Health Care and the Experts: Financial Analogy?

Some co-author or other saw the Myers (fragment-of-a-) Health Care Plan which I put up last Easter, which started with

1. Allow unlicensed health care, wherever it's clearly labeled as such; it won't get public support but people can choose to spend their money on it. The argument against this is apparently that people will make bad choices. Yeah, some will, probably including me and you. So? I've never understood the way some people believe that they (or those they select) can make good choices for others; in fact I'm moderately cynical about licensure requirements as they are now structured, whether for medics or morticians or cosmetologists.

His comment says

I came to look at Chelyuskin but chanced upon healthcare. Your item 1 is the only time I can remember when I totally disagree with you. You say: Some people will make bad choices including you and me. This equates mistakes by poor slobs who lost their houses and livelihoods in 2008 with "mistakes by TJM," that same TJM who, I suspect, belongs to that tiny minority who made money in 2008, because he has both sharp analytical mind and enough money to hire a top-notch money manager. Besides, this just won't work politically: as soon as a poor slob somewhere takes her child to an unlicensed healer, and the child ends up with an amputated limb, the outcry for regulation will be irresistible and, IMHO, justified.

I wasn't sure how to respond to this money-management analogy, and I let it go; I'll give it a try now...

I'm astonished -- and encouraged, because I would not have expected item 1 to be the only total disagreement even in this post, much less in general. And of course it's possible that I'm totally wrong...but I haven't changed my mind yet. Let's take it one step at a time.

The first point of disagreement, a very big one: No, I didn't make money in 2008. In fact in September 2009 I said

I haven't posted for a long time, but it's not that I haven't made any mistakes. Indeed, I've participated to some extent in one of the biggest mistakes of my lifetime -- the market crash of 2008.

Personally, I did see the bubble as such, earlier than some...

In fact I lost much less than I might have because (like my "top-notch money manager" -- I must remember to tell him about that description) I was expecting a downturn at some unpredictable point Real Soon, a small-to-middling wealth-effect recession whenever the bubble popped, and also of course because I avoided real estate. But I did lose, because we weren't expecting what happened. Was this an issue of expertise, in any useful sense of that term? People with far greater expertise than mine, including both the then-current and currently current heads of the Federal Reserve, were denying the problem -- even denying the limited problem that I saw then. (Indeed, since a big part of the problem was excessive risk-taking -- i.e. excessive confidence -- I think those public statements contributed to our still-continuing doldrums in addition to the policy errors I believe they made.) There were indeed a very few people who actually made money by understanding a part of what was going on: a short-seller named Eisman was quoted in late 2008 in The End Of Wall Streets Boom

“We always asked the same question,” says Eisman. “Where are the rating agencies in all of this? And I’d always get the same reaction. It was a smirk.” He called Standard & Poor’s and asked what would happen to default rates if real estate prices fell. The man at S&P couldn’t say; its model for home prices had no ability to accept a negative number. “They were just assuming home prices would keep going up,” Eisman says.

S&P denies that; I haven't heard any coherent excuses for the way they performed as the Supreme Appointed Financial Experts of the American economy (co-equal with Fitch and Moody's, of course). I dunno. Still it's my understanding that Eisman made money whereas on the average, people with more to lose (them with money managers) lost more, disproportionately more, than those with less. That's a Good Thing, as far as it goes -- it didn't go as far as it should because of Too-Big-To-Fail, i.e. some high-income people had their losses made good at the average guy's expense -- but it doesn't fit well with a belief that experts protect us from making disastrous mistakes. As I said in that Sept 2009 post, "To a disturbing extent, I think expertise in (macro)economics has been discredited. I don't believe this is adequately answered by Greg Mankiw's [remarks about economics being non-predictive]". I agree with parts of Brad DeLong's remarks a few days ago in What To Do About Jobs? that

given that most of what we macroeconomists were saying in 2007 was wrong, what, if anything, do we have to say today? Bear in mind that what turns out to have been wrong was pretty much everything that had been done since 1950....

Well, with part of it. As the the Economist (Ryan Avent) said last week,

The narrow point to focus on, however, is that the story in which the housing bust gave us the recession, because America suddenly had lots of houses and workers it couldn't use doesn't appear to fit the data. The economy muddled on despite the housing bust for two years, at which point, for some reason, all sectors suddenly decided that the outlook for growth was much worse than they'd previously believed.

As he says, that fits the Scott Sumner story I've blogged about before, which can be read as very conventional textbook macro and which blames most of the recession on the experts of the Federal Reserve, who simply did the wrong thing in a big way. (There's still room for other blames, of course.) On a more micro-economic level, I'd say that expert stock-picking advice is also of dubious value: I'm a moderate believer in a very weak form of the efficient-market hypothesis, and if this country were to adopt a deduction-free progressive consumption tax system (which it should do on grounds of efficiency/fairness/sanity) I would almost certainly stop using a money manager -- the money-manager's value is rather strongly dependent on his understanding of a complex system that really shouldn't exist. (Also dependent on the fact that his services are mostly deductible, i.e. you're helping to pay. Thanks!) What would I do then? I would switch to a passive management pattern, which in pure investment terms is at least as good and likely better:

In the United States, indexed funds have outperformed the majority of active managers, especially as the fees they charge are very much lower than active managers. They are also able to have significantly greater after-tax returns.

Most of my decisions would then have to do with asset allocation:

The conclusion of the study was that replacing active choices with simple asset classes worked just as well as, if not even better than, professional pension managers. Also, a small number of asset classes was sufficient for financial planning.

Hooray for Malkiel! And for Samuelson and Bogle!. This doesn't prove that financial expertise is worthless, but I don't think it has the kind of value you're suggesting.

