want to do is to routinize and mechanize as much of the medical process as we can, and the one spur, the workable incentive, that we know encourages this is that combination of greed, profits, the division of labor and specialization, and the urge to find cheaper ways of doing things which comes from that odd but unique interaction of capitalism and markets.

It is a basic truism that if you do not identify the source or cause of a problem then you cannot discover a workable solution to said problem. The current laboring of the elephant will indeed produce a mouse to address the perceived problems of healthcare unless we grasp the basic points—that we want more, not less, high-tech medicine and that to get from here to there we have to harness both markets and capitalism to our desires, not attempt to abolish them from the system.
Read the complete article here.

Problems With Census Bureau Household Income Number

The New York Times is reporting that we had "A Decade With No Income Gains." The Census Bureau’s annual report on income, poverty and health insurance shows that median household fell to $50,303 last year, from $51,295 in 1998, in constant dollars.

There are four serious problems with the statistic. One, it does not track an individual household over time. When one does a longitudinal study, looks at households that existed at the beginning and end of a decade, there is income growth.

Two, because a household is any unit of people living in the same residence, as the population grows, there are more new households, especially in 2007 before the economic downturn. New households tend to be younger and have lower incomes, which lowers the average and median.

Three, we are in the period where baby boomers are retiring. The Census bureau does not count spending savings or wealth as household income. Their work income declines and makes the household income number look lower. Plus as people live longer, there are more senior households with lower reported incomes, especially since government programs, such as Medicare, food stamps, subsidized senior housing, and other transfer payments do not count towards income.

Fourth, the Census numbers come from a household survey. The Census Bureau states in the report, "Moreover, readers should be aware that for many different reasons there is a tendency in household surveys or respondents to underreport their income." To make any statement about a change in household income over a decade, one has to assume that the sample of persons responding a decade ago, misstated their income by the same amount as those responding recently to the survey. It is pure speculation that the amount of under-reporting is a constant over time.

When one tracks a household over time, there is income growth. Additionally, the amount of work hours needed to purchase necessities, such as food and clothing, continues to decline and we have more cash available for other purchases, such as LCD TVs, laptops, etc.

The full government report, "Income, Poverty, and Health Insurance Coverage in the United States: 2008" is available here.

Wednesday, September 9, 2009

The Saddest Part Of The Health Care Reform Effort

The saddest part of the health care reform effort is the aversion to change the known, underlying, fundamental, structural problems of the US health care system. The Congressional and Presidential endeavors to expand health coverage and alter medical costs, insurance and reimbursement focus on the current deficiencies instead of the causes.

Our elected officials' attempts to call a patchwork repair a permanent solution to the health care problem create the mainstream public's dissatisfaction with all the proposals.

Our health care system, through government policies and interventions, has fortified itself from the normal economic, capitalistic forces that affect all other services and products in the US and that deliver services and products to as many as possible at the lowest achievable costs while maintaining quality.

Despite the dialogue in the press, the media and by elected officials, correcting our medical services requires dealing with the forces that distort the proper functioning of a cost effective, competitive, market serving, demand meeting health care system at its roots and not through a band-aid solution.

A long-term fix to our health care system requires removing the distorting forces, which will allow capitalistic, competitive forces to reestablish themselves.

The structural problems with our health system are well documented. They are just not part of the government proposal to fix health care.

Some of the structural problems with health care that need fixing for a permanent solution are:

To fix the medical system, the government needs to remove the tax advantage that employers have for providing a health insurance benefit. The government needs to eliminate the employer tax deduction for providing a health insurance employee benefit.

The government needs to allow health insurance to be sold across state lines to allow insurance portability and to increase insurance competition.

The government needs to override state licensing laws to allow medical professionals, such as physician assistants, nurse practitioners, etc. with less training than doctors to provide cheaper medical care for simple health matters.

The government needs to increase the supply of doctors and other medical professionals in the US, which has not grown to match US population growth.

The government needs to lower the cost of medical training.

The government needs to change Medicare and Medicaid to a Food Stamp model. The government should give vouchers to seniors and the poor to purchase their own private health insurance.

