“Economics” Category

Explaining the Impact of Low Rates

Barry Ritholtz has a good explanation of how low interest rates helped precipitate the housing bubble.

Merely regulating lending institutions isn’t the largest issue. The issue is central banks, no matter how intelligent the people running them are, don’t fully understand what’s going on in the economy nor the effects of their monetary policy. Greenspan seemed justified in keeping interest rates low at the time–we just entered a recession due to the technology bubble’s collapse, and September 11th threatened to make it magnitudes worse. Under those conditions, low interest rates seem justified.

But they also helped inflate another bubble, one that led to a financial crisis. This perfectly illustrates why government having such an integral role in the economy is so dangerous.

March 20th, 2010

Obama’s Grand Plan: Price Controls

Obama has released his own version of health care reform, and his new idea is price controls:

The president’s bill would grant the federal health and human services secretary new authority to review, and to block, premium increases by private insurers, potentially superseding state insurance regulators. The bill would create a new Health Insurance Rate Authority, made up of health industry experts that would issue an annual report setting the parameters for reasonable rate increases based on conditions in the market.

Support for price controls is based on the assumption that health insurance companies are charging their customers exorbitant prices to profit. That’s what the administration has been implying over the past few days when talking about rates rising by 39 percent. He means to say they’re taking advantage of people to profit.

The problem is, that’s false. The average profit margin for the industry is an anemic 3.4 percent. For comparison, Apple’s expected profit margin for the second quarter is 39 percent, yet there isn’t much complaint that Apple is price gouging consumers.

If rates are forced to hold steady by the federal government, this doesn’t magically eliminate what’s actually causing rising rates: increased costs for the insurers. The insurers will still have to pay those costs. Which means insurers will be forced to pare down what they cover, so they can remain break-even or profitable. In other words, the government may force insurers to ration care through these price controls. Is there any doubt that the president will use this to lambast the insurers as heartless crooks, and claim it as evidence why the government needs to be further involved in the health care market?

This doesn’t address the economic causes of rising health care costs. Instead, it uses the currently popular sentiment that business only exists to bleed people of their money to create an enemy for the people to rally against, and a progression where government control of health care is the only eventuality.

Forcing people by law to purchase health insurance, and setting health insurance rates by fiat, are just inching the foot farther into the door. Government-controlled health care lies just beyond the door.

February 23rd, 2010

Hayek vs Keynes Rap

The Hayek vs Keynes Rap. Very well done, and it stuffs quite a lot of information in. If you want a quite good overview of the Keynes and Hayek debate (perhaps the most relevant debate in the 20th and now the 21st century) in a wonderfully-silly format, watch it.

January 25th, 2010

Should the Fed Have More Power?

David Leonhardt asks a good question: if the Federal Reserve couldn’t predict the last housing bubble, how can they predict the next one, and solve it?

They didn’t just not predict the last bubble, they helped start its inflation by lowering interest rates so low after the tech stock collapse and September 11th attacks. They did this for a good reason — to help prevent the resulting recession from being too painful — but as always, their actions had unintended consequences. It inflated an even larger and more connected bubble, which precipitated a market crisis that could have brought down the entire financial system.

The problem isn’t so much that they (or anyone else) can’t predict the next bubble. They can. The problem is having someone with as much power as the Federal Reserve, trying to even out the business cycle, when they don’t have a real understanding of how the economy is functioning at the moment, and what it will do in the future. The economy is much too complex to understand, and as a result, they try to correct for problems they see, and create even larger issues.

The Federal Reserve helped cause the housing bubble, and they weren’t under political pressure to do certain things. They were just wrong. The federal government itself is constantly pressured to do things for political, rather than economic, reasons, and this terribly distorts the market.

The business cycle is inevitable, but government action accentuates it even more.

January 6th, 2010

Indebted Nation

Edmund Andrews explains why the U.S.’s debt is such a problem:

The problem, many analysts say, is that record government deficits have arrived just as the long-feared explosion begins in spending on benefits under Medicare and Social Security. The nation’s oldest baby boomers are approaching 65, setting off what experts have warned for years will be a fiscal nightmare for the government.

