Financial Regulation

As a finance person, I assume some may wonder what I think of the financial regulation bill meandering through Congress. As it is a lazy holiday weekend, I’ll outsource it:

In two weeks, I am supposed to speak on a panel entitled “Financial Re-regulation.” My question is, what re-regulation? To me, re-regulation means you would reverse some step that you took toward deregulation. But the new financial reform bill does not reverse any of those steps, as far as I know.

For example, the new bill does not repeal Gramm-Leach-Bliley, a 1989 law that ratified the de facto breakdown of the separation between commercial banking and investment banking, which is often blamed for the crisis. You would think that for symbolic reasons, if nothing else, you would repeal that law and go back to Glass-Steagall. Of course, I do not think there is much connection between GLB and the crisis, so I am not advocating repeal. I am just pointing out an inconsistency between one narrative of the financial crisis (it was caused by GLB) and the actual response.

In fact, if you wanted to restore the distinction between commercial banking and investment banking, you would need an entirely new law. That is because Glass-Steagall did not contemplate money market funds (are they commercial banking or investment banking?) or mortgage-backed securities (same question) or credit default swaps (ditto). There is no clear-cut inherent distinction between commercial banking and investment banking. It is true that some folks have a reasonable intuition that combining certain functions may be anti-competitive or unsafe and unsound, but that intuition needs to be articulated in a way that speaks to the modern financial world.

Back to the main point–if we are re-regulating, then what was deregulated? For example, where did subprime mortgages come from? Can anyone point to a particular legal or regulatory barrier that was removed in the last two decades? If so, has the new legislation restored this barrier?

When banks created structured investment vehicles (SIVs), collateralized debt obligations (CDO’s), and other innovations, did this require a specific deregulation? Were the actions of the credit rating agencies a result of their becoming deregulated in some way? In my own analysis of the crisis, I point to capital regulations that rewarded CDO’s, SIVs, and the manufacturing of AAA-rated securities. But that was not deregulation. And it was not reversed by the legislation.

Perhaps the centerpiece of the new legislation is a consumer protection agency for financial products. But if the core problem was a lack of consumer protection, what we should have seen was banks extracting profits from loans and foreclosures. Instead, banks got wiped out by losses. As Tyler Cowen points out, given where the losses took place we should be talking about predatory borrowing.

As I have said before, there is no coherent narrative that connects an analysis of the causes of the crisis to the financial reform legislation as written. Rather, the bill serves to deflect blame from government’s role in pursuing housing policy through dubious mortgage market intervention and from the mutual overconfidence of large financial institutions and their regulators.

The new law is not re-regulation. The regulations it contains are largely irrelevant to financial stability. And potential regulations that would improve financial stability (such as increasing the use of subordinated debt to discipline banks or requiring sizable down payments on mortgages) are not in the bill.

To sum up: The bill is largely an effort by politicians to say they “did something” without really doing anything.

Senate planning to regulate health insurance premiums

From the New York Times:

Fearing that health insurance premiums may shoot up in the next few years, Senate Democrats laid a foundation on Tuesday for federal regulation of rates, four weeks after President Obama signed a law intended to rein in soaring health costs.

Not sure how this will work. If the underlying health care costs continue to rise, but the amount of money insurance companies collect is capped, then that seems to me to be government mandated bankruptcy. Perhaps this is a hidden way to cap health care expenditure without directly taking on doctors. Normally, I’d say “Price caps lead to scarcity” which they do in a normal market, but since the government now mandates coverage and mandates benefits, I’m not sure how this will turn out.

But make no mistake, this bill, if it passes, will mean the government runs our health care. You may like that or not, but it is. And, as many have said so far, the health care bill just passed is the beginning, not the end.

Taxes

This is a post I’ve been meaning to write for a while. With the growing debt problem we have, there is now a debate about cutting spending and/or raising taxes. Everyone wants to cut spending, just not the same thing. I’ll blog more later on this trade-off, but first a primer on taxation.

