Monday, August 31, 2009

Decade's Downward Trend In US Job Creation

Andy Harless, chief economist at Atlantic Asset Management, makes the point that over the last decade, there is a downward trend in job creation and job destruction in the US.

In his blog post, "Job Losses Are Not the Problem" on Employment, Interest, And Money Blog, Harless writes:
And the most salient feature of the current episode is that there has been unusually little creation. From the 1990’s to the 2000’s, the quarterly job creation rate fell from about 8% to about 7%. Since 2006, it has fallen to about 6%.
Read his entire blog posting here.

Saturday, August 29, 2009

Rationing Health Care Versus Resource Allocation By Prices

Many people, including editorial writers and bloggers, who are worried about more government involvement in health care, cite rationing as a likely outcome. Their argument is that there will be a decision maker who decides what medical procedures are approved and what are not, or that in the alternative, the government will limit the amount of funds available for health reimbursement, which will force doctors or government officials to limit the availability of medical procedures, i.e., ration health care.

Those in favor of current proposals for reforming our health system say the medical market already rations health care because many people cannot afford health insurance or are otherwise uninsured.

Functioning medical markets do not ration!

Markets set prices and producers and buyers make individual decisions based on these prices. Markets do not prevent anyone from producing a good or service if they are willing to invest the resources to do so. Likewise, markets do not prevent people from buying goods and services within their budgets. The individuals decide how they will spend their money. Individuals decide if they spend their money on a new car every few years or if instead they want some elective surgery, a new lcd tv versus a new computer, a fillet Mignon in a fancy restaurant versus a Big Mac, etc. The whole process is how an economy allocates resources based on peoples' preferences.

In a rationed economy, such as that proposed for health care reform, the government or some other decision maker decides how much the producers produce of an item and they also decide how much individuals can buy or use. The governing body artificially sets prices, and these prices are not signals to users or producers. There are no profit motives to create efficiency incentives or to reallocate resources to meet excess demand with extra production.

One of the differences between rationing and a market is that rationing creates tremendous inflexibility and rigidity in production and use that does not respond to changing needs, demands and resource availability and scarcity. Black markets often spring up to compensate.

If government only bakes bread instead of making pasta, you will eat a lot of bread and no pasta. A market-based system will never allow something like that to happen. A government-planned system could. Just visit Cuba or read about Russia thirty plus years ago.

Anyone who says our capitalistic system rations because something is expensive does not understand markets and market pricing or they are just trying to make health care reform look better based on incorrect logic.

Many have written much about how our current system of health and tax laws distorts the health marketplace. The employer tax deduction grossly distorts the price signals to the users and to the suppliers. Restrictive licensing laws and limited medical school enrollments curtail the supply of available doctors to meet the ever-growing demand.

The list goes on and on, but the President and Congress are not willing to propose anything that will restore accurate pricing signals to the health market place or increase the supply of medical providers to meet demand and lower costs. A normal price signaling mechanism and removal of unnecessary barriers to entry into the medical field, as exists for almost every other product, would end most of the problems we see in health care today.

This post is derived from a comment I left on August 11, 2009, on Megan McArdle's blog post, "Rationing By Any Other Name" on the Atlantic, Asymmetrical Information Blog.

Friday, August 28, 2009

FDIC Insurance Fund Is Not Backed By US Full Faith And Credit

FDIC insurance fund is not backed by US full faith and credit. See below excerpt from FDIC counsel on this matter, available at
Your October 7, 1987 letter asks whether the full faith and credit of the United States Government stands behind the Federal Deposit Insurance Corporation and its deposit insurance fund.... I stated that a joint resolution of Congress (H.R. Con. Res. 290) adopted in March 1982...because of its status as a non-binding resolution, did not serve to create any legal liability on the part of the United States Government to support the funds. You now ask whether Congress has passed a statute that makes the United States Government legally liable for any and all obligations of the FDIC.
[I]t is our opinion that Title IX of CEBA merely represents an expression of the intent of Congress to support the FDIC's deposit insurance fund should the need arise.
Congress PROBABLY will back the FDIC, but legally it is not required to do so, nor are the courts legally required to support any depositor's claim against the FDIC for funds, if insurance funds are not available.

Additionally, there is payee (creditor) risk. The FDIC states, "In a payoff, however, any outstanding transactions or checks presented after the bank has closed cannot be paid or charged against the account."

Any merchant who does business with a customer who is using a debit card or check and the bank fails before the item clears, will not be paid and will have to seek out the customer for payment.

A similar post was added as a comment to an online Time article by Justin Fox about FDIC insurance at

Thursday, August 27, 2009

Is Government Mandated Health Insurance Constitutional?

In an August 22, 2009, Washington Post article, "Illegal Health Reform," David B. Rivkin Jr. and Lee A. Casey argue that Congress cannot mandate the purchase of healthcare insurance.

President Obama's proposal to reform the medical system requires every individual to obtain medical insurance.

Rivkin and Casey write:
But can Congress require every American to buy health insurance?

In short, no. The Constitution assigns only limited, enumerated powers to Congress and none, including the power to regulate interstate commerce or to impose taxes, would support a federal mandate requiring anyone who is otherwise without health insurance to buy it.
Read the complete Washington Post article by Rivkin and Casey here.

