Archive for the ‘Economics’ Category

A Different Perspective

September 26, 2008

The Antiplanner takes on some meltdown myths. His perspective is microeconomic so it’s a little more like Allison’s than much of the other economic analysis I’ve linked to.

Just Keep Digging

September 21, 2008

The New York Times has obtained a copy of the proposal of the Treasury Department’s bailout plan. I am not a lawyer nor am I an economist, but this strikes me as both unprecedented and chock a-block of moral hazard.

Section 2(a), for example, allows the Treasury Secretary to purchase mortgage-related assets from any financial institution. In other words, Treasury will now have the power to act as Lehman Brothers, Countrywide, Fannie Mae, and many other fallen companies. It will buy mortgages that companies want off their books for risk and chargeoff reasons. This will enable banks to avoid the consequences of their actions as well as saddle the Treasury with the absolute worst assets possible. How could that come back to bite us?

Section 2(b)(2) sets aside section 3109 of Title 5. By my reading of that section, this means that Paulson can hire consultants at whatever rate for whatever purpose without any oversight by the normal federal channels. He was previously chairman and CEO of Goldman Sachs: I wonder if he’s got some cronies that need some easy money from an advising gig.

Section 2(b)(3) allows Paulson to designate financial institutions as “financial agents” of the federal government and perform whatever duties that might entail. It seemed vague until I started looking around for what a “financial agent” does. The covering part of the code suggests that it just means that they can accept public money or public bonds. The Code of Federal Regulations goes into more detail, naturally, and I think I can see why this seemingly unimportant section was added to the proposal. The regulation expands on what the code means by “national banking association” and lists credit unions, commercial banks, and other financial instutions that are backed by governmental deposit insurance.

The proposal generalizes these specific references to just “financial institution” and I think this means that investment banks will be able to act in this regard. I am not an expert on this but I am fairly well-versed on how the Federal Reserve System operates—this might enable investment banks to participate in that System such that federal bonds created out of thin air could be routed through them. In other words, the Federal Reserve could “extend credit” (read: print money) to investment banks at the federal funds rate.

Section 4 says that Paulson will let Congress know what he’s done in three months and then every six months after that. Section 8 further limits the oversight by making Paulson’s actions “committed to agency discretion.” Knowing that every word in this proposal has specific legal meanings, I discovered that “committed to agency discretion” basically takes the Supreme Court out of the equation. If Congress passes this proposal as law, it will have written off our precious system of checks and balances—all in the name of “doing something.” Again, I can’t see how this could possibly backfire.

Section 5(b) gives Paulson the right to manage the mortgage-related assets, which seems like a given, but expands it to include the revenues from those assets. (There could be something insidious about managing portfolio risks, but I’m not familiar enough with that side of the equation to speculate.) So Treasury gets to control the proceeds of these mortgages: if they can be rehabilitated, they could provide quite a funding source that’s outside the province of the House of Representatives. That’s a little conspiracy theorist, to be sure, but the words are there and they mean something.

Section 5(c) authorizes Paulson to sell the assets at whatever price and terms he decides. He can also do some other financial transactions with which I am unfamiliar. I can envision a day when things settle down and Paulson just repatriates the assets. Or makes a killing and secures a nest egg for the Executive to use at its discretion.

Section 5(d) indicates that though this authority will only last for two years—two years!!—on new assets, it will continue on existing assets for as long as they’re held. Actually, it doesn’t even have to be an existing asset so long as Paulson commits to buying the assets prior to the authority’s expiration. This is about as “in for the long haul” as government gets.

Section 6 puts taxpayers on the hook for up to $700 billion. But it’s not just a total of $700 billion, but $700 billion at any one time. So the amount actually spent could greatly exceed that depending on portfolio churn and decreasing valuation of those assets. Aside from the incredible size of the outlay, this amounts to a blank check on the taxpayers.

Section 10 raises the debt ceiling of the federal government to $11.315 trillion from $8.184 trillion—an increase of $3.131 trillion. Looking at 31 USC 3101, it’s hard to believe that the debt ceiling was $2.8 trillion back in 1989 or $5.95 trillion as late as 2002. The amount of this increase is unprecedented and one wonders if $700 billion represents just the direct outlay. This $3.131 trillion expansion might represent the true costs of the bailout, hidden from general revenue through bond issuance.

