After the ACA -- Crafting an Alternative to Obamacare

I gave a talk at Hoover, encouraging those of us who are less than fans to speak up and outline the alternative to Obamacare. Podcast here.

Repeal and status quo is not enough. We need to listen, and point out how a radically freed and competitive system will address the genuine concerns that motivate many to support the law despite its flaws -- preexisting conditions, health care for the poor, outrageous cost and so forth.

The essay "After the ACA" lays it out in some detail.  The talk is a lighter discussion of where we are, but emphasizes how sitting back and letting the ACA unravel will just lead to an even more expensive and incorherent system. Stand up and state the alternative.

Financial Reform in 12 Minutes

I was on a panel yesterday at a fascinating conference, "The US Financial System–Five Years after the Crisis."  The conference was run simultaneously at Hooover and Brookings, with a live video link. Which went dead exactly as I was proclaiming the wonders of modern technology, but otherwise worked remarkably well. Alas, the conference was run under "Chatham house rules" so I can't tell you all the remarkable things that the Very Important People said. I can pass on surprise that there was so little disagreement between the Brookings and Hoover sides. I was expecting a spirited defense of Dodd-Frank from the East. Instead, they piled on it, if anything more eloquently that the West, with only one very thoughtful but still lukewarm defense.  I hope the presentations will eventually be made public, as they were uniformly interesting -- even the ones I disagreed with I thought were wrong in very interesting and thoughtful ways.

I was given 12 minutes to comment on the state of financial reform, is too big to fail over, are we ready for the next crisis. My answer follows. Yes, faithful readers will recognize something of a moving average, which will continue both to move and to average.

Have fun

Financial Reform in 12 Minutes

Is too big to fail over? No. Are we ready for the next crisis? Absolutely not. 

The Dodd-Frank act is “more cowbell” – a dramatic expansion of the same regulatory structure that failed before. Unless fixed, it will fail again in even more spectacular fashion.

The basic structure of Dodd-Frank is a huge expansion of regulation – largely “discretionary, judgmental, and micro-managing” as nicely put by an earlier panelist – to try to prevent any large and “systemically important” institution from losing money again, and a “resolution authority” in place of bankruptcy court should it fail anyway.

The premise of “resolution authority” is that large financial institutions are too complex to go through bankruptcy.  So instead, the mess will be dumped into the lap of appointed officials who will figure out over a weekend who gets how many billions of dollars. If it is so complex that bankruptcy can’t fixed, to write down ahead of time who gets what, how in the world are these poor folks going to figure it out on the spot?  This idea is a triumph of discretion over rules.

They won’t. Politically powerful creditors will scream that they too are too “systemic” to lose money, much as Goldman Sachs threatened if it should not get its collateral from AIG.  “Resolution” only matters with a crisis in the background as in fall 2008, amid general panic. Of course these large and well-connected creditors will be bailed out.

Seeing this in advance, and all the rules up for grabs, other creditors will run at the first hint that resolution might be coming. Seeing that run develop, the FSOC will be forced to bail out ahead of time.

The pretense that regulators can and will spot trouble brewing and stop banks from taking risks, as they abundantly failed to do in 2008, and again when faced with European sovereign defaults, is a triumph of hope over experience.

The “macroprudential” idea that the Fed can spot “bubbles” forming, and can and will stabilize asset prices by artfully controlling interest rates, intervening in many markets, and controlling the details of financial flows, so that nobody loses any money in the first place, is a triumph of pipe dreaming. (An earlier panelist eloquently called it “profoundly misguided.”)

Like all previous crises, the next crisis will not conveniently repeat the last one, with a real estate boom and bust provoking a run in shadow banking. It will erupt from an unexpected quarter. What out there today looks today like subprime mortgages did in 2004? Sovereign debt is a good possibility.  Europeans have learned that buying the bonds of high-yield “do what it takes” countries makes money, as Americans learned for subprime mortgages. A realization that sclerotic growth is settling in as the new normal, upending long-term budget projections, could be the trigger.  Detroit could be LTCM, California, Illinois, and Greece could be Bear Stearns, and Italy could be Lehman Brothers.

We used lots of sovereign debt to bail out of the last crisis and stimulate in its wake. Issuing more sovereign debt remains our and Europe’s fire extinguisher. We are utterly unprepared for a crisis of sovereign debt itself.

There is an alternative.

The crisis was a run. The tech stock bust did not cause a crisis, because tech stocks were stocks. When stock prices fall, it’s too late to run. The housing bust led to a crisis because houses were funded, in the end, by overnight debt, which ran.

Institutions are not systemically dangerous. Run-prone assets are dangerous.

So, why not just ban run-prone assets? We could require that all run-prone fixed-value liabilities, including deposits, overnight debt, and money-market shares, must be backed 100% by short-term treasuries; ideally in separate or at least ring-fenced institutions.  Mortgage-backed securities can be held, without government guarantee, via long-only, floating-value mutual funds in your and my 401(k) accounts, by pension funds and by endowments. Banks, and everyone else, must then finance risky investments primarily by equity, with perhaps some long-term debt. Equity will no longer be just a “cushion” but a main source of funds.

Why not? The bank answer is “the Modigliani-Miller theorem fails for banks, so borrowing will be more expensive.” The MM theorem does indeed fail – because the government subsidizes and guarantees debt! Sure, banks want to maximize the value of those subsidies, and greater equity dilutes them.  In addition, even if equity-financed banks charged 20 basis points more for loans, in equilibrium, remember that we lost almost 10% of GDP and 10 million jobs 5 years ago, and they have not yet returned. That’s a big price to pay.  If we want to subsidize borrowing, we can do it transparently, on budget, rather than by subsidizing or even tolerating run-prone debt.

The other answer is, people need a large supply of fixed-value “liquid” assets to make transactions. It is said that we need banks to “transform” liquidity and maturity, even if imperfectly.

That may have been true in 1938. In 2013 financial, transactions, and communication technology have  changed everything. Instant communications – technical change – and index funds – financial engineering -- mean you no longer need fixed-value, first-come-first-serve, run-prone assets to have perfect liquidity. You could bump your iphone and pay for coffee by selling an S&P index fund share, and the store buys a share in a floating NAV mortgage-backed security fund, all in milliseconds. In fact, most current transactions are simply netted by banks, with nothing exchanged. In the 1930s we could not look up the value of the stock index to make the transaction; we needed to offer a fixed-value claim. Now we can.  2013 index funds and ETFs carry none of the asymmetric-information illiquidity that 1938 individual stocks suffer.  And, as a minor benefit of our fiscal profligacy, $18 trillion of Treasuries can back every imaginable genuine economic need for fixed-value run-prone debt.

How do we get there? Much – much – higher capital requirements are a good first step. But they choke on two practical problems: First, what’s the denominator? Risk weights can be gamed, and prescribing a ratio of capital to total assets incents banks to find clever ways to take on more risk at the same asset value. It’s not hard to buy beta. Second, what’s the minimum? 20%? 50%? 100%? The right answer is “the more the better,” and “so big that it doesn’t matter,” but that’s hardly satisfying.

I think a simple tax is the answer – though since “tax” is a dirty word, let’s call it a “systemic externality fee” – on debt, and especially on short-term debt or any other contract where the investor has the right to demand payment, and fail the firm if not received.  Every dollar of such funding will cost, say, a 10 cent fee. Payments due later generate smaller fees. I think we’ll see a lot less run-prone debt, fast. (We could at least stop subsidizing debt!)

Then, we won’t have to argue about risk weights and precise capital ratios, we won’t have to intensively regulate bank assets, we won’t tempt regulatory arbitrage, we won’t ask the Fed to decide whether houses in Palo Alto are a “bubble,” we will not hear the periodic call “we must recapitalize the banks” (at taxpayer expense), and, most of all, we can escape the chokehold on competition and innovation posed by our current expanding regulatory mess, together with the capture, cronyism, and politicization to which it is swiftly leading.