Wednesday, August 26, 2009

US National Debt: How Big Is $9 Trillion?

An awe inspiring chart from Political Math about our national debt. It compares the actual 1945 and 2016 projection of national debt share by category.

Read the August 25, 2009, Political Math blog post that references the chart above, "How Big is $9 Trillion? – Willful Omissions From Paul Krugman"

It certainly is easier to cut defense spending after a major war than it is to cut domestic government entitlement programs and interest payments on our existing outstanding debt.

has reason to think the US debt will be $14 trillion and not $9 trillion. Read her blog post on the debt here.

USDJ Rakoff Rejects SEC-BofA Settlement.

The Securities Law Blog: "USDJ Rakoff Rejects SEC-BofA Settlement" by Mark J. Astarita, Esq. on Wednesday, August 26, 2009.

An excerpt of his post:
Judge Rakoff wants the explanation behind why a Bank of America proxy statement last November misled investors about bonuses for employees at Merrill Lynch, which was about to be acquired by the bank. On Tuesday, he stated another desire: to get the SEC to better explain why had agreed to a settlement without pressing the bank’s executives harder.

...starting to suggest an apparent willingness on the part of the Commission to let a big player off the hook....
Read the entire blog post here. It also has excellent links to articles about the history of this SEC case.

RIP: Sen. Edward "Ted" Kennedy

Bloomberg: Edward Kennedy, U.S. Senator and Democratic Icon, Dead at 77

New York Times: Edward Kennedy, Senate Stalwart, Dies

Wall St. Journal: Sen. Edward Kennedy Dies After Battle With Cancer

The Washington Post: Mass. Sen. Ted Kennedy Dies at 77, After Cancer Battle

Los Angeles Times: Edward Kennedy dies at 77; 'liberal lion of the Senate'

Boston Globe: Senator Edward M. Kennedy is dead

Reuters: U.S. Senator Edward Kennedy dies

CNN: Massachusetts Sen. Ted Kennedy dead at 77

Tuesday, August 25, 2009

Hidden Costs Of Free Government Health Care: The French Example

City Journal has an article about the true cost of having free government health care in France. Read "Paying for Le Treatment" by Guy Sorman, City Journal, 24 August 2009.

Sorman writes:
France’s costly national health insurance is mostly financed by taxes on labor. A Frenchman making a monthly salary of 3,000 euros will pay approximately 350 of them (deducted by his employer) for health insurance. Then the employer will add approximately 1,200 euros, making the total monthly cost to the employer of this individual’s services not 3,000 euros but 4,200. High labor costs in France affect not only consumer prices but also unemployment rates, since employers are reluctant to pay so much for low-skill workers. Economists agree that unemployment rates and the cost of national health insurance are directly related everywhere, which partly explains why even in periods of economic growth, the average French unemployment rate hovers around 10 percent.

High as they are, taxes on wages are not enough to cover the constant deficits that national health insurance runs. France imposes an additional levy to try to close the insurance deficit—the CSG (contribution sociale généralisée)—which applies to all income, including dividends, and which Parliament increases every year.
The French system negatively affects employment in France and increases the cost of drugs in the US for Americans.

Read the entire article here.

Monday, August 24, 2009

Manufacturing Workers' Productivity At All Time High

A very good post with charts by Mark Perry on his Carpe Diem blog,"Manufacturing Output Per Worker Hits Record High."

Perry shows that while US manufacturing has trended upward since 1970, with occasional recessionary dips, employment in the US manufacturing sector has been continuously declining since WWII. Manufacturing employment has declined from from 38.75 percent of the workforce in 1943 to 8.99 percent in July 2009.

The US is producing more with fewer workers. Productivity is good because it lowers the prices of goods and raises the wages of those employed. In other words, what is taken as a sign, by Lou Dobbs and other similar media pundits, as a sign of the deterioration of the US economy is actually one of the reasons for the US's high standard of living when compared to the rest of the world.

While Perry did not discuss other countries, I will note that the US manufactures about 3 times as much as China. It is not obvious to US residents since many end products, low value consumer goods that the average consumer purchases say made in China and give the consumer a false impression that China produces more than the US.

Read Perry's complete post here.

Sunday, August 23, 2009

Households Are Getting Richer; Not Stagnating

Read the post by St. Lawrence University Economics Professor Steve Horwitz, "More Evidence That We're All Getting Richer" on The Austrian Economists Blog. (HT: Don Boudreaux).
From 1980 to 2006, the percentage of US households earning $100,000 or more (in constant 2006 dollars) grew from 8.6% to 19.1%. The percentage between $75k and $100K grew from 10.3 to 11.3 percent. At the other end, the percentage under $15K fell from 16.6% to 13.4% and the percentage between $15K and $34K fell from 26.2% to 23.3%. Thus all three categories below $35K fell a total of 6.1 percentage points.
Read the entire blog post here.

Of course, the most recent numbers will show some set back due to the current recession, but Horwitz's numbers show that the long-term trend for the improvement in the standard of living in the US is still positive. Most likely, the US will resume improving the household standard of living once this recession ends.