First, we know that if something is taxed, you get less of it. This is pretty widely believed across the political spectrum, which is why we have “sin” taxes on alcohol and tax credits to buy houses right now. In fact, part of the problem with taxation is that governments need a certain amount of money to function, yet the only way they can get it involves a response. One of the big problems with most government budgeting processes is assuming “all else equal” when that is never the case. An increased tax on X will lead to less of X so you can’t assume the tax rate * X = revenue obtained. It will always be less – how much is up for debate.

It also goes the other way. It is true that tax cuts on X will create more of X. Need a great example? Can anyone guess what country, in the whole entire world, has the lowest consumption tax? A consumption tax is a tax on stuff you buy – not just food, but clothes, electronics, video games, even more durable items like cars and stoves. It’s the United States! Is it any wonder we are the world leader in consumption?

This is also the problem with income taxes. Raise income taxes and you get…less income? How does that work? Think of it like a bonus. I used to get a (modest) bonus when I worked for a financial services company. But because of the tax rate on bonuses, about 50% of it went to taxes. That meant that my company had to pay more to get the incentive they wanted to me in take home pay. A nice headline bonus number is nice, but you quickly divide by 2 to get at the reality. And so the incentive is muted. This effect is much less pronounced among most of the middle class, but as you get into the six-figure income range, it starts to matter a lot more. My take is that it is not really that people work less as much as they get to a point where they can structure their income differently to avoid massive taxes. This is one of the main reasons why “taxing the rich” is not as effective as it may seem – they are ready, able and willing to move the item being taxed as much as they can to avoid the tax.

Now, what is a VAT tax? There is much talk of this these days. A VAT stands for Value Added Tax and you can think of it as a sales tax all the way through the supply chain. So when your Honda dealer buys tires from a supplier, they pay taxes on the tires. And when you buy your Honda, you pay tax on the car, but subtract from it the portion of the tax already paid on the tires – only on the part where Honda “added value.” The good thing, and the bad thing, about a VAT is that it is pretty hidden. The tax paid by the final consumer is pretty small as it is incrementally collected. That is good because it reduces the distortion a little bit (the final item is still more expensive by the total amount of tax paid). But that is bad because in many ways it makes it much easier to raise the tax without anybody noticing as much and thus reduces the incentives of politicians to be a bit more frugal. A VAT is a consumption tax, and the US not having one is the primary reason it has such low consumption taxes in general.

There are many more. Employers pay payroll taxes, which is a tax on the total amount of compensation they give their employees, including all benefits, not just salary. This is where healthcare gets an exemption that causes employers to provide healthcare. The Social Security tax is 14%, half paid by you (it is called FICA on your paycheck) and half paid by your employer. Those of you who have been contractors or self-employed know this because you found yourself paying the whole 14%. And, as of this year, Social Security is now in deficit and will become a net drain on tax revenue instead of a net provider. Medicare has it’s own line item on your paycheck, but that is a small fraction of the actual cost.

Property taxes mostly go to local governments – both taxes on your car and real estate. So do things like hotel taxes and rental car taxes. Governments love those because they get to tax visitors instead of their own citizens.

So, what to do? Liberals want to tax the rich, but at least they now are admitting that this is not enough. Consumption taxes are low enough that they are a good place to start, but most people dislike them because they fall a bit more on lower income earners (who spend a larger % of their income on consumption goods). Most economists agree that reducing spending is preferable to raising taxes because of the effects on growth, but that is a post for another day.

Health Care – Economic Implications

$800B of the $900B cost of the health care bill is subsidies – i.e. payments from the government to individuals or families to help pay for health care. This is necessary for the mandate part of the bill to be remotely feasible. Most people want health care, they simply can’t afford it, so fining them won’t help. They need subsidies to pay for expensive health care.

The problem is that subsidies cause higher spending on the thing subsidized as we all worry about the burden of higher health care costs. We’ve done nothing to lower costs, we’ve simply shifted them from the uninsured and underinsured to the government (i.e. all of us taxpayers who fund the government’s operations).