Let me put it this way:

• Failure to consult such an expert now and then is really stupid. There are a lot of things a financial specialist knows that are not intuitive; important things.
• Many of these are routine things, how to file this-and-that.
• Many of these are simple things you really ought to learn yourself (why it probably makes sense to own more bonds and fewer stocks as you get older, etc. etc. etc.)
• Some of the others are simply not true, and we don't know which until it's too late (why the top tranche of a pile of mortgage-backed securities deserves its AAA rating, etc. etc.)
• Unlimited trust for your expert is not wise.
• Compulsory obedience to your expert is a really really bad idea, which fortunately is not employed except for the way that S&P and the other experts are embedded in the laws about risk ratings, which effectively required banks to invest in disastrous mortgage-backed securities...
• Perhaps the most important financial skill you can have is that by which you evaluate an expert; nobody else can do this for you, but certification and track-record-checking and recommendations are all important.

Your analogy between medical and financial services is not one that would have occurred to me, but it may have merit. Failure to consult an actual medical expert now and then is really stupid. Medical specialists do indeed know a lot of unintuitive things. Many of these are routine. Many are things you should learn for yourself. Many are false. Trust is a good thing, unlimited trust is a bad thing, compulsory obedience is a really bad thing. Certification and track-record and recommendations...yup. Okay, I'll take the analogy. :-)

Seriously, I think you're saying, effectively, that

If there's one seriously bad (but non-fatal) outcome from an unlicensed healer, public outcry will correctly push us back to requiring licensure

It seems to me you're forgetting something: the licensed doctors we have now are responsible for some 100,000 fatal errors per year (perhaps a little less, perhaps a lot more; see Wikipedia.) Those deaths are on top of a death-toll which I believe to be very much larger: deaths caused by the FDA's prevention of innovation. I'd suggest reading one article, Theory, Evidence and Examples of FDA Harm by Tabarrok and Klein:

Three bodies of evidence indicate that the costs of FDA requirements exceed the benefits. In other words, three bodies of evidence suggest that the FDA kills and harms, on net...

Or you might prefer The FDA: Neither Safe nor Effective ending with a Friedman quote:

“‘The FDA has already done enormous harm to the health of the American public by greatly increasing the costs of pharmaceutical research, thereby reducing the supply of new and effective drugs, and by delaying the approval of such drugs as survive the tortuous FDA process.’ When asked, if you could do anything to improve health in America, what would you do? Friedman replied: ‘No more licensing of doctors. No more regulation of drugs. Not of any kind. Period.’”

Actually, I don't quite agree, but my position is a whole lot closer to Friedman's than to anything that's likely to happen, and I'd accept his as being substantially better than what we have now. (And if we magically went to his, I like you and most others would go right on consulting a conventional MD -- but the MD I consulted might not be in the US. It might depend on what happened to the insurance industry, which would now be free to sell the sort of insurance policy that I'd want to buy.)

Or then again, maybe not.

Update:Stiglitz, Nobel Prize-Winning Economist, Says Federal Reserve System 'Corrupt' according to the Puffington Host:

To Stiglitz, the core issue is that regional Fed banks, such as the New York Fed, have clear conflicts of interest -- a result of the banks being partly governed by a board of directors that includes officers of the very banks they're supposed to be overseeing.

The New York Fed, which was led by current Treasury Secretary Timothy Geithner during the time leading Wall Street firms like Citigroup, JPMorgan Chase, AIG, and Goldman Sachs were given hundreds of billions of dollars in taxpayer bailouts, presently has on its board of directors Jamie Dimon, the head of JPMorgan Chase. He's been there for three years. He replaced former Citigroup chairman Sanford "Sandy" Weill.

"So, these are the guys who appointed the guy who bailed them out," Stiglitz said. "Is that a conflict of interest?" he asked rhetorically.

That really might explain the Fed's behavior... in finance as in medicine, the incentives of regulatory capture and crony capitalism apply. People who exert government's influence are always going to be pushed towards exerting it in favor of those who can exert influence on their behalf, and regulation -- especially licensure, as the power to say who can't compete with you -- is always going to be a Very Good Thing from the point of view of those who have a seat at the table. They may even sincerely believe that they are the only true experts, and that those who do things differently are simply not good for the public. (Or then again, maybe not.)

Update, June 13: In the end, the wealthiest did lose proportionately less from the recession: CONVERSABLE ECONOMIST: Wealth by Distribution, Region, and Age says:

Those in the 90-100th percentiles of the wealth distribution have median wealth of $1,864,000, and mean wealth of $3,716,000 in 2010. That's also the part of the wealth distribution that had the smallest percentage decline in the median and the mean from 2007 to 2010.

I believe that, and I suppose it might have something to do with financial advice, but my current reaction is simply that housing was the most overvalued part of the economy, and those below the top 90% had more of their wealth in housing--and were more likely to have to use up their savings due to job losses in the family. I don't think it has any implications for the health-care analogy.

Thoughts on Greece, and us

A large part of what holds Greece back, and us as well, is fairly described as rent-seeking--manipulation of public power for private profit, one way or another. In Greece, as in the Latin America of my childhood, it's much more likely to take the form of simple corruption: imagine (as I was told in Greece last week) an underpaid government official who approves environmental permits, and who provides faster service for those who provide extra money. And then he slows down the uncompensated permits sharply, to encourage the trade. It's not that he is lazy or works few hours, it's not even that there are too many such officials -- all that is often said but seems to be wrong. It's simply that his work product tends to detract from actual GDP, even as it's added at "cost" to official GDP. If he weren't doing that, Greece would be richer.

Other kinds of rent-seekers include those who profit from government-imposed monopolies, like the Athens taxi-drivers now striking, unpredictably blocking port and airport. Rent-seeking is a pretty broad category in my mind. I suppose that all countries end up with issues of regulatory capture and indeed of crony capitalism; government makes rules, and these rules will tend to promote the interests of those who have something to offer to the rule-makers, or some credible threat they can make. That interest-promotion is "rent," paid to the people who've managed to make some government power into their own property, legally or not.