Saturday, August 22, 2009

Will The FDIC Allow Banks To Avoid Accounting Standards?

Will banks have to bring more off balance items, such as securitized assets, onto their books as will be required by new generally accepted accounting standards, or will the banks be allowed to deviate from the accounting standards that apply to all other companies?

The FDIC will consider the matter next week according to a article, "Will Bank Regulators Diverge from GAAP?" by Marie Leone.
Bank regulators are set to discuss accounting standards next week, with an aim toward determining the potential affects that off-balance-sheet rules may have on some financial institutions. During the past year, bankers have fretted about new accounting rules that would force them to bring back on their balance sheets billions of dollars worth of assets — a move bankers have argued will throw regulatory capital ratios into chaos.
Read the complete article here.

Friday, August 21, 2009

Prediction Markets: A Bettor Way Of Forecasting

ABC National Radio has a 12 minute audio discussion about prediction markets, their use and high degree of accuracy by Andrew Leigh, an Economics Professor at the Australian National University.
Betting on political outcomes, economic outcomes, even box office success for movies: there's a burgeoning industry based on prediction markets.

Andrew Leigh, our regular Wryside Economics commentator, argues that betting markets are more accurate than polling when it comes to political predictions, in particular.
He is also an author on Core Economics blog.

Thursday, August 20, 2009

No Adverse Selection In Health Insurance

People who have the highest medical expenses are often the ones who do not buy health insurance. Adverse selection does not exist in medical insurance markets. It is risk adverse individuals, who take the best care of themselves, who are most likely to buy expanded coverage.
For decades, insurance companies have been pricing policies based on the belief that adverse selection comes into play among their customers. But Keane, a professor of economics at the W. P. Carey School of Business, says it does not. There are no empirical data proving adverse selection, he says. Other factors are operating and, in fact, insurance companies often benefit from "advantageous selection," in which the best risks also are their best customers.
Read the complete article here.

Three Quarters of US High School Graduates Not Ready for College

Only 23 percent of US high school graduates have the skills to succeed in college, based on standardized ACT testing. Read the complete article here or below.

Wednesday, August 19, 2009

High Medical Bankruptcy Rate Is A Myth And Exaggerated

There is no objective evidence to indicate that a government-run health care system in the United States will reduce personal bankruptcies. The U.S.-Canada comparative analysis strongly suggests that bankruptcy statistics are being exaggerated and distorted for political reasons.
Read The Medical Bankruptcy Myth, by Brett J. Skinner, published Wednesday, August 19, 2009, online in the Journal of he American Enterprise Institute.

College Tuition Rose Faster Than Medical Costs

Mark Perry on Carpe Diem blog noticed that college tuition from 1979 to 2009 increased more than health care costs. College tuition rose an average of 7.74 percent per year while medical care costs rose 6 percent per year in the same period.

I actually believe improving education in the US and reducing college costs are a more important issue than health care reform. What ever happens to health care reform, there will always be enough able bodied workers in the US. Costs is really the only concern about medical care and the government is mostly responsible for that result through the employer deduction for health benefits.

However, without educated graduates from our high schools and colleges, the US economy will not grow sufficiently for an improvement in the standard of living of its residents. The US will either have to substitute foreign educated workers or face periods of slow economic growth.

The issue in education, unlike in medicine, is the quality of the service provided. The poor quality of US education leads to a large number of poorly educated, unprepared students, dropouts and graduates in this country. Poorly educated Americans will hurt our economic growth.

Read Perry's entire post here.

Tuesday, August 18, 2009

SEC Schapiro Missed Stanford Fraud In 2003

While Mary Schapiro was a Vice Chairman at the NASD (now FINRA), the securities industry self-regulatory organization, the NASD failed to follow up on information that the Stanford Financial Group was a Ponzi scheme. See the CNBC article, "Stanford Regulators Admit Not Pursuing '03 Fraud Claim."

In 2003, Leyla Wydler, a Stanford employee, alleged that the group was running a Ponzi scheme. Who would know better than an employee at the firm that it was a fraud, but the NASD did not follow up on the claim.

As ridiculous as it may sound, the NASD at the time had a policy not to follow up on brokerage employee claims of fraud. It only followed up on customer allegations of fraud. The policy continued until this past March.

If employees cannot be whistle blowers to the brokerage industry's self-regulatory organization, what hope is there for weeding out fraud and deception?

The disclosure came in prepared testimony for a Senate Banking Committee hearing on Monday from Daniel Sibears, Executive Vice President of the Financial Industry Regulatory Authority, FINRA.

Schapiro joined the NASD organization in 1996 as President of NASD Regulation and became Vice Chairman in 2002. In 2006, she was named NASD's Chairman and CEO.

The whole incident occurred during her time at NASD (FINRA). Can we hope for any better supervision and review of allegations at the SEC?

Isn't the fundamental problem that the securities and brokerage industry watchdog agencies are dysfunctional, too big, too rigid, too set in their ways and not cognizant of what they can do to gain knowledge of industry fraudulent practices in a timely manner and remove criminal practices?

