TOPICS IN POLITICAL ECONOMY

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.

WHERE ARE THE TRUE REFORMERS?

The real problem in Washington, Holman Jenkins reminds us in a grim column in today's Wall Street Journal, is: 

. . . the giant riverboat gamble that Washington can save the economy by doing what comes naturally—spending money carelessly, creating massive new entitlements without funding them, dishing out cheap credit to politically favored sectors, telling business people where and how to invest.

Current healthcare legislation working its way through the Congressional sausage factory is described by Jenkins as "the equivalent of climbing aboard a train about to plunge into a canyon and deciding what it really needs is a bomb on board," thanks to the expansion of coverage paid for largely with flimsy assumptions about "cost savings."

Jenkin's wishes that Larry Summers and Ben Bernanke would step up and try "to steer Team Obama off its suicide mission."  

I would note that Council of Economic Advisers Chair Christina Romer recently observed, there is a "budgetary catastrophe looming for our children and grandchildren."  Was the White House listening?

There are plenty of good, robust proposals for real reform ready for implementation, Jenkins reminds us:

The hopper is hardly barren of ideas, like raising the retirement age, enacting the Breaux Commission's Medicare proposals, instituting a flat tax and eliminating the tax distortions that every serious economist knows contributed to the housing bubble and the health-care bubble.

 

Anybody listening?

 

 

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 BIG, BAD ENERGY BILL: H.R. 2454

1. If you think the world is getting warmer . . . and

2. If you think that carbon dioxide emissions are a factor in such trends . . . and

3. If you think that human activity is a sufficiently significant generator of such emissions . . . and

4. If you think a warmer world has a net "bad" impact on humans . . .

Then you certainly shouldn't be supporting the massive Waxman-Markey energy bill making its way through the Washington DC sausage factory on Capitol Hill.

The reason is simple: if you want to reduce consumption of energy sources that contribute to carbon dioxide emissions with minimal impact on output and with maximum stimulus to innovation, you need to increase the relative cost of such energy. The current energy bill tries to avoid doing this - mainly by creating valuable licenses to pollute that will mainly distributed by elected politicians.  There is no better design for a political cesspool than such a mechanism. 

The gory details of the current draft can be found at http://www.thomas.gov/cgi-bin/query/z?c111:H.R.2454, but at roughly 900 pages I am sure you don't have the time (nor do I - or any Congressman or Senator) to go through it. But the basic thrust should make the Al Gore crowd very happy - and amply substantiates Vaclav Klaus's summing up of the knee-jerk environmental gang:  "the biggest threat [today] to freedom, democracy, the market economy and prosperity [is] ambitious environmentalism."

H.R. 2454 is, simply put, a "command and control"  vehicle  which is intended to promote a massive expansion of Federal government power to determine how Americans should live.

The alternative, a straightforward tax on carbon emissions, with revenue used to reduce taxes, is fairer, provides the right incentives to consumers and producers of alternative energy sources, stimulates innovation without government subsidies and provides far fewer playing fields for lobbyists seeking to game the system for their clients. 

For starters, there is a plethora of proposed federal standards - for renewable electricity, low carbon fuels, building codes, appliances, and vehicles - that are either mandated or subject to implementation by coercion, e.g. withholding federal monies raised through the sale of allowances to pollute. The bill requires that by 2012, local building codes must mandate that new buildings are 30% more energy efficient than currently. Forget local building codes that reflect local realities.

But the real "cesspool" creator is the failure of Waxman-Markey to let market forces determine the price of licenses to pollute.  Instead, in the initial year of implementation 85% of the licenses will be distribute for free under Congressionally-mandated distribution formulae, as the accompanying graphic from David Wesselman's article in the May 23 Wall Street Journal clearly shows. It reflects the efforts of more than 800 lobbyists over the past several years in wining, dining, and contributing campaign monies to your elected representatives.

 

The administration of this "cap and trade" system is full of "special reserves" and similar escape valves, the administration of which will draw in the political class like flies feast on honey, even if, as is intended the percentage of licenses auctioned off increases over the years. 

Now, let's see how President Obama responds to this monstrosity.  As he put in when he was campaigning, "If you're giving away carbon permits for free, then basically you're not really pricing the thing and it doesn't work -- or people can game the system in so many ways that it's not creating the incentive structures that we're looking for."  If he sticks to his sound analysis of this issue, he will demand that the vast majority of allowances be auctioned off immediately. And revenues accruing from the auctions will result in lower taxes for some individuals - as he also promised.