We need a financial system that can absorb booms and busts without creating a run or a crisis, rather than dreaming that regulators can produce a world without booms and busts. We need to regulate financial institutions’ liabilities, not micro-manage their assets, and especially not try to manage the price of every asset in which they might invest. We must escape this crazy system in which our government subsidizes debt, guarantees debt, increases the demand for debt by regulating it as a safe asset, and then tries to regulate financial firms away from issuing that debt.

We need to insulate the financial system from looming government financial trouble rather than more deeply intertwine them.

Update: John Taylor posts the conference program; Russ Roberts asked a great question 

Banking news

There are two interesting tidbits of banking news in today's (9/10/2013) papers.

The Wall Street Journal has a long page 1 article, "Life on Wall Street Gets Less Risky" describing what it's like at Morgan Stanley under the new regulatory regime. Two bits caught my eye

Your No. 1 client is the government," John J. Mack, Morgan Stanley's chairman and chief executive from 2005 to 2009, told current CEO James Gorman in a recent phone call. Mr. Gorman, who was visiting Washington that day, agreed

....regulators prowl the office floor looking for land mines, and Mr. Gorman phones Washington before making major decisions...

About 50 full-time government regulators are now stationed at Morgan Stanley. There were none before 2008, when it was regulated as a brokerage firm instead of a bank.

This is a useful anecdote to remind people what "regulation" means. I get asked all the time, "doesn't the financial crisis mean we need more regulation?" They seem to think "regulation" is something you pour in like gas in the tank. Or maybe they envision "regulation" as a simple set of impartial rules. You know, there is a 50 mph speed limit, which everyone routinely violates, a huge crash, so we enact a 30 mph speed limit and put a lot of cops on the road.

No, we put 50 cops in your car. And how long can this possibly go on before the cops start asking where you're going and why? How long can 50 regulators sit in the bank approving every decision, before "you know, you haven't made any green energy loans in a long time" starts coming up? But contrariwise, how long before those 50 regulators come to the view that Morgan Stanley's survival and prosperity is their job? 50 full-time government employees calling the shots on every deal at a supposedly private bank is a good picture to keep in mind of what "regulation" means.

It also means bureacracy and a return to the cozy banking world of the 1950s.

There now are 3,000 different limits that restrict such things as how much capital traders can put at risk, up from 30 before the crisis....  

Wall Street culture has long valued grueling hours, lunches at desks and late nights in the office. In 2011 and 2012, Morgan Stanley's fourth-floor capital markets division overlooking Times Square, where several hundred bankers help arrange stock and bond deals, started emptying out earlier in the day, according to two former employees who worked there at the time.....

The three-martini lunch, 2-pm tee time and "mad men" suits can't be far behind.

But there is good news in this too.

..go-go trading businesses once hailed as its future are gone or curtailed. In their place, the storied investment bank has embraced the retail-brokerage business—peddling stocks and doling out financial advice to ordinary investors

For the high-rolling traders who used to make more than $10 million a year, Mr. Gorman has had a simple message: Take fewer risks or take their act to a hedge fund, where failure doesn't threaten the financial system as much.... Traders and others have left for hedge funds and private-equity firms.

...Michael Reed, who worked at the PDT desk for 16 years before leaving in 2010, laments the decline of the firm's trading culture. "Personally, I find it sad," he says. "They used to be a peer of Goldman Sachs. Now, they're just another retail brokerage." 

This is great!  The Volcker rule, which seemed awfully hard to define and implement as regulatoin, seems to be happening in spirit. Trading is moving out of big government-subsidized, too big to fail, commercial banks. Free marketers, cheer. This function is not dying. It is moving to hedge funds, where it belongs. And which everyone knows can fail.

You know, like LTCM.

Oh wait, maybe this isn't so great. "Systemic" never had any limits. How long until regulators decide the new hedge funds are "systemic?" The "intermediated finance" view gaining more and more popularity at the Fed says that leveraged intermediaries willing to buy are they lynchpin of the financial system. "Fire sales" will break out just as much if they fail...

Well, maybe I worry too much.

The other heartwarming big picture: Banks have figured out that maybe the Modigilani-Miller theorem works after all. You can operate with lower risk, lower beta, lower return on equity. That's what's going on, basically, at Morgan Stanley. And made even clearer in the Financial Times:

Credit Suisse’s chief executive has laid out a vision for a banking industry with lower but more sustainable returns and has vowed to never again make losses. 

Brady Dougan... said Credit Suisse’s aim of an average 15 per cent after-tax return on equity was a much more dependable promise over the long term than the sector’s pre-crisis 20 to 30 per cent targets.

Lower risk, lower beta, less chance of failure, lower return on equity. So much for the claim banks had to give shareholders an absolute ROE independent of beta and volatility. 

Nasdaq freeze

An anonymous correspondent explained last week's Nasdaq freeze thus.

The truth about what happened Aug 22 to the Nasdaq is that new limit-up/limit-down rules took effect in derivatives (exchange-traded products) listed at Arca at the same time that new options began trading marketwide that day. Since the market is full of complex, multi-leg trades, bad data propagated, affecting Goldman’s options-trading algorithms Tuesday, spawning hundreds of derivatives trading halts by VIX expirations Wednesday, and producing bad data in the consolidated tape by Thur, halting Nasdaq trading. So the real culprit was the SEC. But it’s bad form to say publicly that the regulator is responsible for jeopardizing the market.

I can't vouch for the story, or even for understanding it all. But I'm interested in several emerging stories that some trading pathologies are in part unintended consequences of SEC regulation. It's also not the first time I hear of financial market participants afraid to speak out and earn the disfavor of their regulator.

Macro-prudential policy

Source: Wall Street Journal

Not a fan. A Wall Street Journal Op-Ed. Link to WSJ. Link to pdf on my website. Director's cut follows:

Interest rates make the headlines, but the Federal Reserve's most important role is going to be the gargantuan systemic financial regulator. The really big question is whether and how the Fed will pursue a "macroprudential" policy. This is the emerging notion that central banks should intensively monitor the whole financial system and actively intervene in a broad range of markets toward a wide range of goals including financial and economic stability.

For example, the Fed is urged to spot developing "bubbles," "speculative excesses" and "overheated" markets, and then stop them—as Fed Governor Sarah Bloom Raskin explained in a speech last month, by "restraining financial institutions from excessively extending credit." How? "Some of the significant regulatory tools for addressing asset bubbles—both those in widespread use and those on the frontier of regulatory thought—are capital regulation, liquidity regulation, regulation of margins and haircuts in securities funding transactions, and restrictions on credit underwriting."

This is not traditional regulation—stable, predictable rules that financial institutions live by to reduce the chance and severity of financial crises. It is active, discretionary micromanagement of the whole financial system. A firm's managers may follow all the rules but still be told how to conduct their business, whenever the Fed thinks the firm's customers are contributing to booms or busts the Fed disapproves of.

Macroprudential policy explicitly mixes the Fed's macroeconomic and financial stability roles. Interest-rate policy will be used to manipulate a broad array of asset prices, and financial regulation will be used to stimulate or cool the economy.

Foreign central banks are at it already, and a growing consensus among international policy types has left the Fed's relatively muted discussions behind. The sweeping agenda laid out in "Macroprudential Policy: An Organizing Framework," a March 2011 International Monetary Fund paper, is a case in point.

"The monitoring of systemic risks by macroprudential policy should be comprehensive," the IMF paper explains. "It should cover all potential sources of such risk no matter where they reside." Chillingly, policy "should be able to encompass all important providers of credit, liquidity, and maturity transformation regardless of their legal form, as well as individual systemically important institutions and financial market infrastructures."

What could possibly go wrong?

It's easy enough to point out that central banks don't have a great track record of diagnosing what they later considered "bubbles" and "systemic" risks. The Fed didn't act on the tech bubble of the 1990s or the real-estate bubble of the last decade. European bank regulators didn't notice that sovereign debts might pose a problem. Also, during the housing boom, regulators pressured banks to lend in depressed areas and to less creditworthy customers. That didn't pan out so well.

