Risk is an unavoidable part of our economy. Without risk-taking, none of the conveniences of the modern world would have come to market. The problem is that government encourages some risks and discourages others based on political factors unrelated to inherent riskiness, and one risk that the government has consistently encouraged is lending to a homebuyer. This encouragement obviously causes companies to act differently than they would have otherwise, but is the government-induced mortgage lending good or bad for the economy?
To encourage home ownership, the government passed regulations mandating that banks make loans that look bad on paper. Incentives were put in place to lower the banks’ risk if someone defaulted on the mortgage (an indirect way of subsidizing the mortgage), but this just shuffled the risk around rather than actually lowering it. Attempts at hiding these risks caused the government to set up more and more elaborate mechanisms to grease the mortgage market, and financial intermediaries responded to these incentives by treating risky mortgages as if they were far less risky than they really were. The bankers didn’t know where the risk went, but it wasn’t with their bank.
On the surface, the risk of lending to homebuyers appears low. Homeowners will do whatever they can to avoid getting thrown out of their homes, so there really isn’t as much risk in a mortgage as there would be in a similar-scale commercial investment. The problem is that the banks already knew this and had been treating people accordingly, but the government wanted more mortgages written. The rails were greased, and a derailment became inevitable.
While home prices were rising, the risks being swept under the rug didn’t matter very much. Once a bubble started to form, more homes were being purchased by speculators and landlords than people who actually intended to live in them. Speculators and landlords do not have the same aversion to foreclosure, so banks required 20% down payments and other assurances that the loans would be repaid. This assurance was always some variation on “prices are going up, so even if I default you can seize the house and sell it at a profit.” As long as speculators and landlords were a relatively small fraction of homebuyers, these assurances were sufficient.
Meanwhile as the bubble inflated, homeowners cashed out their equity to improve their lifestyles. When people they ran out of equity, they stopped spending. This decrease in consumer spending set off ripples through the economy, and it turned out that just about everyone who lost a job as a result of the slowdown happened to own a house. A shock to the real estate system causes house prices to stop rising. In fact, the amount that people were willing to pay dropped below where owners were willing to sell.
This inability to agree on a price has happened in the past, and the usual result is for home sales to freeze until inflation causes home values to catch up with the prices that sellers demand. This time, however, the fraction of speculators in the market wasn’t so small. Speculators didn’t want to have houses, they wanted to sell houses. A clearance sale ensued, lowering prices and making millions of legitimate homeowners upside-down on their mortgages. Suddenly a vast number of homes had zero or negative equity, consumer spending skidded to a halt, and the real estate market got even worse.
All of that risk that had been swept under the rug came out at once.
Shifting risk around the economy is just as important as shifting money around the economy, but risk is harder to understand and easier to ignore. The government moves money around the economy all the time. It’s a very inefficient process, but people at least understand the principles involved. When the government moves risk around the economy, it does just as inefficient a job but voters tend not to notice. When a spending project like the Bridge to Nowhere is discovered, people get outraged at the politicians (rather than, say, the construction workers). When a risk-sharing project like Freddie or HAMP blows up, politicians take advantage of the confusion and lay blame on the people who specialize in taking calculated risks. Sure, the incentive schemes of bankers are imperfect. These imperfections led to some of the problems of their companies, but the severe distortions of the mortgage market induced by the government are much more directly linked to the problem and responsible for far more of the risk that ended up knocking the economy to its knees.
No amount of punishing banks for doing what the government told them to do is going to fix the underlying problems, because the government is still telling the banks to do precisely the same things that led to the current housing crisis. As a consequence of the government’s risk-shifting, money is being shifted from responsible people (renters and prudent homeowners) to rescue irresponsible homebuyers. The current loan modification program is comically inefficient; it would actually be cheaper for the federal government to buy the distressed home outright and give it to the homebuyer. This isn’t working, so the government will need to try something else. Either the government is going to unwind its subsidies on home buying and cause a lot of short-term pain, or the government is going to come up with an even more elaborate shell game to sweep the risks under another rug.
The government’s fixation on increasing home ownership has led to increasingly complex and risky schemes to get banks to play along. It was inevitable that greasing the rails for so long would lead to a derailment. It is clear that this particular case of risk-shifting has damaged the economy, and it will continue to cause occasional disasters until the government gives up on this obsession.
Tuesday, February 9, 2010
Tuesday, January 19, 2010
Why do banks pay these bonuses anyway?
With all the flak that financial companies get for paying bonuses, one might wonder why the companies do it at all. The short answer is that they are legally obligated to honor the contracts they’ve written. But this just begs the question, why would companies sign these contracts in the first place? The answer is that bonuses are the most efficient way to rent an investment banker’s best judgment in order to increase the bank’s profitability.
What makes a bonus better than a salary or a commission? Different pay schemes attract different kinds of people, and the people who make the best investment bankers are the type who would be motivated by bonuses. To see why this is the case, we need a bit of background.
Due to a combination of upbringing, skill, experience, personality and responsibilities, different people have different levels of discomfort with financial risks. The technical term for this discomfort is risk aversion, and generally the risk that bothers someone is the risk that is outside of his or her control (if the person really wants something, there is no “risk” that he or she won’t put forth effort). The more one’s earning swing with these uncontrollable outside forces, the more he or she expects as a base salary to compensate for the uncertainty.