Remember Cash for Clunkers? How about the first time homeowners tax credit? Both are subsidies – the government handing out money to assist people in buying cars and houses. What was the goal? To increase purchases of cars and homes. So, we now subsidize health care without cost controls means we ease the pressure on doctors and hospitals to lower costs: the government is now helping all sorts of folks get health care. But this was the point, wasn’t it?

The problem is that by releasing this pressure, we will see costs rise again. Markets work like this: if prices rise, many people get priced out of the market, which causes demand to drop. This drop in demand means that less gets sold at those higher prices. Competition then rewards the innovator who can provide the same service for less – they get no only those who have exited the market due to higher costs, but will also get some switching who were paying more. Thus prices go down. This competition mechanism is what is broken in the current system – we only see the cost of healthcare via monthly or annual premiums, not each time we go to the doctor, so the cost-consumer link is separated by space and time. And this bill continues to separate them for those who are assisted by it:

The second part of the subsidies, estimated to cost $466 billion during the next decade, would limit out-of-pocket expenses for deductibles and co-payments. This help, for individuals with salaries of $27,000 and families with income of $55,000, would be significantly more generous than any version of the legislation Congress has considered.

What we now know is that 50 million uninsured and premiums at $10-12K per year (or whatever they are now) is a socio-political breaking point. The current legislation will provide subsidies to ease this tension by reducing that annual cost with subsidies and reducing the uninsured to about 20 million or so. But, what happens now? With no cap on the cost and no incentive with copayment or coinsurance to say ‘no’ to procedures, the cost of healthcare will continue to rise until the costs after subsidies are once again $10-12K per year and we again have 50 million uninsured, but now we’re spending billions each year, let’s say the subsidy is $8K per family, so now the total cost is $18-20K. What happens now? Those same folks are again priced out of the market, and Congress is forced to increase the subsidy. Or, perhaps, they do this:

One part of the subsidies would consist of tax credits to help Americans afford insurance premiums, guaranteeing that they would not spend more than a specific portion of their income for them, ranging from 3 percent to 9.5 percent.

Which guarantees that nobody is priced out of the market, but guarantees that as the costs continue to skyrocket, the government picks up the increase, year after year.

And then what? Remember, Medicare and Social Security are mandatory spending on entitlements, just like this health care bill. In 1965, they accounted for about 25% of federal expenditures, now they are around 55% of spending and growing. Defense spending? About 50% in 1965 and about 20% now.  All other spending has been basically flat.

The problem is that Medicare, Medicaid, Social Security, and now this Health Care entitlement are all mandatory (in that no politician will touch them), mostly tied to an aging baby boomer population, and highly linked to rapidly escalating health care costs. I do not see how this ends well for us as a country. If the debt markets start losing faith in the US and the interest we pay on our growing debt starts going up, this will go from ‘bad – we should do something’ to ‘terribly awful – our government may default on it’s debt’ really fast. Things like hyperinflation or a massive dollar devaluation (both basically the same thing) follow. We are not that different from Greece.

Healthcare bill nears…something

Timothy Noah and Chris Wilson at Slate put the healthcare bill at 80% likelihood of passing. 

I think, merits of the bill aside, it would be better politically for the Democrats to have done something major, even if unpopular among certain folks, than to have piddled away almost an entire election cycle and have nothing to show for it. If they want job security, they should do something else.

What do you think?

A thought on change

Another wrinkle that a lot of people leave out is that many of us have, and more of us should have, a bias towards the status quo on any issue. It’s a bias that can be overcome if the people advocating change make a really good case, but we place the burden of proof squarely on those who want to change something. If they don’t make a good case for the specific change they propose, the other side isn’t obliged to do anything. But of course the other side can make a case for a different change, if they want to, in which case the burden is on them.

Note that this isn’t to say the status quo is perfect. It’s just that we have full information about it, because the experiment has been run and the outcome is there for all to see. We can see the good points and the bad. But with any hypothetical change, we really don’t know what is going to happen. The benefits that proponents of the change promise may occur, or they may not. There will almost certainly be unintended consequences. We don’t really know. And that suggests a need to move slowly, test things out, communicate honestly about what does and does not seem to work, and so forth. The exact opposite of bumper sticker politics and rushing through legislation before the public can digest it and weigh in.