More deeply, the hard-won lessons of monetary policy apply with even greater force to the "macroprudential" project.

First lesson: Humility. Fine-tuning a poorly understood system goes quickly awry. The science of "bubble" management is, so far, imaginary.

Consider the idea that low interest rates spark asset-price "bubbles." Standard economics denies this connection; the level of interest rates and risk premiums are separate phenomena. Historically, risk premiums have been high in recessions, when interest rates have been low.

One needs to imagine a litany of "frictions," induced by institutional imperfections or current regulations, to connect the two. Fed Governor Jeremy Stein gave a thoughtful speech in February about how such frictions might work, but admitting our lack of real knowledge deeper than academic cocktail-party speculation.

Based on this much understanding, is the Fed ready to manage bubbles by varying interest rates? Mr. Stein thinks so, arguing that "in an environment of significant uncertainty . . . standards of evidence should be calibrated accordingly," i.e., down. The Fed, he says, "should not wait for "decisive proof of market overheating." He wants "greater overlap in the goals of monetary policy and regulation." The history of fine-tuning disagrees. And once the Fed understands market imperfections, perhaps it should work to remove them, not exploit them for price manipulation.

Second lesson: Follow rules. Monetary policy works a lot better when it is transparent, predictable and keeps to well-established traditions and limitations, than if the Fed shoots from the hip following the passions of the day. The economy does not react mechanically to policy but feeds on expectations and moral hazards. The Fed sneezed that bond buying might not last forever and markets swooned. As it comes to examine every market and targets every single asset price, the Fed can induce wild instability as markets guess the next anti-bubble decree.

Third lesson: Limited power is the price of political independence. Once the Fed manipulates prices and credit flows throughout the financial system, it will be whipsawed by interest groups and their representatives.

How will home builders react if the Fed decides their investments are bubbly and restricts their credit? How will bankers who followed all the rules feel when the Fed decrees their actions a "systemic" threat? How will financial entrepreneurs in the shadow banking system, peer-to-peer lending innovators, etc., feel when the Fed quashes their efforts to compete with banks?

Will not all of these people call their lobbyists, congressmen and administration contacts, and demand change? Will not people who profit from Fed interventions do the same? Willy-nilly financial dirigisme will inevitably lead to politicization, cronyism, a sclerotic, uncompetitive financial system and political oversight. Meanwhile, increasing moral hazard and a greater conflagration are sure to follow when the Fed misdiagnoses the next crisis.

The U.S. experienced a financial crisis just a few years ago. Doesn't the country need the Fed to stop another one? Yes, but not this way. Instead, we need a robust financial system that can tolerate "bubbles" without causing "systemic" crises. Sharply limiting run-prone, short-term debt is a much easier project than defining, diagnosing and stopping "bubbles." [For more, see this previous post] That project is a hopeless quest, dripping with the unanticipated consequences of all grandiose planning schemes.

In the current debate over who will be the next Fed chair, we should not look for a soothsayer who will clairvoyantly spot trouble brewing, and then direct the tiniest details of financial flows. Rather, we need a human who can foresee the future no better than you and I, who will build a robust financial system as a regulator with predictable and limited powers.

*****
Bonus extras. A few of many delicious paragraphs cut for space.

Do not count on the Fed to voluntarily limit its bubble-popping, crisis management, or regulator discretion. Vast new powers come at an institutionally convenient moment. It’s increasingly obvious how powerless conventional monetary policy is. Four and a half percent of the population stopped working between 2008 and 2010, and the ratio has not budged since. GDP fell seven and a half percent below “potential,” in 2009 and is still six points below. Two trillion didn’t dent the thing, and surely another two wouldn’t make a difference either. How delicious, in the name of “systemic stability,” to just step in and tell the darn banks what to do, and be important again!

Ben Bernanke on macroprudential policy:

For example, a traditional microprudential examination might find that an individual financial institution is relying heavily on short-term wholesale funding, which may or may not induce a supervisory response. The implications of that finding for the stability of the broader system, however, cannot be determined without knowing what is happening outside that particular firm. Are other, similar financial firms also highly reliant on short-term funding? If so, are the sources of short-term funding heavily concentrated? Is the market for short-term funding likely to be stable in a period of high uncertainty, or is it vulnerable to runs? If short-term funding were suddenly to become unavailable, how would the borrowing firms react--for example, would they be forced into a fire sale of assets, which itself could be destabilizing, or would they cease to provide funding or critical services for other financial actors? Finally, what implications would these developments have for the broader economy? ...

As if in our lifetimes anyone will have precise answers to questions like these. In case you didn't get the warning,

... And the remedies that might emerge from such an analysis could well be more far-reaching and more structural in nature than simply requiring a few firms to modify their funding patterns.

A big thank you to my editor at WSJ, Howard Dickman, who did more than the usual pruning of prose and asking tough questions.

The Republic of Paperwork

Mark Steyn, while writing on other matters, came up with this gem:

40 percent of Americans perform minimal-skilled service jobs about to be rendered obsolete by technology, and almost as many pass their productive years shuffling paperwork from one corner of the land to another in various “professional services” jobs that exist to in order to facilitate compliance with the unceasing demands of the microregulatory state. The daily Obamacare fixes — which are nothing to do with “health” “care” but only with navigating an impenetrable bureaucracy — are the perfect embodiment of the Republic of Paperwork.

Et tu, Brute?

Politico's Byron Tau has a hilarious story:

Pot legalization activists are running into an unexpected and ironic opponent in their efforts to make cannabis legal: Big Marijuana...


Medical marijuana is a billion-dollar industry ... and like any entrenched business, it’s fighting to keep what it has and shut out competitors. Dispensary owners, trade associations and groups representing the industry are deeply concerned — and in some cases actively fighting — ballot initiatives and legislation that could wreck their business model. ...

...their businesses — still illegal under federal law — benefit from exclusive monopolies on the right to sell legal pot... those same federal laws that prohibit growing, selling and using keep pot prices high.

This spring, the Medical Marijuana Caregivers of Maine joined the usual coalition of anti-pot forces that includes active law-enforcement groups, social conservatives and public health advocates to oppose a state bill that would legalize possession of small quantities of the drug. 

Are we prepared for the next financial crisis?

This is the title of a very well-prepared video made by Hal Weitzman, Dustin Whitehead and the Booth "Capital Ideas" team, based on interviews with many of our faculty. Direct link here (Youtube)

Stopping Bank Crises Before They Start

This is a Wall Street Journal Oped 6/24/2013

Regulating the riskiness of bank assets is a dead end. Instead, fix the run-prone nature of bank liabilities.

In recent months the realization has sunk in across the country that the 2010 Dodd-Frank financial-reform legislation is a colossal mess. Yet we obviously can't go back to the status quo that produced a financial catastrophe in 2007-08. Fortunately, there is an alternative.

At its core, the recent financial crisis was a run. The run was concentrated in the "shadow banking system" of overnight repurchase agreements, asset-backed securities, broker-dealers and investment banks, but it was a classic run nonetheless.

The run made the crisis. In the 2000 tech bust, people lost a lot of money, but there was no crisis. Why not? Because tech firms were funded by stock. When stock values fall you can't run to get your money out first, and you can't take a company to bankruptcy court.

This is a vital and liberating insight: To stop future crises, the financial system needs to be reformed so that it is not prone to runs. Americans do not have to trust newly wise regulators to fix Fannie Mae and Freddie Mac, end rating-agency shenanigans, clairvoyantly spot and prick "bubbles," and address every other real or perceived shortcoming of our financial system.

Runs are a pathology of financial contracts, such as bank deposits, that promise investors a fixed amount of money and the right to withdraw that amount at any time. A run also requires that the issuing institution can't raise cash by selling assets, borrowing or issuing equity. If I see you taking your money out, then I have an incentive to take my money out too. When a run at one institution causes people to question the finances of others, the run becomes "systemic," which is practically the definition of a crisis.