Compensation schemes can be split into four broad categories based on how risk averse the person is: entrepreneur, pure commission, salary + bonus, and pure salary. Of course the real world is a bit more complicated (for example, franchising is somewhere between entrepreneur and pure commission).
Entrepreneur. People who have really low risk aversion and high self-confidence will often become entrepreneurs. They put forth their best effort and compulsively micromanage all of the factors under their control, but acknowledge that there is a lot of uncertainty out there. This is a high-risk/high-reward endeavor.
Pure Commission. People with a little more risk aversion or a little less self-confidence want the thrill and sense of accomplishment that comes with entrepreneurial success, but without the possibility of financial ruin hanging over their heads. An employer thinks this is probably a real go-getter and is willing to bankroll the effort. The employer, however, wants to make sure he or she gets maximum effort by paying on commission. Now both the employer and employee do well if things go well, and if it turns out that the market really stinks this year, the employer bears the loss. For this insurance, the employer keeps a big cut of the profits.
Salary + Bonus. The next group is okay with ups and downs, but needs a safety net due to responsibilities, personality or other needs. A lean year means no vacation and no eating out, but at least it doesn’t mean losing the house. Since the employer is agreeing to pay a decent wage even if everything goes wrong, financial incentives are important to get maximum effort. The implied insurance is costly in the sense that even if there is a fantastic year, the employee only gets a small fraction of what he or she won for the company.
Pure salary. The last group values stability over thrills. They are so hesitant to stomach ups and downs, that it is easier for the company to just pay a flat wage and monitor him or her closely.
If this seems similar to investment decisions, that’s because it is. The person is investing effort and expecting a payoff in money.
Now put yourself in the shoes of a bank trying to hire investment bankers. Wild risk-taking will make the bank unstable, so something safe like a pure salary would be best. Since there is no financial incentive for success, the bank needs to monitor a salaried employee very carefully. Close monitoring implies that the company knows what would be “right” in each trade, and this is so subjective that it would lead to endless lawsuits. Pure salary is infeasible. The next step up the ladder is salary + bonus. Bank and banker can agree on what the investment is worth at the end of the year (and if they don’t agree then plenty of accounting firms will be happy to investigate the matter for a fee), so the bonus is based on this output.
In the rarified air of the ivory tower, this is the optimal incentive scheme. The reality is that no incentive plan is perfect; people can and do game the system. Another serious problem is what happens at the low end of the output spectrum. Big risks have huge potential payoffs, but if they don’t pay off the bonus doesn’t go negative. High rewards for success and low penalties for failure create a culture of excessive risk-taking even if that isn’t what the bank wanted.
The problem is not that people take risks. Without risk-taking, none of the conveniences of the modern world would have come to market. In a well-functioning market, a bank that took bad risks would go out of business, go through bankruptcy, get seized by the FDIC (which at least ensures that depositors get their money back), or otherwise get punished. The industry would learn from those mistakes, and everyone (except for a few unlucky bondholders) would be better off.
When the government bails out banks beyond the scope of FDIC insurance, a situation similar to the salary + bonus effect emerges. Banks get to keep huge profits if they make winning bets, and they get bailed out if the bets don’t pay off. This leads to excessive risk-taking.
If people are furious at banks for using a less-than-perfect contracts for investment bankers, maybe they should take a closer look at the incentives that government is setting up for the banks. The government has a choice in how it deals with bank failures: it can let ineffective institutions die off or it can prop them up and let them continue to damage the economy. On the other hand, banks have little choice in how they pay their bankers: using something other than bonuses would actually make things worse.
What makes a bonus better than a salary or a commission? Different pay schemes attract different kinds of people, and the people who make the best investment bankers are the type who would be motivated by bonuses. To see why this is the case, we need a bit of background.
Due to a combination of upbringing, skill, experience, personality and responsibilities, different people have different levels of discomfort with financial risks. The technical term for this discomfort is risk aversion, and generally the risk that bothers someone is the risk that is outside of his or her control (if the person really wants something, there is no “risk” that he or she won’t put forth effort). The more one’s earning swing with these uncontrollable outside forces, the more he or she expects as a base salary to compensate for the uncertainty.
Compensation schemes can be split into four broad categories based on how risk averse the person is: entrepreneur, pure commission, salary + bonus, and pure salary. Of course the real world is a bit more complicated (for example, franchising is somewhere between entrepreneur and pure commission).
Entrepreneur. People who have really low risk aversion and high self-confidence will often become entrepreneurs. They put forth their best effort and compulsively micromanage all of the factors under their control, but acknowledge that there is a lot of uncertainty out there. This is a high-risk/high-reward endeavor.
Pure Commission. People with a little more risk aversion or a little less self-confidence want the thrill and sense of accomplishment that comes with entrepreneurial success, but without the possibility of financial ruin hanging over their heads. An employer thinks this is probably a real go-getter and is willing to bankroll the effort. The employer, however, wants to make sure he or she gets maximum effort by paying on commission. Now both the employer and employee do well if things go well, and if it turns out that the market really stinks this year, the employer bears the loss. For this insurance, the employer keeps a big cut of the profits.
Salary + Bonus. The next group is okay with ups and downs, but needs a safety net due to responsibilities, personality or other needs. A lean year means no vacation and no eating out, but at least it doesn’t mean losing the house. Since the employer is agreeing to pay a decent wage even if everything goes wrong, financial incentives are important to get maximum effort. The implied insurance is costly in the sense that even if there is a fantastic year, the employee only gets a small fraction of what he or she won for the company.