Only when the forces that contributed to the current state of our health care system are dealt with straight on, instead of through a patchwork response, will we have an effective, believable solution to health care. A believable, effective proposal will garner the public's support.

Congress Exempted Itself From Health Care Public Option

A Washington Examiner article, "Congress has already exempted itself from Public Option" by Mark Tapscott, Editorial Page Editor, Washington Examiner, September 8, 2009.

Video, "House Committee Already Exempted Itself from Public Option" by Robert Moffit of the Heritage Foundation.

Tuesday, September 8, 2009

For Tennis Fans: Oudin's Believe Sneakers Are Available From Adidas

[Information on Oudin's 2010 Courage Adidas tennis shoes is available here. Oudin's 2009 Believe Adidas tennis shoes are no longer available.]


As a favor to tennis fans everywhere, Melanie Oudin's sneakers are made by Adidas and are available for purchase from the company's website. The 17 year old Melanie Oudin is the underdog women's fan favorite of the US Open Tennis in Forest Hills.

[Information on Oudin's 2010 Courage Adidas tennis shoes is available here.]

I am not employed or compensated in anyway by Adidas. Also, I do not know anyone who is employed by Adidas. I do have a daughter and I have experience with past fashion trends and fads. I do know that celebrities, sports players, recording artists and movie stars are the major influences on future clothing trends and the cause of much parent stress in children clothing shopping.

Does The Market Work As Well Without The SEC?

John Carney in his blog post, "Is The SEC Completely Useless?" wonders if the equities market does a better job than the SEC.

Carney mentions a recent research study, "Option Grant Backdating Investigations and Capital Market Discipline" by Kenneth A. Carow, Indiana University Kelley School of Business, Randall A. Heron, Indiana University Kelley School of Business, Erik Lie, University of Iowa Henry B. Tippie College of Business and Robert Neal, Kelley School of Business Indiana University, published in the Journal of Corporate Finance, August 12, 2009.

An excerpt from the Carow et al article's abstract follows:
Our results suggest that capital markets disciplined companies with suspicious option grant histories, often prior to, and irrespective of, any public revelation of an investigation into the matter.
As I wrote in my blog post, "The SEC Chases Fraud After The Fact" on August 15, 2009:
While the contra-factual of life without 75 years of an SEC is difficult to envision, the existence of the SEC did not prevent major securities and investor fraud. Additionally, the SEC is always requesting more funding and staffing to investigate and litigate fraud. It is unclear that the 33 and 34 Acts have decreased fraudulent activities.
It does not help any proponents for the continued existence of the SEC that, today, the SEC charged Philip Barry with running a $40 million Ponzi scheme that existed for thirty years and defrauded 800 investors.

From the SEC complaint:
From January 1978 through at least February 2009, Defendants conned hundreds of investors into investing over $40 million in the Leverage investment funds by promising lofty, but false, investment returns with guaranteed safety of principal and making numerous other misrepresentations.
Carney's complete blog post follows:

Monday, September 7, 2009

Health Care Statement by Rep. Mike Rogers (R-MI)


Worth a replay. (HT: Mark Perry, Carpe Diem)

Congressman Mike Rogers (R-MI) asks why should we switch to a health system that has worse survival rates for serious diseases, such as breast, bladder and prostate cancers and punish the 85 percent that have coverage under the current system.

Saturday, September 5, 2009

Government Wage Statistics Miss Reduction of Employee Benefits

Many blogs are incorrectly citing the recent government statistic of an increase in average hourly wages as a sign that employers are paying more for labor and that workers got salary increases. The government numbers on wages, however, do not accurately reflect the effects of a reduction in benefits on total compensation.

From definition of average hourly wage from BLS:
"Employee contributions for old-age, survivors, and disability insurance (OASDI), health insurance, unemployment insurance, workers’ compensation, and private pensions are considered pay; employer contributions to these benefits, however, are not [emphasis added]. Money withheld for income taxes and union dues is counted as pay."

If an employer decreases benefits or switches the cost to the employee, then the government does not record the loss of benefits as a decrease in compensation.

