Saturday, June 30, 2012

Two More Cents on the Obamacare Decision

Update from the last post on the Supreme Court decision

There is in fact a huge difference between a tax on people without health insurance and a mandate enforced with a penalty.

A mandate is a mandate, a law that everyone must have health insurance. If the minor penalty envisioned in the ACA isn't sufficient (it's not) to get people to buy health insurance, it was entirely within HHS power to find more effective means of enforcement.  They could literally have sent inspectors around and drag you off to jail for not having health insurance.

A tax is only a tax.  If you pay the tax, there is nothing else they can do to you. And taxes have to be approved by Congress, not just HHS. And there is no way Congress is going to vote in a $10,000 head tax for not having health insurance. 

Since the penalty under the mandate is so much less than the cost of health insurance, it was already pretty clear that they were going to have to start using strong-arm tactics to enforce the mandate.

They could have started by requiring proof of health insurance for getting a passport, student loan or grant, unemployment check, or any other interaction with the Federal Government.  That was, according to the fawning New Yorker article on Obamacare, already contemplated.  Next, go to the point of sale: they could have required that delivery of any health service must include a check of health-insurance status and report to authorities. They could have used medicare funds to force states to make proof of health insurance a requirement to get a driver's license. In the end, yes, they could have sent inspectors around to check health insurance status and haul people off to jail.  You think I'm kidding? They already send inspectors around to check immigration status and haul people off to jail. 

Now, none of this can happen. By construing the penalty as a "tax," and holding it unconstitutional as a "mandate," Roberts has clearly said that the penalty is the only recourse the Federal government can use to enforce its mandate. It is only a tax on individuals who don't have health insurance. It is not a law that people must have health insurance, enforceable by the usual array of legal administrative and regulatory sanction.  

The minute HHS tries anything beyond the penalty to coerce people to buy health insurance (which it will--it must), HHS will be sued (which it will).  The suit will say: "A mandate is unconstitutional. It's only a tax. We paid the tax. Go away." The suit will go to the Supreme Court. In the current court, it will win in a heartbeat.

That pretty much undermines the whole mandate business just as effectively as striking it down would have done. 

Friday, June 29, 2012

New Paper

In my "real" academic life, I just finished a new paper, "Continuous-Time Linear Models," find it here if you're curious.  It's a pedagogical piece really, showing how to do all the familiar discrete-time time-series tricks in continuous time.  Comments welcome. I thought of advertising it as evidence that blogging hasn't turned my mind to mush, but I'm afraid real continuous-time econometricians will see it as proof of the opposite proposition.

Thursday, June 28, 2012

My 2 Cents on the Supreme Court and Obamacare

I think the court did the right thing. And pretty much what I expected.

They overturned the mandate under the commerce clause. Hoorray! There is some limit to the commerce clause!  I think they had to do this. If they upheld the whole thing, they would have said there is no limit whatsoever to Federal power.

They upheld the mandate as a tax. Swallow hard, free-market friends.

If the Federal government has the power to adjust your taxes based on whether you buy an electric car, cover your roof with solar panels, use 1 btu of petroleum to create 1 btu of corn ethanol, take out a mortgage on your mansion, hire a nanny to take care of your kids, and all the other silly things it does in the tax code, it surely has the power to adjust your taxes based on whether you buy health insurance.

Roberts: "The Constitution permits such a tax, it is not our role to forbid it, or to pass upon its wisdom or fairness."

Yes, the administration didn't call it a tax. But for the court to overturn this whole law,  one of the Administration's proudest accomplishments, based on that technicality would have been petty and political. They did the right thing to look at the big picture.

I think our country needs a lot more Supreme Court decisions that say "we think this is a really stupid policy, but alas, it is constitutional."  (And, "we think this is a great policy, but alas it oversteps the constitution.")

As I said before, the mandate was never the weakest part of this law as a matter of economics.  It's the rest of the perfectly constitutional thousands of pages, and the perfectly constitutional thousands more arbitrary regulatory decisions that are the problem. Relying on the court to throw out the bathwater on the basis of the mandate was always a stretch.

We should not rely on the court to determine economic policy or write laws. That's what Congress and Administration are for. If you don't like the health care law, try to find someone of either party with the courage to say just how he or she will repeal and replace, and vote.

This will be healthy for both parties. Defenders can't say how wonderful it would all have been except that the nasty polticized court threw it out. They will have to own Obamacare as it falls apart at the seams. Opponents will have to work to repeal, and explain what they will replace with.

Yes, it would be nice if the constitution forbade silly economic policy, and it would be nice if it forbade arbitrary discretionary regulation.  For that you need to overturn a century's worth of precedents. Nobody even asked the court to do that in this case. (Time to start!)

Disclaimer: This is based just on news reports. I haven't read the decision yet, and will comment more when I do. There are lots of other issues.

Update: Two more cents here in a follow-up post.  "Tax" and "Mandate" really are very different in important ways. 

Tuesday, June 26, 2012

RIA State Registration Deadline Approaches

This Thursday is the deadline for mid-sized RIAs who no longer meet the $90 million AUM number to register with their states rather than the SEC, and it appears that many have not done so. sys that hundreds of medium-size RIAs are procrastinating and have not made their state registrations.

Despite numerous messages from the SEC, it appears that many advisors have not made the registration filings, and there is no guarantee that the state will accept the filings, even if filed on time.

With roughly 2,500 RIAs affected by the change in registration requirements, there could be a signficant number who are going to be late, and who may face issues with not being registered with any regulator, a potential violation of state and federal law.

If you are one of the firms that has not made your state filings, contact us at and we will see if we can assist you with your registration, or help you find someone to help you with the process. has more details at Procrastinating RIAs Could Face SEC De-Registration

Sand in the gears

Today's Wall Street Journal has a beautifully informative editorial, "Employment, Italian Style." Snippets:
Once you hire employee 11, you must submit an annual self-assessment to the national authorities outlining every possible health and safety hazard to which your employees might be subject. These include stress that is work-related or caused by age, gender and racial differences. You must also note all precautionary and individual measures to prevent risks, procedures to carry them out, the names of employees in charge of safety, as well as the physician whose presence is required for the assessment.

Once you hire your 16th employee, national unions can set up shop. As your company grows, so does the number of required employee representatives, each of whom is entitled to eight hours of paid leave monthly to fulfill union or works-council duties. Management must consult these worker reps on everything from gender equality to the introduction of new technology

Hire No. 16 also means that your next recruit must qualify as disabled. By the time your firm hires its 51st worker, 7% of the payroll must be handicapped in some way,...

Once you hire your 101st employee, you must submit a report every two years on the gender dynamics within the company. This must include a tabulation of the men and women employed in each production unit, their functions and level within the company, details of compensation and benefits, and dates and reasons for recruitments, promotions and transfers, as well as the estimated revenue impact....
This kind of thing is hard to track down. You can't easily find a prepackaged "list of regulatory sand in the gears lowering productivity and employment in Italy," the way we can find (statutory) tax rates, spending numbers, interest rates, and so on.  So like the drunk in the old joke, looking for his car keys under the light even though he knows he dropped them a block a way, much economic discussion focuses on those headline issues ("Stimulus!" "Austerity!" "Bailout!" "Leave the Euro!" "Raise/lower taxes!") and ignores all the sand in the gears.

The journal writes, 
All of these protections and assurances, along with the bureaucracies that oversee them, subtract 47.6% from the average Italian wage, according to the OECD.
I wish the WSJ had footnotes or links, even in its online edition, to make it easier to track down  numbers of this sort. A quick tour through the OECD website provides some horrifying numbers on
 Labor tax wedges of 40-50%, to which we must add “non-tax compulsory payments (NTCPs)” which "represent a strong increase over and above the overall tax burden. E.g., in 2011, the compulsory payment wedge for the average single worker was 50.4% compared with the corresponding tax wedge of 47.6%" And remember, once they give you a euro, you still pay another 21% VAT before you can eat that plate of delicious pasta.  But the WSJ paragraph suggests 47.6% is the effective wedge of regulation on top of explicit taxation. (If readers know where it came from, add a comment.)

Also left out is the effect of this kind of hyper-regulation on corruption. You can imagine when the inspector comes in to see if all the paperwork is up to date how the conversation evolves. (Ask Luigi Zingales)

Cleaning up this mess is what we mean by "structural reform." How to achieve it politically seems like a nightmare to me.  Fighting each of ten thousand regulations one by one seems hopeless. Each one sounds good, each one taken alone seems minor, each one has an entrenched interest backing it and an army of bureaucrats whose jobs depend on its enforcement. And the economy dies the death of a thousand cuts. Can you really abolish it all in one fell swoop or grand bargain?