But What If . . .?    But what if any one of beliefs (1)-(4) with which I started this note are incorrect? And there are, in fact, many reputable scientists who cast doubt on at least one of the four. 

If there is legitimate doubt on these issues, then the impact of passing Waxman-Markey is likely to be similar to that of the 18th Amendment to the Constitution in 1919 establishing Prohibition. It took 14 years for Congress to grasp the magnitude of its mistake, which created millions of lawbreakers and gave rise to criminal gangs that live on today.

Waxman-Markey, in anything close to its present form, would be an even costlier piece of ill-considered legislation.

And the best that could be said for legislation that enacted a carbon tax instead of "cap and trade" is that it would do less damage.

DANGER: SAUSAGE FACTORY AT WORK

Major federal legislation dealing with our health care system is currently winding its way through the Congressional sausage factory.  Seasoned observers (and many lobbyists) feel that the probabilities of such legislation becoming law before the end of the year are considered good. 

But the legislative process is never a pretty picture in such matters, and the resulting product  could be highly dangerous to our economic health. Instead of addressing the root causes for distortions in pricing, costs, modalities in treatment and assurance of supply, Congress appears to bent on simply establishing new entitlement programs, mandates, and cost controls.

Only when there is a clear and present danger that serious economic disruption caused by the mistaken policies of the past does the Federal government seem able to identify the true underlying causes and take effective action. 

Case Study: Natural Gas Supply.  Consider the history of natural gas price regulation.  In 1954, bowing to political pressures “to protect consumers,” the Federal government began a process that eventually led to widespread shortages of gas and a costly, convoluted, Rube Goldberg pattern of market inefficiencies. The situation reached near-crisis stage in the winters of 1976-1977, when many schools and factories in the Midwest were forced to close due to a shortage of natural gas to run their facilities – while at the same time there was substantial supply in Louisiana and other gas-producing states.

As a result, finally, legislation was passed in 1978 that started the industry on the road to de-regulation, although the final lap was not completed until 1992.  There have been no significant problems with natural gas supplies since that time.

How to Create A Market Failure.  Federal tinkering with the U.S. health system has an even longer history, going back to World War II.  At that time, responding to union pressures for higher wages than allowed for by the wartime wage/price control system, the Federal government permitted employer-paid health insurance benefits to be considered nontaxable to the employees (and exempt from employers’ matching Social Security contributions). 

By 1982, Congress – and the public – were told clearly, in President Ronald Reagan’s first Economic Report, that the growing costs and inefficiencies in the health care industry “are due to inappropriate tax policy and inadequate incentives for both consumers of medical services and providers of health care to reduce costs.” Tax policy created excess demand and spending for gold-plated health insurance – and marginal medical services.  Medicare reimbursement schedules discouraged newly-minted MDs from primary care careers and enticed them into more lucrative specialty niches. Paying for hospital stays and treatments rather than patient outcomes provided perverse incentives for hospitals.

Clearly, not much has happened at the Federal level in the ensuing 25 years to address the problem.  Instead, it has tended to grow worse.  Economic growth and swelling tax revenues permitted politicians the luxury of adding new benefits (e.g. Medicare’s prescription drug program) without addressing the underlying problems. “No crisis?  No real problem” summed up Washington's attitude.

Current Prospects.  Two years ago, writing in this space, I was cautiously optimistic that “the laboratory of the states” was moving policy in potentially useful directions. Some of these efforts, as well as others by the Veterans’ Administration, have been bearing modest fruit and are now being imitated by others. It would be disheartening if further initiatives were put on hold or pushed aside by the prospect of “one size fits all” Federal legislation.

While the odds of new legislation that makes the current mess worse are better than even, chances appear to be brightening for at least one long overdue reform. Confronted with the costs of expanding coverage for the uninsured, the Administration uncharacteristically has told Congress that the legislation must be paid for in additional revenues. It has even intimated that it would go along with taxing employer-paid health benefits, something Obama slammed John McCain for advocating during the Presidential campaign. 

If applied across the board, eliminating this tax-free benefit would net the government well over $100 billion a year in additional tax revenues. More importantly, it would provide the incentives for individuals and their employers to rethink what kind of health insurance they really need and do away with the thicket of health savings plans based on tax avoidance dreamed up by financial advisors.  Finally, this step would eliminate the highly unfair treatment of self-employed individuals, who have to pay for their insurance with after-tax income.

It would be a pleasant surprise if, unlike the sorry history of government’s role in the natural gas supply market, the legislative sausage factory could produce one major, substantive improvement in approach to health care without the whip of a genuine crisis, presently scheduled for 2017 - when Medicare runs out of cash.