Maybe our regulatory agencies are too big to fail also and need to be broken up into more responsive and flexible entities that can navigate the waters of bad brokerage industry practices.

Monday, August 17, 2009

Obama's Push For Charter Schools Is A Wonderful Surprise

The biggest political and policy surprise from the President is no longer related to healthcare. Arne Duncan, the Education Secretary, is threatening to withhold stimulus funds to persuade states to rewrite their education laws to allow more charter schools and to promote the use of student test scores to judge teacher performance. See Sunday, August 16, 2009, New York Times article, "Obama Pushes States to Shift on Education" by Sam Dillon.

Health reform is mostly about cost containment and affordability. It is about budgeting and living within the country's means. It will happen with or without Presidential or Congressional action, because eventually the public will not endorse the increase in taxes or debt needed to fund the government's medical entitlement programs projected cost explosion. Additionally, insurance companies and the medical establishment will not allow a significant percentage of middle class families to go without health insurance solely due to affordability issues when the government cannot step in as an insurer of last resort.

Education is a much more fundamental problem affecting the US's future. Schooling is about investing in all our futures. An educated America is a productive, economically growing and politically stable country. Without massive quality investment in our future generations, the US will not be able to continue to enjoy its wonderful standard of living or maintain a low unemployment rate.

Duncan's actions are a complete surprise because the policies diverge from expectations based on his background, Obama's campaign promises and the President's actions and background.

Obama and Duncan are very pro union. Despite the teachers' unions strong opposition to charter schools and evaluation of teachers based on student test scores, Duncan is pushing for both and using a very strong persuasive tool, money.

Charter schools are traditionally non-unionized. Comparative studies of union and non-union charter schools clearly show that students at unionized charter schools perform worse than at non-union charter schools and like regular public school students.

If Obama adheres to the goal of increasing charter schools without additional demands that these schools use union teachers, it will be a great achievement towards improving the public educational system of our children.

Saturday, August 15, 2009

The SEC Chases Fraud After The Fact

A comment I posted on The Baseline Scenario blog, "An Inside Perspective on Regulatory Capture."
Due to a misdiagnosis of the 1929 stock market crash, the US creates a huge regulatory and enforcement structure, the SEC, to prevent investor and securities fraud and stock market crashes. In the subsequent 75 years, investor and securities fraud continues, including Enron, Madoff and many other similarly notorious cases over the period. Many of the SEC protections, such as insider trading, are common law rights recognized prior to the creation of the 1933 and 1934 Acts and the SEC.

Contractual legal rights are a powerful mechanism for protecting the rights of parties to commercial transactions. In fact, most transactions are based on contractual protections as opposed to regulatory protections. Shareholders and other interested private parties, and not the SEC, often sue to enforce their legal rights in securities transactions, when courts have recognized their right to sue to protect themselves.

While the counterfactual 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.

Unlike banking, where FDIC insurance creates moral hazard, distorts the risk reward relationship of bank investments and makes the government (and the FDIC) an interested and potentially aggrieved party, the SEC is not in a similar relationship to the parties and transactions it supervises.

Maybe in a market economy as enormous and as complicated as the US capital markets and economy, it is impossible to have an adequate regulatory supervisory structure. It might be better to allow private participants to negotiate and protect themselves on a transaction level. The SEC is always chasing the fraud after it has happened. Is that worth the expense and false expectation of investor and securities protection?

Friday, August 14, 2009

Federal Taxes Distort Geographical Growth

Higher wages and higher cost of living go hand in hand, but federal taxes are on nominal wages. The higher real taxes lowers employment and wealth growth in the more expensive areas of the US, according to a paper by David Yves Albouy, Assistant Professor of Economics, University of Michigan.

"The Unequal Geographic Burden of Federal Taxation" by David Albouy of the University of Michigan and National Bureau of Economic Research, Journal of Political Economy, 2009, vol. 117, no. 4, © 2009 by The University of Chicago. All rights reserved.
Since federal taxes are based on nominal incomes, workers with the same real income pay higher taxes in high-cost areas than in low-cost areas, without receiving additional benefits....

For federal taxes to not distort the location choices of workers, the correct principle is that taxes should be independent of where workers live....For example, in the New York metropolitan area, wage levels are 21 percent above the national average, which, interacted with an effective marginal tax rate of 33 percent, creates a 7 percent federal surtax on labor income for locating there....

Because federal taxes are not indexed to local wage levels, workers are induced to leave cities with high wages and move to cities with low wages. As a result, unindexed federal taxes lower employment levels and property values in high-wage cities while having the opposite effect on low-wage cities. In equilibrium, these price changes compensate workers for federal tax differences across cities, but the resulting geographic distribution of employment is inefficient, reducing overall welfare.

Thursday, August 13, 2009

Can Business Learn From Obama's Healthcare Efforts?