Certainly not if you don't try. 

The WSJ headline was
Prime Minister Mario Monti has issued a new "growth decree" to revive Italy's moribund economy. Among other initiatives, the 185-page plan proposes discount loans for corporate R&D, tax credits for businesses that hire employees with advanced degrees,.. 
Not to belabor the obvious, but this is incredibly depressing. More special programs are not what Italy needs. I hope there are better ideas in the rest of the 185 pages.

Monday, June 25, 2012

McCloskey Wisdom

I recommend a gorgeous essay by Deirdre McCloskey, "Factual Free Market Fairness" (hat tip, Kyle N's comment on Sunday's post "Legal News").  Some choice bits:
I’m from economics and history, and I’m here to help you... The High-Liberal political philosophers... rely...on a factual story which they take to be so obvious as to not require defense.  I claim that on the contrary their master narrative is mistaken, as anthropology or economics or history.
The story is, in a few brief mottos to stand for a rich intellectual tradition since the 1880s:  Modern life is complicated, and so we need government to regulate.  Government can do so well, and will not be regularly corrupted.  Since markets fail very frequently the government should step in to fix them.  Without a big government we cannot do certain noble things (Hoover Dam, the Interstates, NASA).  Antitrust works.  Businesses will exploit workers if government regulation and union contracts do not intervene.  Unions got us the 40-hour week.  Poor people are better off chiefly because of big government and unions.  The USA was never laissez faire.  Internal improvements were a good idea, and governmental from the start.  Profit is not a good guide.  Consumers are usually misled.  Advertising is bad. ....

No.  The master narrative of High Liberalism is mistaken factually.  Externalities do not imply that a government can do better.  Publicity does better than inspectors in restraining the alleged desire of businesspeople to poison their customers.  Efficiency is not the chief merit of a market economy: innovation is.  Rules arose in merchant courts and Quaker fixed prices long before governments started enforcing them.

How do I know that my narrative is better than yours?  The experiments of the 20th century told me so.  ...anyone who after the 20th century still thinks that thoroughgoing socialism, nationalism, imperialism, mobilization, central planning, regulation, zoning, price controls, tax policy, labor unions, business cartels, government spending, intrusive policing, adventurism in foreign policy, faith in entangling religion and politics, or most of the other thoroughgoing 19th-century proposals for governmental action are still neat, harmless ideas for improving our lives is not paying attention.

In the 19th and 20th centuries ordinary Europeans were hurt, not helped, by their colonial empires.  Economic growth in Russia was slowed, not accelerated, by Soviet central planning.  American Progressive regulation and its European anticipations protected monopolies of transportation like railways and protected monopolies of retailing like High-Street shops and protected monopolies of professional services like medicine, not the consumers.  “Protective” legislation in the United States and “family-wage” legislation in Europe subordinated women.  State-armed psychiatrists in America jailed homosexuals, and in Russia jailed democrats.  Some of the New Deal prevented rather than aided America’s recovery from the Great Depression.

Unions raised wages for plumbers and auto workers but reduced wages for the non-unionized.  Minimum wages protected union jobs but made the poor unemployable.  [JC: In both cases, I would add, minorities were especially hurt.] Building codes sometimes kept buildings from falling or burning down but always gave steady work to well-connected carpenters and electricians and made housing more expensive for the poor.  Zoning and planning permission has protected rich landlords rather than helping the poor.  Rent control makes the poor and the mentally ill unhousable, because no one will build inexpensive housing when it is forced by law to be expensive.  The sane and the already-rich get the rent-controlled apartments and the fancy townhouses in once-poor neighborhoods.

Regulation of electricity hurt householders by raising electricity costs, as did the ban on nuclear power.  The Securities Exchange Commission did not help small investors.  Federal deposit insurance made banks careless with depositors’ money. The conservation movement in the Western U. S. enriched ranchers who used federal lands for grazing and enriched lumber companies who used federal lands for clear cutting.  American and other attempts at prohibiting trade in recreational drugs resulted in higher drug consumption and the destruction of inner cities and the incarcerations of millions of young men.  Governments have outlawed needle exchanges and condom advertising, and denied the existence of AIDS.....
It goes on like this. There's no need for me to keep quoting. Just go bask in the whole original.

The case for free markets, and social freedom, is practical. It need not be ideological. It's based on the clear lessons of history. We all have the same stated goals. It's not about who cares more. It's about what works.

Admire McCloskey's post also for the writing. The author of "The Rhetoric of Economics" (Article and  Book -- an absolute must-read for every young economist) knows what she's doing! Rather than write an article expanding on one of these points, or a three-volume encyclopedia explaining the factual basis of all of them, she make the withering case by stating each point just once, but layering all of them in one place. 

Sunday, June 24, 2012

Legal News

Two legal items in last week's news caught my eye: The legal challenge to Dodd-Frank, and a challenge to Virginia's "certificates of need" for new hospitals.  I've written about both from an economic, and slightly political-economy viewpoint. The legal challenges are a new and interesting angle.


I am troubled by Dodd-Frank's reliance on discretionary power given to appointed functionaries. "Systemically important" is whatever they determine it to be, even after the fact.  There is no rulebook, no way to know ahead of time how to avoid "designation" and "resolution" and little recourse if you disagree. This strikes me as a poor mechanism from a moral-hazard, rules-vs-discretion, precommitment-vs-expost authority economic basis, and worse from a political economic basis of avoiding capture, "crony capitalism," keeping regulation from being subverted to stifle competition, and so on. But, knowing little about law,  I didn't think it was unconstitutional. All sorts of silly laws are constitutional.

"Certificates of need" for hospitals are one of the many barriers to entry enacted by state governments and enforced by state regulators. To start a hospital, a state board needs to give you one of these certificates, and all your competitors get to come to the hearing and complain that you're stealing their business. In Illinois, keeping up the profits of incumbents is written right there in the statute defining the board that hands out certificates.

Again, horrible economics, but governments have been using the fig-leaf of consumer protection to stifle competition and prop up politically-connected incumbents for centuries if not millenia.

Well, perhaps the framers of the constitution had more foresight than I thought. There is an interesting prospect that both of these horrible bits off economics are in fact unconstitutional and can be brought down by legal challenge.

Both threads will come together this week. We will hear on the constitutional challenge the law now called Obamacare even by its defenders.  But here the legal challenge -- the mandate -- is one of the least objectionable pieces of economics. I  wish stupid economics were unconstitutional, and lawyers could go after the heart of the bill.  If the separation of powers case for Dodd-Frank works, perhaps they will, for the ill defined terms, arbitrary power, regulator discretion and so forth in the health law make even Dodd-Frank look good.

In the big picture, our Obamacare debate has focused on health insurance, but the awful economics and regulatory destruction of the health care markets should be higher on the list. Why can't you walk in to a hospital and have any idea what the real prices are? Why does "thank you, I'll pay cash" mean you'll get socked with a huge bill, not a nice discount? Anti-competitive regulation is a big answer.  Perhaps the Virginia case can begin the dismantling of state and federal regulation strangling competition in health care.


The main legal challenge to Dodd-Frank centers on the Consumer Financial Protection Bureau.  Gray and Purcell start with a nice quote from President Obama
"Our financial system only works—our market is only free—when there are clear rules and basic safeguards that prevent abuse, that check excess, that ensure that it is more profitable to play by the rules than to game the system." We completely agree.
As do I. "Rules." Which is not how Dodd-Frank is structured:
The FSOC can declare a financial firm "systemically important"—that is, too big to fail—based on "any" "risk-related factors" that it "deems appropriate." And the CFPB can punish even responsible lenders who in good faith offer loans that the bureau later deems to be "unfair," "deceptive" or "abusive."

Those open-ended standards place no limits on the regulators' power. Indeed, in January newly appointed CFPB Director Richard Cordray told Congress that he believes it is "probably not useful" to try to define in advance what an "abusive" lending practice is. Instead, he intends to use his enforcement powers to retroactively punish lenders based on his view of the "facts and circumstances" of each case.
They echo my complaints about the FSOC.

Stupid, yes. But unconstitutional? Their argument rests on separation of powers, and "checks and balances:"
The Constitution empowers the president and Congress, as well as our courts, to prevent regulators from running amok with excessive, arbitrary or even partisan regulations.