The Democrats have failed the communication test rather spectacularly in this case. And a lot of people who are NOT stupid or uninformed can articulate real problems with the bills Congress has passed. And so, for these people, the Democrats haven’t met the burden of proof and we should default to the status quo for a few more years.

This isn’t about a preference for public vs. private sector solutions either. I would apply the same kind test to a proposed change that involved privatizing something the government currently does. The lack of information is the same no matter which way you are going.

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This whole post was from a commenter on Megan McArdle’s blog. I couldn’t have said it better myself.

Politics and Politicians

There has been a lot of angst and anger amongst liberals and progressives following the defeat of Susan Crowley in the Massachusetts Senate race. It seems that the Health Care bill is now on its death bed. But that is not the topic today.

First, we start with Tyler Cowen, “A Simple Theory of Political Jobs“:

Political jobs would be torture for most people.  You have no freedom.  You are underpaid and over-bugged.  You lose a lot of your privacy.  You have to stop writing emails or saying what you think.  You don’t get to read many good books or go for many quiet walks.  It’s hard to be a non-conformist.  And so on.

Yet it’s really hard to get top political jobs.  So who gets them?  People who truly, deeply love the power.

Plus “doing what the voters want” very often feels like, or can be described as, “doing the right thing.”

I have a keen interest in politics and the idea that government, done well, can truly help. But I will never be a politician because of the environment described above. He didn’t even mention the bureaucratic junk you have to deal with every day.

I think regardless of how you slice it, you have politicians who care primarily about getting power, then staying in power. And herein lies the problem. Things like Health Care and Climate Change, in particular, are things that need to be addressed, but require short term pain in order to get the long term benefit. The Health Care bill the Dems tried to pass we a massive giveaway that was pretty transparent to all. Most liberal/progressives supported it on the grounds that the uninsured need help no matter what, conservatives and libertarians opposed it on the grounds (primarily) that it was vastly unaffordable in even the medium term. To pass health care reform, it will be necessary to reduce the amount and type of care we all get. The question is who will do it an how? The current bill doesn’t do that – or rather it claims to, but anyone looking at the recent past knows that the “medicare reform” was never going to happen because as soon as the AMA opposes it, congress backs down like they do every year with the medicare reimbursement reduction that they suspend annually. And “evidence-based medicine” was never going to fly either as we saw with the very simple case of mammograms. The fact is, Congress is not willing to stand in between a patient and their doctor.

We see a similar pattern in Climate Change. Until I hear a majority of congressmen saying “This bill will raise the price of energy – that is the whole point” I won’t really be paying all that much attention. There are lots of shenanigans about cap-and-trade, and “frameworks” for progress, etc. but right now, the vast majority of Americans are not willing to pay more for gasoline (for their cars or indirectly in the price of virtually everything we buy that is shipped via truck) to avert climate change. Until they are, this one isn’t going anywhere. The infrastructure for burning fossil fuels gives them such a huge head start on alternative energy that all the subsidies in the world are not going to help in the short to medium term. And so, I predict nothing will happen in the US for a while on climate change. Things will have to get a lot worse before that happens.

And you know what? This is, on the whole, good. I think the Democrats vastly overestimated their “mandate” when Obama was elected because there is no such thing as Blue/Red and all that stuff is really overblown. Many moderate locations (Congressional Districts and States) very slightly crossed from R to D in 2008 and the Dems threw a party. Well, the new folks weren’t that different from the old folks, they just had (D) after their name. They still represent the same set of people. And I think on Health Care, the majority of Americans are not willing to pay a ton of money for an incremental extending of care to uninsured – it was not the reform they wanted. And now congress responds.

What to do about health care? I like this from Megan McArdle:

Raise the Medicare tax by half a percentage point, and eliminate the tax-deductibiity of health insurance benefits for people making more than $150K a year in household income, $100K for singles.  Then make the federal government the insurer of last resort.  Any medical expenses more than 15% or 20% of household income, get picked up by Uncle Sam.