But as his [Obama's] approval ratings slip—only half of Americans support his policies, the “lowest level since Inauguration Day,” according to a Quinnipiac University poll released August 6—some people wonder if Obama is trying to do too much, too fast. It’s a situation that any number of chief executive officers have faced, say faculty at Emory University and its Goizueta Business School.
Read "Managing at the Speed of Change" published August 12, 2009, in Knowledge@Emory for a strategic review of the President's attempts to enact financial regulatory and health care change. The authors mention several possible policy mistakes and propose a few helpful suggestions.
“An outsider should not act like a preacher and assume he or she knows everything about the business,” Sheth says. “It’s a good way to quickly develop adversaries, as we’re seeing with President Obama’s efforts at rapid change. It's like antibodies fighting the new intruder.”
The entire article is available online here.

Wednesday, August 12, 2009

Use Carbon Permit Proceeds To Lower Taxes

Greg Mankiw published an excellent and fairly easy to understand post on his blog today on why carbon allowances should be auctioned and not given away and why the proceeds from the auction should be used to offset income taxes.

Mankiw says, "But that requires a cut in income or payroll taxes to be a key part of the environmental policy."

Of course we can expect the Democratic and liberal economist chorus to disagree with Mankiw mainly because he is conservative and the policy he advocates is not what Obama is proposing. Mankiw's analysis and conclusion are correct, but that will have little effect on stopping those voices that are opposed to anything recommended by conservative economists.

Read his complete blog post, "Wonky Talk about Carbon Taxes" here.

A Video Explanation Of High Frequency Trading

For those of you who prefer videos and diagrams to written descriptions of complicated subjects, I am posting below a video that explains high frequency trading. There is also a free itunes version of the same video available for download here.

High-frequency trading from Marketplace on Vimeo.

High-frequency trading is creating a ruckus on Wall Street. Marketplace Senior Editor Paddy Hirsch explains high-frequency trading and why some people are upset about it.

Paddy Hirsch has 26 other excellent videos about finance and economics available here.

Why Does Obama Keep Pushing Health Care?

I wrote the following comment on March 27, 2009, to a Wall Street Journal opinion piece, "National Health Preview." It seems as true today as it did 5 months ago and I thought it was worth repeating it and publishing it on this blog.
What is motivating President Obama to persist in seeking universal health care? If his main constituent groups did not benefit in some way, he would not propose universal care. Unions gain because it removes health care coverage from the bargaining table and allows unions to negotiate for other items. Minorities make up a majority of the group without health insurance and a rationed, restricted coverage is probably better than no coverage, especially when Obama's plan is to have the wealthy, as opposed to the users, bear the costs for the coverage. In addition, minorities make up a large share of the Medicaid government health program for the poor and universal health care would probably increase the health coverage benefits to this group.

It would push senior Medicare coverage into universal coverage and stealthily allow for a future decrease in senior benefits by limiting all beneficiaries' health costs and not just seniors. The savings from the reduced expenditures on seniors will subsidize the other groups' costs.

Congress and the President will most likely continue to have their existing separate health coverage with exceptional benefits fully paid by the taxpayers.

Therefore, while many would see over time a noticeable decrease in the quality of their health care through delays, rationing, denials and spending caps, Obama's main constituency groups will see an improvement and President Obama and Congress will continue to have their existing health coverage.
In rereading it, I notice I did not mention any benefit for the broad swath of Americans who have health insurance, mostly paid for by their employers. The failure of Obama to articulate a benefit for most of America who do not see the cost of their medical care and who are overwhelmingly satisfied with their medical care and medical insurance is probably the single biggest reason for the President's failure, at this point, to have broader support for his health care plan.

If most people do not understand what is in it for them, why would they support the President's plan? If some parts of the plan annoy, frighten and scare them, why would they not react vociferously against the plan?

If Obama were an attorney handling a jury trial, the equivalent would be that he did everything except convince the jury, which in this case is most of the American people. At this juncture, the failures and obstacles appear to be the result of strategic decisions, or lack of decisions, made by the President.

In the end, the results will be solely the President's doing, whether it is success or failure. I do not think there is any more that the President could ask for when introducing a major initiative. If he cannot make a case that convinces Americans, then the proposal should not be passed. After all, it is for their benefit and if they do not want a different health delivery and insurance structure then they should not have to have it.

Tuesday, August 11, 2009

Was There A Subprime Created Crisis?

Yes, there is a mortgage crisis. Many homeowners have mortgages they cannot afford. Many have homes worth less than the mortgage. Many borrowers are defaulting on their loans. Many homes were foreclosed upon or are in foreclosure proceedings.

But was this a subprime created crisis? We know that mortgages are categorized as prime, Alt-A and subprime, with the lowest risk for prime, then Alt-A and the highest risk for subprime.

If we answer yes, then preventing a recurrence requires new regulations and industry structure that limits subprime mortgages and expanding home ownership was a mistaken goal.

If we recognize that subprimes did not cause the crisis, but instead they were just the most vulnerable that were first to feel the early effects of the recession that eventually reached the Alt-A and prime mortgages, then they were just an early warning system, a canary in a mine, and not in any way a cause of any of the housing or economy problems.

At this point, we know that this is one of the worst recessions in a very long time. The economy declined and unemployment increased much more than we expected would happen in a recession. We also know that many homeowners with low risk prime mortgages, in addition to Alt-A and subprime, are defaulting on their mortgages and are in foreclosure or were foreclosed.