Therefore, if an employer stops paying a $100 per week for health insurance for an employee and if in its place the employer gives the employee a $50 per week raise, then the government views the net loss as a wage increase. It is really a loss of total wages to the employee, as the employee must now pay more, or all, for his share of health insurance.

It is very likely in this recession, benefits that are not counted as wages, such as pension or health, were reduced by employers. The government numbers miss this change.

Friday, September 4, 2009

Retail Health Clinics Get Good Marks

TIME article by By Jeffrey Kluger, Tuesday, Sep. 01, 2009, "Drive-Thru Medical: Retail Health Clinics' Good Marks."
"These findings provide more evidence that retail clinics are an innovative way of delivering health care," says Dr. Ateev Mehrotra, a professor at the University of Pittsburgh Medical School and the lead author of the study. "Retail clinics are more convenient for patients, less costly and provide care that is of equal quality."
Read the entire TIME article here.

The Real Health Care Problem Is Structural Not Moral

"It's the System". by Paul Howard, City Journal, September 3, 2009.
Changing its tactics in the health-care debate, the White House has begun stressing the moral imperative to provide health insurance to all Americans. “I am my brother’s keeper, I am my sister’s keeper,” President Obama now argues. “And in the wealthiest nation on earth right now, we are neglecting to live up to that call.” But Obama is just plain wrong that America is neglecting its obligations to the most vulnerable. The real health-care problem is not moral but structural and systemic.

We already spend hundreds of billions of dollars every year providing health care to the elderly, through Medicare, and to the poor, through Medicaid. The first of these programs—which, experts estimate, may squander up to $60 billion every year in waste, fraud, and abuse—is running a staggering, and unsustainable, long-term deficit of $38 trillion. The second is in even worse shape, with a 2006 survey finding that as many as half of all physicians have either stopped accepting new Medicaid patients or limited the number they’ll see because reimbursements are so low. On paper, poor patients have great government insurance; their only problem is that they can’t find a doctor.
Read the entire City Journal article here.

Thursday, September 3, 2009

Credit Cards Cause Inflation

John Geanakoplos and Pradeep Dubey argue in their June 2009, research paper, "CREDIT CARDS AND INFLATION" that the issuance and use of credit cards causes inflation by increasing the velocity of money.
The introduction and widespread use of credit cards increases trading efficiency but, by also increasing the velocity of money, it causes inflation, in the absence of monetary intervention.
Read their complete paper available for free download here.

Fogel Forecasting The Cost Of Healthcare

An excellent article, "Forecasting the Cost of U.S. Healthcare" by Robert Fogel, winner of the Nobel Prize in Economics in 1993 and economics professor at the University of Chicago Booth School of Business. It is one of the best articles on the underlying drivers of healthcare costs and spending. (HT: Arnold Kling).

Fogel's conclusion:
Consequently, there is no need to suppress the demand for healthcare. Expenditures on healthcare are driven by demand, which is spurred by income and by advances in biotechnology that make health interventions increasingly effective. Just as electricity and manufacturing were the industries that stimulated the growth of the rest of the economy at the beginning of the 20th century, healthcare is the growth industry of the 21st century. It is a leading sector, which means that expenditures on healthcare will pull forward a wide array of other industries including manufacturing, education, financial services, communications, and construction.
From a broader business perspective, the logical conclusion is that employees are willing to accept lower wages for better healthcare benefits. Therefore, healthcare is neither a unique employer cost concern nor a company competitive disadvantage.

From the US government's perspective, Medicare is still a funding problem for the federal government. Since longevity is increasing, as is the proportion of the elderly, and most medical costs are in the last few years of life, Medicare will see increases in its share of the costs. While the data shows a 1.6 income demand elasticity, i.e. for every 1 percent increase in income, there is a 1.6 percent increase in medical expenditures, there is no reason to believe that Americans are willing to see their taxes increase to cover the increasing Medicare costs.

Additionally, the median income of the 65+ age group is less than 60 percent of all households' median income (65+: $27,798 , All HH: $48,201, US Census Bureau, 2006 data). Therefore, there is the need for taxpayers to continue to subsidize the medical costs of seniors, including cost increases, either through the current Medicare program or through some other government benefit or income transfer program.