TOPICS IN POLITICAL ECONOMY

TWO BIG HOLES IN FINANCIAL REFORM LEGISLATION

Financial regulatory reform draft legislation is making its way through the Congressional sausage factory: 253 pages in the House version and 1,136 pages for the Senate's (Senators tend to be more wordy than Representatives).

But, despite their weight, there are two gaping holes in both versions: not a word dealing with the biggest bad actors in the mortgage market (Fanny Mae and Freddy Mac) or with the financial sector that posed the biggest threat to a nationwide financial panic - money market funds.

While there are plenty of issues to debate within the draft legislation, let's focus here on the two missing chapters.

Fanny and Freddy. According to the Washington Post, the federal government's seizure of these two government-sponsored housing agencies  has cost the taxpayers $121 billion.  And more dollars are likely to be needed to keep them afloat. And then there's the issue of the original federal housing agency, the FHA, which now looks like it, too, is going to need a multi-billion bailout.

If Congress and the Treasury can't confront the underlying problems arising from federal intervention in the residential mortgage market (making it too easy for high risk borrowers to get government-subsidized  credit), they clearly haven't addressed one of the principal factors in the credit crisis of the past two years. Of course, that would be a lot harder to do, politically, than beating up on bankers.

Money Market Funds. For some reason, outside of Paul Volcker's vigorous warnings and substantive proposals from The Group of 30, almost no one at the center of policymaking in Washington appears to be seriously concerned about the role poorly designed money market funds (MMFs) played in the credit crisis.

Promising to hold MMF share prices to $1.00, helped by SEC regulations permitting questionable accounting to maintain that price, and acquiescing in SEC mandates to use credit rating agency marks on all their holdings, the MMF sector literally "blew up" last September. That was when one of the oldest and biggest funds, The Reserve Fund, "broke the buck" thanks to its $785 million investment in Lehman Brothers highly-rated commercial paper. 

The money market fund sector has evolved into a trillion dollar "shadow" banking system - but it is regulated by an SEC that is subservient to the investment companies that sell and manage MMFs and is generally clueless about banking issues (and how to catch Barney Madoff). 

While the SEC has requested comments on various proposals dealing with possible MMF reforms, the likelihood of serious, fundamental changes is very dim without a legislative directive.

Bottom Line. It would be most constructive if some of the heavy hitters in the Washington sausage factory could add a little more substance to the financial regulatory reform package that is currently moving down the production line.

THE HEALTHCARE DEBATE: THE PUBLIC OPTION

Bob Samuelson, the sharpest economic columnist in the country (at the Washington Post, no less), has written an incisive and devastating analysis of the "public option" proposal in pending healthcare legislation. 

He calls it "an exercise in political avoidance: it pretends to control costs and improve access to quality care when it doesn't." 

If you are at all interested in how this major policy debate is going to be settled, read Bob's column - and send it around to others.

PRESIDENT OBAMA AND THE COLA: PANDERER IN CHIEF

On October 5th, I commented - critically - on the legislation moving through Congress to award Social Security recipients a special $250 payment.  Due to a small projected decline in inflation for 2009, there will be no cost-of-living  (COLA) increase in Social Security monthly stipends for 2010.

Now President Obama has come out in favor of this $13-$14 billion post-Christmas present (financing unspecified by the White House), thus joining the pandering politicians in Congress at throwing money at what might be called "the grasping geezers." 

The original legislation which provided for COLAs said that upward adjustments in COLA would always be made (my social security check went up 5.8% this year), but if prices declined (as in 2009, for the first time since the COLA was instituted) downward adjustments were ruled out. Talk about a sweetheart deal.  But not sweet enough, apparently, especially for frequent voters. 

The White House says that seniors are among those "hardest hit by this recession."  In a class with automobile workers??  The  Presidential statement points to the decline in home values, but ignores the reality that, so long as seniors stay in their current residence, the fluctuation in home values has no impact on them - only their heirs. Yes, maybe their retirement savings accounts have fallen in value - but so have those of "juniors."  And juniors didn't get a 5.8% increase in Social Security stipends this year.