Given the severity of this recession and the amount of unemployment, if subprime loans were not made, we would still have an increase in mortgage defaults and foreclosures in prime and Alt-A mortgages.

If the difference in this recession between subprime and prime is just how soon they used up their resources and started defaulting on their mortgages, then subprimes were an early warning and a not a cause of or contributor to the crisis.

Then we should not restrict subprime loans or have a consumer financial protection agency for mortgages. We should recognize that the banks did not lend unscrupulously to poor credit risks, and that expanding home ownership was not a problematic goal. Instead, the severity of the recession hit all mortgage borrowers hard. In fact, our mistake was not understanding the early signs of the subprime crisis and next time, if anything like this happens again, we will see subprimes as an early warning of further economic problems. Having outstanding subprime loans would be a valuable resource and an early economic indicator.

Why should we disable an early warning system? As renters as opposed to homeowners or as prime borrowers instead of subprime, these individuals would still lose their jobs and be unable to meet their expenses, such as rent. Unemployment would still be high and we would still be in a recession.

Instead of restricting home ownership and subprime mortgages and instead of criticizing the banks for making poor loans, let us plan for the next subprime crisis and recognize subprime loans as canaries in mines that will warn us of the next severe downturn in the economy.

Does Inaccurate Measurement Of GDP Lead To Misstatements About The Economy And Misleading Research?

A comment I posted on William J. Polley Blog, "GDP...not a good measure of national welfare (but still very useful)."
Within the economic arena, as opposed to general welfare, does an incomplete and possibly inaccurate measurement of GDP lead to misstatements about the economy and misleading research? For example, at beginnings of unemployment increases are there greater proportions of workers who take on non-measured home based jobs like caring full-time for an invalid parent, doing major home repairs, etc. A reconstructed unemployment might be lower than measured, GDP might be higher at early stages of recessions, and it might explain some of the inability of the market to reduce measured unemployment.

If there are problems measuring GDP, then do we know how GDP responds? For example, in Cash for Clunkers, the new car purchases are added to GDP, but the destruction of the older vehicles is not subtracted. If instead we had a trade in program for new energy efficient homes that required destroying the older, less energy efficient home, we would reach a different result about GDP effects. The new home purchase would add to GDP as for cars, but the destruction of the old home would result in a reduction of GDP because imputed rent on homes is included in GDP unlike cars.

We would get different economic multiplier effects, etc. about two very similar programs and draw misleading conclusions unless we recognized the data inconsistency. Given what we know about the problems with GDP and recognizing that there are also hidden problems, do we know how economic research and measurements are biased by the GDP inaccuracies? Have we adopted mistaken policies due to inaccurate data?
Read the entire blog post including comments here.

Monday, August 10, 2009

Too Big To Fail Or Too Big To Survive

A thoughtful analysis and article by John Carney on Business Insider, "Why Do Banks Grow Too Big To Fail?"
So why are there big banks? The primary reason for any firm to grow is to avoid some of the transaction costs of using the markets. The transactions costs avoided by centralizing costs in one firm include the difficulty of discovery the relevant prices, as well as the costs of brokering deals and raising capital from outsiders.

But this avoidance of the market is also a disadvantage, as avoiding market prices subtracts from a bankers knowledge and makes efficient economic calculation difficult.

This is actually the central economic dynamics of a capitalist economy. Prices are important to economic calculation but they involve transaction costs. Eliminating transaction costs from dealing with external price markets is the leading explanation for why firms exist at all, and why they grow. But this also has a cost of making prices less transparent, and economic calculation more difficult. The size of any firm is probably dependent on how these things balance out: transactions costs and calculational chaos costs.
Read the entire article here.

I would add to Carney's article that the failure to have accurate pricing in the big institutions misled the firms on the riskiness of their endeavors, postponed the recognition, internally and on accounting statements, of the decline in the value of their investments in securitized assets and contributed to the credit tightening and financial crisis.

Friday, August 7, 2009

SEC Chief Calls For Self-funded SEC

According to an article in the Financial Times, SEC Chairperson Mary Shapiro is calling for a change in the budgetary process at the SEC. Shapiro wants the SEC to be self-funded, which would allow the Commission to use the $1 billion in annual registration and transaction fees it collects. The proposal eliminates the need to go to Congress for approval of the Commission's annual budget. Of course, the current level of fees exceeds the money budgeted to the SEC.

Read the entire Financial Times article, "SEC chief in call for funding shake-up" by Joanna Chung, Brooke Masters and Francesco Guerrera. Published: August 6 2009 03:00:
The US Securities and Exchange Commission should fund itself directly from industry fees, a system that would allow it to tackle more complex investigations and invest more in technology and skilled people, Mary Schapiro, its chairman, told the Financial Times.
The complete article is available here.

Can't We Have Better Economic Critiques Of The Efficient Market Hypothesis (EMH)?

Brad DeLong is unhappy with a Robert Lucas Economist article defending the effcient market hypothesis.

The following is a comment I posted on Brad DeLong's Blog, Grasping Reality with Both Hands, about his posting,"Why Oh Why Can't We Have Better Nobel Laureates in Economics (Robert Lucas Suddenly BFF with Ben Bernanke Edition)."