Pure salary. The last group values stability over thrills. They are so hesitant to stomach ups and downs, that it is easier for the company to just pay a flat wage and monitor him or her closely.
If this seems similar to investment decisions, that’s because it is. The person is investing effort and expecting a payoff in money.
Now put yourself in the shoes of a bank trying to hire investment bankers. Wild risk-taking will make the bank unstable, so something safe like a pure salary would be best. Since there is no financial incentive for success, the bank needs to monitor a salaried employee very carefully. Close monitoring implies that the company knows what would be “right” in each trade, and this is so subjective that it would lead to endless lawsuits. Pure salary is infeasible. The next step up the ladder is salary + bonus. Bank and banker can agree on what the investment is worth at the end of the year (and if they don’t agree then plenty of accounting firms will be happy to investigate the matter for a fee), so the bonus is based on this output.
In the rarified air of the ivory tower, this is the optimal incentive scheme. The reality is that no incentive plan is perfect; people can and do game the system. Another serious problem is what happens at the low end of the output spectrum. Big risks have huge potential payoffs, but if they don’t pay off the bonus doesn’t go negative. High rewards for success and low penalties for failure create a culture of excessive risk-taking even if that isn’t what the bank wanted.
The problem is not that people take risks. Without risk-taking, none of the conveniences of the modern world would have come to market. In a well-functioning market, a bank that took bad risks would go out of business, go through bankruptcy, get seized by the FDIC (which at least ensures that depositors get their money back), or otherwise get punished. The industry would learn from those mistakes, and everyone (except for a few unlucky bondholders) would be better off.
When the government bails out banks beyond the scope of FDIC insurance, a situation similar to the salary + bonus effect emerges. Banks get to keep huge profits if they make winning bets, and they get bailed out if the bets don’t pay off. This leads to excessive risk-taking.
If people are furious at banks for using a less-than-perfect contracts for investment bankers, maybe they should take a closer look at the incentives that government is setting up for the banks. The government has a choice in how it deals with bank failures: it can let ineffective institutions die off or it can prop them up and let them continue to damage the economy. On the other hand, banks have little choice in how they pay their bankers: using something other than bonuses would actually make things worse.
Saturday, January 9, 2010
Not-So-Gigantic Shift
A number of people who dislike President Obama seem to be of the impression that the Democratic Party is imploding, and that public outrage will cause virtually every competitive seat to go Republican in November. When such groups gather (in person or on a website’s comment area), the ideas are echoed and take on the appearance of certainty.
Large swings have happened before, but in cases like the "Republican Revolution" of 1994 there was a leader and a positive agenda. Historically the balance of power shifts more gradually because voters, for some reason, give incumbents a LOT of slack when it comes to poor performance. Mayor Ray Nagin, having botched New Orleans’ evacuation for Hurricane Katrina (which was entirely a city function) and having made repeated stupid comments about chocolate cities and knowing the mind of God, was re-elected.
That said, even an incremental change in the US Senate can cause huge shifts in the legislation passed by that body. A net increase of two or three seats would give the Republicans significant leverage in toning down the majority’s agenda. A net increase of four seats could halt that agenda in its tracks. The current wave of Democratic resignations seems designed to get the most vulnerable incumbents off of the ballot. Conservative impatience with Republicans may also lead to strong third-party candidates that will only split the anti-Democrat vote.
A majority of Americans may be dissatisfied with President Obama’s leadership, but simply assuming that this will translate into a sea change in Congress is foolish. People who want to see an end to the President’s brand of "bipartisanship" and "transparency" need to take action to make competitive seats go Republican in November.
Large swings have happened before, but in cases like the "Republican Revolution" of 1994 there was a leader and a positive agenda. Historically the balance of power shifts more gradually because voters, for some reason, give incumbents a LOT of slack when it comes to poor performance. Mayor Ray Nagin, having botched New Orleans’ evacuation for Hurricane Katrina (which was entirely a city function) and having made repeated stupid comments about chocolate cities and knowing the mind of God, was re-elected.
That said, even an incremental change in the US Senate can cause huge shifts in the legislation passed by that body. A net increase of two or three seats would give the Republicans significant leverage in toning down the majority’s agenda. A net increase of four seats could halt that agenda in its tracks. The current wave of Democratic resignations seems designed to get the most vulnerable incumbents off of the ballot. Conservative impatience with Republicans may also lead to strong third-party candidates that will only split the anti-Democrat vote.
A majority of Americans may be dissatisfied with President Obama’s leadership, but simply assuming that this will translate into a sea change in Congress is foolish. People who want to see an end to the President’s brand of "bipartisanship" and "transparency" need to take action to make competitive seats go Republican in November.
Monday, December 28, 2009
Why are we in the UN?
There are a number of people, primarily on the Right, who think of the UN as worse than useless and actually harmful to the US. “Imperfect” doesn’t begin to describe the UN, but decades of US foreign policy under both parties can’t be completely wrong. Hopefully. Maybe looking at the pros and cons of the US-UN relationship will shed some light on the matter.