But Dodd-Frank does not honor checks and balances. It eliminates them. The CFPB is not subject to Congress's "power of the purse,"... Instead, Dodd-Frank lets the CFPB claim more than $400 million from the Federal Reserve each year and prohibits Congress from even reviewing that budget. The president's control over the CFPB is limited because by law he can remove the agency's director only under strictly limited circumstances. Finally, Dodd-Frank limits the courts' review of CFPB's legal interpretations.
The details of the complaint adds lovely detail on the Alice-in-Wonderland quality of the words "abusive" "deceptive" and "unfair" practices, (see p. 10), adds the legal argument that theyare ex-post-facto constructs. Maybe the prohibition on bills of attainder can apply to regulatory decisions?

I wish the suit emphasized more the FSOC rather than the CFPB, which is a larger component of Dodd-Frank and a much bigger danger. But you don't have to be too much of a conspiracy theorist to realize why the big banks under the FSOC's thumb aren't willing to sign on to a complaint. It's rather courageous that so many small banks signed on. Given the CFPB's wide discretion, they are putting themselves at real risk.

Will it work? I don't know. The obvious counterargument is that this structure is set forth in legislation, passed by Congress and signed by the President. If they want to give up their power, they can do so. The complaint (p.29) already tries to counter this by pointing out precedents on the limitations of Congress' ability to devolve its power.

The complaint and oped get really mad about the director's appointment
Moreover, Mr. Obama nullified one of Congress's few remaining limits on the CFPB—namely, Senate review and confirmation of its nominated director—by deeming the Senate to be in "recess" during a short break in early January and unconstitutionally appointing Mr. Cordray director without the Senate's advice and consent
But this point is really not about the structure of the bill, it is a criticism of President Obama's action. The statute says the director should be approved by the Senate. If the Administration acted unconstitutionally in its appointment of the director, I can see how they can reverse that action, but I don't see how that makes the statute unconstitutional. But it's better for me not to play lawyer.

Still, I do find the idea attractive (am I being too hopeful?) that something so awful in its economic structure is also unconstitutional -- and for much of the same reasons.


The Insitute for Justice summary of their complaint against Virgina's bureau is a nice primer on how state "consumer protection" is really "competitor protection,"
If you want to offer new healthcare services, even something as routine as opening a private clinic, you have to obtain special permission from the [Virginia] state government. And permission is not easy to come by: Would-be service providers have to persuade state officials that their new service is “necessary”—and they have to do so in a process that verges on full-blown litigation in which existing businesses (their would-be competitors) are allowed to oppose them. Not surprisingly, this process can be incredibly expensive, and it frequently results in new services being forbidden to operate at all.

To be clear, this requirement (called a certificate-of-need or CON program) has nothing to do with public health or safety. Separate state and federal laws govern who is allowed to practice medicine and what kind of medical procedures are or are not permitted. Virginia’s CON program only regulates whether someone is allowed to open a new office or purchase new equipment; it is explicitly designed to make sure new services are not allowed to take customers away from established healthcare services.
Both in Virginia and Illinois, these restrictions were also put in place in the name of "cost control," i.e. to stop businesses from "needlessly" building too much capacity. Our national policy is now going to echo these bright ideas.

Well, you had me when you said hello, but why is this illegal, especially unconstitutional? Heck, taxi medallions work the same way.  The IJ website says only
The Constitution protects individuals’ right to earn an honest living free from unreasonable government interference, and it prevents states from putting up unnecessary barriers to interstate commerce.
Sorry guys, the constitution as currently interpreted doesn't say anything about a "right to earn an honest living."  See the 1873  Slaughterhouse Case, (comments from George Will here) which found that "a citizen's 'privileges and immunities,' as protected by the Constitution's Fourteenth Amendment" do not extend to economic freedoms, so  "a state may grant business monopolies to some of its citizens but not to others without running afoul of the Constitution." See Wickard v Filburn which found that the Federal Government can stop a farmer from growing wheat for his own use without permission. (Recently reinforced by Justice Scalia, in Gonzales v Raich.) And  it's going to be hard to argue that opening a clinic or buying an MRI machine is protected interstate commerce.

Yes, libertarians go to sleep each night praying that these interpretations will be reversed some day. But that is a different than hoping Dodd-Frank, Obamacare, Certificates of Need, and other ham-fisted economic policy can be declared unconstitutional on their own.

Not being a lawyer, I didn't track down the legal arguments on this one any further. I'll just leave the attempt as a ray of hope.

Wednesday, June 20, 2012

Operation Un-Twist

This morning's WSJ has a great piece by Todd Buchholz, titled "Washington Should Lock in Low Rates" This is in the context of increasing speculation that the Fed will do another "operation twist," buying long term bonds and selling short term bonds in an effort to drive long term rates even further down.

Long term rates are absurdly low.

I don't know who in their right mind is lending the US government money for 10 years at 1.59% and for thirty years at 2.67%. You have to believe inflation will be lower than these values just to get your money back, let alone make any real return.  (The best I can do is to opine that these are not long-term investors, and they think they can get out before rates rise. I will admit that understanding such low rates is stretching my rational-investor efficient-market prejudices.)

Well, no matter. When offered a screaming good deal, you should take it!

Restructuring US debt to longer maturities has all sorts of advantages. (Restructuring. I am not advocating stimulus!) It buys lots of insurance, very cheaply.

Think about what happens with very long term debt vs. rolling over one or two year debt, which is what the US does now.  Sooner or later, interest rates will surely rise to normal, 5-6%. If we are rolling over debt, that means the US Treasury has to come up with an extra 4-5% times the outstanding stock of debt, each year, to pay interest. 5% of $15 trillion is $750 billion, more than half our current (and already unsustainable) deficit. Oh, and by then the debt will be a lot more than $15 trillion by then.

And that's just the "return to normal" scenario. What if the exploding euro leads bond investors to wake up that all debt of highly-indebted, sclerotic-growth, perpetual-deficit, can't-cure-runaway-entitlement governments is dubious?  Greece didn't get in trouble trying to borrow for one year -- it got in trouble trying to roll over debt. If that moment comes and the US has lots of long-term debt outstanding, it just means a mark-to-market loss for bondholders. If we are rolling over short term debt, then the debt crisis comes to the US. And there is no Germany to bail us out.

Todd goes beyond the usual 30 year Treasuries, and advocates 50 or 100 year Treasuries. Good idea! I have wilder ideas. We should think about bonds with no principal repayment at all. 30 years of coupons, or even perpetuities. These bonds never have to be rolled over -- you never have to issue new debt to pay off the principal of the old debt. Or, if we want to maximize the duration of the bonds, issue the opposite: zero-coupon 50 year bonds.  At least that puts off any problems for 50 years!  If restructuring physical debt is hard, do what the private sector does: Massive fixed-for-floating swaps could lengthen the US maturity structure very quickly without unsettling somewhat illiquid markets for seasoned bonds.

Lots of smart money is locking in absurdly low rates. Why not the US?

The Treasury is trying, a bit. But the Fed is undoing what the Treasury is trying with "twist." And the Treasury isn't going nearly long enough, in both my and Todd's view.

Why is the Fed undoing even the Treasury's small lengthening? The Fed seems to think that shortening the maturity structure will lower long-term rates, and this will stimulate the economy. I doubt it can lower long term rates at all, but we don't have to fight about that. Even if it could lower 10 year rates another, say, 15 bp, from 1.59% to say 1.44%, really, how much stimulation would that accomplish? Is the economy really sluggish (and it is) because it's strangling on 1.59% -- substantially negative in real terms -- 10 year benchmark rates?

Todd takes a darker view.
The short answer is: out of shrewd political self-interest...borrowing short gives the illusion of a lower budget deficit, flattering President Obama's fiscal profile—if anything can flatter a deficit-to-GDP ratio approaching 9%.

With a generous Federal Reserve squeezing short rates down to zero, the interest cost of existing debt looks pretty meager at 1.4% of GDP. But this is a terrible trade-off that makes President Obama look better while almost guaranteeing that our children are worse off. Issuing 100-year bonds, or at least 50-year bonds, would require a higher interest rate, perhaps 3%. Sure, that would put more pressure on near-term deficit reports. But leaders should be willing to let their personal image take a dent if it clearly helps the American people. Locking in 100 years of borrowing at a 3% rate would be the best deal since Pope Julius paid a pittance to have Michelangelo paint his ceiling
To emphasize what Todd says very briefly, borrowing short only helps deficit "reports," and gives the "illusion" of a lower deficit. Standard budget accounting does not mark to market, so borrowing at 3% yield for 50 years counts as 3% interest cost, even though the one-year return on the bonds may only be zero -- the government could buy back the bonds next year at appreciated prices, and the carrying cost is zero. 