Now that the President has endorsed it, the $250 pandering payment is probably unstoppable in Congress, despite a growing sense that Federal spending is on a suicidal track. Only a resolute, far-sighted leader in the White House could have mustered the political courage to derail a craven, populist proposal.

But we don't have a lion in the White House; we have a free-spending fox. 

SOCIAL SECURITY COLAS: THE PANDERING POLITICIANS AT WORK

Here's a letter I have just sent one of my Senators.  The leaders of this classic example of the mob at work are Senator Sanders from Vermont and Congressman Pete DeFazio of Oregon.  The official title of the legislation is The Emergency Senior Citizens Relief Act (H.R. 3597 in the House, S. 1685 in the Senate). If you agree with the thoughts, send something similar to your Senators and Congressman - or, better yet, your newspaper.

Dear Senator Casey:

I understand you are a co-sponsor of legislation to provide a one-time payment of $250 to all Social Security recipients, since there will be no cost-of-living (COLA)  increase for them this year.  Your proposal would increase federal outlays by $14 billion.

I am one of those potential recipients. And I strongly oppose your proposal. The reason there is no COLA this year is because consumer prices have declined. When consumer prices increase, my Social Security check increases; but it doesn’t decrease if prices decline. That was the deal when Congress wrote COLA into the Social Security System in 1975.  A lot of working people would say that’s pretty good deal – if they’re still working.

You argue that medical costs keep going up.  But most Social Security recipients are on Medicare, which insulates them from the bulk of such cost increases.

My bus fare hasn’t gone up in years: I pay nothing, thanks to my senior pass.

You say you will make up the $14 billion in handouts by increasing Social Security taxes on the working rich.  Sounds very familiar: robbing Peter at work to pay Paul at home.

Seniors have been insulated from economic hardship more than any other age group during this economic recession.

Senator, stop pandering to us.

  Sincerely,

    James B. Burnham

THE PERILS OF MODELING: FINANCE AND CLIMATE

The 10-year plateau in global temperatures is beginning to draw considerable attention.

A recent New York Times article, "Momentum on Climate Pact is Elusive," documents the fears of global warming pessimists that the prospects for "action" are weakening in the face of hard data. Some pessimists are also warning that the relative stability in temperatures could prevail for another decade due to "cyclical shifts in the oceans" - but rest assured, their models promise us that the long-run outlook is decidedly grim. 

Modelers' Hubris. The faith that such forecasters have in their models would be touching if it were not so dangerous.  While the most reputable forecasters admit to the vast complexities and unknowns in modeling global climate patterns, that doesn't stop many of them - and their publicists, like Al Gore - from calling for massive economic dislocations designed to forestall modest possible increases in temperature.

You would think that such individuals would take a few lessons from the recent travails of chastened hedge fund managers and the  financial market modelers and quantitative analysts who fed them great ideas.  They, too, used massive computers and reams of data, along with sometimes plausible theories, to forecast future trends in stocks, bonds, options, and the like.  They even had the history of  multi-billion dollar collapse of hedge fund LTCM in 1998 to warn them of "long tails" in statistical distributions.

When it comes to climate modeling, while many of the data time series are longer than those of financial modelers, they are subject to much more "measurement error." The daily record of Interest rates and stock prices is a lot more certain and precise than global average temperatures in the 19th or 20th centuries.

Of even greater importance, consider the problems in measuring the amount of solar radiation that reaches the earth. While climate pessimists credit the sun spot cycle with a very modest impact on the earth's temperature, some reputable scientists argue that it has a major effect (see Scafetta and West, "Is Climate Sensitive to Solar Variability?" Physics Today, March 2008).

 According to NASA, we only have modestly accurate data on solar radiation since 1979, when the first satellite designed to take such measurements was launched.  Even now, while we can measure solar radiation to within a few watts (per square meter of earth surface area), the measurement error is greater than the natural fluctuation which takes place over an 11-year sun spot cycle.