We now have $12 trillion of debt, are paying $202 billion of interest on it this year, and it’s estimated by the White House to rise to $700 billion per year by 2019.

November 23rd, 2009

Spending is the Problem

Keith Hennessey charts future growth in spending compared to growth in taxes:


That’s about as scary as things get. Spending growth is almost entirely due to entitlement spending — Social Security, Medicare, and Medicaid. Entitlements are driving us toward financial ruin.

The graph makes this choice quite clear: either we significantly cut spending, or we raise taxes precipitously, on all members of society.

Reforming Social Security and Medicare are the most important challenge for the U.S., yet Democrats will soon pass law which will add more subsidies to the system. They are pushing us down the latter path.

November 20th, 2009

Debt Bias

James Surowiecki on the tax code’s debt bias:

If the benefits are illusory, the costs are all too real. Economies work best, generally speaking, when people are making decisions based on economic fundamentals, not on tax considerations. So, as much as possible, the tax system should be neutral between debt and equity, and between housing and other investments. It’s not, and, worse still, as we’ve seen in the past couple of years, debt magnifies risk: if companies or individuals rely on large amounts of leverage, it’s much easier for bad decisions to lead to insolvency, with significant ripple effects in the wider economy. A debt-ridden economy is inherently more fragile and more volatile. This doesn’t mean that the tax system caused the financial crisis; after all, the tax breaks have been around for a long time, and the crisis is new. But, as a recent I.M.F. study found, tax distortions likely made the total amount of debt that people and companies took on much bigger. And that made the bursting of the housing bubble especially damaging. So encouraging people to take on debt qualifies as a genuinely bad idea.

He is absolutely correct. The federal government’s encouragement of debt-taking, and of homeownership through the mortgage deduction Surowiecki highlights and Fannie Mae and Freddie Mac, set the stage, helped inflate the bubble, and magnified the losses in the recent recession.

Without the federal government’s involvement through Fannie Mae and Freddie Mac, and the tax code,1 the 2007-08 financial crisis would not have happened. Recession, yes; crisis, no.

Government involvement in the market distorts it, sometimes with disastrous results, no matter how good intentions are.

  1. Let’s not forget the federal reserve’s low interest rates after September 11th which, at the time, seemed prudent, but with hindsight now are very culpable for the bubble. That highlights quite nicely the problem with attempting to manage an economy as complex as ours, and provides a nice lesson for the current administration and Congress’s proclivity toward doing so. []
November 15th, 2009

Who Needs Accountability?

Greg Mankiw’s chart of actual unemployment data versus the administration’s predictions:


The Obama administration predicted that, without the stimulus, unemployment would be at about 8.8% in October; with the stimulus, just under 8%. This is what was used to justify the stimulus passed.

In reality, unemployment has not only tracked higher than what they predicted it would be if the stimulus was passed, but higher than what they predicted it would be without the stimulus.

So there’s two possible interpretations here. First, the administration’s economists can’t accurately predict what will happen (the “baseline” of unemployment was worse than they expected), and second, the stimulus failed.

What we’re left with, then, is not being able to trust the administration’s judgment on the economy, or not being able to trust their judgment on the economy.

The argument I’ve heard is that unemployment would have been even worse without the stimulus. Well, okay. That means, though, there’s no accountability — the administration can take certain actions, and when it fails, they can just change the measures for success (that they created) so they look favorable.

Convenient, and dishonest.

November 8th, 2009

“Rational Irrationality”

The New Yorker’s John Cassidy describes the impetus for bubbles to build in the context of the 2007-08 financial crisis:

In a situation like this, what I do affects your welfare; what you do affects mine. The same applies in business. When General Motors cuts its prices or offers interest-free loans, Ford and Chrysler come under pressure to match G.M.’s deals, even if their finances are already stretched. If Merrill Lynch sets up a hedge fund to invest in collateralized debt obligations, or some other shiny new kind of security, Morgan Stanley will feel obliged to launch a similar fund to keep its wealthy clients from defecting. A hedge fund that eschews an overinflated sector can lag behind its rivals, and lose its major clients. So you can go bust by avoiding a bubble. As Charles Prince and others discovered, there’s no good way out of this dilemma. Attempts to act responsibly and achieve a coöperative solution cannot be sustained, because they leave you vulnerable to exploitation by others. If Citigroup had sat out the credit boom while its rivals made huge profits, Prince would probably have been out of a job earlier. The same goes for individual traders at Wall Street firms. If a trader has one bad quarter, perhaps because he refused to participate in a bubble, the results can be career-threatening.