By the time they failed in 2008, Lehman Brothers and Bear Stearns were funding portfolios of mortgage-backed securities with overnight debt leveraged 30 to 1. For each $1 of equity capital, the banks borrowed $30. Then, every single day, they had to borrow 30 new dollars to pay off the previous day's loans.

When investors sniffed trouble, they refused to roll over the loans. The bank's broker-dealer customers and derivatives counterparties also pulled their money out, each also having the right to money immediately, but each contract also serving as a source of short-term funding for the banks. When this short-term funding evaporated, the banks instantly failed.

Clearly, overnight debt is the problem. The solution is just as clear: Don't let financial institutions issue run-prone liabilities. Run-prone contracts generate an externality, like pollution, and merit severe regulation on that basis.

Institutions that want to take deposits, borrow overnight, issue fixed-value money-market shares or any similar runnable contract must back those liabilities 100% by short-term Treasurys or reserves at the Fed. Institutions that want to invest in risky or illiquid assets, like loans or mortgage-backed securities, have to fund those investments with equity and long-term debt. Then they can invest as they please, as their problems cannot start a crisis.

Money-market funds that want to offer better returns by investing in riskier securities must let their values float, rather than promise a fixed value of $1 per share. Mortgage-backed securities also belong in floating-value funds, like equity mutual funds or exchange-traded funds. The run-prone nature of broker-dealer and derivatives contracts can also be reformed at small cost by fixing the terms of those contracts and their treatment in bankruptcy.

The bottom line: People who want better returns must transparently shoulder additional risk.

Some people will argue: Don't we need banks to "transform maturity" and provide abundant "safe and liquid" assets for people to invest in? Not anymore.

First, $16 trillion of government debt is enough to back any conceivable demand for fixed-value liquid assets. Money-market funds that hold Treasurys can expand to enormous size. The Federal Reserve should continue to provide abundant reserves to banks, paying market interest. The Treasury could offer reserves to the rest of us—floating-rate, fixed-value, electronically-transferable debt. There is no reason that the Fed and Treasury should artificially starve the economy of completely safe, interest-paying cash.

Second, financial and technical innovations can deliver the liquidity that once only banks could provide. Today, you can pay your monthly credit-card bill from your exchange-traded stock fund. Tomorrow, your ATM could sell $100 of that fund if you want cash, or you could bump your smartphone on a cash register to buy coffee with that fund. Liquidity no longer requires that anyone hold risk-free or fixed-value assets.

Others will object: Won't eliminating short-term funding for long-term investments drive up rates for borrowers? Not much. Floating-value investments such as equity and long-term debt that go unlevered into loans are very safe and need to pay correspondingly low returns. If borrowers pay a bit more than now, it is only because banks lose their government guarantees and subsidies.

In the 19th century, private banks issued currency. A few crises later, we stopped that and gave the federal government a monopoly on currency issue. Now that short-term debt is our money, we should treat it the same way, and for exactly the same reasons.

In the wake of Great Depression bank runs, the U.S. government chose to guarantee bank deposits, so that people no longer had the incentive to get out first. But guaranteeing a bank's deposits gives bank managers a huge incentive to take risks.

So we tried to regulate the banks from taking risks. The banks got around the regulations, and "shadow banks" grew around the regulated system. Since then we have been on a treadmill of ever-larger bailouts, ever-expanding government guarantees, ever-expanding attempts to regulate risks, ever-more powerful regulators and ever-larger crises.

This approach will never work. Rather than try to regulate the riskiness of bank assets, we should fix the run-prone nature of their liabilities. Fortunately, modern financial technology surmounts the economic obstacles that impeded this approach in the 1930s. Now we only have to surmount the obstacle of entrenched interests that profit from the current dysfunctional system.

Two on financial reform

I recently read two interesting items in the long-running financial regulation saga.

First, a very thoughtful, clear, and succinct speech by Philadelphia Fed President Charles Plosser titled "Reducing Financial Fragility by Ending Too Big to Fail." It's interesting to see a (another?) Fed President basically say that the whole Dodd-Frank / Basel structure is wrong-headed. Two little gems:

 There is probably no better example of rule writing that violates the basic principles of simple, robust regulation than risk-weighted capital calculations.
...
Remember that Title II resolution is available only when there are concerns about systemic risk. Just imagine the highly political issue of determining whether a firm is systemically important, especially if it has not been designated so by the Financial Stability Oversight Committee beforehand....

...Creditors will perceive that their payoffs will be determined through a regulatory resolution process, which could be influenced through political pressure rather than subject to the rule of law

No surprise, I agree.

Second, Anat Admati and Martin Hellwig have an addition to their "Banker's new clothes" book (my review),  23 Flawed Claims Debunked.  Don't miss the fun footnotes.  Anat and Martin get some sort of medal for patience in wading through dreck.

Epstein on the IRS and more

Richard Epstein has a lovely essay, "The Real Lesson of the IRS Scandal" As lots of commentators left and right are realizing, this kind of outcome is baked in to our regulatory system. A small excerpt:

The dismal performance of the IRS is but a symptom of a much larger disease which has taken root in the charters of many of the major administrative agencies in the United States today: the permit power. Private individuals are not allowed to engage in certain activities or to claim certain benefits without the approval of some major government agency. The standards for approval are nebulous at best, which makes it hard for any outside reviewer to overturn the agency’s decision on a particular application.


That power also gives the agency discretion to drag out its review, since few individuals or groups are foolhardy enough to jump the gun and set up shop without obtaining the necessary approvals first. It takes literally a few minutes for a skilled government administrator to demand information that costs millions of dollars to collect and that can tie up a project for years. That delay becomes even longer for projects that need approval from multiple agencies at the federal or state level, or both.

The beauty of all of this (for the government) is that there is no effective legal remedy. Any lawsuit that protests the improper government delay only delays the matter more. Worse still, it also invites that agency (and other agencies with which it has good relations) to slow down the clock on any other applications that the same party brings to the table. Faced with this unappetizing scenario, most sophisticated applicants prefer quiet diplomacy to frontal assault, especially if their solid connections or campaign contributions might expedite the application process. Every eager applicant may also be stymied by astute competitors intent on slowing the approval process down, in order to protect their own financial profits. So more quiet diplomacy leads to further social waste.

Richard goes on to skewer the FCC, the EPA, and the FDA. The fight over approval of liquid natural gas exports, which Richard doesn't mention is a perfect example.

I think the point is larger still. The ACA (Obamacare) under Health and Human Services and financial regulation under the Dodd-Frank act are even more stark instances of the phenomenon.  The regulations are immense, vague, contradictory, and demand discretionary approval by regulators.  For a company to speak out against those acts is very dangerous.

India's sclerosis was once described as the "permit raj." That describes our future well.

But at least Americans are still outraged at this sort of thing. At least, unlike most other over-regulated countries, regulatory discretion is still traded for political support, not suitcases full of cash. However, what Epstein makes clear is, a witch-hunt at the IRS won't solve the problem.

The larger answer here seems pretty clear to me too. Why do we have tax-exempt status for any political groups? Actually, why do we have tax-exempt status for any groups at all? It's easy to be a non-profit -- just don't make any money.  When you look at what a lot of "non-profits" do, how efficiently their money is used, the idea that we should be subsidizing most of them seems pretty silly. If we chucked out the whole tax-exempt business entirely, and allowed people to give money to any group they feel like giving it to without tax preference one way or another, the whole temptation for the IRS to hand out this subsidy in nefarious ways would vanish.

The Role of Monetary Policy, Revisited

I am giving a talk Thursday May 30, titled  "The Role of Monetary Policy, Revisited."  The event is at Booth's Gleacher Center in downtown Chicago, reception 4:30 and talk 5:15. It's part of a series of talks sponsored by the Becker-Friedman Institute.

The talk is based on  an essay I'm working on, and will be presenting at a few central banks this summer. Once per generation we re-think what central banks do, can't do, should do, and shouldn't do. Milton Friedman's famous 1968 address marked the last big transition. I think, we are in a similar moment. I will look at the big picture in the same spirit. I'm aiming at a serious talk, grounded in academic research, but accessible.