I spent last week on Spetses, with various extended-family events relating to my granddaughter's baptism. It's interesting and educational to listen to Greeks and Greek-Americans talking about their fiscal crisis; I'd hoped to get some time specifically listening to Yannis Ioannides and Anna Hardman, and did, but not enough for real understanding. Yannis' basic Greece-is-not-bankrupt statement surprised me considerably (see Ioannides Says Greece Not Bankrupt, Must Change Economy: Video - Bloomberg). He thinks Greece really can pay its debts -- and he thought that even before the ’Restricted Default’ deal of this week, so I presume he thinks his case has been strengthened. He's an advocate for the austerity measures, which I suppose makes him one of the Serious People of whom Paul Krugman said this week in 1937! 1937! 1937! - NYTimes.com that

OK, so we’re going to demand harsh austerity in the debt-crisis countries; and meanwhile, we’re also going to have austerity in the non-debt-crisis countries. Plus, the ECB is raising rates. So demand will be depressed in both crisis and non-crisis economies; this will lead to a vigorous recovery through … what? The Serious People are determined to destroy all the advanced economies in the name of prudence.

I'm mostly on Krugman's side there; we're combining monetary policy from the ECB which may be reasonable for Germany but not for Greece, along with drastic contractions of an uncomfortably the-beatings-will-continue-until-morale-improves flavor. Or so it seems to me. But Yannis isn't supporting austerity to reassure bond markets as Krugman says; Yannis thinks that the "austerity" (including the deregulation of taxi medallions being protested) is part of breaking or at least limiting the rent-seeking system. Well, I'm not sure he or Anna ever said "rent-seeking" but that's my understanding of what they did say, and when I look for related material online I find things like BusinessInsider's querying a member of the `professional "elite" class' of Greece, who said

We want the Greek economy reformed. An end to the of unimaginable waste of taxpayers money,...cronyism and corruption. A much smaller and reformed public sector... A pursuit and prosecution of presently wide spread tax evasion practices. The above would immediately provide us with a considerable primary surplus, enabling us to keep repaying our debt, an obligation we wish to honour. ... Unfortunately it appears that the average Greek, does not view things the same way.

That certainly sounds like the viewpoint of the Greeks with whom I spoke. And how big is the corruption problem? Well, Transparency International said

The Greeks paid an average of €1,355 ($1,830) in bribes [in 2009] for public services such as speeding up the issue of driver's licenses and construction permits, getting admitted to public hospitals or manipulating tax returns, ... Bribes paid for private sector services such as lawyers, doctors or banks were even higher...

So really, Yannis and those he supports (to the extent that I understand what's going on here) are not so much engaged in economics as in political action aimed at restructuring Greek culture. Otherwise, the bailouts fail. In The Painful Arithmetic of Greek Debt Default | e21 - Economic Policies for the 21st Century I see

How does corruption limit the capacity for tax and spending reform? Tax avoidance, which relies on bribery to avoid prosecution, is a national pastime in Greece – the envelope used in the bribe even has its own name, the “fakelaki,” confirming the age-old adage that the Greeks “have a word for it.” Bribery is so rampant in Greece that real estate developers’ method of obtaining cheap land is to burn down public land, squat on the burned parcels, and pay off public officials to permit this. Greece’s forest fires, particularly in the Peloponnese in 2007, have been a source of public outrage for years, and yet the developers continue to squat on the land with impunity. Is a society that permits that sort of lawlessness capable of tax reform?

Maybe. Maybe not. I respect Yannis, but if the average Greek doesn't believe in it to begin with, I don't see a happy ending to this story.

Corruption is by no means the only problem, and an end to rent-seeking would not necessarily make Greece fit comfortably into the Eurozone. Clearly, little Greece will never be the target of the ECB's monetary policy. Krugman, in Anatomy of a Euromess, said that

Spain’s troubles are not, despite what you may have read, the result of fiscal irresponsibility. Instead, they reflect “asymmetric shocks” within the eurozone, which were always known to be a problem, but have turned out to be an even worse problem than the euroskeptics feared.

David Beckworth took Krugman's analysis and extended it in "Optimal Currency Area" terms within Eurozone Periphery and the Euro, saying

If a region’s economy is not in sync with the currency union’s business cycle and the above listed shock absorbers ("flexible wages and prices, factor mobility, fiscal transfers, and diversified economies") are absent then it does not makes sense for a country to be a part of the currency union. Instead, the country should keep its own currency which itself will act as a shock absorber.

It's no great surprise to see that in his graphs, Greece ends up as the most ill-placed. But I believe that part of the "austerity" program is intended to increase the flexibility of the job market (by pruning job protection programs, as has been tried before) and maybe, if the austerity programs are accepted, maybe things will work out. For a while. Public Pensions and Labor Force Participation: The Case of Greece

The pension system of Greece is a representative case of the “Mediterranean welfare state”, which is characterized by extensive segmentation, very high payroll tax rates, and yet inadequate pension benefits. In order to explain this paradox we construct an economic–demographic model. We show that in the period 1980–2000, the segmentation of the system and the very low labor force participation rates of the Greek economy have resulted in very high payroll tax rates in relation to the current level of benefits. On top of these problems, the expected adverse demographic developments in the period 2005–2050 will render the pension system completely unsustainable.

Still, the near-term need is to cut the rent-seeking (including corruption) and collect the taxes and shrink the regulatory/welfare state. Maybe. And can it be done? Well, my own approach in Greece, even more than in the US would be:

automate, eliminate, simplify, outsource.

Almost all of a government's functionality should be virtual... Well, maybe I will make a separate post about that, sometime.