Is this really they story? I don't know anything about politics, but it is tough to believe. As Todd points out, what's another drink among sinners? If you weren't bothered by 9% deficit-to-GDP, you probably think of another percent or so as valuable fiscal stimulus. If you're an anti-Obama, he's-spending-us-to-oblivion Tea Partier, it's hard to see that an extra percent or so of bogus-accounting interest cost is going to make you feel that the Administration is serious about deficits.

Moreover, surely the Administration hopes still to be in office in four years, and hopes the economy returns to normal growth, which means normal interest rates, by then. This isn't about "our children," this is about us, very soon. If they're doing it for political calculus, they are cooking their own goose. (Or maybe Hilary Clinton's goose!)

I think the answer is much simpler. "The right maturity structure of government debt" is something economists haven't thought about much, the functionaries in charge at the Treasury have thought less about, certainly in these big-picture terms, and the higher-ups at Treasury and in the political parts of the Administration even less so still. They've got enough on their hands.

If my theory is true, that people just haven't thought about what a great deal markets are offering, and how valuable that insurance could be, perhaps there is hope of a quick, healthy, un-twist.

But, as the car salesman says, the big sale prices aren't going to be here forever.

Monday, June 18, 2012

Bloomberg TV link

I did a Bloomberg TV interview this morning on Euro debt crisis. I can't seem to insert the video here, so you'll have to follow the link if you're curious.

Update: I figured out how to embed bloomberg vidoes!

Sunday, June 17, 2012

A glimmer of hope?

Weekend Update.

On Monday the Greeks decide whether to vote for the Easter Bunny or Santa Claus to solve their fiscal problems. What is Europe planning to do next?

Sunday's New York Times had an unusually cogent article on European events over the weekend, reporting on events with thoughtful analysis:
The head of the European Central Bank and other euro zone leaders worked on Saturday on a grand vision... the plan will push for countries to remove the regulations and layers of bureaucracy that inhibit competition, keep young people out of the work force or make it difficult to start a new business....

Over the years, countries have repeatedly pledged to clear the rules that hinder competition and led to chronically anemic growth. If the euro zone grew faster, tax receipts would rise and the debts of countries like Spain or Italy would seem less daunting
Halelujah! Growth -- the classical, growth-theory, higher productivity, bend-up-the-trendline, long-run kind of growth, not the quick espresso stimulus kind of growth (if that even works) -- is the only hope for Europe to repay debt rather than face the awful choices of default or inflation. At least we understand this is the central answer and without it, all the rescue plans will fail.

For years the mantra has been, stimulus and crisis management today, and "structural reform program" to be implemented in the vague far off future. They've figured out it won't work. Decades of previous good times did not bring structural reform. 
“There is a long-standing agenda on growth,” Mr. Draghi told a gathering of economists on Friday in Frankfurt. “It is time to implement it.”

But it is unclear whether yet more pledges of reform, which would face significant hurdles, will calm financial markets.

The euro zone has no shortage of plans and pacts intended to end years of sluggish growth and impose discipline on its 17 members.

The challenge for Mr. Draghi and the plan’s authors....will be to package their plan in a way that makes investors believe something will get done.

The most difficult task for Mr. Draghi and the other leaders may be to establish a binding timetable, to ensure that political leaders do not drag their feet.
Correct. Quite a challenge, I'd say. How do you establish a "binding timetable?"
The leaders are “only capable of acting at gunpoint” — when markets force them to, Willem H. Buiter, chief economist at Citigroup, said...
But once markets "force them to" act, by a huge bank run, refusing to buy government debt, running from the currency, it will be too late for a structural reform plan to have any chance.


What about the immediate problem, the bank run, no longer "imminent" but gaining steam every day?
Under the plan, euro zone leaders will seek to establish the central bank as supreme bank regulator with broad powers, in place of the relatively toothless European Banking Authority.

Countries would also create a deposit insurance program to augment national programs. The goal would be to reassure ordinary depositors and prevent bank runs, an imminent danger in Spain as well as Greece. But any sharing of financial burdens almost automatically encounters opposition in Germany.
Catch 22. We've got a bank run. How to stop it? Ah, deposit insurance! But who is going to pay for that? "Countries" are not credible. The whole problem is that "countries" used their banks as piggy banks, stuffing them with sovereign debt. So, if the countries default on their sovereign debt, the banks go under, and the same "countries" obviously don't have the money to guarantee deposits.

A cross-national deposit insurance scheme, while banks are already stuffed with sovereign debt, is back to Plan A, run for the exit and stiff Germany with the bill. Which "automatically encounters opposition in Germany."

A Supreme Bank Regulator  to stop banks from gorging on sovereign debt in the first place might have been  good idea, perhaps. (The concept "sovereign debt is risky" isn't necessarily beyond the ability of national regulators to comprehend, even with Basel rules denying it.) But it's way too late for that now.

Bottom line: Waffling again. No serious plan to stop the bank run already in place. You can't stop the crisis by saying you'll invent a totally new regulation regime to keep the banks from taking risks.


What about looming sovereign defaults?
For now, the most important new tool is a half-dozen rules known as the Six-Pack, which took effect in December. In coming months, the European Commission will be able to impose fines on euro zone countries of up to 0.2 percent of their gross domestic products if they flout rules on public debts and deficits.
Oh yeah, right. The same Spanish government you just lent 100 billion euros to pour down the rathole of its banks, that one. You're going to tell them to pay you a fine of 0.2 pct of GDP because they're borrowing too much money..from you?

The one big lesson to learn from this debacle is that deficit limit rules do not avoid sovereign defaults. A currency union without fiscal union needs to allow sovereign default.

As far as quelling the panic, good luck that "we really mean the deficit targets this time" will have any effect.


What are they going to do now, to stop the unraveling that is likely to happen in weeks?
Mario Draghi, the president of the central bank and one of the authors of the plan, said Friday that it would be unveiled within days, ahead of a meeting of European leaders at the end of June.
Well, that's good. I hope there still is a euro at the end of June.


Bottom line. Mr. Draghi is saying the right words on growth. But these plans to address bank runs and sovereign defaults are not realistic. And the pace of events is quickening. The time to actually implement a pro-growth policy, and stop financial panic by convincing markets it will really happen, is getting shorter and shorter.

Friday, June 15, 2012

Euro explosion

The European bank run is on, and with it the slow-motion train wreck  will move to high speed.

The Wall Street Journal reports €600 to 900 million  a day are flowing out of Greek banks, and  the outflow may rise above a billion euros per day. At the end of April there were only €166 Billion deposits to flow. Count the days.  And Greeks -- those who can't move money abroad or move themselves abroad -- are "hiding money in jars, under the bed, even burying it in the mountains."

In related news, I read last week say that payments are simply stopping in Greece. If there's a chance to pay in Drachma next month, why pay in euros now? Shipments are stopping -- if your invoice might get paid in drachma, no point in sending goods today. This is simple implosion.  Spain has already lost about € 100 billion of bank deposits and Italy is losing them quickly.
What's going on? Keynesian economists love to talk about how great leaving the euro will be, because then salaries can be cut by depreciation rather than explicitly.

But if you have a bank account, leaving the euro means that you go to bed one night with € 10,000 in your bank account. The next morning, you have 10,000 drachmas. Those drachmas are going to be swiftly devalued to about 1/3 or so of their original value. In addition, it's a good bet there will be capital controls and exchange controls, so you can't get money out of the country or buy things with euros.

People understand this. They get out now.  To an account holder, the country leaving the euro is the same as the government seizing bank accounts. Burglars at least know enough not to advertize their visits in newspapers for two years before they visit.

The run means everything will happen super fast from here on in. The time to dither around and make pronouncements is running out.


How do you stop a bank run?

1. One common prescription is for the government to guarantee deposits. But that won't work, since the whole problem is that the government is out of money and the banks are stuffed full of government debt.

Spain discovered a version of this conundrum last week. Spain borrowed € 100 billion to recapitalize  banks. The result was not only a continued run on the banks, but a sharp rise in Spanish government interest rates.