But don't bet on it.

STRESS TESTS, KEYNES AND THE BANKING SYSTEM

So, the well-meaning civil servants have dutifully ground through the numbers and their politically-attuned Treasury/White House managers have signed off on the "stress tests" of 19 major shareholder-owned financial institutions.  (Notice that the Social Security System and major public employee pension funds - e.g. the State of California's mega fund Calpers - have not had to undergo similar scrutiny.)

What do we know now that we didn't know yesterday?  Not a great deal more.  The regulators took these institutions' current balance sheets, posited a set of assumptions about future economic conditions and loan losses, and let the Excel spreadsheets generate a set of numbers and ratios. These purport to estimate the "capital buffers" each institution has to have to weather a more severe economic downturn. A fairly simple exercise for any reasonably competent MBA.

The Reality.  What has been the true purpose of this exercise?  The answer can be found in John Maynard Keynes' "The General Theory of Employment, Interest, and Money."  But it has all to do with "confidence" and nothing to do with spending and fiscal stimulus. 

The answer is in Chapter 12, "The State of Long-Term Expectation."  Long term expectations, Keynes pointed out, do not depend solely on forecasts, but also depend upon "the confidence with which we make this forecast."  The state of confidence, in turn, is critical to determining the appetite for investment and enterprise. I suspect that more than a handful of Federal Reserve governors and staffers, and a few Treasury Department types, have been re-reading this classic essay in recent weeks.

In other words, since the rating agencies have been shown to be close to useless in such matters, and the credit default swap market had been so bad-mouthed by politicians and journalists, and the regulators themselves were shown to have been clueless, a hopefully credible alternative had to be immediately established.  

Washington's "stress tests" have been one in a series of actions designed to restore confidence in the financial system and among bankers.  This is to ensure that depositors and other lenders are comfortable in entrusting their funds to such institutions, who in turn will be able to extend credit.   

The Politics. The results of the stress tests rest on fairly credible assumptions: the "more adverse" stress simulation assumed a two-year loss rate of 9.1% of total loans (the highest rate in at least 90 years) and the highest unemployment rate since the 1930s. Ten of the 19 financial institutions evaluated were seen as needing to augment their "Tier I" capital to cope with such a  downturn, but the initial reaction in the market is that this should be feasible without a major problem.

As I have suggested in this corner before, "modern money is magic." Destroy my confidence in my bank - any bank - and you destroy money, as represented by that bank's deposits, as I withdraw my deposit and turn it into currency, gold, or some other borrower's liability (Treasury bills?). The stress tests, originally announced in February, were designed and orchestrated primarily to restore confidence in major financial institutions.

In short, the entertaining saga of the "stress tests"  has more elements of a long-running, elaborate Japanese noh drama than technocratic public policy - but that doesn't mean we can't congratulate the dramatists for a useful script. 

THE CHRYSLER BANKRUPTCY: ECONOMICS, POLITICS AND MORAL HAZARD

Economics and politics can make for a messy stew.  And the Chrysler Chapter 11 bankruptcy filing  ("Give them another chance!") is a pretty big kettle. 

The true tragedy is that this mess (and the forthcoming General Motors imbroglio) could have been avoided - in 1979-1980, when Chrysler was bailed out with a $1.2 billion federal government loan guarantee and a quasi-Chapter 11 bankruptcy. Rather than let a badly managed company truly go under, President Jimmy Carter bailed out the company and stiffed a lot of creditors. Detroit took note that when disaster threatened, Washington could probably be counted on, creating "moral hazard" - for taxpayers.

So, here we are again ("Groundhog Day" for you middle-aged movie fans?) with a prostrate Chrysler (plus GM) trying to avoid the cemetery.

As I wrote in this blog last November 16th, "if Chrysler, and all its stakeholders, had been eliminated as an independent automaker in 1980, much as LTV, Bethlehem, and various other American steel companies disappeared into bankruptcy over the past ten years, chances are that GM management and workers would have “seen the light.”  They would have taken the necessary drastic and painful steps to get their house in order. This is what U.S. Steel did after Wilbur Ross and Lakshmi Mittal (two rank outsiders) established  their credibility with the steel workers’ union and  reorganized much of the faltering U.S. steel industry."

Look Who's Running the Asylum. The fatal flaw with the government-assisted Chapter 11 bankruptcy filing (taxpayers will have $12 billion in loans outstanding to Chrysler) is that Wilbur Ross and Lakshmi Mittal are not on the scene.  Instead, the majority shareholder (55%) will be - the automobile workers' union! How can we expect such an organization to compete effectively, even assuming a level playing field, against Ford and foreign-owned manufacturing plants already in the U.S.?