Blog followers, students, colleagues, friends, and even glider pilots are most welcome. Please rsvp so they know how many people to plan for.

The event announcement invitation and rsvp links are here on the BFI webpage

There is also an event announcement and rsvp link on the Booth Alumni events webpage here.

Problems viewing this e-mail? View it in a browser.

The Becker Friedman Institute for Research in Economics of the University of Chicago cordially invites you to The Role of Monetary Policy Revisited A talk by John H. Cochrane, AQR Capital Management Distinguished Service Professor of Finance at the University of Chicago Booth School of Business Thursday, May 30, 2013 4:30 p.m. Reception 5:15 p.m. Talk and Q&A Executive Dining Room, Sixth Floor University of Chicago Gleacher Center 450 North Cityfront Plaza Drive Chicago, Illinois (map and directions) Please join us as University of Chicago Booth School of Business Professor John Cochrane reexamines Milton Friedman's 1968 presidential address to the American Economic Association. In this famous speech on the role of monetary policy, Friedman argued, "There is always a temporary trade-off between inflation and unemployment; there is no permanent trade-off." Starting from this perspective, Cochrane will reevaluate the role of monetary policy 45 years later. Is it effective? Can it fill all the roles people expect of it? How should monetary policy be conducted going forward? RSVP Please respond online by May 23. Please extend this invitation to others who might find the program of particular interest. Complimentary valet parking will be available at the Gleacher Center entrance. QUESTIONS If you have questions or require advance assistance, please contact Maria Bardo-Colon at 773.834.1898 or bfi@uchicago.edu. John H. Cochrane The AQR Capital Management distinguished service professor of finance at the University of Chicago Booth School of Business, Cochrane's scholarly work focuses on finance, monetary economics, macroeconomics, health insurance, time-series econometrics, and other topics. He is the author of Asset Pricing, a coauthor of The Squam Lake Report, a research associate of the National Bureau of Economic Research, a senior fellow of the Hoover Institution at Stanford University, and an adjunct scholar of the CATO Institute. He blogs as The Grumpy Economist. Cochrane earned a bachelor's degree in physics at Massachusetts Institute of Technology and PhD in economics at the University of California, Berkeley. He was a member of the University of Chicago Department of Economics before joining Chicago Booth.

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Doctor-owned hospitals

In writing about the ACA and our health-care problems, I started to think more and more about supply restrictions. In every other industry, costs come down when new suppliers come in and compete. Yet our health-care system is full of restrictions and protections to keep new suppliers out, and competition down. Then we wonder why hospitals won't tell you how much care will cost, and send you bills with $100 band aids on them.

In that context, I was interested to learn this week about the ACA's limits on expansion of doctor-owned hospitals. The Wall Street Journal article is here, and I found interesting coverage in American Medical News. The text and analysis of the amazing section 6001 of the ACA is here

In astouding (to me) news, the ACA prohibits doctor-owned hospitals from expanding, and prevents new doctor-owned hospitals at all, if they are going to serve Medicare or Medicaid patients. From WSJ

The Affordable Care Act aimed to end a boom in doctor-owned hospitals, a highly profitable niche known for its luxury facilities. Instead, many of the hospitals are wiggling around the federal health-care law's growth caps and even thriving. 

Only in medicine is "highly profitable niche known for its luxury facilities" a bad thing. Didn't the left like employee-owned companies, worker cooperatives and all that? And when is getting around silly restrictions "wiggling?" Et tu, WSJ?

The law,  passed in 2010, blocked building any new physician-owned hospitals and prevented existing ones from adding beds or operating rooms in order to qualify for Medicare payments

Now, let's see if it takes you more than 10 seconds to figure out the unintended consequences of this brilliant idea. Don't peek...

...to grow without running afoul of the rules, some of the country's roughly 275 doctor-owned hospitals are expanding their operating hours, increasing procedures in ways not restricted by the law and rejecting patients on Medicare...

"they are scheduling operations later and on weekends, instead of 7 a.m. to 5 p.m." North Cypress Medical Center outside Houston is building up practice areas, such as same-day surgeries, that don't require admitting patients overnight...  Forest Park Medical Center in Dallas has stopped accepting Medicare patients, allowing it to escape the law's restrictions entirely.

Then, some try to give up and do what the government wants....

The Surgical Institute of Reading in Pennsylvania tried to sell itself to a local community hospital. "We couldn't expand, but we thought a partnership would allow us to continue our practice," said its board chairman, Charles Lutz.

But the Federal Trade Commission blocked the merger, saying the sale would decrease competition and could lead to higher costs for patients and the government.

Let's see, reorganizing so you are allowed to expand decreases competition? You just can't make this stuff up.

As a reader of this blog might expect, for-profit institutions, run by crucial employees, are run efficiently, make money and serve their customers

...many physician-owned hospitals have enjoyed 20% to 35% profit margins in recent years. U.S. community hospitals' profits hovered around 7% in 2010... new Medicare measurements showing that doctor-owned hospitals represent about half of the top 100 facilities whose performance will merit bonus Medicare reimbursements because of their cost efficiency and patient satisfaction.

They even provide a

"5-star atmosphere" and a gourmet restaurant with a wine list and cigars

From American Medical news,

When the federal government sorted through the first round of clinical information it was using to reward hospitals for providing higher-quality care in December 2012, the No. 1 hospital on the list was physician-owned Treasure Valley Hospital in Boise, Idaho. Nine of the top 10 performing hospitals were physician-owned, as were 48 of the top 100.

So why in the world does the government want to restrict them? WSJ:

But any effort to undo the expansion limits faces an uphill battle with Democrats, because the restrictions were a deal-breaker for hospitals when the White House sought their support for the law in 2009, industry lobbyists say.

and AMN:

The American Hospital Assn. and the Federation of American Hospitals continue to back that section of the ACA. Several key lawmakers, including Senate Finance Committee Chair Max Baucus (D, Mont.) and panel member Chuck Grassley (R, Iowa), are in strong support of community hospitals in the debate.

Aha. In return for political support for the ACA the major hospitals put in this blatant supply restriction against efficient competitors. And we wonder why health care is so expensive.

In related news, what's with the crazy hospital bills which nobody pays? A New York Times article has two tidbits.

Until a recent ruling by the Internal Revenue Service, ... a hospital could use the higher prices when calculating the amount of charity care it was providing, said Gerard Anderson, director of the Center for Hospital Finance and Management at Johns Hopkins. “There is a method to the madness, though it is still madness,” Mr. Anderson said.

Aha. Quote $100 for a band-aid, and when the patient doesn't pay it, write it off as a tax loss. The next one is really clever.

To make money from Bayonne Medical, the new buyers made some big changes in the hospital’s business strategy. 

First, they converted Bayonne Medical from a nonprofit to a for-profit hospital...Next, they moved to sever existing contracts with large private insurers, essentially making Bayonne Medical an out-of-network hospital for most insurance plans.

Under New Jersey law, patients treated in a hospital emergency room outside their provider’s network have to pay out of pocket only what they would have paid if the hospital was in the network. But an out-of-network hospital can bill the patient’s insurer at essentially whatever rate it cares to set....

In recent years, Bayonne Medical put up digital billboards highlighting the short waits in its emergency rooms in an effort to attract more patients....

While the law was aimed at giving patients more hospitals to choose from, it “has had the unintended consequence of rewarding folks for these inflated charges,” said Wardell Sanders, president of the New Jersey Association of Health Plans...

Community leaders in Bayonne...said the buyers were always candid about the methods they intended to use to make the hospital a profitable enterprise.

Really, does nobody every think for a minute, "Hmm, if we pass this law, what awful unintended consequences will it have?"

Solar Panel Tariffs

It's time to start a new series on "energy idiocy." You just can't make this stuff up... From today's WSJ:

BRUSSELS—Chinese solar-panel manufacturers will face import tariffs of up to 67.9% at European Union borders under a plan from the 27-nation bloc's executive body...