Why didn't it work? "Recapitalize" means that the Spanish government owns stock in banks. If the banks lose more money, the Spanish government loses money -- but the government still has to repay the 100 billion loan. Unfortunately, the Spanish government is broke. And what do these banks own? Spanish real estate and a lot of Spanish government debt.
...That would raise pressure on the Spanish government, which has come to rely on local banks using ECB funds to buy sovereign debt. According to the latest Spanish Treasury data, while foreign investors have reduced their holdings of Spanish bonds to 32% of the total in March from 36% in December, Spanish banks have raised their holdings to 41% of the total in March from 35% in December
2. The second run-stopping prescription is for the central bank -- the ECB in this case -- to open the spigots. They already are. Ask yourself, where are banks getting the cash to redeem all these deposits anyway? They sure aren't selling assets -- real estate loans and government bonds. The answer is, the ECB is lending them the money.

But wait, isn't the ECB only supposed to lend against collateral? Yes, and that collateral is largely government bonds.  The ECB knows it's taking junk collateral.  If the ECB doesn't stop this massive lending, it understands well that it will essentially end up monetizing all the debt of the southern tier, and a huge inflation will eventually break out. The ECB knows that too. How long will it continue to lend?

If the ECB decides to stop this massive lending, then the game is up. The banks fail, the governments guaranteeing the banks fail, and chaos erupts --whether or not the governments decide to turn the remaining euros in to monopoly money.

3. As in the US "bank holiday," governments can try to shut down the banks, impose capital controls, etc. But if it's not just very temporary illiquidity, the run starts up the moment you reopen the banks. And if you so much as breathe a word you're thinking of doing it, the run starts ahead of time. Whoops, it's too late. Continuing from the journal here
According to the senior [Greek] banker, the current rate of deposit outflows--of €1 billion or less per day–remains "manageable" since the banks keep large cash buffers on hand to deal with the withdrawals. But if those outflows were to grow four- or five-fold, Greece would be forced to impose deposit and other capital controls.
4. The last way to stop this run is to try, even at this late date, to commit fully and forecefully that no country will leave the euro.

That will be hard. Pronouncements at this date have little weight. The only way to do it is to be very clear of the awful things a government will allow rather than leave. It will default on its sovereign debt. It will cut government salaries and entitlements. It will allow bank failures, and it will allow foreign banks to come in and swoop up the assets. All of these things will be awful. But the government has to persuade voters it understands that leaving the euro will be worse.

Even that will not be enough. To a government in fiscal stress, bank accounts look like an ice cream bar to a hungry child. Greece and Italy have already passed wealth and property taxes. "Tax the rich" rhetoric is strong. People with bank accounts fear expropriation and punitive wealth taxation as much as devaluation. Somehow, the government has to persuade them their bank accounts are safe from depredation in the euro.


Why are we here?

I've been writing for two and a half years about mistakes in Europe, and won't repeat all of that now. But there are two central points to make.

1. The euro was explicitly set up as a currency union without a fiscal union. (And it turned in to one without a bank regulatory union.) That can work, a fact which practically all commentators ignore.

The central ingredient is: sovereigns who can't pay their bills default. The European central bank does not print up euros to bail out sovereign creditors, either directly or via the subterfuge of lending to banks who then buy the sovereign debt.

The euro was explicitly set up this way. The main problem is, when the crisis came, nobody bothered to read the instruction manual.

2. As many times in history, strapped governments have forced banks to take on their debts. A sovereign default is manageable. A country-wide banking crisis is much worse.

The liberal consensus wants "more regulation" to stop banks from taking risk. The regulators stuffed the banks with sovereign debts, and treated those debts as riskfree for years. They also confused "the banking system cannot fail" with "no individual bank can fail."


Paul Krugman, writing May 18, wrote a few almost-sensible paragraphs about Europe, echoing many of these points. (His article is for once about economics, not the evil character of Republican politicians, so there is some substance to talk about.) Since I agree so rarely with Krugman, I thought I'd celebrate with a few quotes, though with some quibbles and some interpretations that I'm sure he would disavow.

Mostly, I agree with his main point, that the emerging bank run means the crisis is likely going to move much more quickly now.
Right now, Greece is experiencing what’s being called a “bank jog” — a somewhat slow-motion bank run, as more and more depositors pull out their cash in anticipation of a possible Greek exit from the euro. Europe’s central bank is, in effect, financing this bank run by lending Greece the necessary euros; if and (probably) when the central bank decides it can lend no more, Greece will be forced to abandon the euro and issue its own currency again.
Comment: As above. Change "forced to" to "choose to" and I'm on board. There is an option. Sovereign default. Let banks fail -- meaning their senior debt becomes equity and they are recapitalized. Good banks buy the assets of bad banks.  But the Europeans probably won't have the stomach for it.
This demonstration that the euro is, in fact, reversible would lead, in turn, to runs on Spanish and Italian banks. Once again the European Central Bank would have to choose whether to provide open-ended financing; if it were to say no, the euro as a whole would blow up.
Comment. Right again. The only thing keeping any money in Spanish and Italian banks is the idea that leaving the euro really can't happen. Once it's clear that exit, devaluation -- along with likely currency controls, bank closures, deposit seizures, and sky-high wealth taxes -- are on the table, the run will start in earnest.
Yet financing isn’t enough. Italy and, in particular, Spain must be offered hope — an economic environment in which they have some reasonable prospect of emerging from austerity and depression. Realistically, the only way to provide such an environment would be for the central bank to drop its obsession with price stability, to accept and indeed encourage several years of 3 percent or 4 percent inflation in Europe (and more than that in Germany).
I agree with the first two sentences. But the only hope for such an economic environment is shock liberalization. (Despite Krugman's "savage cuts" these economies still spend half of GDP, with direct intervention, state industries, and other off the books interventions bringing the total even larger.)

Not only is inflation not "the only way" to provide such long-term growth, it isn't a way. When has deliberate, anticipated and announced inflation ever brought long-term prosperity? You must be kidding.

On the other hand, I agree that inflation is the most likely path that Europe will choose. Not because inflation works any Phillips curve magic, but because inflation is the "easy" way to engineer a massive default of government and bank debt.

By arithmetic, here are the options:

1) Government default. (Restructuring, really)  If done right away, this would have meant private-sector losses. Now that so much debt has been rolled in to banks, it means bank failures too.

2) The Germans pay for everything. Not happening. There is not enough taxing power in Germany to repay the entire debt of Portugal, Spain, Italy, and Greece, plus their banks losses and their ongoing deficits.

3) The ECB buys up the sovereign debt, or lends to banks on sovereign "collateral," effectively doing the same. By turning trillions of debt in to money, we get inflation. Inflation engineers the sovereign default and bank debt default implicitly.

4) Shock liberalization, privatization, freeing of markets, selling state assets. Remove the highly distorting taxes of the "austerity" plans, which said loudly "don't start businesses here, don't hire anyone here, and if you have some wealth I suggest you get it to the Bahamas ASAP." Return quickly to strong real growth. Pay back the debt. Fairly radical reform of unsustainable entitlements.

My obvious choice is number 4. The Europeans' most likely choice is number 3. It can be sold as "stimulus" and "liquidity provision," and it kicks the can down the road. The inflation won't happen for several years. Then it will be easy to blame speculators and hoarders and markets and expectations and so on.

But Krugman's wrong on the size of the inflation. Several years of 3-4 percent inflation is nowhere near enough. To write down PIGS debt by half, you have to double the price level. And you have to do it before the debt rolls over. So that means doubling the price level -- 100% inflation -- in under two years or so. If you do it over several years, the overall rise in the price level has to be even higher.

To my mind an inflation so large that it wipes out half of PIGS and bank debt is about the same result as breaking up the euro directly. And the Germans will probably leave before that happens. 
Both the central bankers and the Germans hate this idea, but it’s the only plausible way the euro might be saved. For the past two-and-a-half years, European leaders have responded to crisis with half-measures that buy time, yet they have made no use of that time. Now time has run out.
I'll go with this only because "plausible" includes the chances that European leaders will take it. I agree with the second sentence, though I suspect the "full measures" in my mind -- default, bank restructuring, commitment to euro and open markets, shock liberalization -- are different from what I presume from other writing that Krugman does -- endless stimulus financed by Germany
So will Europe finally rise to the occasion? Let’s hope so — and not just because a euro breakup would have negative ripple effects throughout the world. For the biggest costs of European policy failure would probably be political.

Think of it this way: Failure of the euro would amount to a huge defeat for the broader European project, the attempt to bring peace, prosperity and democracy to a continent with a terrible history. It would also have much the same effect that the failure of austerity is having in Greece, discrediting the political mainstream and empowering extremists.
And now in full-throated agreement. The currency union, without fiscal union, will be a horrible thing to lose.

