Ear Rational Thoughts

This is just too perfect

Tyler Cowen relays a humorous story under the title A Census ad on a Metro bus, socialist calculation debate edition:

Chug relates to me that he saw the following, plastered on the side of a Metro bus:

If we don't know how many people there are How will we know how many buses we need?

The comments point to related ads for schools and hospitals:

• schools
• hospitals

Government and Desert

Bryan Caplan on the deserving poor:

... David Balan surprisingly endorsed the old-fashioned view that only the "deserving" poor are entitled to taxpayer assistance. As the debate proceeded, however, he admitted that in the real world, a lot of undeserving poor would receive support as well. The problem, if I understand his position correctly, is that we don't have the political will to distinguish the two.

I found this a rather cavalier admission. If the government taxes us to satisfy our obligation to the deserving poor, it seems like a gross breach of trust for the government to turn around help any Tom, Dick, or Harry who happens to have low income [my emphasis]. If a philanthropist gives you money to help war orphans, you've got a moral obligation to look before you hand over his money - to make a good faith effort to check whether the person you want to help is a bona fide war orphan.

His point seems to be related to the point I made here:

while the government may give the people what they want, what the people absolutely do not want is accountability. What they want from the government are freebies. As long as the government is long on freebies, it will prosper. But actual accountability, in the sense of, say, producing measurable benefits...? That's the opposite of what the people want from the government.

The common thread in both points is that the government's incentives to do "the right thing", vs just the easy and popular thing just aren't there.

Taxes Per Person

Greg Mankiw raises a good point:

Some pundits ... claim that Americans are vastly undertaxed compared with other major nations. ... The most common metric for answering this question is taxes as a percentage of GDP. However, high tax rates tend to depress GDP. Looking at taxes as a percentage of GDP may mislead us into thinking we can increase tax revenue more than we actually can. For some purposes, a better statistic may be taxes per person.... Here are the results for some of the largest developed nations:

France	.461 x 33,744 = 15,556
Germany	.406 x 34,219 = 13,893
UK	.390 x 35,165 = 13,714
US	.282 x 46,443 = 13,097
Canada	.334 x 38,290 = 12,789
Italy	.426 x 29,290 = 12,478
Spain	.373 x 29,527 = 11,014
Japan	.274 x 32,817 = 8,992

The bottom line: The United States is indeed a low-tax country as judged by taxes as a percentage of GDP, but as judged by taxes per person, the United States is in the middle of the pack.

Unintended Consequences

Alex Tabarrok on some interesting-if-unsurprising research:

[The study] looks at the effects of a program that gave poor households a voucher to purchase a computer. ... Households with incomes directly below a cutoff level were given a voucher while households with incomes directly above the cutoff were not. Thus, households which were very similar were treated differently and this lets the authors use a regression discontinuity design that makes their results credible as representing a causal effect.

... we see that households with incomes just below the cutoff were much more likely to have a computer than households with incomes just above the cutoff - thus the voucher program has a big effect on computer ownership. ... [It] shows similarly that the voucher program increased computer usage since computers were used much more often in households with incomes just below the cutoff than in the non-eligible-for-voucher households with incomes just above the cutoff.

What's interesting about it is that the study also showed that an increase in computer usage to play games was apparent, while an increase in usage to do homework was not. And as a result:

Not surprisingly, with all that game playing going on, the authors find that the voucher program actually resulted in a decline in grades

A classic case of unintended consequences. It's worth appreciating that anyone who a priori would have claimed that giving computers to poor people would've actually reduced their grades would have likely been dismissed. It's especially important when thinking about the new health care bill, which is claiming great improvements in both coverage and cost, and those who claim the seemingly counterintuitive opposite are being dismissed. But then that's why the consequences are unintended...

The ruling class

Arnold Kling:

I've been thinking about the ruling class in terms of the following matrix, which sorts people by college attainment and skill level, giving sample occupations for each category.

	not college educated	college educated
skilled	electrician	engineer
unskilled	manual laborer	public school teacher*

My theory of the ruling class is that it comes from the lower right quadrant. That is, people who are highly educated but lacking in useful skills. ...

My theory is that the ruling class gets its strongest support from people in the lower-right quadrant. They identify strongly with the ruling class. Placing an artificially high value on educational credentials is in the interest of the ruling class and everyone else in the lower-right quadrant. If it were not for the protection provided by credentialism and government employment, my guess is that many of those in the lower-right quadrant would have incomes no higher than those of people who are not college educated.