A particularly nasty slant in President Obama's presentation of the plan (which may well be modified by a federal bankruptcy court) was his dissing of hedge funds and various smaller creditors who forced the bankruptcy filing (most of the major creditors were banks with TARP capital infusions). Maybe he forgot that a major hedge fund, Cerebus (and its shareholders, who no doubt include a lot of pension funds) has lost at least $7.5 billion.  As the Financial Times put it yesterday,

 Americans remember Washington as a far more paternalistic place in 1979, but respect for private contracts and protecting taxpayer dollars was higher given the terms of the first Chrysler rescue and today’s messier sequel.

The Politician At Work.  Throughout all his Administration's maneuvering, however, in Obama one can see a relatively, for a Democrat, non-ideological politician at work.  The rule of thumb he is following in trying to salvage Detroit's ailing giants is "the uniform distribution of dis-satisfaction," an age-old Washington formula that political foxes employ whenever needed. And cheap shots at risk takers who aren't on the Federal dole are costless.

There are no lions in the White House.

"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.

SENSIBILITY AND SPENDING SPLURGES

All of a sudden, spending splurges are the hottest thing in Washington.  With the Federal Reserve having brought interest rates down to near zero, politicians of all stripes (and a sizable percentage of economists) are now embracing massive spending (and borrowing) programs as the way to “stimulate” an economic recovery.

 

A Work in Progress.The result is an emerging proposal from President-elect Obama’s team for a $750+ billion “recovery” package. It is split between roughly 60% for spending and 40% for lower taxes (most of which involves, indirectly, eliminating or reducing Social Security payroll taxes for lower income households - more on this in a later post).  No doubt the House and Senate versions of the bill will differ – and the “compromise” will simply be to include each other’s spending proposals. Look for a final price tag approaching $900+ billion.

Much of the spending is standard anti-recession fodder: extending unemployment benefits, increases in food stamp allotments, federal funding for highways, and additional funding for Medicaid programs.  But a sizable chunk is for states to spend on infrastructure and education and for federal programs emphasizing “green” technology and the like. 

The incoming Chairwoman at the Council of Economic Advisors, Christina Romer, has dutifully cooked up heroic “job impact” estimates for the various components of the package totaling 3-4 million jobs saved or created.

The direct short-term economic impact of the “stimulus” package is likely to be trivial, despite the hard work by Professor Romer.  By the time the checks are in the mail, the environmental impact statements approved, and the competitive bidding process completed, it will be close to the third quarter of 2009. 

 

Four Factors. In the meantime, four important factors already present should be working their way through the economy:

1.        Lower gasoline prices.  If sustained at current levels, compared to the average price in 2008 this stimulus will be running at a $130 billion annual rate, according to the economists at PNC Bank.

 

2.     Healthier credit markets. Commercial paper volumes and maturities are increasing;  money market funds are venturing beyond investment in short-term Treasury securities. In other words, firms' ability to borrow for working capital should be increasing.

 

3. Inventory reductions by business.  These should be over well before the start of the third quarter, and new orders at distributors and manufacturers will be rising once again.

 

4. The drop in “financial uncertainty indicators” over the past several weeks. Spreads between interest rates on risk-free assets (e.g. Treasury bills) and private sector risk have narrowed; volatility in key stock market indices has been reduced, and the use of the word “uncertainty” in the press has declined.  Such indicators are the basis for two Stanford University economists to declare, “economic uncertainty is now dropping so rapidly that we believe growth will resume by mid-2009.” (They called the start of the recession with commendable accuracy).

 

Who Needs It?  So, who really needs a splurge in spending?  I suggest there are three categories of players (at the Washington level) in this game:

• Politicians who promised an expansion of government during the 2008 campaign (much of Obama's "stimulus" package consists of his specific campaign spending promises).

• Economists who mistakenly believe they can micro-manage the economy and its key sectors (energy, housing, etc.) with targeted spending programs.

• Anyone, politicians and economists included, who is reassured (or who thinks other people are reassured) by seeing government "do something" (e.g. spend money) rather than do nothing.

The rest of us will grind our teeth, remind people that all taxes start with spending, and just hope that the recovery becomes apparent soon enough to encourage fiscal conservatives in Congress to block any legislation needed to fund the remaining parts of the “stimulus” package. If there is one clear issue shaping up for the 2012 election, it is deficit reduction and major tax increases.