But what's kicking off the run is that governments are being tempted to leave. I wonder whether Mr. Krugman and his colleagues have any regrets for the many elegies they have written to the wonders of separate currencies and devaluation, the prospect of which is now causing the run.


Bottom line: I'm pretty pessimistic. The run is on and will intensify.  Alternatives exist, but they are so unpalatable to standard views that I think massive intervention by the ECB as the most likely current policy.

The ECB will print euros like mad and lend them to banks, which will continue to buy government debt.  Southerners will take the ECB money and put it in Northern banks. The ECB ends up owning the debt through the banking system. The ECB understands the danger full well, but will give in.

After that, there is a sliver of hope. A shock liberalization could give a return to robust growth and sustainable government finances within a year. Then the debt would not default, and the ECB and its banks could sell back all the sovereign debt they have bought.

But unless that miracle happens, within a year or so the ECB's collateral will evaporate in the inevitable sovereign defaults, the sovereign defaults will mean bank defaults, and the euro will inflate away rather than break up. An immense, and utterly avoidable tragedy.

So, given that there's no way they'd take my radical advice, if I were in charge I would recommend changing the "austerity" conditions on bailouts and ECB financing, with their emphasis on higher distorting taxes and vague promise of structural reform sometime in the next century, to "reform" conditions demanding a tight schedule of structural reforms within months.

The Secrets Behind Becoming an Elite Advisor

Great article for advisors, but it leaves out one important point - before leaving your firm, joining a new one, or starting an RIA, consult a securities attorney who knows the business. Too many advisors come to us after the fact, when a couple of bucks in the beginning could have avoided or minimized the problem.

The Secrets Behind Becoming (and Remaining) an Elite Advisor

Thursday, June 14, 2012

Taylor's "First Principles"

I recently read John Taylor's "First Principles" This is a really good book in many ways.

It's very accessibly written. I am often asked for recommendations of easy-to-read books that illuminate modern macroeconomics. Since I spend most of my time reading papers full of equations, I don't often have a good answer. This book belongs high on the list.

This is no ordinary what's-wrong-with-the-world, five-step-plan-to-greatness book, of which we see so many these days. It's also not a generic why-free-markets-are-great book. We always need more of those, but this isn't one.

This book is fundamentally about rules vs. discretion, commitment vs. shooting from the hip, and more deeply about whether our economy and our society should be governed by rules, laws and institutions vs. trusting in the wisdom of men and women, given great power to run affairs as they see fit.

The preference for rules is one of the most important lessons of modern macroeconomics.

Macroeconomics should really be called intertemporal economics. Every important piece of analysis is about how people balance the present and the future. Save for the future or consume today? Invest in a new factory or not? Start a new business or go home and play golf?  And intertemporal decisions are all about expectations. If you're deciding whether to consume or invest, your expectations about how that investment will pay off are crucial.

That much is not controversial. For this reason, there is a lot of policy talk about "managing expectations," "giving confidence" and so on. Much new-Keynesian advice, now in vogue at the Fed, centers on announcements the Fed should make in order to guide our expectations.

The central insight on which John builds is this: rules, institutions, laws, and pre-commitments lead to much better outcomes when expectations matter so much to decisions.

John puts it better and more succinctly than I have: 
If people are forward-looking, and adjust their behavior to new circumstances, then economic policy works best when formulated as a rule. Government's adherence to known rules allows people to have a better sense of what is coming, and therefore to make more-informed decisions about long-range plans. (p. 23)
John continues, 
Setting out a sensible rule and sticking to it also helps policymakers resist interest-group pressure. Rather than having to consider the merits of every special-interest plea for more government support, a rule can set a standard that applies to all cases and limits the role of government broadly. 
This is a second bit of wisdom. A rule "we don't have dessert on weekdays" leads to a better dinnertime conversation with your kids than if every night is separately negotiated. 

Macroeconomics is behind law in this regard. For centuries, we've understood that giving wide discretion to legal officials is a bad idea. Judges should not be empowered to "do what you think best at the time." Giving such power might seem attractive -- after all, an unconstrained judge can surely always find a better solution to a given problem. But our legal system understands the horrible incentives for prior behavior if the judge is unconstrained ex-post.  We don't even give our legislature complete freedom; we constrain it with  constitution. Taylor rightly connects the more technical macroeconomic literature on rules and pre-commitment vs. discretion to this larger social and legal wisdom. (See the nice Hayek and Friedman quotes on p. 22)

Somehow, that lesson is lost on much policy-oriented macro, and increasingly on financial regulation.

In macroeconomics, it is largely a result of Keynesian thinking. Though Keynes wrote about expectations, the ISLM models used by his followers pretty much live out of time, with today's income driving today's consumption and so on. The resulting policy analysis is not really intertemporal at all. It emphasizes "what do we do now?" over "how should policy systematically react to recessions, given that people will learn to anticipate such policy and may therefore undermine its effects?"

Our new financial regulation basically just gives unlimited discretion to the Financial Stability Council, meaning mostly the Fed, to do whatever it thinks right.  The hope that a huge fire department will lead people to buy their own fire extinguishers, be careful about playing with matches, and not try to bribe the firefighters to come to their house first, seems pretty hopeless to me.

Of course, there is a reason people don't want to follow rules. The discretion to do anything you want is always  more powerful ex-post. The problem is, great power ex-post leads to bad economic behavior ex-ante, so you end up worse after the fact.  By precommitting to actions ex-post, you end up in a better situation overall, but once the precommitment has its intended calming effect, and ignoring how today's action will affect tomorrow's expectations, you could always do better just this once by deviating from the rule.  Please, dad, just this once? John doesn't really describe this tension, but I think it's important to understand why it's so hard to live by rules.

The rules lesson is also one of the hardest to communicate to a non-economist audience. And to a lot of economists too, I might add!  The natural inclination to always ask "What should we do now?" is nearly impossible to resist. And when asked, say, "should the Fed raise or lower rates today?" if you answer, "The Fed should follow x rule," you (I) quickly see eyes glaze over, and people start to play with their cell phones. "Yes, that's all very nice, but will you please tell us what should the Fed do now?" "Well, it should follow a rule...."

So this book is about the value of rules, institutions, and law in macroeconomics.

I highly recommend the chapter "Who gets us in and out of these messes."  Many of my students are unaware of basic macroeconomic policy history. John's uniting theme of the rise of activist policy in the 60s and 70s, the return to rules-based, long-run oriented policy in the 80s and 90s, and the return to activism since then is well told.

I also like it because it's decidedly non-partisan. Nixon's wage and price controls and Geroge W. Bush's stimulus checks come in for harsh criticism, and Taylor praises much Clinton-era policy as he does Reagans'.

The book really comes alive, of course, in discussing monetary policy. Taylor is justly famous for the "Taylor rule" advocating that the Fed's interest rate policy should be fairly mechanically related to inflation and output.

In "More Focus" (p. 123) John laments the Fed's multiple goals. By trying to manage both inflation and unemployment, the Fed tends to veer too much in one of the other direction unpredictably. And now that the Fed worries about the allocation of credit to particular markets, the financial health of big banks, and a host of other concerns, things will just get worse. So, says John  (p. 125)
The first step toward a more consistent policy would be to remove the dual mandate [inflation and unemployment] and bring the Fed's focus to a single goal. That goal should be price stability. 
I couldn't agree more. But then John becomes much more middle-of-the-road than the stirring rules, laws, and institutions vs. discretion preamble and this statement would suggest. You might conclude that  if the Fed's job is to ensure "price stability," it should just keep the CPI as close to a fixed level as possible, and that this mandate should be written in stone somewhere.  

John only asks that the Federal Reserve act be rewritten from its current "promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates" to "promote effectively long-run price stability within a clear framework of overall economic stability."  (He will have to add "financial stability" too, as most of the Fed is now a financial regulator.)  I see lots of room for short-run discretionary action in that mandate.

He follows, as he should (it's his book!) with a plea for the Taylor rule
..under a Taylor rule, the Fed, or any other central bank, is supposed to change its interest rate in response to both inflation and GDP. Specifically, the rule says that the Fed should set the interest rate equal to 1 1/2 times the inflation rate plus 1/2 ties the percentage amount by which the GDP differs from its long-run growth path, plus 1. 
This still sounds a lot like dual mandate doesn't it? Responding to GDP "helps mitigate the recession." And there is a lot of discretionary wiggle room in defining that "long-run growth path." Orphanides' analysis of the Fed in the 1970s suggests that they weren't feckless stimulators, instead they just didn't know that the long run growth path had trended down so badly. The same debate really rages today. Doves may rightly say "we're following the rule, it's just that GDP is further below trend than you think." 