Europe, like the US, subsidizes the installation of solar panels. So, we subsidize things to make the prices to consumers go down and encourage the industry. Then when the industry is encouraged and prices do go down, we pass tariffs to make prices go up.  This is almost as fun as oil, which we subsidize to make prices go down, then pass regulations to try to stop people from using it.


The US doesn't get to indulge in any Europe bashing here,

The U.S. has already placed tariffs on solar-panel imports from China.

We also subsidize ethanol, but only from midwestern corn. We have tariffs against ethanol from Brazilian sugar cane, which is a whole lot better environmentally (is a lot less closer to using 1 btu of petroleum to produce 1 btu of ethanol, wash away topsoil and fertilizers down the Mississippi, drive up corn prices)* but seems not to show up at the Iowa caucuses.

Of course it was a bit of a miracle that prices came down in the first place. Usually,  subsidizing and protecting an industry in the idea that just making it bigger makes it cheaper leads to large inefficient industries. The correlation between big and cheap comes from competition. Hence revealing that it was the Chinese who figured out how to exploit European subsidies and actually make panels cheaper.

If you have any remaining thought that concern for the environment motivates any of this mania, reading between the lines of the rest of the story will put that to rest:

Suntech Power Holdings ..and its subsidiaries will face tariffs of 48.6%, according to the document. Tariffs on LDK Solar ... will be 55.9%, and tariffs on Trina Solar Ltd.... will be 51.5%. JingAo Solar Co. will face tariffs of 58.7%..

Most other Chinese companies in the sector that cooperated with the investigation will pay the average tariff of 47.6%. Those that didn't will pay a tariff of 67.9%, according to the document.

The tariffs vary specifically company by company, and reward those that played along politically.

...European manufacturers have filed a separate complaint against the Chinese firms alleging they receive Chinese-government support

They are shocked, shocked to find that subsidies and bailouts are occurring in the Chinese solar panel industry.

European import duties would deal a blow to these (Chinese) manufacturers, which have been piling up losses and struggling to refinance huge debts. 

In March, Suntech sought bankruptcy protection in China, after defaulting on a $541 million bond repayment it owed mainly to Western investors.

Western investors, who appaarently are not as well connected as the western investors in European solar panel plants.

LDK and Trina are both facing large debt repayments. LDK's hometown of Xinyu, China, bailed out the company in 2012, agreeing to repay $80 million of its debts.

Here in the land of free markets, we never bail out large politically connected solar panel plants....

If we want to subsidize solar panel production (debateable, but "if") for environmental reasons, and if China decides to tax their citizens to provide the subsidies rather than us tax our citizens, the appropriate response is flowers, chocolates, and a nice thank-you card.

Update: Donald Boudreaux at Cafe Hayek did a much better job.

*Update: A reader catches me with possibly out-of-date facts. I'll leave his comment here and postpone getting in to a sidetrack about corn ethanol. I'll look in to it, as it seems a good topic for another "energy idiocy" post at some point.

The tariffs on Brazilian ethanol were removed back in 2011. In fact, because of the misinformation around environmental impacts of corn ethanol, California imports Brazilian cane ethanol in remarkable quantities (and at remarkable expense, compared to Midwestern corn ethanol). We also repealed the VEETC at the same time we eliminated the tariff, which is what I assume you’re referencing in your comment about subsidization of corn ethanol. There are still incentives for some ethanol feedstocks, but corn is explicity excluded.

The information about the energy consumed to produce ethanol is also considerably out of date.... And the stuff around environmental impacts is very much in dispute—but life-cycle “science” is so lacking in data one is usually left trying to prove a negative when defending the issue

I won’t dispute Gulf of Mexico hypoxia, but there’s remarkable progress being made with agricultural production today. We still need to get homeowners to stop fertilizing their lawns at a rate 4-8X what farmers use in cornfields if we’re going to stop it, but at least the corn farmers are cleaning up their act.

Finance: Function Matters, not Size

"Finance: Function Matters, not Size" This is the new title of the published version of "The Size of Finance," which I posted on this blog here as a working paper. If you enjoyed the original, here is the better final version. If you didn't, here it is all fresh and new.

Published version (my webpage)
Published version (Journal of Economic Perspectives)
Growth of the Financial Sector" symposium (Journal of Economic Perspectives)

Cyprus and Resolution Authority

Holman Jenkins has a revealing Cyprus update in today's Wall Street Jounal. For those of you who haven't been following the news, Cyprus' banks failed, borrowing huge amounts of money and investing it in Greek debt (yes).  Cyprus was bailed out by the EU after a chaotic week, including an agreement that large depositors would lose some money, called a "bail-in."


Since us economists have been saying that unsecured creditors and uninsured depositors should lose money when banks fail, it was sort of a watershed moment. I expressed some reservations at the political, discretionary, and chaotic nature of the bail-in. It turns out I underestimated that nature.

From Holman:

A few weeks ago, the Central Bank of Cyprus published a curious set of "clarifications for the better understanding of the resolution measures." The principle of a bail-in—that uninsured creditors should suffer losses before taxpayers are on the hook—turns out to contain a few lacunae. "Financial institutions, the government, municipalities, municipal councils and other public entities, insurance companies, charities, schools, and educational institutions" will be excused from contributing to the depositor haircuts, though insurers later were removed from the exempt list.

There will be no haircut on the €9 billion ($11.8 billion) the European Central Bank injected, for political reasons, in 2012 to keep Cyprus's Laiki Bank temporarily afloat—€9 billion that has now somehow become a liability of Bank of Cyprus depositors, whose losses are bigger as a result.
...
We should mention another possible offense, in a sense, against creditor priority in reports that certain connected customers withdrew funds just before the haircuts. A daughter and son-in-law of Cyprus's president seem to make a good case that their transfer of €10.5 million to a London bank was a coincidence, but then they proffered a "voluntary haircut" anyway via a donation to a church fund for the poor. Hmm
...
we have to chuckle when legislators on Capitol Hill talk about ending "too big to fail"—as if there is any chance of stopping politicians from bailing out whatever institutions politicians decide their own interests require bailing out, or any chance of imposing legal order on what are invariably chaotic, highly politicized decisions in the heat of crisis.
...
Cyprus turns out to be a good template after all. Modern financial systems may be incompatible with the rule of law that mankind has labored so mightily to build over the centuries.

This all matters for our financial "reform." Recall, lots of financial institutions were bailed out in 2008-2009, meaning really that their creditors were bailed out. (Normally, when an institution fails, who gets what is determined by bankruptcy law; the creditors become the new owners, the institution is suddenly recapitalized, and either continues or is carved up depending on what makes more sense to the new owners.)

On the theory that "bankruptcy doesn't work for big banks" the Dodd-Frank law posits a "Resolution Authority," composed of Administration officials, that will sit in the place of bankruptcy court and decide who loses money, with pretty much discretion to do what they want. To get paid off, make sure you persuade the "authority" that you losing money would be a "systemic" danger. It might help to have your campaign contributions up to date. I wrote about that danger in a Regulation article here.

The GM bankruptcy here is a small template. As Holman points out,  when politicians and political appointees have great power to decide who gets money and who doesn't, watch out. Oh, no, I forgot; our political appointees are so much more uncorruptible than the Eurocrats that sort of thing can't happen here. (That was a joke)

His last two paragraphs are better than anything I can write. Go read them again. My one disagreement: Modern financial systems are fine. Modern political systems have abandoned rule of law in favor of a monarchic rule by discretion of appointed bureaucrats. That is incompatible with any financial system.

Energy Idiocy

What is it about energy that send all sides of the political spectrum into spasms of babbling idiocy? Here are two items heard on my jog yesterday, courtesy of NPR, one from the right, one from the left, with the NPR interviewers mindlessly accepting idiocy in the middle.

Start with NPR's coverage of Gina McCarthy's Senate confirmation hearings. The issue is the EPAs efforts to close down coal-fired power plants to reduce carbon emissions

ELIZABETH SHOGREN, BYLINE: For four years, Gina McCarthy has been heading up the EPA's office in charge of air quality. She's crafted rules that are cleaning up exhausts from old coal-fired power plants. Some of those plants are opting to shut down instead of installing expensive pollution controls. Republican Senator John Barrasso from Wyoming says those rules have cost jobs.