My comment to DeLong's posting follows:
"The disappointment with economists is not because there were none of us who forecast the possibility of the crisis we are in, but rather that economists like Robert Lucas and myself [Brad DeLong] did not listen with sufficient care and attention to hte Michael Mussa posse."

You inadvertently are the best defense of Robert Lucas, his article and the efficient market hypothesis. If a respected economist at a top ten economics school, such as yourself, did not find the analysis and predictions of Dean Baker, Richard Thaler, Robert Shiller, and Michael Mussa compelling so that you would take action, make investment decisions based on their advice, and argue for policy changes, what can be expected of other economists, policy makers, and home buyers?

Additionally, you admit you were in the midst of writing a paper, presumably with economically cogent, logical and correct arguments against the conclusions of the economic doomsayers.

It is not that Shiller saw the heightened potential of the decline in home prices that is important. What is important is that there was no reason to believe that his predictions and analysis were any more or less accurate than any other prediction in the noisy environment of future home price predictions. Economic research on bubbles shows that they can also last a long time and revert to fundamental levels gradually as opposed to crashing.

Is timeliness an important factor for your respect of the predictions that home price levels were unsustainable or can a bubble crash prediction be made a few years too early and still be respected? Is predicting the extent of the downturn important? Was Shiller's prediction any more than what goes up must come down?

I assume that the economists you mentioned have made other predictions over the years. How accurate are their other predictions as to results, timing, duration and severity? Were these four and others who made the same predictions just lucky this time?

Your behavior is a defense of the efficient market hypothesis. Given the information that you knew and that was available to you, you could not credibly see the coming decline in home prices and you did not act or invest as if a decline was coming. That is all the efficient market hypothesis says. Available information is not actionable to the extent that it will allow someone to make profits beyond that expected by chance and risk.

Thank you for showing through action that Robert Lucas, Eugene Fama and many other EMH proponents are right.

Thursday, August 6, 2009

Laffer's Recipe For Fixing US Health Care

In a August 5, 2009, Wall St. Journal article, "How to Fix the Health-Care ‘Wedge’" Arthur Laffer argues than Obama misdiagnosed the problem with the US health care system.

Laffer says, "Consumers are receiving quality medical care at little direct cost to themselves. This creates runaway costs that have to be addressed. But ill-advised reforms can make things much worse."

Laffer adds, "Implementing Mr. Obama’s reforms would literally be worse than doing nothing."

Laffer concludes, "Because Mr. Obama has incorrectly diagnosed the problems with our health-care system, any reform based on his priorities would worsen the current inefficiencies. Americans would pay even more for lower quality and less access to care."

Read the entire article here.

Did CBO Underestimate The Cost Of Health Care Reform By A $Trillion?

Stephen Parente, a principal of the consulting firm Health Systems Innovations as well as the director of the Medical Industry Leadership Institute and an associate professor in the finance department at the Carlson School of Management at the University of Minnesota, believes that the Congressional Budget Office has underestimated the cost of the Democrat's plan to fix health care.

Parente says in an article, "Another Trillion?" published in the Summer 2009 issue of CITY Journal, a quarterly magazine of urban affairs, published by the Manhattan Institute, and edited by Brian C. Anderson:

The CBO is actually being kind to the would-be reformers. Its analysis likely understates—by at least $1 trillion—the true costs of expanding health coverage as current Democratic legislation contemplates. Over the last few months, my colleagues and I at the consulting firm Health Systems Innovations have provided cost estimates of health-care reform to both Republican and Democratic members of Congress, and we’ve posted these estimates on our website as well. We believe that the Democratic bills currently under consideration in the House and Senate would cost $2.1 trillion and $2.4 trillion, respectively—much higher than CBO’s figures.
Read the entire article here.

The difference in the cost estimates is due to different projections of the number of people who will use the public option. Parente and HSI use newer, non-public industry data to estimate public option usage. Parente used 2006 year data and CBO used public data from the year 2000 without seeking to of purchase the private industry data for the 2006 year for its analysis.

Wednesday, August 5, 2009

Wall Street Too Blind For Incentive Compensation

An excerpt from Why It's Not Really So Bad That We Won't Fix Wall Street Pay by John Carney. His premise is that Wall Street employees cannot recognize the riskiness of their activities and incentive compensation will not make them change their behavior.
The compensation theory requires bankers to have known the they were making risky investments when they bought triple-A rated securities but acted imprudently because the personal rewards were great and the personal losses were small. That's just not what happened in the years leading up to our crisis.

What really led to our crisis was that so many bankers were wrong. Take Ralph Cioffi, the Bear Stearns money manager who ran the two hedge funds that blew up in the early months of this crisis. He was just about the most knowledgeable banker in the world when it came to mortgage backed securities, especially one built from subprime mortgages. Bear Stearns originated the very first subprime, CRA securitization. If anyone was in a position to know that he was taking undue risks it would have been Cioffi.