This is certainly an accurate description of the self-creating nature of bubbles, but the piece runs off the rails. Cassidy goes to great lengths to detail the feedback-loop nature of bubbles, and then concludes that since this is inherent in the nature of unfettered markets, that the solution is to restrain this tendency.

The entire piece rests on that single assumption: that disastrous bubbles like the one we just passed through are purely caused by free markets. This assumption, however, is a poor one; convenient, because it means solutions are simple (regulate executive pay, regulate the risk financial firms can take, as he prescribes), but ultimately a shortcut that doesn’t accord with reality.

Speculative bubbles certainly are inherent to markets; that much is true. Centuries of history bears that out. But behind the most damaging ones often lies government support.

The subprime bubble did not happen in a vacuum — it happened with encouragement and financial support from the federal government. The federal government encouraged investment in the mortgage market through Fannie Mae and Freddy Mac’s legally-created market advantages over other firms1. The two GSEs ended up owning some 5 trillion dollars, nearly half, of mortgages by 2008. Moreover, they began buying subprime mortgage-backed securities in significant amounts in 2002, just as the market ramped up. By 2004 they owned 168 billion dollars worth of subprime mortgage-backed securities, almost half of the entire subprime mortgage-backed securities market.

Buying these securities took them off the originator’s balance sheets, thus allowing them to create even more mortgages and securities. In other words, the GSEs provided incredible liquidity in the subprime market through the federal government’s good credit, allowing it to really take off. This all supported government policy — increasing homeownership — but we all know the results.

Moreover, credit-default swaps, which caused uncertainty in September 2008 as to who owed who else and how much (and thus threatened to cause a cascade of failures), were created in 1997 to shift risk to get around regulatory capital requirements. Attempts to control how firms operate tend to result in more complex operations to get around it, which can make the situation even worse than the original one.

That is the flaw in Cassidy’s piece; ultimately it is an excellent description of bubbles, but his unwarranted (and ultimately false) assumption that this crisis is the result of the market makes its conclusions worthless.

  1. The two GSEs could borrow capital at rates close to the rate the federal government borrows at, because the market assumed they were backed by the government. In effect, taxpayers were financing the mortgage market through the federal government’s good name. []
September 28th, 2009

The New Financial Capitol

Financial firms are shifting focus toward Washington, D.C. because of the government’s growing role in the finance industry:

Before the financial crisis, BlackRock’s chairman Laurence Fink would speak with federal officials at most a few times a month, for instance when they called him in New York for information about mortgage markets or pensions funds or other areas in which his company was active. But now, as the chief executive of the nation’s largest asset manager, Fink says he talks to officials at least once a day. He plans to open an office in Washington by next year to influence policy and has hired the lobbying powerhouse of Quinn Gillespie & Associates.

This is what happens when government decides to take a more affirmative role in regulating and organizing the economy: companies try to influence government policy more.

The reason is obvious. Since the federal government is now the biggest player in the financial industry, and has the power to “save” a company with government funds, block their compensation policies, or even regulate away their line of business altogether, companies have no choice but to try to influence government policy in their favor. It’s only logical, but nonetheless tragic.

This is what a greater government role in the economy does. It creates corruption. Rather than survive and succeed based on their market success, companies will now compete based on who they know in Washington. This isn’t capitalism. This is what strong government entails.

(Via Jeffrey Miron.)

September 23rd, 2009

McArdle on Rationing

Megan McArdle on rationing, or to be more accurate, government planning:

Mechanisms to distribute tin without prices have been tried, and found wanting.  So have mechanisms to distribute practically every other good you can think of, from housing to hotdogs.  Rent control distorts the housing market and discourages landlords from building or improving their housing stock.  Price controls on bread result in shortages, and often distort the non-controlled sectors of the market. Fuel subsidies result in your precious tax dollars being diverted to Columbian roadside vendors who will siphon the gas out of your tank at great danger to themselves and pay something closer to market rates for it.  Etc.