CON: The UN is irrelevant
To get an idea why the United Nations has difficulty being relevant, imagine trying to get 192 nations to agree on anything. This is an oversimplification of course, but it gets at one of the main impediments to effective UN actions. It takes a majority of those nations to form a resolution in the General Assembly. Consider that only 89 of them are rated as politically free or only 83 of them are rated as even moderately economically free, and one begins to understand why the General Assembly isn’t exactly the beacon of humanity that it’s made out to be.
To do anything really substantial, the Security Council needs to be involved. This requires the unanimous consent of China, France, Russia, the United Kingdom, and the United States. Getting these countries to agree on the color of an orange would be a challenge.
PRO: The UN is occasionally relevant
There are some things on which the vast majority of people can agree, such as refugees should be sheltered. The UN operates a number of agencies that are, in effect, global charities.
CON: The UN is toothless
Then there are things on which the not-so-free majority of countries can agree, such as covering for each other when a minority gets oppressed or a democratic movement gets crushed. While the UN may be of minimal utility as an observer in international conflicts, it is astonishingly inept when dealing with human rights issues within a country’s borders (Somalia, Sudan, Yugoslavia, etc.).
PRO: The UN is toothless
If the UN was capable of operating as an armed world government, it would not suffer the presence of a national superpower like the US or, someday, China. Since the UN Security Council is composed of the victors of World War II (and France), they are the ones who would have the most to lose from switching the UN from a confederacy to a federation. This switch could never happen without the Security Council’s consent, so the UN’s toothlessness is assured for the foreseeable future.
CON: Enemies of the US have bases of operation in New York City
The countries that have permanent missions to the UN have them in New York City, even if they don’t have diplomatic relations with the US. This gives these countries the ability to move non-official cover agents in and out of the US, not to mention diplomatic pouches filled with who-knows-what.
PRO: Enemies of the US need to keep their agents in New York City
While I’m not aware of the US ever opening a diplomatic pouch, all of the other tools of spycraft are available to watch over the people working at these UN missions. It’s not that an Iranian secretary is going to accidentally drop a map of nuclear sites; it’s that the CIA can gather all of the dirty laundry on the people who do the negotiating at the UN. Having an envelope full of the proverbial blackmail photos can help the US (or its allies) get an edge in day-to-day international disputes.
The UN may have devolved into letting the inmates run the asylum, but it is a massive bureaucracy with many moving parts that the US government seems to think is worth greasing once in a while. Whether the pros really outweigh the cons, however, is an open question.
CON: The UN is irrelevant
To get an idea why the United Nations has difficulty being relevant, imagine trying to get 192 nations to agree on anything. This is an oversimplification of course, but it gets at one of the main impediments to effective UN actions. It takes a majority of those nations to form a resolution in the General Assembly. Consider that only 89 of them are rated as politically free or only 83 of them are rated as even moderately economically free, and one begins to understand why the General Assembly isn’t exactly the beacon of humanity that it’s made out to be.
To do anything really substantial, the Security Council needs to be involved. This requires the unanimous consent of China, France, Russia, the United Kingdom, and the United States. Getting these countries to agree on the color of an orange would be a challenge.
PRO: The UN is occasionally relevant
There are some things on which the vast majority of people can agree, such as refugees should be sheltered. The UN operates a number of agencies that are, in effect, global charities.
CON: The UN is toothless
Then there are things on which the not-so-free majority of countries can agree, such as covering for each other when a minority gets oppressed or a democratic movement gets crushed. While the UN may be of minimal utility as an observer in international conflicts, it is astonishingly inept when dealing with human rights issues within a country’s borders (Somalia, Sudan, Yugoslavia, etc.).
PRO: The UN is toothless
If the UN was capable of operating as an armed world government, it would not suffer the presence of a national superpower like the US or, someday, China. Since the UN Security Council is composed of the victors of World War II (and France), they are the ones who would have the most to lose from switching the UN from a confederacy to a federation. This switch could never happen without the Security Council’s consent, so the UN’s toothlessness is assured for the foreseeable future.
CON: Enemies of the US have bases of operation in New York City
The countries that have permanent missions to the UN have them in New York City, even if they don’t have diplomatic relations with the US. This gives these countries the ability to move non-official cover agents in and out of the US, not to mention diplomatic pouches filled with who-knows-what.
PRO: Enemies of the US need to keep their agents in New York City
While I’m not aware of the US ever opening a diplomatic pouch, all of the other tools of spycraft are available to watch over the people working at these UN missions. It’s not that an Iranian secretary is going to accidentally drop a map of nuclear sites; it’s that the CIA can gather all of the dirty laundry on the people who do the negotiating at the UN. Having an envelope full of the proverbial blackmail photos can help the US (or its allies) get an edge in day-to-day international disputes.
The UN may have devolved into letting the inmates run the asylum, but it is a massive bureaucracy with many moving parts that the US government seems to think is worth greasing once in a while. Whether the pros really outweigh the cons, however, is an open question.
Sunday, December 6, 2009
The Climate Is Changing
The argument for pre-emptive measures to halt man-made global warming tends to go something like this: the planet Venus has surface temperatures hot enough to melt lead, this heat is maintained by a carbon dioxide (CO2) fueled runaway greenhouse effect, industrial activity on Earth increases atmospheric CO2, rising CO2 will raise Earth’s temperature via a greenhouse effect, therefore industrial activity must be curtailed to save the Earth. If you sensed that some important details were missing from that argument, you are correct. Venus’s atmosphere has about 230,000 times as much CO2 as Earth’s. In fact, there is an order of magnitude more carbon in Venus’s atmosphere than there is in all of the atmosphere, oceans and crust of the Earth. There is also some evidence that Venus’s oceans boiled away first, then the CO2 built up to ridiculous levels.