Wait Til Next Year! A mini-test of sorts is now underway, since the current minimum in solar sun spot activity is the deepest in a century, according to NASA.  By itself, that would suggest less radiation is reaching the earth, and cooler times are ahead.

So, rather than rush to judgment with coercive "cap and trade" regimes and similar steps to reduce carbon emissions, let's simply asked the climate modelers to give us hard forecasts for the next five years, backed up with their own money via bets in Las Vegas (financed by home equity loans and hedge funds?). 

WHOLE FOODS AND HEALTHCARE: REALITY V. IDEOLOGY

There is a wonderful tempest in an (organic) teapot currently swirling around Whole Foods, the leading purveyor of organic products and assorted liberal bloggers.  It demonstrates clearly the yawning gap between knee-jerk, ideological thinking and the way the world is actually made a better place.

The CEO of Whole Foods, John Mackey wrote an op-ed for the Wall Street Journal describing his company's high-deductible health insurance plan.  He also suggested various ways in which less government and more individual choice could result in a fairer, less costly system for everyone. The Wall Street Journal's headline writer entitled the piece, "The Whole Foods Alternative to ObamaCare."

Mackey pointed to his own Company's plan, developed painfully over the past six years, as a example of what could be done under existing federal and state  law to maximize choice and employee satisfaction. (See his 2004 talk to the State Policy Network for illuminating details, including about how employees votes help to define the benefit package.)

For the cardinal sin of doubting that the federal government is the solution to health care's problems, the liberal blogosphere has descended upon Mackey with an outpouring of nastiness and a call to boycott the leading purveyor of granola to the literati of the left. At last count, his company's website forum on the issue had over 14,000 posts. 

By all accounts, Whole Foods treats its generally younger workers very well, as its low employee turnover rate would suggest. Its high deductible plan is something that many organizations have been moving towards in recent years, with generally positive results for both employees and employers. It would be nice to think that such facts should help shape the debate about how to reform health care.  

Read Mackey's op-ed  - and go buy a few granola bars from the nearest Whole Foods.

 

MAN-MADE CLIMATE CHANGE: THE CASE FOR SKEPTICISM

If you think there is a "consensus" among scientists regarding human responsibility for climate change, read the letters to the editor in the July 27 issue of Chemical and Engineering News, published by the American Chemical Society.

Members of the Society were incensed by a June 22 editorial, written by the editor-in-chief, asserting that

The science of anthropogenic climate change is becoming increasingly well established. The scientific consensus on the reality of climate change has become increasingly difficult to challenge, despite the efforts of die-hard climate-change deniers.

Nearly all of the correspondents attack the editor-in-chief (of a scientific society's publication) for condemning skepticism - a critical driver of scientific discovery.

A substantial majority of the letter writers are quite open to the possibility of global warming, but highly doubtful of the assertion that it is primarily driven by man-made activity. The summaries of the scientific basis for skepticism are highly readable and strongly recommended.

Yet another reason to oppose the massive energy bill winding its way through Congress (see "The Big, Bad Energy Bill, June 12).

HEALTH CARE REFORM: AN UGLY DUCKLING THAT DESERVES TO DIE

In 1993, the Clinton Administration tried to reform health care with a “White House knows best approach.”  That effort  crashed and burned, deservedly so.  

President Obama is trying the opposite tack: He is telling Congress, “Here are my general objectives – affordable health-care for everyone, ‘deficit neutrality,’ and no reduction in current benefits – and, please, Congress, you figure out how to pay for everything."

Once again, the President is all “fox” and no “lion.”  He is saying,  "Let Congress do the heavy lifting and I will market the outcome if I can say it meets my criteria."

An Ugly Duckling Emerges.  After reading the transcript of the President's July 22 news conference, it is clear he sees health care reform legislation as his ticket to re-election in 2012, just as George W. Bush used Medicare drug entitlement legislation to ensure re-election in 2004.  In other words, President Obama will sign any comprehensive reform bill so long as it purports to be "deficit neutral," increases coverage to nearly all Americans, and doesn't eliminate any benefits for current Medicare and Medicaid beneficiaries.  