I mean, fine, let’s not call it rationing.  Let’s call it “Fred”.  You’ll still end up with a crappy, overcrowded housing stock and shortages of basic goods.  What philosophical principal [sic] favors this?

This is why I wrote the “rationing” article. We’ve already had the debate on whether markets or government boards are better at deciding prices and supply, both in economics departments and in the real world. From 1920 to 1980, that was basically the defining question. Government planning lost the debate.

September 1st, 2009


Whether health care should be rationed has become an important part of the health care reform debate. Critics of the Democrats’ general plan have said that government shouldn’t ration health care.

The response from some has been some variation of this:

In truth, rationing is an inescapable part of economic life. It is the process of allocating scarce resources. Even in the United States, the richest society in human history, we are constantly rationing. We ration spots in good public high schools. We ration lakefront homes. We ration the best cuts of steak and wild-caught salmon.

The argument is that because the market allocates resources across society already, that it “rations” resources, that there is nothing wrong with government rationing access to health care or what treatments can be had.

But the two are not equivalent at all. When the “market” allocates something, it does so through an uncountable number of individual choices based upon each individual’s own unique knowledge, each made voluntarily and with no right to force someone to make a decision.

Let’s use computers as an example. There are consumers who demand them, there are companies which design and build them, and there are others which supply the raw materials necessary to construct them.1 There is an incredible amount of information necessary to know what kind of computer is desired (notebook or desktop, how much processing power, what kind of keyboard, what size screen, what software,…), how many and at what price. Just think of the amount of information which goes into that calculation; not only what consumers are demanding, but also the expertise to know if it is possible to do at an affordable price, and what resources are necessary to do so.

So in the allocation of computers, there are many actors involved with an insurmountably-large amount of data involved, too. But here’s the hard part: each actor only knows a part of the entire data whole. The consumer knows what they want and how much they’ll pay, but they don’t know if it’s reasonable to expect it for the price they’ll pay; the company designing them knows what is possible and what isn’t, but not what the resources to build them will cost and whether there are sustainable supplies of them; and the resource-suppliers only know how much they have and what the resources cost. But each piece of the data whole is vital to creating the right kind of computer, building just enough for the people who demand them, and getting them to those people. Add into this the factor of time — that each of these variables changes daily — and the complexity is quite clear.

These actors signal their piece of knowledge to each other through the market. Consumers only buy computers they want; the companies designing them buy the resources they need to build the computers demanded by consumers; and resource-suppliers increase prices on certain resources when they become scarce. This is how the market allocates resources: it coordinates monumentally-complex distributions of knowledge and the actors that have it into a cohesive network which works quite efficiently.2

This is is important because it shows how something which seems rather simple — buying a computer — is a complex interaction of individuals which create it, and can’t be efficiently decided by government. That is, a government body has no chance at all of accurately deciding what computers people want, who should design and build them, and for what price, because no one actor can know every piece of data.

But more importantly, it shows that this is all voluntary. The consumer decides what they want (within limits of what is possible), the company designing it decides how they will meet that demand, and the resource-suppliers decide first whether they will supply them at all, and second for what price. No one is required through force to do something. It is a voluntary arrangement.

But that is not how government works, and this comes to why the argument that market allocation and government rationing are the same thing is false. Government has the unique power of force: it can force people to do what it pleases, or ban them from doing what it doesn’t want them to do. So when government rations health care, it is does so through what is and isn’t legal. If it doesn’t think a certain breast cancer drug, which extends the life of people with breast cancer by a few more years, is worth its cost, then it bans it; no one can access it. It’s illegal.

The market would certainly “ration” the drug — if it’s incredibly expensive, then only the people who can afford it, or afford an insurance plan which supports it, will have it. But at least that drug is still available. When government rations, it’s illegal; when the market does, you can still get it. It’s just difficult, due to its cost.