The problem with the climate change argument is not so much a tendency for stretched analogies, but rather a problem with the predictive power of climate models. The Intergovernmental Panel on Climate Change (IPCC) uses very complex models to predict what will happen to the Earth’s climate when certain things change. These models do a good job of explaining the past, but never seem to anticipate what happens next. Sounds like a strange problem for a model to have, but “overfitting” is actually a well-known problem in statistics.
Whenever there is a cool summer or other evidence that the Earth is not about to burst into flame, mainstream climate researchers come out after the fact and explain that this or that happened, but don’t worry because the planet will get back to baking in short order. Inconvenient facts like decreasing temperatures since 1998 are dismissed. This is a shame, since as recently as the 1970s scientists were warning us of an impending ice age. If only the ice age doomsayers had held on for a couple more decades!
If the world is going to throw trillions of dollars at a problem because a model predicts doom, the world might demand a reasonable level of performance from that model. The world might also want to know why natural sources led to wild fluctuation of Earth’s climate in the past but that any change today must be of artificial origin (the simplest explanation is that the dinosaurs were using SUVs and coal-fired power plants).
Note that decreasing temperatures since 1998 do not mean global warming is not happening. All sides agree that Earth’s climate is full of complex feedback mechanisms, and the planet could just be shifting gears on an upward trajectory. However, since the last ten years caught mainstream climatologists by surprise, and a natural explanation is at hand (a particularly calm sunspot cycle), it would be prudent to make sure that a multi-trillion dollar effort won’t be made moot by some random blip in natural variation.
There are a number of environmental problems that need to be addressed even if global warming turns out be a complete fabrication. The problem is that environmentalists have put all of their stock in one boogeyman called CO2. CO2 became too important, and economic interests in continuing the gravy train of government funding appear to have led some researchers to proclaim that global warming is a threat no matter what the evidence says.
Since cuts to space programs mean we won’t have another planet to live on for quite some time, it makes sense to take care of the one we’re on. However, the solution is not to have government regulate the economy to death. For example, classifying CO2 as a pollutant would mean any business with a carbon footprint over 250 tons per year would have to install fantastically expensive mitigation technologies. (Yes, the EPA says its regulations only target those over 25,000 tons per year but the law says 250 tons of any pollutant gets you on the list, and the EPA doesn’t have the authority to change that number.) There are about 6.1 million such “polluters” in the country. Making them install useless carbon control technology is just the kind of job-killing move that the economy needs right now.
The solution to this problem is to let someone make money from solving bits of it. A cap-and-trade scheme is helpful when it deals with actual pollutants rather than a natural component of the atmosphere. Furthermore, businesses that sell mitigation technologies should be incentivized to work with developing nations rather than lobbying Western leaders for a captive customer base in the developed world.
One additional course correction is to make sure that the money from solving the problem actually goes to those trying to solve the problem as opposed to fearmongers who benefit financially from continued panic no matter the actual facts.
The problem with the climate change argument is not so much a tendency for stretched analogies, but rather a problem with the predictive power of climate models. The Intergovernmental Panel on Climate Change (IPCC) uses very complex models to predict what will happen to the Earth’s climate when certain things change. These models do a good job of explaining the past, but never seem to anticipate what happens next. Sounds like a strange problem for a model to have, but “overfitting” is actually a well-known problem in statistics.
Whenever there is a cool summer or other evidence that the Earth is not about to burst into flame, mainstream climate researchers come out after the fact and explain that this or that happened, but don’t worry because the planet will get back to baking in short order. Inconvenient facts like decreasing temperatures since 1998 are dismissed. This is a shame, since as recently as the 1970s scientists were warning us of an impending ice age. If only the ice age doomsayers had held on for a couple more decades!
If the world is going to throw trillions of dollars at a problem because a model predicts doom, the world might demand a reasonable level of performance from that model. The world might also want to know why natural sources led to wild fluctuation of Earth’s climate in the past but that any change today must be of artificial origin (the simplest explanation is that the dinosaurs were using SUVs and coal-fired power plants).
Note that decreasing temperatures since 1998 do not mean global warming is not happening. All sides agree that Earth’s climate is full of complex feedback mechanisms, and the planet could just be shifting gears on an upward trajectory. However, since the last ten years caught mainstream climatologists by surprise, and a natural explanation is at hand (a particularly calm sunspot cycle), it would be prudent to make sure that a multi-trillion dollar effort won’t be made moot by some random blip in natural variation.
There are a number of environmental problems that need to be addressed even if global warming turns out be a complete fabrication. The problem is that environmentalists have put all of their stock in one boogeyman called CO2. CO2 became too important, and economic interests in continuing the gravy train of government funding appear to have led some researchers to proclaim that global warming is a threat no matter what the evidence says.