Meanwhile, a little more time has been bought. The Economist remarks that

the biggest risk to the euro zone is that its leaders will begin thinking that they've solved the problem. As growth figures worsen in coming months, markets will once again become antsy. Euro-zone officials had better be preparing for a way to convince them anew that they want this thing to work.

And I go back to the pattern I established last winter, of exercise and education

This morning I spent 45 minutes trying to pound a few modern Greek words and phrases into an aging memory; until a month ago, this would have required a major effort of willpower, but lately I've been doing it every day with no problem...

As I commented to my son's mother-in-law, see-gah-see-gah mah-THAY-no, which I think means "little by little I'm learning;" since her response was "bravo, Tom, ah-krih-VOS!" (precisely), maybe it does. And maybe I will eventually learn some economics too. Or then again, maybe not.

Upstate NY Demographics and School Consolidation

This is a doom-and-gloom post. Well, not really. But partly. It's not obvious that school consolidation would actually contribute to the solution, but there really is a problem. Let's look at it.

The image here, which is as it says from Cornell's Program on Applied Demographics, shows the Hamilton Central School district in the recent past and probable near-term future. Fifteen years ago we had 879 students -- we're down by more than 300, i.e. if the line kept going down we'd have a negative number of students in thirty years or so. Of course we won't do that, but we may reach 400 even sooner than the 2017 suggested by the (pessimistic) blue line on the graph. School consolidation is an obvious thing to think about, wouldn't you say?

What's actually going on here? Well, of course a lot of young people move out of upstate NY looking for jobs, a lot of people move out of NY altogether looking for jobs (and lower taxes, and following businesses which are following the people and looking for lower taxes too) and in any case my generation of Baby Boomers are aging fast -- and expensively. Here are two charts on Madison County demographics from the same Cornell group, at County Projections.

Just pick Madison as the county, and then consider 1990 and 2035.

As you can see, back in 1990 we had a bulge in high school (just before leaving to go find a job or college) and in 2035 they think we still will, but it's thinning out, no longer dominating the oldsters who use up the Medicare and pensions that our juniors will be trying to pay for. As our state office of mental health puts it,

In 2011, the first of the post-war “baby boom” generation (those born between 1946 and 1964) will reach the traditionally defined “old” age of 65 years. This “elder boom” will result in a doubling of the number of older adults from 35 million in 2005 to 70 million by 2030. In New York State, the number will increase over 50% from 2.4 million to 3.7 million.

So, fewer and fewer students, and the money is needed elsewhere. We cannot afford to go on spending $20K per student per year, and as time goes on we will get less able to afford it. It's not a comfortable picture. It doesn't have to be that way, of course: there's a whole lot that the federal government does to make things worse, that doesn't have to happen. We might end up looking at American history to see what kind of population influx we have handled before, and dramatically increasing the immigration rate. That would cause problems, but they'd be different problems; the projections would change. And the "elder boom" doesn't have to be that bad, if we don't retire -- you weren't going to retire, were you? Actually, maybe we can retire. On current projections we can't afford the Medicare that we've been promising each other (well, our kids won't be able to afford it on our behalf) but if we got rid of a bunch of anti-innovation laws and regulations, I think we'd do just fine. Moore's Law is applying to robotics and 3d printing; we should be able to afford much more than we ever did before -- unless innovation is blocked, as it so often is. I'm happy to blather on about that as I have before on this blog, but I don't see much that can be done about it locally, or even at the state level.

And Cuomo may be trying hard to spin his budget cuts, but he has to make some big ones -- the state is losing the ability to pay for what it used to pay for. Sure, some of that is due to the Great Recession and still-horrendously-high unemployment which keeps government outlays high and income low, some of that will return if and as the overall economy recovers (please note Japan's Lost Decade, still going strong after 20 years, if you think it has to recover) but some of it is just the way that New York never had a plan to fulfill the promises we've made to each other.

So, think about it. What would you cut? And don't say "well, I wouldn't cut X, that's no answer" even if X=education; look at New York state and local spending 2011 and decide: what would you cut?

Update: I should have put a link to the state budget data, at least to the (PDF)Executive Budget Briefing Book saying, on page 13 of 101,

New York public schools spend more per student than any other state – fully 71 percent above the national average – yet New York ranks 40th in graduation rates and 34th in the nation in the percentage of adults who have a high school diploma or the equivalent.

So what would you cut? Would education really be altogether off your list?

The Greenspun Recovery Plan: November 2008

My co-author, rather than updating his Project Afghanistan page for 2010, sends me a link to Philip Greenspun's Economic Recovery Plan -- minimum steps for averting a Depression in the U.S. , with a note that I "will probably find this congenial", probably meaning that it's closer to my views than his, but interesting. So I look at the minimum steps as of two years ago for averting a Depression in the US, and the first thing I notice is that we didn't do those things and we didn't get a Depression, so they weren't minimal steps for avoiding a Depression. QED. (I think we avoided a Depression because the Fed wasn't quite as stupid as it was in the 30s, but I've probably talked about that enough and Greenspun never mentions it.) Greenspun says the minimal steps are

Reducing Government Spending In 2006 we were spending roughly 36 percent of GDP on government at local, state, and federal levels ... We need to [reduce] government spending to 30 percent of GDP within two years and ...

Well, actually I often think about this measure of the size of government; I don't like it much, especially when transfer payments are most of government spending, and ultra-especially when the big transfers like SocSec and Medicare are going to older people, who have other income, sometimes more income than the younger ones, and are also taxpayers. Government salaries are hardly more than a rounding error here. Let's say my income this year is $100 and yours is $10; the government takes $40 from me, carefully evaluates your needs, gives you $10 and spends the rest on other stuff. I now have $60 and you have $20. Now let's suppose that we replace this with a linear tax which is simpler, but nominally even higher: the government takes (50%-$20) from everybody, so it takes $50 from me and $5 from you over the year, and gives each of us $20 in weekly payments. I end up with $70, you with $25. Okay, has the government expanded or shrunk? It collected $55 where before it collected only $40, and borrowed nothing in either case, so obviously it's "bigger" -- or is it? Or is this the wrong question? I'd choose a linear tax at the Federal level (no deductions at all, except that your 401(K) can hold any investment paper you like including your bank account, so money is taxed only as you spend it), and I'd watch state/local experiments with more complicated schemes, but I don't believe "spending/GDP" would measure the result in an interesting way. No, this is not congenial.