Finally, section 11 asserts that this proposal conforms to the Federal Credit Reform Act of 1990, which enables Paulson et al. to not have to adhere to its strictures and prove that it conforms. I wasn’t at all familiar with the FCRA, but its purpose is to “provide a more realistic picture of the cost of U.S. government direct loans and loan guarantees.” From what I can gather, the FCRA eliminated the cash accounting reporting of loans and loan guarantees in favor of a more accurate, long-term view of the funding. By asserting compliance, they may be able to circumvent this requirement and present a rosier picture of their activities.

In short, this proposal grants the Treasury Secretary far-reaching and unaccountable powers. It sets up extensive moral hazards for both public servants and private financial institutions and opens up an unlimited line of credit on the American economy. Most importantly, it is an overreach of the proper function of our constitutionally-limited government. The government has no business being so entwined with business: it is time for “a separation of state and economics, in the same way and for the same reasons as the separation of state and church.”

[UPDATE: There is now a lot more analysis of the proposal that suggests I’m reading things correctly.]

The Not-So-Free Market

September 18, 2008

When the federal government took over Fannie Mae and Freddie Mac, I thought little of it since they were both quasi-governmental corporations anyhow. There was always an implied blank check on the taxpayers’ wallets which was being made explicit. It bugs me that the government is in that business at all but that’s water under the bridge and I figured that most people would not hold the free market responsible for the bailout.

When Lehman Brothers and Merrill Lynch failed without government intervention, I thought that maybe the government was going to let this situation run its course. I do not pretend to suggest that there weren’t bevies of regulators overseeing these companies at every step of their fall—just that the government wasn’t acting as guarantor with our money.

But this AIG failure and subsequent takeover by the government, where the federal government has an 80% equity stake, worries me considerably. Both presidential candidates are clamoring for greater regulation and pillorying Wall Street as if it was a free-for-all casino. Pundits are wondering “if financial behemoths like AIG are too large and/or too interconnected to fail but not too smart to get themselves into situations where they need to be bailed out, then what is the case for letting private firms engage in such kinds of activities in the first place?” Can the nationalization of our financial sector be far off with this sort of hue and cry?

“What is the case for letting private firms engage in such kinds of activities in the first place?” Have we degenerated so far that this is an honest question? The case is that it is not the government’s job to manage or provide credit. The case is that people have the right to property and liberty: they can form financial institutions whose only safety net is prudent management and a sense of fiduciary obligation. In a world without a lender of last resort, they either make the right decisions or they go bust—so they don’t take unnecessary risks with the knowledge that they won’t be allowed to fail.

And what of the pretense that our financial sector is unregulated and out of control? I’d submit that it is one of the most overseen and regulated parts of the economy, second only to health care. With the Fannie Mae guarantee and the Community Reinvestment Act mandate, lenders made questionable loans because they were insulated from the accountability inherent in loans going bad. These actions provided an incentive to try for the most profit since the worst case wasn’t detrimental to the lender.

Why is the government meddling in these transactions in the first place? When a transaction like this becomes politicized, it introduces unintended consequences and unforeseen distortions. The two parties in a transaction have financial incentives to mutually benefit; government interference inevitably favors one party over the other or punishes both parties. Its only role in financial transactions is to protect the sanctity of contract, thereby establishing recourse should either party fail to adhere to the contract.

In the end, this whole financial crisis comes down to financial participants being able to shunt away risk whether by exacting Fannie Mae guarantees, insurance policies, or willful blindness. In a free market, imprudence of that sort reaps its own consequences—businesses fail and the shareholders take a big hit. In a mixed economy, the taxpayers are left holding the bag.

[UPDATE (9/18/2008): Wait, Wall Street, you’re supposed to be more confident now. Come on!]

[UPDATE (9/21/2008): Columnist Walter Williams agrees that this mess has the stink of government all over it.]

Did We Do That?

September 6, 2008

Much hay has been made of McCain’s ignorance of economics, but I submit that neither candidate has any grasp of the basics. Both bloviated today about the latest unemployment figures—pegged at 6.1%, which used to be considered full employment—and bemoaned the problems of the American economy. Further, this morning on NPR some pundit was wailing about how this trend was very unusual since it was a 0.4% jump in a single month and a lot of the “lost” jobs occurred in service sectors.

Warren Meyer hit it on the head: the federal minimum wage was increased on July 24th so August would have been the first full month under the new rate. Minimum wage laws have the natural effect of shedding jobs.