So this is a long way to say: simply because the current health care system, one of the most regulated industries in our country, is not optimal does not mean we should give government the right to decide what health services are and aren’t allowed. The government cannot efficiently “ration” care, because it is much too complex and changes too quickly for a single actor to understand fully, and because government rations by force, not by voluntary choice.

It means we should work to reduce costs and make the current health care system, one of the most regulated industries in our country, more open and free to the individual to make choices.

  1. And this is a simplistic look at the actors involved: many parts in a computer are designed and built by other companies, which must source either other pre-constructed goods, or the raw material necessary to manufacture them. []
  2. “Efficiently” meaning that each actor’s desires are met, or closely approximated. []
August 30th, 2009

The Acumen Fund

The Acumen Fund provides capital to for-profit companies whose goal is to help solve poverty:

We believe that pioneering entrepreneurs will ultimately find the solutions to poverty. The entrepreneurs Acumen Fund supports are focused on offering critical services – water, health, housing, and energy – at affordable prices to people earning less than four dollars a day.

The key is patient capital. We use philanthropic capital to make disciplined investments – loans or equity, not grants – that yield both financial and social returns. Any financial returns we receive are recycled into new investments.

I find this absolutely fascinating. I wrote about exactly this kind of company when I first began writing TightWind.

It is a difficult proposition, both for Acumen and for the companies they provide funds to, because their target market does not have much funds. But unlike the developed world, their market has something incredible — a vast amount of untapped potential.

I am glad that they are not afraid to be a for-profit company, and to support for-profit companies. Non-profits certainly have their place, but for-profit firms are self-sustaining and, more important, build reserves of capital that can be invested in other areas to further develop their market.

June 30th, 2009

Waxman-Markey’s Cost

Martin Feldstein on the cost of cap-and-trade:

The Congressional Budget Office recently estimated that the resulting increases in consumer prices needed to achieve a 15 percent CO2 reduction — slightly less than the Waxman-Markey target — would raise the cost of living of a typical household by $1,600 a year.

June 1st, 2009

Henry Blodget on the 90% Tax

Henry Blodget:

Thanks to our stupidity bailouts, we now own major stakes in these firms–at mind-boggling expense. So it’s not clear why we want to destroy them. But that’s what we seem determined to do.

Believe it or not, hidden inside these companies are thousands of decent, competent people whose households bring in more than $250,000 a year. Many of these folks had NOTHING to do with the gambling addiction that bankrupted their firms. Many of them still have a choice where to work. And now that they’ve learned that their family’s pay will be capped at $250,000 indefinitely, many of them will quickly decide that now is a good time to pursue their careers elsewhere. (That is, unless their firm takes the easy and obvious step of just paying them a fatter salary, which just renders the whole thing a farce.)

The real lesson here, unfortunately, is that it’s a disaster for the government to run private companies.  We used to understand that.  But ever since we started telling ourselves that we had to save bankrupt institutions by taking them over and pretending not to ‘nationalize’ them, we have apparently forgotten.

David Moffett, the man hired to run Freddie Mac after it was placed in conservatorship in 2008, already quit because of the politicization of his job. But no one cared.

Let me be clear: this is not about “getting back” at the people who supposedly caused the financial crisis.1 Nationalizing A.I.G. and providing aid to other firms is, at its best, a means of saving firms which were thought to be integral to the financial system. This is about saving these firms to save the system.

I did not support “saving” A.I.G. and other firms for precisely this reason: when government becomes involved in the economy, it inevitably politicizes it and fucks it up. I cannot get more blunt than that. This is what is happening now. President Obama and Congress (both Democrats and Republicans) were embarrassed by the bonuses paid by A.I.G., and so they are creating a magnificently-stupid tax to save themselves from people’s anger. They are not doing this for the country. They are doing it to save their political careers.

This is what happens when governments create messes: they try to shift blame to others. They create scapegoats. This isn’t a joke, this isn’t a game, and this isn’t justice. These are the first steps of the destruction of our economy.

(Via Marginal Revolution.)

  1. And let me be even more clear: Although A.I.G. and other firms deserve blame for the crisis, if you want to blame someone, the federal government is your prime candidate. []
March 20th, 2009