Greenspun goes on:

What about Keynes? Japan is a good example of the failure of Keynesian economics in the globalized era. The country spent hugely on public works projects in the 1990s,...

Well, yeah. As Sumner has written over and over again (and as Bernanke wrote years ago), Japan's central bankers have repeatedly chosen a monetary policy calculated to prevent growth no matter what fiscal policy was adopted. Very odd, but Greenspun isn't making a suggestion so much as countering a fiscal-policy suggestion -- yet he never brings monetary policy into it, which I find even odder.

Now we get into strange territory:

Investor Representation on Public Company Boards Right now the shareholders of a public company are at the mercy of management. ...

I don't get this one at all. If management salaries and bonuses are "looting" companies, then investors should do better by choosing the least-looted companies; we are perfectly free to vote with our feet. I think that my simplified no-deductions tax scheme would reduce the value of superstar friends-of-Bill-or-George-or-Barack managers, I see crony capitalism and regulatory revolving doors as significant problems for democracy as well as startup businesses, but I don't see where Greenspun is coming from here.

Depreciation of Capital Expenses...

Oh, please. I believe this to be another non-problem: if a cash-flow-negative company has good earnings prospects it can borrow the money for its first few years. This is routine. If it doesn't, then flexible depreciation won't help.

Education... Our country's best performing schools (all of them private) have non-unionized teaching staffs. We can't afford to experiment with unionized teachers anymore...

Ummmm, well, absotively posilutely maybe. Or not. I could see a federal role for educational infrastructure, mostly in the form of teaching/testing material (especially educational computer games) to be freely used by anyone who likes it. I would like to introduce competition for every school...I would like lots of stuff. My impression of the overall generational impact of the teachers' unions is extremely negative, but I would put this way down on any list of stuff I'd like.

Transportation System Reform... Public transit unions should be eliminated because ...

I think I see a theme here. Greenspun doesn't like unions. Well, I dunno as how I like what they've gradually grown into all that much myself, but if Greenspun thinks that businesses don't invest in NYC because they're afraid that public transit stoppages will keep workers from getting to work, I think he's going just a teensy bit over the top. The main transportation reform we need is for transportation of bits so telecommuting works better than it does. (This will greatly relieve NYC traffic congestion, but congestion charges should be applied also: my E-ZPass should be charged a few cents, about once a block, whenever I drive in NYC -- rather than just once on the GW Bridge as I head to the city and Icon Parking. And E-ZPass should be required for driving in the city. Period. But the Feds should have nothing to do with it, and it has little to do with averting a recession, so it doesn't belong here.)

Predictable Product Liability System We need a fixed range of prices for people killed or injured by products...

Wow. Well, I guess we're working on Exodus 21 KJV

28 If an ox gore a man or a woman, that they die: then the ox shall be surely stoned, and his flesh shall not be eaten; but the owner of the ox shall be quit. 29 But if the ox were wont to push with his horn in time past, and it hath been testified to his owner, and he hath not kept him in, but that he hath killed a man or a woman; the ox shall be stoned, and his owner also shall be put to death. 30 If there be laid on him a sum of money, then he shall give for the ransom of his life whatsoever is laid upon him. 31 Whether he have gored a son, or have gored a daughter, according to this judgment shall it be done unto him. 32 If the ox shall push a manservant or a maidservant; he shall give unto their master thirty shekels of silver, and the ox shall be stoned.

Wow. I guess I sympathize with Greenspun, and with those who disagree with him. Hmm... It doesn't belong here. What else?

Labor Market Deregulation We may soon have deflation. Workers who are young or with poor skills need entry-level jobs in order to build skills and experience. They won't be able to get them if the minimum wage is set higher than the market-clearing wage. ...

Well, here again I think I'm seeing a tendency to look at the current (2008) emergency and see one's prior preferences as solutions to whatever's wrong. Yeah, I think that some entry-level unemployment, along with the increasing use of gadgetry in your neighborhood McDonald's and Burger King, are driven by the minimum wage. And I'd like to get rid of it, as one of the items that gets replaced by the weekly payments of my linear tax scheme above. But I'm averse to pushing it into a "minimum steps" for Depression-aversion.

Substitute Web-based Education and Trade for Foreign Aid We don't spend a large percentage of GDP on foreign aid, but the perception is that the absolute amount is large and nearly all of it is wasted or siphoned off by Third World officials. ...Let's start with a simple message that business investors can embrace: "We've eliminated all U.S. foreign aid spending."

That's interesting, and again I can mostly support his substitution (especially the end to farm subsidies) as better support for developing-country economies. But I simply wouldn't put it in this list at all.

Immigration Policy ...With our crushing overhang of government debt, entitlement programs, and public-employee pensions, the only question we can afford to ask about an immigrant is "How much in taxes will this person pay and for how long?" Countries such as New Zealand apply a point system.

Well, that's interesting. And I do think that our excess housing inventory could have been fixed, reducing the minor recession that we would have gotten even if the Fed had chosen NGDP level targeting from (at least) early 2008 onwards, by admitting a whole bunch of people on a points system. And our current immigration system is so awful that any rational basis would be better than what we've got. But It Doesn't Belong On This List.