Since cuts to space programs mean we won’t have another planet to live on for quite some time, it makes sense to take care of the one we’re on. However, the solution is not to have government regulate the economy to death. For example, classifying CO2 as a pollutant would mean any business with a carbon footprint over 250 tons per year would have to install fantastically expensive mitigation technologies. (Yes, the EPA says its regulations only target those over 25,000 tons per year but the law says 250 tons of any pollutant gets you on the list, and the EPA doesn’t have the authority to change that number.) There are about 6.1 million such “polluters” in the country. Making them install useless carbon control technology is just the kind of job-killing move that the economy needs right now.
The solution to this problem is to let someone make money from solving bits of it. A cap-and-trade scheme is helpful when it deals with actual pollutants rather than a natural component of the atmosphere. Furthermore, businesses that sell mitigation technologies should be incentivized to work with developing nations rather than lobbying Western leaders for a captive customer base in the developed world.
One additional course correction is to make sure that the money from solving the problem actually goes to those trying to solve the problem as opposed to fearmongers who benefit financially from continued panic no matter the actual facts.
Thursday, December 3, 2009
Life, Liberty, and the Pursuit of Mandates, Part 2
Even if one believes that the private health care system is flawed for the majority, the proper course of action is to decrease distortions of the market then weave a safety net underneath. In any market that private enterprise can participate in, private enterprise is the more efficient route. Government's idea of cost-cutting is to pay less and demand the same results. In some cases this works (defense contracts have quite a bit of padding on them). In cases like health care, the options are to wring fraud out of the system (which governments are spectacularly inept at doing) or pay below-market rates.
The health care industry has responded to past unfunded mandates by simply refusing to provide the service, for example all of the Emergency Room closures in California. The income prospects (net of liability insurance) in some specialties have led to dwindling numbers of doctors entering them, which will lead to de facto rationing if the government lowers its payments any further. If the government starts dictating specialties to new doctors, it will end up getting lower quality doctors and picking up the tab for liability insurance. Then all those medical malpractice judgments will be paid by taxpayers. The jurors in those cases are taxpayers. This would not be a welcome turn of events for the trial lawyers currently supporting the health reform initiative.
A government-run health plan that muscles out private insurance (the stated goal of many health reform advocates) would operate under incredible constraints, with obligations added or subtracted by the courts pretty much at random. Many backing the current reform effort are Pro-Choice and would be annoyed to discover that a government-run health plan would be banned from covering elective abortions. The idea of collecting a separate premium for this coverage will not work: either the premium is paid to the government (which makes it government funds) or it is paid through an employer who now knows if the person has elected to enroll in this particular coverage or not (a very serious loss of privacy).
A 60-vote majority in the Senate is a rare opportunity for a party to put a stamp on how government operates. A number of Democratic leaders have made statements to the effect that they want some kind, any kind, of government plan in place, and that they will fix the details later. Economic interests adapt to government mandates very quickly (note how credit card companies hiked everyone's rate before the new anti-rate-hiking rules took effect), and even common-sense reforms become difficult.
There are a few smaller reforms that would enjoy broad public and bipartisan support and accomplish the goals of increasing access and decreasing costs:
1. There is no compelling reason to tie health insurance to one's job. Untying these (by expanding the current employer health insurance tax break to include individual policies, or giving everyone a blanket tax exemption for health care costs) would relieve a lot of the consumer-is-not-the-customer problems plaguing health care. It would make the labor market more efficient, since people would not be staying in bad jobs just for fear of losing health insurance.
2. Allowing people to buy health insurance across state lines would introduce a lot more competition than adding a single government insurance plan. Such policies would fall squarely under the federal jurisdiction for interstate commerce, which is important since regulators would need to prevent the massive consolidation that otherwise would occur among insurance companies. Congress can tack on any coverage requirements that it wants, and individuals can “opt out” by buying an in-state plan.
3. Identify the uninsured and target solutions to them rather than trying a one-size-fits-all reform that will end up fitting no one. A number of states have already piloted high-risk pools for those with pre-existing conditions. Allow someone to have this kind of high-risk insurance and a regular health plan until the exclusion period on the regular plan ends. Cost-cutting may bring some healthy or low-income people into the market. For those who still do not buy insurance, allow cheap catastrophic coverage that will prevent an unexpected illness from bankrupting the patient and/or sticking taxpayers with the bill.
Other reforms might meet significant resistance from one political camp or another, but should a special interest really be allowed to keep everyone else from enjoying a better system?
4. Everyone claims that wellness programs reduce medical costs. Whether this really pans out or not, the Medicare Advantage plans that include wellness are doing well enough to stay in business. Create a parallel Medicaid Advantage program and see if this really works.
5. Take some steps toward reigning in medical malpractice costs. The fear of gigantic judgments leads to defensive medicine and drives up costs. The specter of high malpractice insurance costs deters entrants to certain medical fields, too. Specialized medical courts would at least put some rationality into the system; we do this for traffic, foreign intelligence activities, taxes, patents, etc., so why not medicine? The existence of a predictable court system might even end the practice of getting patients to sign away their rights on those agree-to-arbitrate forms. It also seems to be a lot fairer than artificial caps on judgments.
6. Get hospital reimbursements in line with actual hospital expenditures. If the law requires hospitals to treat anyone who staggers into the Emergency Room, the law should provide a way to pay for it. The current practice is massive cost-shifting (such as high Medicare fees to make up for unreimbursed Emergency Room care). Some hospitals are better at managing cost shifts than others, and the ones that aren’t so good at it end up closing their Emergency Rooms to the detriment of the surrounding community. Also, better ties between service and payment will make fraud easier to spot.
