Alternative job opportunities, including entrepreneurship, determine pay scales. It is a bidding contest where the best and highest value use of the intelligence, motivation, education, risk taking and other employment related characteristics of employees determine their salaries. A business is a salary price taker and not a price setter. Wall St. and other businesses that pay high salaries, such as law firms, for talent can only adjust their business models, to the extent allowed by competition, to see if they can afford the going rate for the talent they want to hire. High salaries, like capital investment, are also barriers to entry for new competition and offer a competitive advantage to firms that can afford to pay them.
The fact that there were losses or that results did not justify the pay scales after the fact is irrelevant. The competitive market salary requirement at the beginning of the process for the type of individual employee characteristics desired is what is relevant.
Suppose several horse owners have potentially winning racehorses in the same big purse race, should not each owner hire the best jockey he can afford. Obviously, after the race, the hiring of only one jockey made sense. It is irrational to say after the race that the other, losing owners paid too much for their jockeys and that they should have saved money and used lower paid, average performing jockeys.
The same logic is true for evaluating innovation. Suppose the government or industry believes that a cure can be found for a devastating disease at a reasonable but high research cost. If the research is funded and undertaken, but after a sufficient time no cure or other innovations are found, the original funding was still appropriate. It is the expectations at the beginning of the research process that determines if the funding is appropriate for innovation.
In addition to the competitive advantage, Wall St. needs self-sufficient, confident, intelligent, risk taking, business loving employees to succeed. These types of employees have many career options, including international employment, entrepreneurship, and successful business careers. They also have many education choices and can be doctors, top law firm attorneys, etc. The fact that there were financial industry losses and bad past investments and products does not change Wall St's future need for these types of people.
To be against Wall St salaries is the same as saying that market determined salaries are irrelevant. It is the same as saying that job and employee characteristics are unimportant and that everyone should get the same salary, which can be whatever the government wants including minimum wage.
Tuesday, April 28, 2009
Sunday, April 26, 2009
Did The 2007-08 Oil Price Shocks Cause The Current Recession?
James D. Hamilton, Professor of Economics at the University of California, San Diego, posted an interesting piece on the Econbrowser blog, on how the 2007-08 oil price shocks contributed to, if not caused, the current recession.
It is nice to see an economist focus on realistic initial causes and contributing factors to the current economic problems. Many other economists are too focused on blaming the financial industry and inflated house prices. The latter economists have to resort to undefinable and indefinite causes such as animal spirits.
It is nice to see an economist focus on realistic initial causes and contributing factors to the current economic problems. Many other economists are too focused on blaming the financial industry and inflated house prices. The latter economists have to resort to undefinable and indefinite causes such as animal spirits.
Tuesday, April 14, 2009
Merton Speaks
An one and a half hour speech by Harvard Business School Professor Robert C Merton on March 5, 2009. His insights on finance are always refreshing. He speaks about embedded options in assets and their relation to the current crisis.
Monday, April 13, 2009
We Are Medically Over Insured:
Thoughts On Government Health Care
We are medically over insured and paying excessive premium costs because of it. We also need to distinguish between private health insurance purchased by employers and individuals and the government entitled medical care systems of Medicare, Medicaid and other government-mandated health programs. They are two different problems with two different solutions.
The private insurance system is fixable without a need to resort to a government medical health care system. It requires a reinstatement of market pricing mechanisms. The government medical entitlement system, Medicare, etc., is much more difficult to fix. Obama's call for government medical health care is really an attempt to broaden the coverage base of the Medicare system to include all individuals under 65. It would increase the tax base, dilute the voices of seniors about benefits and costs, and allow for an increase in premiums and a decrease in medical benefits to seniors.
Fifty years ago families had major medical insurance. It covered the in-hospital costs of the hospital stay, including doctors, medicine, diagnostic procedures, surgery, anesthesia, etc. It did not cover doctor visits to his office or prescription medicines filled at a pharmacy. People paid the out of pocket costs for medicines and doctor visits. It did not cover voluntary surgeries, but it did cover the hospital costs of a pregnancy including birth. The insurance was affordable.
Thirty years ago, employers only provided major medical and it covered the hospital and doctor costs of the birth of children. People paid for doctor office visits and medicines. They did not overuse the health care system because they were aware of the costs to them.
A decade ago, one could not purchase a major medical insurance policy for their family and themself because no insurer in my state offered that type of coverage. Recently a TV advertisement offered an ala carte medical plan where the insured could choose their own medical benefits. However, some state do not allow insurers to offer that coverage to its residents. Some states are forcing their residents to buy more health insurance than they want. They are forced to buy a comprehensive health insurance policy that covers doctor visits and medicines.