Now, my short-range recovery plan, for whatever it may be worth, would be Sumnerian -- it would have to do with my acceptance of Sumner's view of the immediate causes of the recession. Note again that Greenspun was writing in November 2008. As Sumner says,

1. The NGDP and RGDP collapse ... occurred almost entirely between June and December 2008. I argue that NGDP targeting could have prevented that collapse..... the financial crisis of September 2008 did not cause a stock market crash, as the markets expected the Fed to continue its multi-decade policy of keeping NGDP growing at about 5% a year. If the markets had given up on the Fed in September 2008, they wouldn’t have waited until October to crash. 6. I argue that stocks crashed 23% in early October on little financial news. Instead, there were ominous reports of rapidly falling orders all over the industrial world. Markets then sniffed out Fed passivity, a failure of the Fed to do what it takes to maintain the Great Moderation. They became demoralized. 7. I argue that the only significant Fed policy during the October crash was the [contractionary] IOR program,

The recession's unemployment has gradually become more structural, but I believe more monetary response would still help a lot. Indeed, I believe QE2 did help a bunch.

Whatever. Yeah, I'm Greenspunish in some ways. Okay, I'd really like "Market Deregulation" on a really large scale -- in fact I'd like to move away from regulatory government to required-insurance government. Hm... that's not a Greenspun concept. Overall, I don't find Greenspun all that congenial. Interesting, and he's dissatisfied with many of the same things I am, but not congenial. There's an overlap between his thinking then and my thinking now, but then I overlap quite a bit with almost everybody.

Except, of course, for me. I hardly overlap with me at all, and since whichever of us is right I'm certainly wrong, these thoughts belong on this blog.

Yeah, the Fed Did It.

(More precisely, the Fed aggravated it; the Fed could have prevented most of it; the extent to which we depend on the Fed's good judgment should shrink, not grow.)

I believe we've been having a three-component economic crisis, each component building on and worse than the one before it, with overambitious or overconfident regulators/legislators making each component far worse than it needed to be. The three components I see are

• the trend-following housing (and financial services) bubble, which the Fed worsened slightly by false reassurances;
• the security-seeking, trend-breaking cash crunch which the Fed worsened greatly by too-tight monetary policy;
• the longer-run tech-based employment recalculation. (All right, the Fed is not guilty here but it mostly hasn't happened yet, and our sensitivity to the mistakes the Fed made this time is growing with time. Cheer up, the worst is yet to come.)

bubble: I've commented on the housing bubble before, and how I think it was worsened by regulators and legislators (and raters) who denied the problem. Investor irrationality was real, but part of that irrationality was the willingness of investors to trust pronouncements by Greenspan and Bernanke, by Barney Frank and others on both sides of the aisle, and of course their willingness to believe that AAA meant "safe". I'm not arguing that interest rates were or weren't too low. (I do not believe that was the problem.) I'm not saying that the regulators were (or are, or will be) stupid or malevolent. I am saying that they were, quite obviously, wrong, and that those who relied on their assurances did very badly. (Those who simply said "prices are rising, I'll bet everything I can borrow that the trend will continue" did exactly as badly; there are always some of those.) I'd fix that (following Arnold Kling) mainly by going back to a world of high down payments. You could still give 100% financing if you wanted, but any federal support (including FDIC guarantees for a bank that offers mortgages) should depend on at least 20% down payment. Leverage would shrink generally, and underwater mortgages would be extremely rare. This would reduce homeownership rates, of course, and that may be regrettable, but it's not obvious that people are helped by encouraging them to make commitments they are likely to break, or be broken by. Of course this version of Kling's reform won't happen; what we're getting instead is expanded trust in that which failed before, to which we add taxpayers having to guarantee more than 95% of mortages, still being pushed on those who can't afford them.

cash crunch: As I've said before, I've become a semi-Sumnerite:

the real problem right now is not a “real” problem. The real problem is a nominal problem. When the growth rate of nominal GDP falls sharply there is always a severe recession. We have a severe nominal shock, a problem which has been understood by economists at least as far back as Hume. At the time, it always looks like the “real problem” was some symptom of the monetary shock, such as financial panic. Thus in the 1930s people thought the collapsing financial system caused the Great Depression, only later did we discover it was too little money.

Investors' efforts to minimize individual risk ended up adding to systemic risk. Actually it seems to me that we knew by February 2008, when Roubini said,

"Cash is king in 2008,"... the U.S. went into recession in December and will stay there for at least a year.

The Federal Reserve under Bernanke ignored what Bernanke had written academically; it brought down interest rates and then declared a "liquidity trap". It did expand the monetary base, but not nearly enough to satisfy demand -- and they neutralized part of their monetary expansion in fall 2008, by paying interest on excess reserves, encouraging hoarding by banks. Cash remained king, mostly because people were worried about too much risk in their portfolios. Here I would agree with Sumner that we should target NGDP (nominal GDP, aggregate cash flow) but I worry that buying Treasury bonds with cash, exchanging one low-risk item for another, might not succeed; we need to cope with people trying to shed risk. The Fed's purchases of mortgage-backed securities seems like a really bad idea: this is not absorbing risk in the sense of variability, it's buying a bet that already failed and attempting to prop up a market that should go downwards because there are too many houses out there for a while. So,