The health care industry has responded to past unfunded mandates by simply refusing to provide the service, for example all of the Emergency Room closures in California. The income prospects (net of liability insurance) in some specialties have led to dwindling numbers of doctors entering them, which will lead to de facto rationing if the government lowers its payments any further. If the government starts dictating specialties to new doctors, it will end up getting lower quality doctors and picking up the tab for liability insurance. Then all those medical malpractice judgments will be paid by taxpayers. The jurors in those cases are taxpayers. This would not be a welcome turn of events for the trial lawyers currently supporting the health reform initiative.
A government-run health plan that muscles out private insurance (the stated goal of many health reform advocates) would operate under incredible constraints, with obligations added or subtracted by the courts pretty much at random. Many backing the current reform effort are Pro-Choice and would be annoyed to discover that a government-run health plan would be banned from covering elective abortions. The idea of collecting a separate premium for this coverage will not work: either the premium is paid to the government (which makes it government funds) or it is paid through an employer who now knows if the person has elected to enroll in this particular coverage or not (a very serious loss of privacy).
A 60-vote majority in the Senate is a rare opportunity for a party to put a stamp on how government operates. A number of Democratic leaders have made statements to the effect that they want some kind, any kind, of government plan in place, and that they will fix the details later. Economic interests adapt to government mandates very quickly (note how credit card companies hiked everyone's rate before the new anti-rate-hiking rules took effect), and even common-sense reforms become difficult.
There are a few smaller reforms that would enjoy broad public and bipartisan support and accomplish the goals of increasing access and decreasing costs:
1. There is no compelling reason to tie health insurance to one's job. Untying these (by expanding the current employer health insurance tax break to include individual policies, or giving everyone a blanket tax exemption for health care costs) would relieve a lot of the consumer-is-not-the-customer problems plaguing health care. It would make the labor market more efficient, since people would not be staying in bad jobs just for fear of losing health insurance.
2. Allowing people to buy health insurance across state lines would introduce a lot more competition than adding a single government insurance plan. Such policies would fall squarely under the federal jurisdiction for interstate commerce, which is important since regulators would need to prevent the massive consolidation that otherwise would occur among insurance companies. Congress can tack on any coverage requirements that it wants, and individuals can “opt out” by buying an in-state plan.
3. Identify the uninsured and target solutions to them rather than trying a one-size-fits-all reform that will end up fitting no one. A number of states have already piloted high-risk pools for those with pre-existing conditions. Allow someone to have this kind of high-risk insurance and a regular health plan until the exclusion period on the regular plan ends. Cost-cutting may bring some healthy or low-income people into the market. For those who still do not buy insurance, allow cheap catastrophic coverage that will prevent an unexpected illness from bankrupting the patient and/or sticking taxpayers with the bill.
Other reforms might meet significant resistance from one political camp or another, but should a special interest really be allowed to keep everyone else from enjoying a better system?
4. Everyone claims that wellness programs reduce medical costs. Whether this really pans out or not, the Medicare Advantage plans that include wellness are doing well enough to stay in business. Create a parallel Medicaid Advantage program and see if this really works.
5. Take some steps toward reigning in medical malpractice costs. The fear of gigantic judgments leads to defensive medicine and drives up costs. The specter of high malpractice insurance costs deters entrants to certain medical fields, too. Specialized medical courts would at least put some rationality into the system; we do this for traffic, foreign intelligence activities, taxes, patents, etc., so why not medicine? The existence of a predictable court system might even end the practice of getting patients to sign away their rights on those agree-to-arbitrate forms. It also seems to be a lot fairer than artificial caps on judgments.
6. Get hospital reimbursements in line with actual hospital expenditures. If the law requires hospitals to treat anyone who staggers into the Emergency Room, the law should provide a way to pay for it. The current practice is massive cost-shifting (such as high Medicare fees to make up for unreimbursed Emergency Room care). Some hospitals are better at managing cost shifts than others, and the ones that aren’t so good at it end up closing their Emergency Rooms to the detriment of the surrounding community. Also, better ties between service and payment will make fraud easier to spot.
Wednesday, December 2, 2009
Life, Liberty, and the Pursuit of Mandates, Part 1
The debate over health care reform has taken on sense of monumental importance for a number of reasons. The White House has basically put its prestige on the line, and this has created a political need to accomplish something called health care reform. Some have even decided to claim the moral high ground by claiming they are fighting for a human rights issue.
The first thing to understand is that there is no right to health care, although it is not difficult to imagine why one might believe there is.
The US's Declaration of Independence states, "We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness." A reasonable level of health care is certainly a precondition for Life, and arguably for Liberty and Happiness as well.
The UN's Universal Declaration of Human Rights also declares, "Everyone has the right to a standard of living adequate for the health and well-being of himself and of his family, including food, clothing, housing and medical care and necessary social services, and the right to security in the event of unemployment, sickness, disability, widowhood, old age or other lack of livelihood in circumstances beyond his control." The US has considered the Declaration of Independence as a moral obligation since the time of President Abraham Lincoln, and the US is a signatory of the Universal Declaration of Human Rights. So the whole matter would appear to be settled.