But the evidence indicates the Cioffi didn't know. He wasn't engaged in risky investments in pursuit of bonuses. He actually believed that the hedge funds, which were 90% invested in AAA or AA securities, were safe. Even after the subprime meltdown began, his faith didn't waiver.
Read the complete article here.

Tuesday, August 4, 2009

Economists Do Not Have Credibility

Economists' predictions do not have credibility. If they did, people would trust the forecasts and heed the warnings. Incentives to economists will not improve the accuracy of their forecasts.

Economists understand the relationship among the components of the economy so that, after the fact, economists are good at explaining related events or the secondary effects. For instance, economists understand that a decline in GDP will cause an increase in unemployment. Economists are just not good at predicting the original decline in GDP, its duration or severity.

When secondary effects start to appear in the economy, such as an increase in unemployment, economists know to look for an earlier causal event, such as a decline in GDP, that they missed seeing earlier.

To predict a future recession does not require any special training or expertise. Recessions are a fact of our economy and they will occur. The forecasting difficulty is to say when it will begin, its duration and its severity. If a recession will begin 6 months later than the prediction, that is 6 months more profits for some business that has the product or service to sell. A business that decreases its availability of a product or service too soon will see those lost profits go to a competitor. A competitor could gain an insurmountable edge.

Many components of GDP, and their interrelationship, move randomly around a trend line. A random movement by its very definition is short term unpredictable. Many times, random movements are offsetting, but other times they move in unison. When economic components move downward together, there is a decline in overall GDP and an economic slowdown.

The randomness of the movement of many components of the economy is what makes economic forecasting inaccurate. Inaccuracy leads to a loss of credibility as a forecaster. Without credibility, businesses and policy makers will continue to ignore the predictions of economists.

Also posted on The Economist Free Exchange Blog.

Monday, August 3, 2009

Ten Reasons Why America’s Health Care Is Better

"Ten reasons why America’s health care system is in better condition than you might suppose" by Scott W. Atlas. [Article title changed to "Here’s a Second Opinion."]
Medical care in the United States is derided as miserable compared to health care systems in the rest of the developed world. Economists, government officials, insurers, and academics beat the drum for a far larger government role in health care. Much of the public assumes that their arguments are sound because the calls for change are so ubiquitous and the topic so complex. Before we turn to government as the solution, however, we should consider some unheralded facts about America’s health care system.
Read the complete Stanford University Hoover Digest article here. [Article title changed to "Here’s a Second Opinion."]

FT Against US Employer Health Care

Matt Miller makes a persuasive case against employer based health care in his Financial Times article:
America’s unique employer-based healthcare system may have made sense 50 years ago, when healthcare was cheap and business faced little global competition. But today’s circumstances are radically different. Soaring health costs strangle business and absorb cash that could otherwise go to wages. The link between healthcare and employment explains why millions of Americans have lost coverage during this recession. Budding entrepreneurs with ill spouses or children stay in jobs they loathe for fear of losing the insurance they need. Keeping employers at the core of the welfare state is bad for business, bad for the economy and bad for families.

With flaws like these you would think a prime goal of health reform would be to give everyone access to group health coverage outside the employer setting. But you would be wrong. Amazingly, this goal was taken off the table at the start. President Barack Obama and Democrats in Congress feared that moving beyond the employer-based system would leave them assailed as “socialists”. Business feared being slammed by unions for “shirking responsibilities”. Unions feared that if health benefits were no longer shaped through collective bargaining, their standing would fall further. Everyone in Washington feared too much “change”.
From The Financial Times article, July 30, 2009, "America’s healthcare should no longer be tied to jobs" by Matt Miller.

Sunday, August 2, 2009

US First In Life Expectancy; Better Than OECD Countries

From a post on the Angry Bear Blog about a University of Iowa Study by Robert L. Ohsfeldt and John E. Schneider, "How Does the U.S. Health-Care System Compare to Systems in Other Countries?":
So the authors controlled for the differing non-health care related deaths to develop a life expectancy table that could more accurately reflect the relationship between health care quality and life expectancy: [Table omitted]

The US jumps from 15th on the list with a life expectancy of 75.3 to 1st with a life expectancy of 76.9.
Read the complete blog post here.
See the authors' summary slide presentation here.

I also posted a similar response on Econlog to a post by Arnold Kling, "Life Expectancy Statistics."

Fun Bobby McFerrin Video For A Sunday Morning

World Science Festival 2009: Bobby McFerrin Demonstrates the Power of the Pentatonic Scale

Saturday, August 1, 2009

Stimulus Did Not Actually Boost 2009.Q2 GDP

The benefit of government spending to 2nd quarter GDP is almost exclusively in defense spending, which was not part of the $787 billion stimulus package. The stimulus' non-defense spending has had a neglible effect on GDP.
GDP Non-defense federal government spending provided a 0.15 percentage point boost to GDP, while state and local government spending contributed 0.30 percentage points, according to the Commerce Department. Federal spending jumped nearly 11%, though much of it was in the defense arena, while state and local government outlays increased 2.4%., Stimulus has yet to really boost GDP.

Milton Friedman Defends Greed

An excellent defense of capitalism and greed by the Economics Nobel Laureate Milton Friedman.

(HT: Mark Perry of Carpe Diem)