Under a major medical plan, people would save money even if they paid the full costs for daily medicines and regular doctor visits. They buy more coverage than they want or need. They overpay and they have an economic incentive to get back the value of their overpayment by visiting the doctor more often than they would with a less comprehensive but more affordable policy. Their medical coverage unnecessarily increases their use of medical services and increases health care costs. Also, they are subsidizing the patients and doctors who overuse the medical system and they have no economic incentive to monitor their costs. In addition, neither major medical nor comprehensive health insurance covers their potential need for long-term care and catastrophic insurance.
In all other types of insurance, people have freedom to design their own plan. They can choose and purchase basic minimum coverage and add extra benefits for an additional cost. In health insurance, the available benefit options are much more limited.
A simple change that would permit an insurer to offer a minimum policy with add-ons in all 50 states would lower health insurance costs. Also, changes that allowed policies that distinguished between hospitalization and doctor visit benefits would lower costs. Additionally, consumers would have a true incentive to monitor and restrain medical costs because there would be more patients paying their own out of pocket medical costs. Those patients that want full medical coverage could get that type of policy but at much more realistic costs, that reflects their usage patterns. Employers who offer medical benefits would also offer both types and employers would see a cost reduction because some employees will choose the less expensive option.
Health insurance costs are excessive because the market pricing system is not working. Part of the failure of the market pricing mechanism for health care is due to our tax system of allowing employers to deduct the cost of employee medical benefits and part is due to restrictive state regulations. Changing both would allow market pricing to work and influence demand and costs at the consumer level.
Fixing government entitlement medical systems, such as Medicare, are much more difficult to design. These programs are the real costs problems facing our government and taxpayers and not private health insurance. Political ramifications constrain the choices and discussions of changes to these government medical systems. The fix however is not to bury this problem in a broadened government entitlement health care system.
The private insurance system is fixable without a need to resort to a government medical health care system. It requires a reinstatement of market pricing mechanisms. The government medical entitlement system, Medicare, etc., is much more difficult to fix. Obama's call for government medical health care is really an attempt to broaden the coverage base of the Medicare system to include all individuals under 65. It would increase the tax base, dilute the voices of seniors about benefits and costs, and allow for an increase in premiums and a decrease in medical benefits to seniors.
Fifty years ago families had major medical insurance. It covered the in-hospital costs of the hospital stay, including doctors, medicine, diagnostic procedures, surgery, anesthesia, etc. It did not cover doctor visits to his office or prescription medicines filled at a pharmacy. People paid the out of pocket costs for medicines and doctor visits. It did not cover voluntary surgeries, but it did cover the hospital costs of a pregnancy including birth. The insurance was affordable.
Thirty years ago, employers only provided major medical and it covered the hospital and doctor costs of the birth of children. People paid for doctor office visits and medicines. They did not overuse the health care system because they were aware of the costs to them.
A decade ago, one could not purchase a major medical insurance policy for their family and themself because no insurer in my state offered that type of coverage. Recently a TV advertisement offered an ala carte medical plan where the insured could choose their own medical benefits. However, some state do not allow insurers to offer that coverage to its residents. Some states are forcing their residents to buy more health insurance than they want. They are forced to buy a comprehensive health insurance policy that covers doctor visits and medicines.
Under a major medical plan, people would save money even if they paid the full costs for daily medicines and regular doctor visits. They buy more coverage than they want or need. They overpay and they have an economic incentive to get back the value of their overpayment by visiting the doctor more often than they would with a less comprehensive but more affordable policy. Their medical coverage unnecessarily increases their use of medical services and increases health care costs. Also, they are subsidizing the patients and doctors who overuse the medical system and they have no economic incentive to monitor their costs. In addition, neither major medical nor comprehensive health insurance covers their potential need for long-term care and catastrophic insurance.
In all other types of insurance, people have freedom to design their own plan. They can choose and purchase basic minimum coverage and add extra benefits for an additional cost. In health insurance, the available benefit options are much more limited.
A simple change that would permit an insurer to offer a minimum policy with add-ons in all 50 states would lower health insurance costs. Also, changes that allowed policies that distinguished between hospitalization and doctor visit benefits would lower costs. Additionally, consumers would have a true incentive to monitor and restrain medical costs because there would be more patients paying their own out of pocket medical costs. Those patients that want full medical coverage could get that type of policy but at much more realistic costs, that reflects their usage patterns. Employers who offer medical benefits would also offer both types and employers would see a cost reduction because some employees will choose the less expensive option.
Health insurance costs are excessive because the market pricing system is not working. Part of the failure of the market pricing mechanism for health care is due to our tax system of allowing employers to deduct the cost of employee medical benefits and part is due to restrictive state regulations. Changing both would allow market pricing to work and influence demand and costs at the consumer level.
Fixing government entitlement medical systems, such as Medicare, are much more difficult to design. These programs are the real costs problems facing our government and taxpayers and not private health insurance. Political ramifications constrain the choices and discussions of changes to these government medical systems. The fix however is not to bury this problem in a broadened government entitlement health care system.