It is incremental change in the right direction, while reducing the life-dislocating problems of massive health care bills. Because it the federal insurance is a % of income and health care costs are not related to income (directly) it will disproportionately help low income folks who find themselves very ill. But the threshold is high enough that it won’t be too attractive to people to skip insurance altogether.

And so it goes…

Increasing Returns and The Fall

So, I’ve been thinking a lot this holiday season about increasing returns. For those who don’t know, this is the “rich get richer” phenomena which seems pretty pervasive to me. Good college football teams get the best recruits, a few popular artists (music, theatrical, etc.) get a majority of the popularity, ‘hot’ technology companies attract the best talent and thus gain more advantage. Those are just a few examples – you can likely think of more. It may be harder to think of something where this is not true. The opposite would be a dampening process, sort of like your air conditioner – when it gets hotter, cool air comes out to reverse the rise, not reinforce it. Can you think of any societal process which is naturally dampening? I haven’t yet, but I’ve not given up either.

The popular get more popular, the rich get richer, the powerful get more powerful. And there are cycles/crashes, obviously – exponential increases aren’t sustainable, and so the same reinforcing process that gave you popularity can also crush you. Ask Britney Spears.

And then I think of socialism/communism. As I’ve stated previously, my primary gripe with those political theories is that they inevitably lead to centralization of power when the group size gets at all large (bigger than a small commune) because it gets too big to self-govern. Then, you get a situation like communist Russia, which is again a rich-get-richer phenomenon. Those in power use that power to stay in power and profit for themselves at the expense of the masses. And socialism inevitably leads to centralization of power as we discover more social problems that need to be solved by the government to be sure that things are done equitably. But this leads to a very large and powerful government, which the larger it gets, the less accountable it becomes to voters. Rinse, dry, repeat and viola, you have an unaccountable, totalitarian government.

So, how much of this is due to the fall? Doesn’t it seem that humanity at some level was designed to live together in a way that the rich give more away, and the poor find themselves to be the major benefactors of that largess without even needing to ask? This is a big part of Jesus’ counter-cultural message – to give away your riches, to give away power, and to eschew the praise of men (popularity). On the one hand, it is better for you – your soul is less tied to those things when you are able to give them away and you live in freedom and not slavery to them. But it is also better for society. We as Christians are the dampening mechanism, at least in some sense. In another sense, that seems impossible.

A lot of what I’ve said here is probably obvious to some. I guess what feels new to me is that this seeming inexorable push for increasing returns to various things is embedded deep on our society and must be a major target of Christ’s redemptive work.

Soundbites on why the current health care bill is not going to help

When you increase the demand for something without increasing the supply, you either get price increases, or shortages.

That is from Megan McArdle. Why? Because we are providing much more access to health care – a good thing by itself – without addressing any of the underlying issues. The Dean of the Harvard Medical School agrees:

In discussions with dozens of health-care leaders and economists, I find near unanimity of opinion that, whatever its shape, the final legislation that will emerge from Congress will markedly accelerate national health-care spending rather than restrain it. Likewise, nearly all agree that the legislation would do little or nothing to improve quality or change health-care’s dysfunctional delivery system.

A few excerpts:

As the dean of Harvard Medical School I am frequently asked to comment on the health-reform debate. I’d give it a failing grade.

…

Speeches and news reports can lead you to believe that proposed congressional legislation would tackle the problems of cost, access and quality. But that’s not true. The various bills do deal with access by expanding Medicaid and mandating subsidized insurance at substantial cost—and thus addresses an important social goal. However, there are no provisions to substantively control the growth of costs or raise the quality of care. So the overall effort will fail to qualify as reform.

…

In effect, while the legislation would enhance access to insurance, the trade-off would be an accelerated crisis of health-care costs and perpetuation of the current dysfunctional system—now with many more participants. This will make an eventual solution even more difficult.

 

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