Not so fast. There are other preconditions to Life, and some of these are mentioned in the UN declaration as well. Namely, Life depends on the availability to adequate food and shelter (there are those who argue if clothing is actually necessary). This means there is a human right to food, and this right is more fundamental than the right to health care (food can sustain Life without health care, but health care cannot sustain Life without food). How has this right to food been handled?
Estimates of the number differ, but there is consensus that millions of people in the US do not get enough to eat. The US also has plenty of food, so much so that many US farms receive subsidies to produce less than their full potential. Combine ample supplies of food, individuals' right to that food, and a breakdown somewhere getting the food to the right people; the only logical conclusion is that the government must step in to rectify this market failure. Indeed, the government has.
Did the federal government buy all of the food and distribute it to the people? Of course not. Government agencies and nonprofits have developed to serve specific populations. The market is functioning just fine for the vast majority of Americans, and the gaps are addressed with as little nonmarket allocation as possible so as to preserve that market. The system is imperfect, but no one is advocating a Universal Food Service approach.
The federal government has regulations mandating minimum standards for food, but this has little to do with delivering food to those who need it. Article I Section 8 of the US Constitution gives the government authority to regulate food, but only if it crosses state lines. Community gardens, farmers’ markets, local produce used in restaurants, etc. are all outside of federal jurisdiction (the idea that anything could be outside the federal government’s jurisdiction comes as a shock to many).
Programs to provide food to those in need exist alongside ("compete with") private enterprise, but the programs serve only those not served sufficiently by the regular market. A problem delivering health care to a segment of the population is similar; an underserved segment of the population is cause for targeted intervention, not cause to uproot the system with which the vast majority of Americans are quite happy.
When the government attempts to provide universal service in competition with private providers, a pattern always emerges. The government stacks the deck in the public entity's favor (e.g., the legally mandated minimum fees for couriers and delivery companies are higher than US Postal Service rates, the taxes collected to educate a child always go to a public school rather than follow the child to whatever school he/she actually attends), consumers show near-universal preference for the private version, and market distortions from stacking the deck put the private version economically out of reach of many who otherwise would choose that option.
The proper thing for these public entities to do is to contract in scope and provide only to those who need them, letting an efficient market handle the bulk of the population. Government bureaucracies don't do contraction very well, so the whole market suffers. Enacting an overbroad government health care plan would be extremely difficult to undo, so too little is definitely preferable to too much.
The first thing to understand is that there is no right to health care, although it is not difficult to imagine why one might believe there is.
The US's Declaration of Independence states, "We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness." A reasonable level of health care is certainly a precondition for Life, and arguably for Liberty and Happiness as well.
The UN's Universal Declaration of Human Rights also declares, "Everyone has the right to a standard of living adequate for the health and well-being of himself and of his family, including food, clothing, housing and medical care and necessary social services, and the right to security in the event of unemployment, sickness, disability, widowhood, old age or other lack of livelihood in circumstances beyond his control." The US has considered the Declaration of Independence as a moral obligation since the time of President Abraham Lincoln, and the US is a signatory of the Universal Declaration of Human Rights. So the whole matter would appear to be settled.
Not so fast. There are other preconditions to Life, and some of these are mentioned in the UN declaration as well. Namely, Life depends on the availability to adequate food and shelter (there are those who argue if clothing is actually necessary). This means there is a human right to food, and this right is more fundamental than the right to health care (food can sustain Life without health care, but health care cannot sustain Life without food). How has this right to food been handled?
Estimates of the number differ, but there is consensus that millions of people in the US do not get enough to eat. The US also has plenty of food, so much so that many US farms receive subsidies to produce less than their full potential. Combine ample supplies of food, individuals' right to that food, and a breakdown somewhere getting the food to the right people; the only logical conclusion is that the government must step in to rectify this market failure. Indeed, the government has.
Did the federal government buy all of the food and distribute it to the people? Of course not. Government agencies and nonprofits have developed to serve specific populations. The market is functioning just fine for the vast majority of Americans, and the gaps are addressed with as little nonmarket allocation as possible so as to preserve that market. The system is imperfect, but no one is advocating a Universal Food Service approach.
The federal government has regulations mandating minimum standards for food, but this has little to do with delivering food to those who need it. Article I Section 8 of the US Constitution gives the government authority to regulate food, but only if it crosses state lines. Community gardens, farmers’ markets, local produce used in restaurants, etc. are all outside of federal jurisdiction (the idea that anything could be outside the federal government’s jurisdiction comes as a shock to many).
Programs to provide food to those in need exist alongside ("compete with") private enterprise, but the programs serve only those not served sufficiently by the regular market. A problem delivering health care to a segment of the population is similar; an underserved segment of the population is cause for targeted intervention, not cause to uproot the system with which the vast majority of Americans are quite happy.
When the government attempts to provide universal service in competition with private providers, a pattern always emerges. The government stacks the deck in the public entity's favor (e.g., the legally mandated minimum fees for couriers and delivery companies are higher than US Postal Service rates, the taxes collected to educate a child always go to a public school rather than follow the child to whatever school he/she actually attends), consumers show near-universal preference for the private version, and market distortions from stacking the deck put the private version economically out of reach of many who otherwise would choose that option.
The proper thing for these public entities to do is to contract in scope and provide only to those who need them, letting an efficient market handle the bulk of the population. Government bureaucracies don't do contraction very well, so the whole market suffers. Enacting an overbroad government health care plan would be extremely difficult to undo, so too little is definitely preferable to too much.
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