The official commentary on HR 3200, the legislation jointly reported out of  three House Committees, claims that half of its costs would be paid for by "significant efficiencies and savings" in Medicare and Medicaid and the rest would be recovered through an income tax surcharge on "the wealthiest." The White House goes even further - with the President insisting that two-thirds of the cost of increased coverage can be recovered through cost savings in existing programs, and coyly indicating he will go along with most any tax increase Congress can agree on. 

The Congressional Budget Office begs to differ: its admittedly incomplete analysis of the House legislation suggests an increased deficit of $239 billion over the ten-year period 2010-2019.

Both the President and Congress seem to find beating up insurance and drug companies, doctors, and hospitals as the way to go to get their savings.  The House legislation is full of mandates telling everyone how to run their business.  It also establishes a "public health insurance" option (cost unspecified) intended to compete with private and nonprofit organizations and force them to be more efficient. (If you like the way the government runs the finances of Medicare and the Pension Benefit Guaranty Insurance Corporation, you will love this new player.)

As it stands, HR 3200 is an ugly duckling, and likely to do little to improve the dysfunctional nature of our current health care system; in all likelihood it will make it - and the budget deficit - worse. 

What Would A Lion Do?  If the President wanted to enact genuine reform, he could take a number of steps that would accomplish some of his objectives. It would mean taking on tough issues directly, rather than accepting dysfunctional Congressional legislation.  Some illustrative, common sense (but politically difficult) measures, which require no budget outlays, could include:

1. Make employer-paid health insurance premiums taxable.  Such a step is just as important for its impact on changing employee preferences for gold-plated insurance programs - which help drive up the cost of health care -  as it is for the additional revenue it would generate.  Leading Democrats such as former Senator Daschle and John Podesta, a former Obama staffer, have promoted a variation on this.

2. Permit a free market in living donor kidney sales for transplants. According to a series of articles in the peer-reviewed American Journal of Transplantation, every additional kidney transplant can save taxpayers $94,000 compared to having patients on Medicare-financed dialysis, as well as improving the quality of life and longevity of such patients. Back of the envelope calculations by Virginia Postrel suggest that giving each living donor about half of these savings would still result in a $4 billion reduction in Medicare spending. 

3. Permit nurse practitioners at a Walmart kiosk (for example) and or pharmacists to perform routine medical office tasks (many state laws place substantial barriers to such activity).

4. Play no favorites among medical specialties in subsidizing doctors' education or Medicare treatment reimbursements; as it is now, primary care and internal medicine practitioners (usually the only ones who can see the patient as an entire human being) are at the bottom of the totem pole, despite substantial evidence that they are best placed to manage patient care. The rapid growth of "concierge medicine" for wealthier individuals is the most visible sign of this fact.

These are just a small sample of the many ideas which market-oriented economists and health care policy experts have studied. Look at the Cato Institute's web site for additional suggestions.  Financially, nearly all of these ideas are cost-free - but they require genuine leadership and spending scarce political capital. Health care reform is an issue that desperately requires both.

Machiavelli wrote that leaders need, depending on the times, to be both a fox and a lion.  Now its time for President Obama to act more like a lion.

"FINANCIAL CRISIS MANAGEMENT 101" FOR POLITICIANS - AND THE PUBLIC

A short course in current financial market realities is badly needed for most members of Congress and a fair number of the chattering class, many of whom are threatening to exacerbate the current situation.

1. Please don't forget that the primary objective of nearly all of the money that has been pumped into commercial and investment banks and AIG, as well as the expansion of government deposit/money market fund insurance by the FDIC and the Treasury was intended to stop a massive and highly dangerous run on the nation's banking system in the last six months of 2008.

2. That effort has been successful. Give the Treasury and the Federal Reserve some credit for what they did, even if their public explanations were unsatisfactory - as they still are.