The Taylor rule was originally an empirical description of Fed actions in the 1980s, a description of how the Fed acted to implement its dual mandate. It only slowly became a normative description of what the Fed should do, in the context of Keynesian and New-Keynesian models that posit a strong stabilization role for the Fed by exploiting a Phillips curve. The Taylor rule actually stands quite a bit to the left of the "inflation targeting" tradition that says central banks should only respond to inflation, ditching the whole GDP response -- because, in John's words (p. 127)
Some Federal Reserve officials worry that a focus on the goal of price stability would lead to more unemployment. But history shows just the opposite.
John answers that the  "dual response" really is a "single mandate." It is a a worthy effort, but one I find strained. The reason for the GDP response is, explicitly in the models, to accomplish a tradeoff between inflation and output volatility.

So, while I appreciate John's robust defense of the Taylor rule against the the Keynesian, activist, dual-mandate crowd, I would also have appreciated his defense of the GDP response against the views of inflation-targeters, price-level targeters, or even advocates of gold or commodity standards. Why not view the Taylor rule's GDP response as a transitionary arrangement on the way to an inflation or price level target, which seems to follow his principles better?

Then, there is the question how to bind the Fed to this rule. Remember, ex-post discretion is always tempting. (Puhleeeze dad, can't we have dessert tonight?) "Writing a policy rule into law" (p. 129) sounds promising.  But though having proposed a quantitative rule, John backs away from of the obvious idea to legislate it. (p. 132)
The most straightforward way to legislate a rule for monetary policy would be .. by reinstating the reporting and accountability requirements that were removed in 2000. ...This proposal does not require that the Fed choose any particular rule for the interest rate, only that it establish some rule and report what the rule is. But if the Federal Reserve deviates from its chosen strategy, the chairman of the Fed must provide a written explanation and answer questions at a public congressional hearing. So while the proposal limits discretion it does not eliminate discretion
Would this work?  The Fed chair regularly reports to Congress now, and explains its actions almost this way, something like:  "Yes, normally we'd be raising rates, but there's the banks, and headwinds from Europe, and unusually high unemployment and so on and so forth."  The Fed notoriously didn't let the  money growth targets get in its way. John writes persuasively (p. 133 ff) that such requirements would have made a difference. Read and decide for yourself.  I suspect Ron Paul would want  a constitutional amendment setting the conversion rate of dollars to gold.

John's capsule of the Fed's extraordinary actions in the financial crisis starting p. 136 is really worth digging out on their own:
The Fed's on-again off-again bailout measures were thus an integral part of a generally unpredictable and confusing government response to the crisis, which, in my view, led to panic.
But, I'm less persuaded that more reporting would have made much difference.  Faced with horrible situations and the ability to act with ex-post discretion, the Fed always will use that discretion. Pretty much everybody thinks the Fed will bail out large financial institutions that get in trouble, no matter what the Fed says, because it can. To me, the lesson of Lehman is that only lack of legal authority to act will prevent that action -- and credibly communicate to markets not to count on the bailout.

But I am being too critical. My intellectual habits are to find the purest simplest answer, ignore what's politically feasible, write it down, and prepare to be ignored. John's are to find a sensible small step that will likely improve matters substantially, and advocate that, with a strong chance of moving the current policy debate. His proposals fill that role admirably.

The final three chapters, "Ending Crony Capitalism as We Know It," "Improving Lives While Spiking the Entitlement Explosion" and "Rebuilding American Economic Leadership" are wonderful. Try to get your liberal friends to read them.

"Crony capitalism" properly stresses the nature rather than amount of regulation. We've given regulators far too much discretionary power, and this discretion is what breeds crony capitalism or worse, outright corruption.  Addressing the trope that the crisis came from "not enough" regulation, (p. 146)
..The government did not need more power or more discretion to regulate more markets or more firms in the wake of the crisis. It already had plenty of power before then. Indeed, it was this very power and discretion that led inexorably to the favoritism, to the bending of rules, to the reckless risk-taking and, yes, to the bailouts. Government bureaucrats hose which existing regulations to enforce and which ones to bend, and they [my emphasis] decided who was bailed out and who wasn't. ..This is textbook crony capitalism: the power of government and the rule of men -- rather than the power of the market and the rule of law -- to decide who will benefit and who will lose
More specifically, (p. 154)
The New York Fed had the power to stop the questionable lending and trading decisions of Citigroup and others. With hundreds of regulators on the premises of such large banks it also should have had the information to do so. The SEC could have insisted on reasonable liquidity rules to prevent investment banks from relying so much on short-term funds to finance long-term investments....
It has a great capsule of why Dodd-Frank is doomed to produce more crony capitalism.

The "entitlement explosion" chapter starts exactly where economists should start -- which is news to most people -- incentives, or rather the horrible disincentives that well-meaning programs unintentionally provide and lead to their predictable failure. Dear liberal friends: it's not about who cares more. It's about what the programs will actually do once people react to their incentives.
Entitlement programs also create powerful disincentive effects... The health care subsidy in the 2010 act declines as a family earns more income and then is cut to zero when 400 percent of the poverty line is hit. This creates a situation where if you work more, you earn less. Consider a family earning $80,000 that gets a health care subsidy from the government of $16,000 under the 2010 health care law, bringing their total income to $96,100.  Now suppose the husband or wife decides to work more. If they increase their income from work by $14,000, bringing their work earnings to $94,000, then their health care subsidy drops to zero. So they get less income by working more, and that's a big disincentive for the economy to grow. (p. 172)
 Dependency is not cultural or psychological. It's just incentives. The rest of the chapter summarizes simple common-sense and (relative to mine!) middle-of-the road solutions in a concise way.

And don't forget "Rebuilding American Economic Leadership." If America enters a few decades of Eurosclerosis, anemic growth, high unemployment, low innovation, large dependency, unsustainable entitlements, crony capitalism, politicized discretionary regulation,  and ultimately a European debt crisis, the ramifications are too ugly to think about.

So.... a review almost longer than the book. But a useful book to read and recommend, especially because it is clear, accessible, measured, and concise.

Sunday, June 10, 2012

More Unusual News from Grupta Trial

SEC Charges Penny Stock Companies and Promoters in Florida

The SEC charged several penny stock companies and their officers as well as three penny stock promoters involved in various stock schemes in which bribes and kickbacks were paid to hype microcap stocks and illegally generate stock sales. These charges are the latest in a series of cases in which the SEC has worked closely with the U.S. Attorney's Office for the Southern District of Florida and the Federal Bureau of Investigation to uncover penny stock schemes.

Saturday, June 9, 2012

Witnesses As Jokesters

Image representing Goldman Sachs as depicted i...
Image via CrunchBase
Trial lawyers are not fond of their witnesses making jokes during testimony, as it can often be viewed as a lack of concern about the nature of the proceedings. However, Lloyd Blankfein, the Goldman Sachs CEO did just that at the insider trading trial of Rajat Gupta, a former Goldman Sachs Board Member.

WSJ Law Blog 
Enhanced by Zemanta

Tampering with documents?

Thursday, June 7, 2012

Crony Capitalism

Luigi Zingales has a nice Wall Street Journal oped today, decrying how crony capitalism has ruined Italy and is on its way to doing so in the US. A tidbit:
In Italy today, even emergency-room doctors gain promotions on the basis of political affiliation. Instead of being told to study, young people are urged to "carry the bag" for powerful people in the hope of winning favors.
Related, the University of Chicago Magazine had a very nice article by Dario Maestripieri explaining just how Italian academia works. Another tidbit:

The year I applied to the biology doctorate program at the University of Rome, there were eight open slots, and the eight winners had already been agreed upon. I wasn’t one of them. A couple of weeks before the concorso, however, the National Research Council offered funding to support two additional fellowships. The baroni did not have time to negotiate these positions, so two outsiders with good résumés and exam scores—a friend and I—were admitted. We squeezed in through a crack in the system. Yet despite the fact that we were straight-A students and had published scientific articles, we couldn’t find a professor willing to serve as our adviser.

The truth was that by filling a slot with an outsider without raccomandazioni or appropriate pedigree, the advisers might lose an opportunity to admit a family member or the child of the prime minister the following year. Admitting two outsiders had been a big mistake—someone would have to pay the price. Eventually, after some arm-twisting, my friend and I found an adviser. Three years later, however, after I finished my PhD, it was made abundantly clear that someone who had entered academia through a crack in the system could not expect to go very far. After doors were shut in my face one too many times, I moved to the United States.
Short version, translated to Chicagoan: "We don't want nobody nobody sent."