SENATOR JOHN BARRASSO: Since you've taken office, 10 percent of coal-fired generated power in the United States has been taken offline. Do you see the EPA having any responsibility for the thousands of folks who are out of work for these plant closures?

GINA MCCARTHY: Senator, I take my job seriously when I'm developing standards for protecting public health to take a look at the economic consequences of those and do my best to provide flexibility in the rules.

SHOGREN: Senator Barrasso continues his barrage, naming coal miners he's met who are out of work for the first time in their lives.

BARRASSO: How many more times, if confirmed, will this EPA director pull the regulatory lever and allow another mining family to fall through the EPA's trapdoor to joblessness, to poverty and to poor health?

So, quick question: What is the ideal number of jobs in the electricity production industry? Answer: zero.

Really. If you want "jobs," the right answer is to shut down all the coal-fired plants, and let all those workers move to installing very inefficient windmills. No, better, hook them all up to stationary bicycles, producing 50 watts each; and then hire a bunch more people to grow food for them on locally-sourced sustainable organic farms. And, as Milton Friedman famously quipped, have them plow the fields with spoons so more people still can have jobs. (Coal mining itself has lost almost all of its "jobs" due to mechanization. Perhaps the senator would like to reverse that.)

Ms. McCarthy could easily have answered: "No, Senator. Industries will still need electricity, and that demand will move to renewables. Look at all the green jobs we will create."  Having started down the coal miner job route, the senator would surely not have had the wit to point out that the real "jobs" cost is in downstream industries that have to pay more for electricity.

Now from the left. The cost-benefit calculation prize of the year goes to NPRs next story, covering a scientific paper that predicts that climate change will cause more clear-air turbulence for flights near the jet stream over the North Atlantic.

BLOCK: Your study finds that by 2050, we might see the frequency of turbulence on flights across the Atlantic doubling and also getting stronger. This has to do with the jet stream. Can you explain why?

WILLIAMS: Well, climate change is accelerating the jet stream, making the wind speeds faster. And this is making the atmosphere more susceptible to the particular instability that causes clear air turbulence to break out. ... The conditions seem to be smooth and all of a sudden, you can hit turbulence unexpectedly ...

BLOCK: Well, do you figure that airlines will have to reconfigure their flight patterns, will have to change how they fly, where they fly?

WILLIAMS: Well, a pilot taking off from perhaps New York in the middle of this century to come across the Atlantic to somewhere in Europe will be looking at twice as much airspace containing turbulence. Now, they're going to face a choice that they could just grit their teeth and decide to fly right through those extra patches of turbulence or if the turbulence is particularly strong, they might instead decide to try to fly around it or above it or below it.

All of this, of course, means that journey times could lengthen if flight paths have to become more wiggly and less of a straight line. This is an increase in journey times, maybe more delays at airports and also, perhaps more importantly, an increase in fuel consumption. And I should mention that fuel is the number one cost to airlines. So any increase in fuel consumption will, of course, imply increased costs to the airlines.

And ultimately, of course, it could be passengers who see the ticket prices going up to pay for that.

BLOCK: Well, the irony there, too, I suppose would be that if you're increasing fuel consumption, you're also increasing the contribution to global warming which will be causing the turbulence in the first place, right?

WILLIAMS: Right. There's a sort of feedback there and it's a bit like poetic justice that maybe the atmosphere is somehow seeking its revenge on planes for causing this problem in the first place.

So much low-hanging fruit here. There have been a lot of attempts to add up the economic costs of global warming. Just how big is this effect? Should Gina McCarthy have answered Senator Barrasso with, "Yes, some miners will lose their jobs. But think how much cheaper airline tickets to Paris will be in 2050 because pilots won't have to fly longer routes to avoid clear-air turbulence?"

Savor the irony. One of the highest items on the global warming agenda is to deliberately raise ticket prices by carbon taxes.

"Feedback." About 2% of carbon emissions are from all aircraft. So how much do carbon emissions rise from slightly longer jet routes? Are we out of the fifth decimal point?

This is all so sad. I don't mind liberals who don't profess to believe in free markets getting it all wrong. But "free market" conservatives shouldn't quickly revert to Keynesian pump priming and public works arguments.  I don't mind conservative bible-thumpers who get science wrong. But bien-pensant "scientific" global warming nannies shouldn't be off by, oh, let's say 10^6 or more on cost-benefit analyses and feedback effects. Each makes their causes ludicrous. And just how incredulous should journalists be not to catch any of this?

The fair price of catfish in Vietnam

Source: Wikipedia

Another fish story.  In recent news, our Federal Government is now taking on the "fair price" of catfish in Vietnam, and imposing large "anti-dumping" tariffs. Can the price of tea in China be far away?

Lovers of free markets and free trade, this is for you. Fry it with a little hot sauce.

Who gets hurt here? US catfish consumers. Who is that? Hint: catfish isn't on the menu in fancy Washington DC restaurants, or even at Spiaggia here in Chicago.

Well, I'm glad we can come to bipartisan agreement -- Republican Congressemen and Senators, and the Administration's trade apparatus -- to take money out of the pockets of relatively poor catfish consumers.

I'm interested in the language and rhetoric that we use to describe economic policy.  I highlighted some particularly interesting words and phrases (all emphasis mine.) 

Press release from Senator Jeff Sessions:

Commerce Department Will Enforce “Fair Value” Pricing, Protect Alabama Catfish Industry Following Letter Organized By Sessions Thursday, March 14, 2013

WASHINGTON—U.S. Sen. Jeff Sessions (R-AL) commented on a decision today from the Commerce Department regarding the need to protect Alabama’s catfish industry from unfairly priced Vietnamese imports and non-market economies. Sessions organized a bipartisan letter to the Commerce Department to urge them to take action.

“Domestic production and fair value pricing are essential aspects of a sound economy. [JC: "fair value pricing?"] I am very encouraged by the findings of the Commerce Department’s 8th Administrative Review. This decision is a step in the right direction to protect US workers and our catfish industry in Alabama. [JC: What happened to the US catfish consumer?] The dramatic catfish production decrease over the last decade can be directly attributed to unfairly priced imports, leaving our local catfish farms at risk. The Commerce Department’s decision to use Indonesia as a surrogate country for Vietnam helps correct unfair competition and ensures that jobs and industry in our state are protected. [JC: well, there you have it. The goverment's job is to "protect industry."]  By enforcing our nation’s trade laws, and fostering an environment that requires healthy competition, I am confident that our local catfish farms will again be a market leader.”

BACKGROUND: On February 7, Sessions organized a letter signed by Senate colleagues, Richard Shelby, Thad Cochran, Roger Wicker, Mark Pryor, John Boozman, David Vitter, and Mary Landrieu regarding the 8th Administrative review, from the Department of Commerce, determining “fair value” pricing for Vietnamese producers’ frozen fish fillets. The Department of Commerce uses surrogate countries to determine the fair value of products for non-market economies. In previous reviews, the Department of Commerce has used Bangladeshi data to set the market price for the Vietnamese producers’ fish fillets despite industry proposals for a surrogate nation with higher quality data available, such as the Philippines or Indonesia. The Bangladeshi prices range from $0.29/lb-$0.43/lb whereas the U.S. price is about $0.80/lb. The lower rates have had significant negative effects on the US market and this continued approach would bolster the volume of Vietnamese frozen fish fillets to the detriment of the United States industry.

Today, the Department of Commerce announced that Indonesia would be used as a surrogate country for Vietnam to best calculate the price per pound of frozen fish fillets. This decision helps ensure that Vietnamese production will be subjected to appropriate and reasonable standards and that domestic catfish producers will not be victims of unfair pricing.