3. Stop asking the banks "Where did the TARP money go?" The complexity and daily volume of multimillion dollar transactions on any large bank's balance sheet makes this essentially a rhetorical question. Stopping the run on bank and money fund deposits was the first and most important step in avoiding an excessive contraction of the banking system.

4. Stop trying to get the banks (and the government mortgage agencies) to lend or guarantee more loans. In a recession, such as we are now experiencing, lenders quite properly become more cautious, as do potential borrowers. Wasn't it the combination of loose lending standards and over-leveraged lenders and borrowers/buyers that made this downturn so serious?  The need to generate income will provide sufficient incentive for lenders to extend new credits. (No bank can cover its overhead investing in Treasury bills at 1%.)

5.  Understand business cycles. All recessions are characterized by sharp slowdowns in credit extensions. In fact, in March loans outstanding at large commercial banks to both business and consumers were still at higher levels than a year ago.  At some point in the near future, we should expect them to be below year earlier levels, as they normally are at later stages of the business cycle.   

6. Stop bad-mouthing bankers and threatening to impose regulatory burdens on hedge funds. You need them (1) to sort out the mess of bad assets still on banks' balance sheets and (2) to restart the markets for securitized mortgages and loans if you want the credit markets to open up fully.

7.  Study what recently happened in Iceland where a politician was appointed to head up the Central Bank and was instrumental in creating a real financial disaster.

CHINA, CONVERGENCE, AND MARKET CAPITALISM

Most of the noise coming out of this week’s meeting of the  G-20  heads of state in London will be about regulation,  “stimulation” and new barriers to international trade.   But there Is very likely to be one truly significant long-run political outcome: the functional acceptance of China by “the West” as a major financial and economic power.

This acceptance will take the form of communiqué  language that makes it clearer than ever that China’s share of voting power in the International Monetary Fund (and, perhaps, in the World Bank) will be increased substantially within the next two years.  This shift in voting power will be facilitated by a large increase in IMF resources contributed by member governments, most prominently the Chinese.  

The Death of Market Capitalism?  At the same time, noisemakers at the G-20 meetings will add decibels to the continuing funereal chorus from the chattering classes about “the death of market capitalism.” This, despite the fact that China owes its rise to global power thanks to its embrace of the key elements of market capitalism:  market prices to provide incentives to producers and letting individuals own the means of production and grow rich.

Market capitalism is not going to wither away just because financial regulators around the world decide to insist on less risk-taking by (government-supported) financial institutions, such as FDIC-insured banks, “too big to fail” investment banks, and government real estate lending agencies (FNMA and Freddie Mac). 

It was a form of market capitalism that lifted 400 million Chinese out of dire poverty in the fifteen years between 1990 and 2005, and which now makes some pundits muse about turning global leadership over to the “G-2” – the United States and China. 

Why Losing Market Share May Be Progress.  If market capitalism is not dying, then perhaps the U.S. is threatened by China because of a shrinking share of global economic output?  This notion surfaces in numerous discussions about China’s extraordinary economic achievements as well as international comparisons  of spending on research and development,  patents issued, educational achievements and a myriad of other measures.

But the emphasis on “market share” is simple-minded and incorrect, if the absolute level of economic well-being continues to improve.  In this situation, which certainly describes the past 15 years or so, a smaller market share for #1 simply reflects more rapid growth by lower-ranked countries. 

Furthermore, as Nobel prize winning economist Edward Prescott and Stephen Parente have suggested, if all countries would dismantle “barriers to experimentation”  (ranging from civil strife to monopolies to trade protectionism), “there is no reason why the whole world should not be as rich as the leading industrial country.”  In short, China’s progress over the past two decades is a strong argument in favor of what is known as the “convergence” hypothesis among economic growth theorists – as well as market capitalism.

Cut the Bad-Mouthing.  So, when China sits down in a much bigger chair at IMF board meetings in 2011, there is no reason to bad-mouth either the U.S. or market capitalism.  Instead, congratulate the Chinese and remind yourself that it was a form of market capitalism that got them there.