Economists tend not to pay enough attention to this sort of thing, in part because it's hard to measure. We argue about taxes and government spending because we can at least try to measure them. We acknowledge that government mandates are the same as taxing and spending, but tend to leave them out because it's hard to get numbers. Intrusive regulation, just as damaging, is even harder to quantify. And pervasive corruption harder still. Yet it's just as much, maybe more, sand in the gears as are headline taxing and spending.

It just looks like mysterious "low productivity." Keynesians see low output and employment and ask for more stimulus.  That's not the problem.

A lot of Luigi's work has been to try to seriously study and measure crony capitalism, which is the only way to address it.  (At some point soon I'll review his book)

Second thought. It is a wonder that US academic institutions, for all their many faults, are so much better than most around the world, and that the best faculty and students gravitate to the US. US universities  are still by and large a pretty severe meritocracy. Now you know why Dario isn't teaching in Rome. And why so much of Italy's great economics talent like Luigi is also working here.

The rot in Europe is concentrated in state systems, with new private universities and research institutes really the bright spots. The US meritocracy is driven by competition among private universities. I don't need to bash you over the head with the obvious conclusions and dangers.

Our advantage is not permanent or innate. Lots of the US system is protected from competition, and there is plenty of mediocrity here too. It also depends on an immigration policy that lets smart people come in, and lets smart students come learn from them.

Tuesday, June 5, 2012

I almost agree with Summers

Larry Summers has an interesting pair of Opeds in the Washington Post and on Reuters. By picking and choosing just a bit, I can find a lot to agree with -- and I can point to the central factual question separating his view and mine.

Interestingly, Larry sides with those of us who think monetary policy is close to ineffective at this moment, and thus neither the problem nor the source of even symptomatic relief.
... one has to wonder how much investment businesses are unwilling to undertake at extraordinarily low interest rates that they would be willing to undertake with rates reduced by yet another 25 or 50 basis points. It is also worth querying the quality of projects that businesses judge unprofitable at a -60 basis point real interest rate but choose to undertake at a still more negative real interest rate. There is also the question of whether extremely low safe real interest rates promote bubbles of various kinds.
Most importantly, Larry thinks this is a golden moment to lengthen the maturity of government debt
Any rational chief financial officer in the private sector would see this as a moment to extend debt maturities and lock in low rates – exactly the opposite of what central banks are doing. In the U.S. Treasury, for example, discussions of debt-management policy have had exactly this emphasis. But the Treasury does not alone control the maturity of debt when the central bank is active in all debt markets.
...Any rational business leader would use a moment like this to term out its debt. Governments in the industrialized world should do so too.
I've been screaming this from the rooftops for a few years now. "Lock in low rates" puts it mildly. When markets start to question whether the US will ever address our budget problems, it will be spectacularly better if we have locked in long maturity debt, and are not trying to roll over short term debt. Then long term interest rates can rise, bondholders take a hit, but we don't have a Greek, Spanish or Italian crisis on our hands. It's good insurance, and remarkably cheap at the current moment. The Treasury is trying, weakly. The Fed is offsetting all these efforts by buying up long term debt and selling short term debt.

Where we differ, of course, is on whether the government should simply restructure the existing debt to long maturities, or whether it should use these low rates to go on a borrow and spend binge.  Larry:
... governments that enjoy such low borrowing costs can improve their creditworthiness by borrowing more, not less, and investing in improving their future fiscal position even assuming no positive demand stimulus effects of a kind likely to materialize with negative real rates. 
There is a rational argument on both sides: It is correct as a matter of economic theory that if the government can borrow at slightly negative real rates, and invest in projects with positive rates of return, then the government's overall fiscal position is better.

The question is, Are there indeed sizeable positive real return projects that our government can, and will, invest in, and realize positive returns?

Let's be clear, what counts here  to "improve their future fiscal position": Can  the government by borrowing spending $1 now  reap more than $1 of tax revenue or realize more than $1 of spending reduction in the future? By spending $1 more now can and will the deficit really decline by more than $1 in the future, in such a clear and transparent way that bond markets see it and believe it? For this exercise, you don't get to count social benefits, external effects, stimulus and so on -- the acid test is simple: $1 more deficit now, results in more than $1 less deficit later.

And "sizeable" is important too. We are running more than $1 trillion dollars of deficits, and these are set to explode. To "improve our fiscal position" in a noticeable way, we need to cut that deficit by say $100 billion dollars. So, suppose the government can finance at zero percent real rates, and suppose that it can find projects with 5% real rate of return -- an optimistic assumption, especially risk adjusted. Still, to make a $100 billion dent in a $1 trillion deficit, that means the government needs to find $2 trillion of investment projects which give a risk free 5% return!

Where are these investment projects?

I note most of our government's "investment" projects consist of high speed rail, altenrative energy boondoggles, photovolatics that need protection from Chinese imports and so on. Say what you will about side benefits, but none of these projects has a remote chance of returning a positive return to the US Treasury.  The Wall Street Journal recently reviewed health and human services "investment portfolio" to savage effect. If the Treasury gets a cent back on these it will be a miracle. As Larry himself found out when running the stimulus program, shovel-ready projects are hard to find, even if you do not want a positive rate of return to the Treasury but simply want to get money out the door.

So what does Larry have in mind as concrete positive return investments?
They should accelerate any necessary maintenance projects..
..accelerating replacement cycles for military supplies. Similarly, government decisions to issue debt, and then buy space that is currently being leased, will improve the government’s financial position as long as the interest rate on debt is less than the ratio of rents to building values..

Well, that's nice. But first of all, does any of this really produce $1 more deficit today and $1 less deficit in the future? If we do a bunch of maintenance now, does that mean we cut budgets in the future? Or will  that simply mean "great, we don't have to pay for maintenance, we can use this year's budget to do new things?"

But even with that warning in mind, is there really two trillion dollars of maintenance and building leases that can be moved forward? Or is this a drop in the bucket of our budget problems?

That's the real weakness. Larry Summers, who knows the Federal Budget far better than I, writing opeds on positive return government investments, can't come up with more than accelerating maintenance and buying some leased space. How much is that? Is it even $10 billion, not the $2 trillion needed to make a difference in the budget?

That's the disagreement, make your own judgements. It's easy to think of all sorts of nice-sounding projects -- which Larry curiously doesn't mention. Roads, bridges, education, etc. Perhaps Larry has too much experience with roads and bridges to nowhere, education money down ratholes and so forth; spending that has some use, but does not produce $1.05 of new tax revenue for every $1 spent. 

OK,  I also question a bit analysis like this:
It is more likely that negative feedback loops are again taking over as falling incomes lead to falling confidence, which leads to reduced spending and yet further declines in income.
This particular "negative [sic] feedback loop" is, to put it politely, a mechanism new to economic theory. Maybe it works. But I prefer policy involving trillions of my dollars to be based on well-worked out theories with some basis in rigorous theoretical and empirical analysis, not just the latest interesting story.

Zuckerberg Sold, Investors Sued

Image representing Facebook as depicted in Cru...
A new lawsuit claims Mark Zuckerberg pulled a billion dollar fast one on Facebook. The class action lawsuit -- filed by disgruntled Facebook shareholders -- claims the 28-year-old CEO had inside info that the stock was grossly overvalued, and he protected his own financial hide by quickly unloading a ton of Facebook stock.
    The suit alleges that the sale might have contributed to the weak performance of Facebook shares, which sank on Monday and Tuesday - their second and third days of trading - to end more than 18 percent below the IPO price. The $38-per-share IPO price valued Facebook at $104 billion. Institutions and major clients generally enjoy quick access to investment bank research, while retail clients in many cases only get it later. It is unclear whether Morgan Stanley only told its top clients about the revised view or spread the word more broadly. The company declined to comment when asked who was told about the research.
    Enhanced by Zemanta

    Monday, June 4, 2012

    Merrill Losses Were Withheld Before Bank of America Deal

    Merrill Lynch & Co.
    From the New York Times:

    Days before Bank of America shareholders approved the bank’s $50 billion purchase of Merrill Lynch in December 2008, top bank executives were advised that losses at the investment firm would most likely hammer the combined companies’ earnings in the years to come. But shareholders were not told about the looming losses, which would prompt a second taxpayer bailout of $20 billion, leaving them instead to rely on rosier projections from the bank that the deal would make money relatively soon after it was completed.