Congressman Rick Crawford:

Washington, Mar 14 -

Today, Congressman Rick Crawford (R-AR) welcomed news for the U.S. Catfish industry after the Commerce Department issued their final results of the 8th Administrative Review of the antidumping duty order on Certain Catfish Filets from Vietnam. The results indicate that Vietnamese catfish will face fair antidumping duties when imported into the domestic U.S. market.  For years, the Commerce Department has been unfairly assigning a near-zero antidumping duty on Vietnamese Catfish, which has led to unfair competition, and a flood of Vietnamese imports. Since 2008, Vietnamese imports of catfish fillets have tripled, and have taken nearly 80 percent of the domestic market. The Department decided to switch from a Bangladeshi surrogate value to Indonesian price index for calculation of antidumping duties...

Crawford issued the following statement after hearing the welcome news:

“For too long, the Arkansas catfish industry has faced unfair competition from non-market economies, such as Vietnam. I am pleased to hear that the Commerce Department heeded my call to assign a fairer price calculation to the value of Vietnamese Catfish. This is a win for the U.S. Catfish industry and the Delta region in the First District of Arkansas. [JC: and noticeably not a win for US catfish consumers] I am confident that the Commerce Department’s decision to fairly enforce our trade laws is a great first step towards a U.S. catfish industry recovery that will create jobs and grow the Delta economy.”

Maybe we should feel a bit sorry for Sessions and Crawford. At least other senators get to lobby for real money, like bank bailouts.

The Department of Commerce memo is worth reading too. Sometimes it's worth seeing just what goes in to our Federal sausage

The product covered by the order is frozen fish fillets, including regular, shank, and strip fillets and portions thereof, whether or not breaded or marinated, of the species Pangasius Bocourti , Pangasius Hypophthalmus (also known as Pangasius Pangasius ), and Pangasius Micronemus .

Frozen fish fillets are lengthwise cuts of whole fish. The fillet products covered by the scope include boneless fillets with the be lly flap intact (“regular” fillets ), boneless fillets with the belly flap removed (“shank” fillets), boneless shank fillet s cut into strips (“fille t strips/finger”), which include fillets cut into strips, chunks, bl ocks, skewers, or any other shape. Specifically excluded from the scope are frozen whole fish (whether or not dressed), frozen steaks, and frozen belly-flap nuggets. Frozen whole dressed fish are beheaded, skinned, and eviscerated. Steaks are bone-in, cr oss-section cuts of dressed fis h. Nuggets are the belly-flaps. The subject merchandise will be hereinafter referr ed to as frozen “basa” and “tra” fillets, which are the Vietnamese common names for these species of fish.

It goes on like this for 54 mind-numbing pages. A random excerpt

Bangladesh is a significant producer of identical merchandise pangasius hypophthalmus
...The production experiences of pangasius producers in Bangladesh replicates those of the Vietnamese respondents in that produce pangasius through commercial pond-based aquaculture. This directly implies that the cost of production, related expenses, and revenues for pangasius farmers in Vietnam and Bangladesh are very similar.

In Indonesia, only 70 percent of the 2011 pangasius production is from ponds, and the record is unclear as to what proportion of the Indonesian pond based aquaculture production is accounted for commercial-based pond aquaculture as opposed to homestead-based pond aquaculture.

The life of a planner is a hard one.

I do feel for the producers. I hope someone knowledgeable will write in, answering the question: what else can you do with a catfish farm? Is it possible to change from catfish to, say, genetically engineered salmon? Trout? Caviar sturgeons? Usually when low-price low-quality competitors appear (and frozen catfish from Vietnam is clearly that), the answer for a domestic producer (if Congress doesn't protect it) is to change to high-value skill-intensive products. 

Capital not a lost cause?

Admati and Hellwig (my review here) (and fellow travelers) may be having some effect! From today's WSJ "Heard on the Street":

There is growing talk among regulators, for example, of forcing banks to issue a minimum amount of long-term debt, cap the size of their short-term liabilities or restrict activities that can be conducted within regulated bank subsidiaries.

At the same time, regulators seem to be focusing more on the need to pre-emptively address potential systemic risks.

Any such moves could further constrain banks' ability to juice returns through leverage while also limiting lucrative activities that fall outside a traditional lending function. That could subdue earnings growth already hampered by the superlow interest-rate environment.

The danger isn't lost on banks themselves. A number of banking groups recently joined together in a public attempt to rebut notions of a big-bank borrowing subsidy.”

OK, 3 out of 4 ain't bad. Admati and Hellwig (and I) take a dim view of asset risk regulation and the chance that regulators have any hope of seeing bubbles emerge. But more capital, and more people understanding that leverage and TBTF is a subsidy to banks, so banks are forced to fight about it... that's progress.

GMO Salmon

Source: http://www.aquabounty.com

This weekend's New York Times brought the interesting story of AquaBounty's genetically modified salmon, which are genetically engineered to grow twice as fast as normal Salmon. A few choice bits:

"In 1993, the company approached the Food and Drug Administration about selling a genetically modified salmon that grew faster than normal fish. In 1995, AquaBounty formally applied for approval. Last month, more than 17 years later, the public comment period...was finally supposed to conclude. But the F.D.A. has extended the deadline...

Appropriately, it has been subjected to rigorous reviews... scientists, including the F.D.A.’s experts, have concluded that the fish is just as safe to eat as conventional salmon and that, raised in isolated tanks, it poses little risk to wild populations.

Why the delay?

... some suspect that political considerations have played a role in drawing the approval process out to tortuous lengths. Many of the members of Congress who oppose the modified fish represent states with strong salmon industries. And some nonprofit groups seem to be opposing the modified salmon reflexively, as part of an agenda to oppose all animal biotechnology, regardless of its safety or potential benefits.

Even the White House might be playing politics with the salmon. “The delay, sources within the government say, came after meetings with the White House, which was debating the political implications of approving the GM salmon, a move likely to infuriate a portion of its base.”

namely,

anti-biotech groups, which traffic in scare tactics rather than science...

This story brings three thoughts to mind.

1. So who is "anti-science?" I can't resist. There were a lot of potshots at Republicans for being anti-science, some well-deserved. But "science" is abundantly clear here. "Science" is indeed wrong at times, but if we want policy based on "science," the safety of GMO foods is about as good as it gets. There's plenty of magical thinking on both left and right, it turns out.

2.  $10,000 dollars invested in the stock market in 1993 is worth $50,000 today ($31,477 after inflation)  yes, even after the crash. It was already worth $37,600 ($32,700 after inflation) in 1999.  Remember, AcquaBounty hasn't sold a single fish. The cost of 20 years delay is enormous, amounting to a huge tax disincentive.

3. We need growth. Where does growth come from? Modern growth theory is abundantly clear. New ideas, new processes, new businesses that raise productivity. Like a new idea that lets us double the growth rate of farmed salmon. And, yes, lower profits of current salmon fishermen, much to the relief of wild salmon.

GMO foods are, potentially, a huge game changer. Once every 50 years or so, we bump up against a Malthusian limit, and a new idea frees us again. Fixing airborne nitrogen. Green revolution. Now, GMO foods. GMO plants are being bred to use less fertilizer and insecticide, i.e. to be better for the environment, as well as to cure vitamin A deficiency, produce less waste, and so on. No, dear Greenpeace, organic farming is not the answer, unless we use a lot more land for agriculture, starve out half the people, or believe in magic.  (It's too bad organizations like this suffer such mission creep. I would happily support their efforts on behalf of endangered species.)

Or maybe not. The lesson of industrial policy is that academic bloggers are just as bad as government bureaucrats in finding the next game changer. But there are hundreds of similar game-changers underway. Read any popular science magazine. Will we let the winners bear fruit?

Why do countries and civilizations fail? When interests vested in the status quo or magical thinking stop that process.  A long decay precedes the crises. I am reminded of the famous failures, such as the Chinese Emperor's ban on long-range shipping, at a time when Chinese ships were way better than Portugese.

Update: A very nice article by Henry Miller on GM foods, titled "Anti-Genetic Engineering Activism: Why the Bastards Never Quit." Henry is obviously much more knowledgeable than I am.