• I'd make NGDP measures tradable in the form of Shiller's trills, creating a permanent market growing to perhaps a billion trills, paying one-tenth of one percent of our GDP, owned by citizens or foreigners but not by our own government.
• Like Sumner, I would announce that we're targeting a 5% growth trend in trill yield (i.e., in NGDP), based on the pre-2008 trend so that if it rises too fast or too slow in one year we compensate the next; this is "level targeting".
• I would give the Fed a stock-bonds-cash portfolio to be rebalanced daily, where the cash can be effectively imaginary (set it at last year's NGDP, most will never be printed) and all stocks are treated equally via a Wilshire Index fund; this rebalancing portfolio is the key difference between me and everybody else, hence probably totally wrong, but it makes sense to me. If investors starts selling stocks, the Fed will automatically buy, or sell if everyone else is buying, so this couple-of-trillion portfolio would automatically tend to stabilize the market. It would probably make money for taxpayers, too.
• How would it stabilize the NGDP trend? When trills (next year's trills; buy them now!) start to fall, the Fed would change the portfolio proportions, giving cash for stocks and perhaps bonds, absorbing risk and satisfying the demand for cash. When trills start to rise above the price level target, the Fed portfolio proportions would change back.
• Actually, I might make this last item more indirect: I might start a prediction market on the proportions required to achieve the actual NGDP target. In effect, I'd be giving knowledgeable parties something to bet on, so that they'd make money by getting it right. I don't want them able to make money by betting on the actual cash value of a trill's annual yield: that's (2008 yield)*(1.05^N), so the "right answer" is known in advance. Bet on the unknown path to that, instead. The Fed would use this prediction market to guide the proportions.

Instead of this, of course, we're giving the Fed a more complex mission as if its people had enhanced credibility. Since their credibility with me has gone way down, I don't find this reassuring.

employment recalculation: Kling talks about recalculation, reallocation of resources including labor in the constant search for "sustainable patterns of specialization and trade", and the unemployment this causes. Sumner acknowledges that some recalculation was required at the beginning, but mostly he just means the structural issues of too big a housing sector (and finance.) Delong and Krugman point to aggregate-demand-based unemployment and say that structural unemployment is on the way, but not yet a big deal. (Of course current unemployment is made worse by underwater mortgages which keep people from moving where the jobs are, and therefore by low-down-payment policies. And it's made directly worse by the cash crunch which motivates companies to sit on their cash, and it's made worse by regulatory uncertainty (and especially health care) and inflation uncertainty. But this is talking about aggregate demand v. structural, with recalculation as part of a slightly different story.)

I'd agree with them all, mostly, but add that recalculation is growing as an issue in a way they haven't (to my knowledge) discussed. My feeling is that overall technological productivity will gradually become the biggest factor in continuing unemployment, in the sensitivity of unemployment rates to (failures in) NGDP trends. I think that our increasing wealth and productivity means that a sharply decreasing fraction of the population is generating stuff we actually need, and a less-sharply decreasing fraction of the population is generating stuff we think we need. When money-trends continue, this doesn't matter because people buy whatever they were planning to buy. When money-trends fail and people want to hide their money, only the essentials keep going and that's a shrinking part of the economy. In the long run, (almost?) all production of goods and services is optional. In the short-to-medium run it would be enough to have the Fed do its job, making sure money-trends continue so people are comfortable buying stuff they want, not just what they think they need. In the long run, we will also need a negative income tax.

My approach to this stuff would be even more drastic, and therefore more unlikely, than my approaches to the preceding problems. So I won't finish this part of this post.

Footnote, since this is stuff that wasn't part of the way I thought through 2008: Aggregate cash flow is NGDP, Nominal Gross Domestic Product, the sum of all the money we pay (or get paid) for all the goods and services we use (and produce). You can divide that by your best guess at an inflation multiplier to get "Real GDP", the theoretical "constant-dollar" value of all those goods and services, but your paycheck and mortgage payment and grocery bill are paid in actual nominal cash flowing around and around, keeping our individual financial plans going by fulfilling the promises that we need to make economics ("sustainable patterns of specialization and trade", as per Arnold Kling) work. If expected NGDP drops, then you're already in a recession. I didn't really follow this argument when Tyler Cowen first recommended Sumner's blog. In the end, it's not that complicated. Think of a zillion spreadsheets carrying business plans and personal plans forward a few years, each projecting current trends. Aggregate cash flow -- that's "Nominal GDP". NGDP. Money. Some of those spreadsheets, some of those plans, will fail and others do better than expected, but generally the aggregate cash flow rises each year as population goes up, as productivity goes up, and as inflation goes on. If it falls or rises a little away from the expected trend implicit in all those individual plans, we adapt. If it falls sharply below trend, then cash isn't going around as expected and plans start failing simply because cash isn't going around: businesses fail and it's not their fault. Things are broken. We have a recession, a bad one.

In fact, people act by plans and promises, betting on their projections, so we get a recession as soon as the expected NGDP growth fails so that people stop buying and employers stop hiring.

Q: That sort of sounds almost convincing. Very odd. But isn't the future causing the present here?

A: Gee, thank you. It's actually close to tautological: expected NGDP is the aggregate of expected cash flow, and your belief that you're no longer going to be able to buy the goods and services you expected to buy will immediately change your behavior, the recession hits as soon as you expect it. So it's your beliefs about the future causing your behavior in the present.

In the current case we had a small recession because a whole lot of investors had believed our regulators and legislators who downplayed the risks of the bubble. They -- the investors -- had believed in the AAA ratings. When they hit reality they bounced, and needed more cash.

Q: But is this the Fed's fault? I mean, apart from Greenspan and then Bernanke denying the bubble?

A: The Fed has a dual mandate: they are supposed to manage inflation and unemployment, by managing the money supply. I'm saying that I mostly believe Sumner: the Fed did expand money somewhat, but they could have avoided most of the pain we've felt if they'd done more. So yeah, it's their fault.

Q: Done more? Done what? Lowered interest rates below zero?

A: Well, first by not paying interest on (excess) reserves, which was and is contractionary. Second, by announcing an inflation target or better an NGDP level-targeting sequence. Third, by expanding their open market purchases; preferably by starting the kind of automatically daily-rebalancing portfolio I described above.

Q: I understand why paying interest on reserves is contractionary; why are they doing it?

A: I don't really understand, but I think it's simply a way to give the banks money so they don't fail, while pretending that it's not Main Street bailing out Wall Street. I'm getting very cynical in my old age.