Health Care

I don't have time to post much, but I want to collect some links regarding health care:

Megan Mcardle on the political implications

Greg Mankiw on the CBO scoring

Bryan Caplan on the separation of health and state. And again on what we owe (morally), the "deserving sick"

David Henderson quoting Gary Becker:

Drafting a good bill would have been easy, he continues. Health savings accounts could have been expanded. Consumers could have been permitted to purchase insurance across state lines, which would have increased competition among insurers. The tax deductibility of health-care spending could have been extended from employers to individuals, giving the same tax treatment to all consumers. And incentives could have been put in place to prompt consumers to pay a larger portion of their health-care costs out of their own pockets.

"Here in the United States," Mr. Becker says, "we spend about 17% of our GDP on health care, but out-of-pocket expenses make up only about 12% of total health-care spending. In Switzerland, where they spend only 11% of GDP on health care, their out-of-pocket expenses equal about 31% of total spending. The difference between 12% and 31% is huge. Once people begin spending substantial sums from their own pockets, they become willing to shop around. Ordinary market incentives begin to operate. A good bill would have encouraged that."

Tyler Cowen on how flimsy the insurance mandate penalty is, and how easy it is to game.

Arnold Kling on how the health care bill was financed:

Relative to current law, I am willing to grant that the legislation will reduce the deficit (assuming no glitches, such as failure to project expenses properly or failure to follow through on promised benefit cuts). It does so by cutting future Medicare benefits by X, and then using a little bit less than X to pay for new subsidies. But in order to actually have a budget that does not collapse by 2030, we have to cut future Medicare benefits by much, much, more than X, and not use the cuts to pay for anything else.

Hyman Minsky

From this post at Econlog, I was directed to Hyman Minksy:

Minsky argued that a key mechanism that pushes an economy towards a crisis is the accumulation of debt. He identified three types of borrowers that contribute to the accumulation of insolvent debt: hedge borrowers; speculative borrowers; and Ponzi borrowers.

The "hedge borrower" can make debt payments (covering interest and principal) from current cash flows from investments. For the "speculative borrower", the cash flow from investments can service the debt, i.e., cover the interest due, but the borrower must regularly roll over, or re-borrow, the principal. The "Ponzi borrower" (named for Charles Ponzi, see also Ponzi scheme) borrows based on the belief that the appreciation of the value of the asset will be sufficient to refinance the debt but could not make sufficient payments on interest or principal with the cash flow from investments; only the appreciating asset value can keep the Ponzi borrower afloat. Because of the unlikelihood of most investments' capital gains being enough to pay interest and principal, much of this type of finance is fraudulent.

If the use of Ponzi finance is general enough in the financial system, then the inevitable disillusionment of the Ponzi borrower can cause the system to seize up: when the bubble pops, i.e., when the asset prices stop increasing, the speculative borrower can no longer refinance (roll over) the principal even if able to cover interest payments. As with a line of dominoes, collapse of the speculative borrowers can then bring down even hedge borrowers, who are unable to find loans despite the apparent soundness of the underlying investments.

That line of thinking sounds so self-evidently true to me.

And then this:

Economist Paul McCulley described how Minsky's hypothesis translates to the subprime mortgage crisis.[10] McCulley illustrated the three types of borrowing categories using an analogy from the mortgage market: a hedge borrower would have a traditional mortgage loan and is paying back both the principal and interest; the speculative borrower would have an interest-only loan, meaning they are paying back only the interest and must refinance later to pay back the principal; and the ponzi borrower would have a negative amortization loan, meaning the payments do not cover the interest amount and the principal is actually increasing. Lenders only provided funds to ponzi borrowers due to a belief that housing values would continue to increase.

... McCulley also points out that human nature is inherently pro-cyclical, meaning, in Minsky's words, that "from time to time, capitalist economies exhibit inflations and debt deflations which seem to have the potential to spin out of control. In such processes, the economic system's reactions to a movement of the economy amplify the movement – inflation feeds upon inflation and debt-deflation feeds upon debt deflation." In other words, people are momentum investors by nature, not value investors. People naturally take actions that expand the apex and nadir of cycles

The phrases I highlighted feel very important. I think the person who develops a way to detect "momentum gains" from "value gains" in an asset price movement will find himself very, very rich...