Politicians, however, are not fans of cause and effect. They like effects—we want higher wages for workers—without enacting the proper causes—ending regulation and taxation on businesses. The degree to which government interferes in the employer-employee relationship is the degree to which jobs and wages are depressed.

It’s basic economics and neither candidate has a monopoly on ignorance of it.

Gas Gougers and Gas Thwarters

June 13, 2008

With prices going over $4 per gallon for the first time ever (in America), the hue and cry has become deafening. But the ignorance surrounding the economics of oil has enabled politicians to co-opt the problem as a vehicle for government expansion: the problem is at root a technical one but this commandeering has clouded the issue. With the price of oil skyrocketing, there are really only two ways to lower it (given that OPEC is effectively beyond our control, no matter how much Congress might wish differently): lower demand through conservation and technological advances or increase supply by tapping domestic resources and expanding refinery capacity.

The former method has been taking place for at least a decade or two and conservation naturally occurs as the price increases, so I’m most interested in the latter means. Increasing the supply is pretty much off the table for political reasons since Congress has prohibited exploratory drilling in the Arctic National Wildlife Refuge and in American coastal waters. There’s absolutely no technical reason why we couldn’t do both and increase our oil supply considerably; thus the technical problem of increasing our oil supply, which wouldn’t exist in a free market, is a political one, which serves to demonstrate just how unfree our market really is.

I was familiar with the ANWR and offshore drilling bans as well as the inability to site new refineries, but I was not aware that oil shale exploration and development was similarly prohibited. I am flabbergasted at, and absolutely bewildered by, these actions. Taken collectively, they serve as an impressive intrusion into the energy market by the government. Politicians in this same government simultaneously attack the oil companies for not doing more to reduce gas prices, rail at foreign nations for restricting supply, and suggest massive tax increases for oil companies to “re-capture windfall profits.” The answer is clearly to stop interfering and let the oil companies do what they need to do—and what they would be glad to do.

The oil companies aren’t the “gougers” in this scenario. Margins on oil are pretty slim and the profits come from the incredible volume. If you look at the breakdown of oil pricing, governments take the largest piece of the pie. But they always want to increase their share but even that comes with a hidden cost: they want to dictate how the pie is made in the first place.

Oil companies, like every other business in America, makes money by serving its customers. It has to carefully price its product to maximize revenue and profits, just like every other business in America. And like every other business in America, any restrictions on how it does that—beyond that of fraud and infringing on people’s rights—distort and hamper its ability to do both. It is high time that we treat oil companies like every other business in America.

Scalping Ain’t Easy

October 9, 2007

John Gruber recently wrote:

Peter Kafka, at Silicon Alley Insider, claims the “obvious solution”
to Hannah Montana ticket scalping—wherein $67 tickets are being
re-sold for upwards of $250—is to raise the initial selling prices
of the tickets, so that the money die-hard fans are willing to pay
goes to the artist and concert promoter, rather than to the scalper,
and then to reduce the prices after the initial high-priced demand

Good advice, I say. And, of course, it’s exactly what Apple did with
the iPhone. Except Silicon Alley Insider didn’t see it that way with
the iPhone, writing “To us, this move suggests the phone is not
selling as well as Apple had hoped,” and “[The real issue] is Apple’s
obvious misjudgment of the market for a flagship product.”

The problem is that concert promoters and the venues they book at aren’t
terribly interested in maximizing their revenue from ticket sales. Their
primary concern is filling up the venues. They charge a premium for
location and a premium for certain acts, but they don’t exactly go after
the scalper market because that market actually makes the process more

If the venue were to charge scalper-level pricing, scalpers wouldn’t buy
the tickets in order to re-sell them. The people who buy the scalper’s
inflated ticket prices may or may not pay the same amount to the venue and
the concert promoters have no idea how much people would be willing to pay
or even what the size of the market might be for these tickets. So they
price the original tickets at a level that works for them.

Scalpers then speculatively buy those tickets in the hopes that they can
make some profit through arbitrage. If they can’t move the tickets, then
they’re out the money. So they only buy what they think they can sell. The
concert venue gets to sell out (and make money from the full audience through
concession sales, programs, t-shirts, and such) and the scalper gets the
chance to make substantial profits with little effort.

Scalping is a legitimate and useful service. People just don’t like paying
more than the face value for anything.