Ryan Avent of the Economist said

It's getting ever more difficult to avoid concluding that the Fed's inflation target is not the 2% we'd all come to expect, but something much closer to zero. This obviously impacts economic behaviour. The Fed could potentially have a significant effect on conditions simply by letting markets know that it's not actually happy with the current inflation trajectory.

Recently (Sept 2010) Bernanke has said that, with good effect; let's hope he goes further. There's some evidence that it will happen, e.g. Calculated Risk's Fed's Lockhart: The Approaching Monetary Policy Decision Dilemma

I think a consensus is building for QE2 in early November.

But I don't trust Bernanke to follow through, or at least I don't trust the Fed he leads...and that's what it depends on.

Or then again (I hope), maybe not.

Update: I see Avent saying in The perils of prediction: Forget forecasts, trust markets | The Economist that

I like to point out that in June of 2008 the Federal Reserve forecast real GDP growth in 2009 of 2.0% to 2.8%, when in fact the economy shrank in 2009 by over 2%. Of course, this doesn't mean that central banks have no basis on which to make policy. All they need do is look at the evidence in front of them. Markets...

I trust markets a lot more than I trust the Fed.

Perhaps I should note that Sumner does not blame the Fed for failure to predict, as he said in TheMoneyIllusion » The Fed doesn’t have a crystal ball

All the major investment banks with their million dollar Ivy League employees missed this crisis (and its eventual impact), and yet the Fed was supposed to have predicted it? The Fed pays much lower salaries than Wall Street.

Indeed, I wouldn't blame the Fed for the housing bubble recession-trigger at all if Greenspan (and then Bernanke) had simply said "Bubble-detection is not part of my job, I can't help you with that." But this is not what I understood them to be saying.

update: Ah-ha! An actual reputable economist, Nick Rowe, says at least that

If I had my druthers, the Fed would buy stocks. Something like the S&P500 index.

This is not equivalent to saying that the Fed should do a large part of its monetary policy via a rebalancing portfolio somewhat similar to what investment people prescribe for individuals, but it's a start. Yay!

(Or then again, maybe not.)

upd: The same Nick Rowe is quoted approvingly by Brad Delong in Against Money-Financed Fiscal Expansion, For Open Market Operations in Equity Indexes

OK. Start with the Fed buying bridges. That will work. Now, wouldn't it be nice if the Fed could also sell those bridges again later, if it needs to, as it probably will. Bridges aren't very liquid. And, the Fed is good at clipping coupons on bonds, but perhaps not very experienced at collecting tolls on bridges. Hmmm. Maybe if the Fed just bought shares in bridges instead, that would be as good as bridges, but even better from the practical point of view. Hmmm. Why stop at bridges? Why not buy shares in everything? Why not just buy the Wilshire 5000, or some such index?

Excellent. The right index identified, along with the need for later sale; we are close to portfolio rebalancing.

Blowing Bubbles: everybody's wrong except me

Back in September I posted some of my Bubble Thoughts about the housing bubble pop which I had anticipated and the "resulting" crash which I had not, saying

Personally, I did see the bubble as such, earlier than some...I sent a message titled "Housing bubble warning" on June 5, 2003. Was I prescient? No, I was just quoting the Economist of that time...

I didn't mention (last September) that I'd become a semi-Sumnerite, a believer in much of the theorizing of Scott Sumner at The Money Illusion, who claims that

even a major misallocation of resources such as the housing boom of 2003-06 does not cause a big enough misallocation to create a recession. That’s why the initial downturn in housing was handled well, with only a minor bump in unemployment between mid-2006 and mid-2008. The big jump in unemployment more recently was caused by a sharp fall in NGDP, i.e. tight money.

I've come to believe him about that, to a large extent, so I owe both of them an intellectual debt of sorts. But today I think they're both wrong...well, also they're both right, and I think they both exaggerate the real differences between them. Sumner is saying in reference to the same article (I think) that I quoted,

Back in May 2003 The Economist said that many countries were in the midst of a housing bubble:

and that

in all 6 countries their predictions were wildly inaccurate for the 4 year time window they specified.

He really doesn't believe in bubbles. Or does he? As quoted above, he does believe in "a major misallocation of resources such as the housing boom." The Economist rebuts that they were giving "Good housing market advice", and that

the story The Economist was telling about what was happening was fundamentally correct

My current view is that the Economist was and is praiseworthily right to call "bubble", but the Economist of 2003 was mildly blameworthy in making the specific predictions it made (I didn't even take these seriously, remembering how "irrational exuberance" had gone on for years) and is mildly blameworthy now to evade the flat admission that anybody who believed those specific predictions and invested accordingly would have lost money. The 2010 Economist sounds like an astrologer or psychic claiming credit for being almost right, which is another way of saying wrong. But that doesn't mean bubbles don't exist; it just means that when markets are irrational it's really hard to outguess them (The market can stay irrational longer than you can stay solvent.) I mostly like Bill Woolsey's response:

I believe bubbles exist. Vernon Smith's experiments provide enough evidence for me. The basic problem is "momentum" traders. They buy into a rising market and sell into a falling market. They have naive expectations, projecting past price changes into the future.

Like Woolsey, I do think bubbles are real, like the Economist I think bubble-probability is worth thinking about from an investment standpoint.

I think Sumner could respond (and maybe has responded) that if you can detect this, then you're free to make money from it -- but I don't think that's an adequate response. I didn't and don't know any good way to bet that "I think this asset is priced above trend" apart from staying away from it: selling short doesn't work unless you have a time-frame in mind. I didn't believe the Economist's specific predictions, but I do think the Economist helped me (and my son) avoid losing money. We avoided investing in stuff which the Economist (and then Shiller) had suggested was risky. Shiller does better, trying to invent financial instruments which I've interpreted as ways in which to make money from such information, so that the markets will in fact become more efficient. But they're far from perfect, and always will be.

Or maybe not?