Sustainability vs Accountability

In this post, I contrasted two quotes. One from Megan McArdle:

If we pass this thing, no American politician, left or right, is going to cut any of these programs, or raise the broad-based taxes necessary to pay for them, without any compensating goodies to offer the public. ... The idea that you pass a program of dubious sustainability because you can always make it sustainable later, seems borderline insane. I can't think of a single major entitlement that has become more sustainable over time.

And the other from Daniel Callahan:

In the end, government must answer to the public, forcing an accountability that is absent in private sector medicine.

I think these two quotes show the precise way in which government breaks down, and which markets excel. It's easier to see by splitting Callahan's quote into two pieces:

1. "In the end, government must answer to the public"
2. "forcing an accountability that is absent in [the] private sector"

If I read McArdle's quote correctly, I believe she would agree with Callahan on #1 - that is, that in the end, the government will answer to the public. Where I think they would disagree - and where I think most libertarians and most progressives would disagree - is on #2.

McArdle points out (rightly, in my view), that while the government may give the people what they want, what the people absolutely do not want is accountability. What they want from the government are freebies. As long as the government is long on freebies, it will prosper. But actual accountability, in the sense of, say, producing measurable benefits, or ::gasp:: actually paying for the things it buys? That's the opposite of what the people want from the government. And it's why the government is always and everywhere doomed to failure.

Entitlement Sustainability

Megan McArdle:

But there is one thing of which I am nearly perfectly certain: If we pass this thing, no American politician, left or right, is going to cut any of these programs, or raise the broad-based taxes necessary to pay for them, without any compensating goodies to offer the public . . . until the crisis is almost upon us. I can think of no situation, other than impending crisis, in which such a thing has been done--and usually, as with Social Security, they have done just little enough to kick the problem down the road. The idea that you pass a program of dubious sustainability because you can always make it sustainable later, seems borderline insane. I can't think of a single major entitlement that has become more sustainable over time. Why is this one supposed to be different?

Contrast that with this, a widely-held belief of the left:

In the end, government must answer to the public, forcing an accountability that is absent in private sector medicine.

It's truly amazing to me that there are people who believe the latter more than the former.

Best. Undergrad. Thesis. Ever.

From the WSJ, the full paper is here. It's the work of "A.K. Barnett-Hart, a Harvard undergraduate" and it's titled The Story of the CDO Market Meltdown: An Empirical Analysis:

Handed in a year ago this week at the depths of the market collapse, the paper was awarded summa cum laude and won virtually every thesis honor, including the Harvard Hoopes Prize for outstanding scholarly work.

It's a massive 115 page document filled with gobs of data, regression analysis, charts and most importantly, conclusions:

The results show that problems in the CDO market arose from a combination of poorly constructed CDOs, irresponsible underwriting practices, and flawed credit rating procedures. One of the main factors associated with the underperformance of CDOs was the inclusion of low quality collateral originated in 2006 and 2007 that was exposed to the residential housing market. The majority of CDOs issued after 2005 contained remarkably high levels of this collateral, allowing the decline in housing prices to cause a rapid deterioration in the financial health of CDOs. Second, the CDO underwriters played an important role in determining CDO performance, even after controlling for the asset and liability characteristics of their CDOs. The unobserved causes for this underwriter effect might be the ability, diligence, or philosophy of the underwriting bank. Lastly, the credit ratings of CDOs failed in their stated purpose, namely to provide a reflection of the CDO’s ability to make timely payments of principal and interest. This failure arose from a combination of over-automation and heavy reliance on inputs whose accuracy was not easily judged.

I admit I only skimmed the full 99 page + biliography document, but my take on her story is that around 2006, CDOs were not particularly exposed to sub-prime mortgages. But they were doing so well that demand for them out-stripped the supply of "good" stuff to include, so sub-prime mortgages were included in massive quantities to fill the gap. Ratings agencies and underwriters tended to have a "if it's made money in the past, it must be good" mindset and so continued to view the new crap-filled CDOs the same as CDOs without exposure to the sub-prime housing market. Which failed to dampen expectations for the now-sure-to-be-underperforming obligations.

It makes a lot of sense. I think there's clear evidence that overall - thinking not just of CDOs - positive feedback plays a huge role in the financial sector.