Sunday, April 12, 2009
Regulations Relocate Risk Taking
Calling for more regulation or a super regulator is a kneejerk reaction that will not prevent future problems. Too often, regulations are about penalizing and criminalizing a past activity after its weaknesses become apparent. Businesses do not like to continue activities that lose money and garner bad publicity. They will change or stop to prevent further damage to their sales and profits before government regulation is proposed or enacted. Allowable activities will be how a financial institution or any regulated company makes it money and profit. Company growth by necessity comes from allowable activities.
Companies and managers will always seek ways to increase sales and profits. Even without bonuses and stock options, managers want their companies to grow to allow for more internal promotion opportunities, raises, benefits and status. The unemployed and new job entrants want companies to grow so there are open positions for them.
There are and will always be people who take greater risk in all aspects of their lives including at their workplace. These workers or bosses will always finds ways to push the envelope. Many times, pushing against the boundaries is good because it leads to better products, processes, cost savings, new jobs and new businesses. Sometimes, pushing the envelope will lead to product, process or company failures. Capitalism is about risk-taking and it has benefited our country and people greatly over the last 200 years. Our standard of living and job growth is still the best in the world. It occurred because capitalism rewards risk-taking.
Regulations do not stop risk taking. At best, regulations relocate the risk taking to a different part of the business or economy. Where there is risk taking, there are both successes and failures. Future market place failures will continue to occur, but in different businesses or products than in the past. However, there are and will continue to be enough successes to make the failures worthwhile. Regulations are about closing the barn door when it is too late. Regulations do not prevent future product and business failures. If they do, capitalism will die. Without risk, there is nothing new and with risk, there is failure.
Companies and managers will always seek ways to increase sales and profits. Even without bonuses and stock options, managers want their companies to grow to allow for more internal promotion opportunities, raises, benefits and status. The unemployed and new job entrants want companies to grow so there are open positions for them.
There are and will always be people who take greater risk in all aspects of their lives including at their workplace. These workers or bosses will always finds ways to push the envelope. Many times, pushing against the boundaries is good because it leads to better products, processes, cost savings, new jobs and new businesses. Sometimes, pushing the envelope will lead to product, process or company failures. Capitalism is about risk-taking and it has benefited our country and people greatly over the last 200 years. Our standard of living and job growth is still the best in the world. It occurred because capitalism rewards risk-taking.
Regulations do not stop risk taking. At best, regulations relocate the risk taking to a different part of the business or economy. Where there is risk taking, there are both successes and failures. Future market place failures will continue to occur, but in different businesses or products than in the past. However, there are and will continue to be enough successes to make the failures worthwhile. Regulations are about closing the barn door when it is too late. Regulations do not prevent future product and business failures. If they do, capitalism will die. Without risk, there is nothing new and with risk, there is failure.
Thursday, April 9, 2009
Incomplete Valuation of Geithner Summers Toxic Asset Purchase Plan
All the analysis and discussions I have read about the US government's toxic asset purchase plan are incomplete. Many of the discussions focus on the non-recourse FDIC loan for up to 85 percent of the purchase price of the assets, but forget to mention the FDIC contingent liability for the deposits.
All of the discussions overlook that the FDIC is on the hook for the deposits of the bank through FDIC deposit insurance. If the toxic assets own by the bank are worth substantially less than their book value, the FDIC will make up the difference to the depositors. For example, if a banks has $200 of deposits and $200 of market value assets, the FDIC will have zero liability. If the $200 of assets are only worth $100 because a $100 of the assets are toxic and worth zero, the FDIC is liable for the $100 difference.
When the FDIC provides a non-recourse loan to private investors to purchase the assets, the FDIC acquires a contingent liability for the loan. The cash from the loan goes to the bank to purchase its assets. The asset purchase lowers the FDIC deposit contingent liability on the deposits by the amount of the cash.
Effectively, the FDIC's deposit contingent liability is transformed into a non-recourse loan with a contingent liability of default by the borrower. The private public partnership purchase of toxic assets does not increase FDIC contingent liabilities. It just transforms them from a deposit liability to a loan default liability.
All of the discussions overlook that the FDIC is on the hook for the deposits of the bank through FDIC deposit insurance. If the toxic assets own by the bank are worth substantially less than their book value, the FDIC will make up the difference to the depositors. For example, if a banks has $200 of deposits and $200 of market value assets, the FDIC will have zero liability. If the $200 of assets are only worth $100 because a $100 of the assets are toxic and worth zero, the FDIC is liable for the $100 difference.
When the FDIC provides a non-recourse loan to private investors to purchase the assets, the FDIC acquires a contingent liability for the loan. The cash from the loan goes to the bank to purchase its assets. The asset purchase lowers the FDIC deposit contingent liability on the deposits by the amount of the cash.
Effectively, the FDIC's deposit contingent liability is transformed into a non-recourse loan with a contingent liability of default by the borrower. The private public partnership purchase of toxic assets does not increase FDIC contingent liabilities. It just transforms them from a deposit liability to a loan default liability.
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